Investing for Beginners

Investing for Beginners
with Joshua Kennon

One on One: Ellis Traub

If you want to take your first walk down Wall Street, Ellis Traub will be happy to show you the way

Ellis Traub
One on one

With four sons about to enter college, Ellis Traub lost everything. Today, he's a widely respected author, Chairman of the NAIC, and CEO of Investware. Learn how you can avoid the same mistakes he did - and save your pocketbook a lot of trouble.

PROFILE



Name: Ellis Traub
Occupation: Author and CEO
Location: Davie, FL
Education: Harvard, Left School to Fight in the Korean War


There are only ten terms that a person needs to know, all of them very intuitive. They can be applied to any company, whether it's General Motors or Lucy's Lemonade stand.".


-Ellis Traub




A Random Walk Down Wall Street: Ellis' Story

JK: You were an airline pilot for thirty-one years. What made you get involved in finance and investing?

Traub: I got involved in finance and investing out of necessity. I made some serious investment mistakes when I had four sons to send to college and lost nearly everything I had. That experience frightened me out of the market for a decade and a half. When I retired from the airline, I needed to take care of my pension and failed again. Fortunately, I stumbled onto the National Association of Investors Corporation (NAIC), a non-profit organization whose mission is to educate amateur investors to be successful. NAIC turned my financial life around.

I was inspired to learn and teach their methods and wrote a software program (to simplify calculations) that ultimately became the organization’s official stock analysis software. From that time forward, I've been dedicated to helping others avoid the same mistakes I made and encouraging them to find out how simple it is to invest successfully in common stocks.



JK: Your first experience with investing is something that a lot of my readers can identify with. One of your mistakes was investing on margin; could you tell us exactly what happened?

Traub: During the 1972 presidential campaign, I met a young fellow who was a broker for a major stockbrokerage firm. Concerned that I wouldn’t have enough to send the kids through school, I asked what I might do to beef up my savings. He recommended that I invest my savings in a hot stock and hold it until two weeks before the election at which time I should sell it for a huge profit. His justification was that the incumbents would continue to pump up the economy prior to the election.

I didn't have a clue and took his advice, selecting the stock that had the biggest daily gain the previous day for my "hot stock."

Needless to say, that was a bad strategy and, when half of Wall Street lost their proverbial shirts, I went along with them, not only having invested all my savings but margining as much as I could and borrowing all I could on my signature. When the dust cleared, I had a house, a car, the debt on them, and fortunately a good job flying airplanes.



JK: Very early on in the book you mention the other mistakes you made as a new investor. Everyday, people write in and they are doing the same things you mention - would you mind repeating them here?


Traub: Those mistakes largely stemmed from my mistaken belief that investing was above and beyond my ability, and the lack of basic investment knowledge.

I didn't start early enough to invest regularly and intelligently. I sought, listened to, and took the advice of someone that wasn't really qualified to offer counsel. I invested without understanding what a share of stock was and what I should expect of it. I sold it without understanding the proper reasons for selling a stock. And I stayed out of the market during my most productive years, losing the best opportunity to make money through long-term stock ownership.



JK: Your first experience with the stock market scared you away for more than fifteen years. Do you think that is a common thing with most new investors?


Traub: I think we're seeing that happening right now. This is the time people should review their holdings, keep the stocks with the best potential, sell the losers (not those with the depressed prices but those whose revenues and earnings aren't capable of growing adequately), and buy others with better potential while they're selling cheap. Instead, people are selling out and running. As simple as it is to learn how to make the right decisions, read Take Stock to find out just how easy, there's no reason for investors to go through the same experience as I did when they can make those now and prosper.



JK: In the book you mention that it was fortunate you didn’t have access to your retirement accounts, or else you would have thrown those into a hot stock as well. Does this mean you think people should have a retirement account [such as a 401k or IRA] separate from their everyday portfolio?


Traub: I think that folks should do anything they can to legitimately and efficiently maximize their accumulation of funds so that they can regularly invest a fixed amount. Certainly programs that offer matching funds or corporate contributions accomplish both goals and add the benefit of tax deferment as well.

The thrust of my comment is really that folks shouldn't jump into any "hot stock" without knowing what they're doing. Had I known then what I now know, I'd have done a better job of picking the company and stayed with it even if the price went down, provided that the company's fundamentals remained as sound as they were when I picked it. I’d also have continued to invest on a regular basis for the next fifteen years.



You don't have to be a genius to make money in the market



THE LONG HAUL

...sell the losers (not those with the depressed prices but those whose revenues and earnings aren't capable of growing adequately...)

- Ellis Traub


Does a person have to be well educated to do well in the stock market?

Traub: Absolutely not! Using technamental analysis as described in Take Stock, a novice can know all they need to about the quality of a company as long as they can tell the difference between a straight and crooked line and the difference between one that slopes up, down, or not at all.

