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Morningstar: Five Rules for Successful Stock Investing

The Five Rules for Successful Stock Investing: Morningstar’s Guide to Building Wealth and Winning in the Market,  by Pat Dorsey, published 2004

Among all the articles, newsletters, and books out there touting the next new investment theme (the Nifty Fifty, a “new era,” Peak Oil, or whatever you want to call it) or technical analysis tool, this book is a refreshing primer on the only proven and timeless strategy – that of long-term value investing through a rigorous study of a company's or industry's fundamentals and to form reasonable projections of where sales, earnings, and the competition will be in the long-run.  For those looking for a refresher or an introduction of valuation tools or a breakdown of several U.S. broad industries, look no further than Pat Dorsey's (Director of Stock Analysis at Morningstar) “The Five Rules for Successful Stock Investing: Morningstar's Guide to Building Wealth and Winning in the Market.

Predictably, the book starts off with the “Five Rules.”  These five rules can be thought of as Morningstar's core investment philosophy.  Dorsey spends the first chapter introducing these five rules – with an emphasis on why it is so important to be able to articulate them in a concise manner and to remind oneself of them on a constant basis.  Quoting Dorsey:

It always amazes me how few investors – and sometimes, fund managers – can articulate their investment philosophy.  Without an investing framework, a way of thinking about the world, you're going to have a very tough time doing well in the market.

I realized this some years ago while attending the annual meeting of Berkshire Hathaway, the firm run by billionaire superinvestor Warren Buffett.  I overheard another attendee complain that he wouldn't be attending another Berkshire meeting because “Buffett says the same thing every year.”  To me, that's the whole point of having an investment philosophy and sticking to it.  If you do your homework, stay patient, and insulate yourself from popular opinion, you're likely to do well.  It's when you get frustrated, move outside your circle of competence, and start deviating from your personal investment philosophy that you're likely to get into trouble.

The Morningstar's “Five Rules” are:

  1. Do your homework.
  2. Find economic moats.
  3. Have a margin of safety.
  4. Hold for the long haul.
  5. Know when to sell.

Make no mistake: Being able to articulate and consistently stick to your core investment philosophy is no easy feat – especially in a challenging environment such as what we are now experiencing in the aftermath of the 2007 subprime crisis.  The book goes on to explain Morningstar's “Five Rules,” the mistakes to avoid (such as swinging for the fences instead of playing the probabilities and averages, or panicking when the stock market declines), and the basics of analyzing/evaluating a company's financial statements, management team, and coming up with a reasonable valuation for the company.  These topics are all covered in the first 13 chapters – and are collectively a great resource for the “lay investor” or the part-time investor who doesn't have a good accounting background.

The final chapters of the book deal with the analysis of certain industries, including health care, banks, asset management, software, hardware, media, telecom, consumer goods, and utilities.  While these chapters only skimmed the surface of what are unique to each industry, they are nonetheless very valuable for those who have not had any “hands-on” experience (either as someone who has operated in or worked as an industry analyst) in these industries.  This wide spectrum of industry analyses is also somewhat unique to investment books, and is, by itself, worth the entire purchasing price of the book (e.g. one figure I found very useful outlines a pharmaceutical company's typical drug development timeline and the cumulative probability of success for each successive “phase” in the timeline).

The Morningstar team's ability to come up with a concise, unique, and highly readable investment work should be applauded.  What's more, one does not get the feeling that Morningstar is trying to sell you anything else besides what you already purchased.  In other words, this book is far from a sales brochure (unlike other books that came from similar investment/economic outfits) – and should be on the bookshelf for every retail investor, financial advisor, and perhaps even some professional investors!


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