|
John Neff was born in 1931 in Toledo, Ohio, USA, and had a difficult childhood. His grades were poor; he had few friends and was not popular in school. When he grew up, he decided to join his father's industrial equipment company. His father's first advice was to keep a close watch on the prices that he paid for goods and services. He reckons that this was the first lesson in investing that he received.
John Neff is a person whose modesty belies his talents. Imagine a disorderly office in a small town, well out of tony Manhattan, the centre of global finance. Who would think that such a place could be the office of a high flying investor? How many of the normally prudent investors would have entrusted their money to him? Well... the answer is thousands. Though he kept a low profile, he was known as the 'investors' investor'.
In the great man's own words in his book John Neff On Investing, he writes "Personally, I prefer a different label: 'low price-earnings investor.' It describes succinctly and accurately the investment style that guided Windsor while I was in charge."
Look at it this way. If you had invested to $10,000 in 1964, the year Neff took over as portfolio manager at Wellington Management's (Vanguard) Windsor fund and allowed the dividends to be reinvested; by the time he retired in 1995, that small investment would have ballooned to $ 564,000. This is an astounding 14.5% return over more than three decades! If that investment of $10,000 had tracked the S&P 500, the investment would have grown to a much lower figure of $2, 33,000, an average of 10.8%. (Forbes, January 6, 2010)
Neff's investment philosophy
"It's not always easy to do what's not popular, but that's where you make your money. Buy stocks that look bad to less careful investors and hang on until their real value is recognized." - John Neff. (Valuewalk)
He was a superb value investor and a contrarian. Deviating from the Benjamin Graham model, he developed his own method of spotting stocks and making investments. While he bought shares with low values, he did not bother to buy stocks that others were busy accumulating. He bought whatever was cheap. If cement stock prices were low he bought those, if airlines stocks were low then he bought those. However, he did emphasize the importance of dividends. He regarded the regular flow of dividends to be more important than even growth. He invested in such a way that his investments had dividend yields of 2% more than the market average. Similarly, his stocks had a P/E ratio that was one-third below the market average.
Neff's fund usually held a portfolio of 70 to 80 stocks. In making his investments, he backed himself. He was so sure of his methods that he often put 5% of his entire portfolio in stocks that he felt were good bargains. In the late eighties, he discovered that financial stocks were going cheap. He risked nearly 37% of his total portfolio in the stocks and came out on top. Yet, normally he exercised great prudence in most of his investment decisions as evidenced by the fact that most stocks formed just about 1% of his portfolio value.
Investment methods
He chose stocks that were not popular among other investors. He followed a pretty straight forward, one can say even dull, method in making investments. His eagle eyes lighted on stocks that had low P/E ratios and good dividend yields. Typically he sought out shares whose P/E ratios were 40% to 60% of the average of the market. Having identified this basic group, he then further winnowed the stocks, by checking if they had sustained and good EPS growth, from anywhere between 7% right up to 20%. For him a company's growth had to be underlined by increased sales. Another aspect of his method was that he paid considerable attention to the dividend record of the prospective companies. His analysis showed that most people bought stocks for their value appreciation, while the yearly dividends would actually add to the share's value. He ascribed his ability to beat the market by up to 3% to this factor.
He writes in his book, Can turtles fly?, "It is critical to understand that a stock's price reflects two underlying variables: (1) earnings per share and (2) the multiple of earnings per share that the market attaches to it."
Criteria for purchase
Neff kept a keen eye on the following metrics in buying stocks; basic growth above 7%, preserve yield protection, while checking the total returns to P/E. He avoided cyclical exposures unless protected by P/E multiple. Instead of calculating peak returns over a long period of say five years, he calculated normal earnings. According to Neff the biggest gains are posted in the nine months before improved earnings are reported. He always chose good companies with strong fundamentals and sales growth.
To summarize, he chose stocks of companies with:
A strong balance sheet Cash flow positive A higher than average return on equity Good management Prospects for near term growth A good product and market in which to sell the product (Valuewalk)
"No solitary measure or pair of measures should govern a decision to buy a stock. You need to probe a whole raft of numbers and facts, searching for confirmation or contradiction. The goal is to develop credible growth expectations for a low P/E company or industry," writes Neff in 'Can Turtles Fly?'.
The Neff formula
He translated the above into a virtually patented formula. He added up the growth rate and the dividend yield and divided it by the P/.E ratio. If for instance the growth rate was 12% and the yield 8%, while the P/E ratio was 10, he arrived at what he called the 'terminal relationship' of 2. This stock would be desirable. On the other hand if the P/E ratio was 20 the 'terminal relationship' would give a number of 1, which he found unattractive. In general, he went for stocks whose Total Return to P/E ratios were double the market average or even the particular industry's average. This calculation took into account his strong feeling that steady dividend income was the key to improving overall value appreciation.
Using this rubric, Neff breaks down his target companies as cyclical growth, moderate growth, highly recognized growth and not so much recognized growth.
Wise advice from Neff
"My style of security analysis examines earnings and sales: (1) earnings growth drives the P/E and the stock price, and (2) dividends come from earnings. Ultimately, growing sales create growing earnings. Squeezing greater earnings from each dollar of sales (called margin improvement) can buttress a case for investing, but margins do not grow to the sky. Eventually, attractive companies must demonstrate sales growth."
"For the expectations to be correct, you have to believe that the P/E multiple would have to go to never-before-reached heights or there is significant earnings to the upside of the estimates. Both expectations are problematic."
"I've never bought a stock unless, in my view, it was on sale."
"Successful stocks don't tell you when to sell. When you feel like bragging, it's probably time to sell."
(Valuewalk, Can-Turtles-fly-blogspot)
Content is prepared by Wealth Forum and should not be construed as an opinion of HDFC Mutual Fund.
Share this article
|
Wise Advice
Can Turtles Fly? That is the title of John Neff's 1999 book and his answer to that question is an emphatic yes! The title aptly sums up his career too. During his 31year tenure steering Vanguard's Windsor Fund (1964 - 1995), his fund delivered a CAGR of 14.5% over three decades. An investment of $10,000 in 1964 would have grown to $564,000 by the time he retired in 1995. John Neff was not only a successful investor, but was known as the fund manager's manager - many fund managers gave him their own money to manage - such was their conviction in his investing sytle.