There are only ten terms that a person needs to know, all of them very intuitive. They can be applied to any company, whether it’s General Motors or Lucy's Lemonade stand.



JK: You talk about technamental investing quite often. What exactly is it?


Traub: "Technamental" investing refers to the technical analysis, charting and identifying significant patterns, of the fundamentals of a company rather than the meaningless meandering of the price and volume of a stock. The movement and trends in revenues, profits, earnings per share, and profit margins tell the investor a great deal about the character and quality of a company and are predictive of the stock's price over the long term.



JK: For readers who don’t know, what is the difference between fundamental analysis and technical analysis?

Traub: Simply stated, fundamental analysis looks at the company and its track record. Technical analysis seeks to find patterns in the movement of prices and volume that will forecast the future movement of the price. There are nearly a hundred different methods of technical analysis. It would seem to me that if any were successful, there'd be only one.



JK: What about those who have their money managed by professionals? Why should they learn about investment analysis?


Traub: The obvious reason is that they can do just as good a job for themselves by understanding the salient issues and save the fees that they would have paid the pro.



JK: Why do you think most people do not invest?

Traub: Number one, they're afraid that it's a gamble and they will lose. They don't know that there's an approach that, while boring and not exciting, lets them earn money with their money.

Secondly, they don't know just how simple it really is to do just that, and how little time and effort it takes to do it right.

Thirdly, many choose to spend all they earn rather than recognize that the time will come when they'd like to be free from the necessity to work but won't be able to do so because they haven't contributed the little it takes every month to make that dream a reality.



JK: In regards to diversification, how many companies do you think is too many?


Traub: More companies than you can comfortably keep track of is too many. With software tools, you can keep track of more than 10 or fifteen comfortably; but, hey, Warren Buffett doesn't hold more than 25 . . . why should I?



The Buy-from-a-Sucker-Sell-to-a-Sucker School of Investing & How to Double your Money in Five Years

HOW MANY STOCKS ARE TOO MANY?

More companies than you can comfortably keep track of is too many. Warren Buffett doesn't own more than 25, why should I?

- Ellis Traub




JK: In the book you talk about the BFS/STS school of speculation. What is it?

Traub: The “buy from a sucker, sell to a sucker” school of speculation I refer to in the book is that for anyone to make money through the purchase and subsequent resale of a stock without the actual value of that stock increasing, she must rely upon the ignorance of either the seller or the buyer or both. The odds are definitely against not being the sucker on either one or the other end of that transaction. It's another way of expressing the "Greater Fool Theory." "I may be a fool to buy this stock at this price; but I'll find another fool to buy it from me at a higher price." This is what fueled the recently exploded "bubble."

The trading mentality relies strictly upon luck and "winning" from another "loser" in order to be successful, where buying and selling at a fair multiple of earnings, when the earnings grows, requires no loser to participate.



JK: What is the rule of five?

Traub: How one expresses it depends upon his/her personality. For the pessimist, it says, "For every five stocks you buy, one will be a loser." For the optimist, which I am, it says, "For every five stocks you buy, four will be good, one of which will do even better than you expect."



JK: What percent growth is necessary to double your money every five years?

Traub: Just under 15 percent, compounded. It's feasible to find the well-managed companies whose earnings can grow at such a rate. And, since we can easily pick those above-average companies, a portfolio of such stocks should easily beat the indexes that contain both below average and above average companies.



JK: One of the most important questions a stockholder can ask is, How long will it take me to recover my initial investment? How would they answer this?

Traub: Most who diligently and conservatively invest as we suggest can actually double their money every five years, not just make their investment back. This requires that they reinvest what they make each year and invest regularly in high quality growth companies for the long term.



JK: Some investors are paying multiples of 50, 60, 80, and 100 for stocks. What is wrong with this?

Traub: You'd have to be Methuselah to be able to get back your investment, much less to double it! Personally, I wouldn't want to have to depend upon anyone paying more than 30 times earnings, at the most, for me to profit from an investment.



JK: You tend to look down on stocks that pay dividends some would argue that it is sometimes preferable for a corporation to pay out a portion of its earnings if it cannot continue to utilize capital at the growth rate it once did. This is especially true in realty trusts and industries such as tobacco, banking, etc. What are your thoughts?

Traub: The nature of efficient investing is such that the actual value of what we own must grow in order for us to maximize the growth of our investment. If we purchase a stock at a reasonable multiple of its company's earnings, and those earnings double, we can sell that stock at any time at the same fair multiple and enjoy the doubling of its price or value. Diluting the retained earnings with which revenue-producing assets can be acquired erodes the ability of the company to produce the kind of growth we're looking for.

Peter Lynch once made the point in an article in Worth magazine that retirees would be better off continuing to invest in growth with its potential return than to hedge and allocate assets to income investing. His rationale, and mine, is that one can make up for a lot of 6 percent years with a 12 or 15 percent return, even with some down years along the way. I believe that one should invest as if she expects to live forever. The return will justify it.



JK: What about those who are approaching or are already in, retirement age?

Traub: Again, my advice is to invest as though you will live forever. Your return will be better over the long haul and you can, at least financially, live forever.



JK: I like your point that not everyone has to have an MBA or CFA behind their name to make them a good investor. If that was the case, then stock brokers would be making their living through their investments instead of commissions.


Traub: Actually, if all stockbrokers were CFA's or MBA's, they'd probably be able to do that. Many are simply salesmen who sell what they're told to sell. The serious professionals typically don't do as well as the amateur can, but not because they're not educated or intelligent enough. Mostly it's because they are burdened by constraints that the amateur isn't; and this is because they have the responsibility for handling other people's money rather than their own. You can be freer than they. You don't have to worry about moving the whole market when you get out of a stock or into it. And you don't have a company policy that keeps you out of some of the more promising, though riskier, stocks. You also don't have to churn your portfolio just to look good to your peers.



JK: Peter Lynch seems to have influenced your investment strategies. In fact, I consider his "One Up on Wall Street" one of the best books ever written.

Traub: So do I. One of his most inspirational quotes came from the first paragraph of that book where he says, "...anyone using the customary three percent of his brain can pick stocks as well or better than the average Wall Street expert." I believe it and my book tells people how to do it.



What was the turning point where you became an advocate of value investing?

Traub: Basically, it was my discovery of NAIC. The logic was irrefutable and the simplicity elegant.



JK: You talk a lot about the NAIC. Many critics would argue that this book is a thinly veiled promotion for joining. How do you counter to that?

Traub: I disagree. It's not at all thinly veiled! NAIC saved my bacon and provide me with the philosophy that enabled me to turn my financial life around. I've just taken what they've taught me and added some minor changes to things that I think could be done a little better. But their basic methodology and approach to investing has been eminently successful for more than fifty years. Why wouldn't I praise it to the heavens, express my gratitude to its founders and volunteers who mentored me and recommend to those looking to maximize what I tell them in my book that great networking and continuing education opportunities are available by joining the organization?



Reader Questions

SPENDING YOUR WEALTH AWAY

Many people choose to spend all they earn rather than recognize that the time will come when they'd like to be free from the necessity to work; but won't be able to do so because they haven't contributed the little it takes every month to make that dream a reality...

- Ellis Traub



Question: What does it mean when stocks are held in a street name?
- Caroline Douglas


Traub: It simply means that stockbroker through which you purchased the stock has actual possession of the stock certificates that make you a shareholder and that they hold them for you. You still have the opportunity to vote those shares; but you don't have the certificates to show for it.



Question: What do you think you would be doing today if you hadn’t dropped out of Harvard during the Korean War?
- Amanda S.

Traub: Goodness knows! I certainly wouldn't have been a pilot.



Question: Why do you think the P/E Ratio is important for investors to consider?
- Michael Wells

Traub: The foundation of long-term investing is the notion that the company's earnings drives the price of a share of its stock. The higher the earnings, the higher the price. The PE is an expression of the price of the stock, expressed as a multiple of those earnings. And it's important to consider that relationship when considering the value issues (the stock's price). You can tell a great deal about that price by considering the PE. If the stock is selling at a very low PE (lower than it typically has sold for), it's a signal that suggests that you need to find out what the current investors know that you don't that makes them unwilling to pay as high a price has they have before. If it's higher than average, it's best to wait until the price comes down before you spring for it.



JK: Related to that; what is the PEG ratio and do you think it is an important factor in considering an investment?

Traub: Where the PE ratio is a measure of investor confidence -- by that I mean that the greater the investor's confidence that the company can produce strong earnings into the future, the higher the price she will pay -- the PEG ratio is kind of the second derivative of that confidence. The actual ratio is the Price divided by projected earnings growth; and, the higher the growth
rate of earnings, the greater the investor confidence.

It's most often used to suggest a limitation on the estimated future PE of a company. Many will limit their PE forecast to a PEG ratio of 1.5 or one and a half times the projected earnings growth. If earnings are projected to grow at 15 percent, then a PEG of 1.5 would suggest that the highest reasonable PE would be 22.5 percent or one and a half times the growth the moment rate.



Question: Is reinvesting your earnings really important?
- E. Rogers

Traub: It sure is. It spells the difference between being able to double your money in five years and not being able to. The "magic of compounding" is what enables you to achieve a 15 percent appreciation in your portfolio. If you were to take out your earnings each year, assuming 15 percent growth, you'd achieve only 15 percent growth each year on your original amount which equals a dollar seventy-five for every dollar invested over a five year period. If, however, you leave your earnings in, then the five-year result would be about 2.01 for every dollar, since the additional 15 percent would grow at 15 percent each year as well.



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