After trying Phil’s Rule #1 system for 6 months and not seeing the results of my efforts, I am leaning towards saying “no.” However, by doing this system, I probably learned more about investing in individual stocks that I ever thought that I would. So, for that reason, I am not sorry one bit for taking on the activity.
I therefore began to search around for evidence of anyone’s success through a Google search. I pretty much hit a dead end, and could not find anyone that really tried the system and found success. I did find another post on the Get Rich Slow blog at the link below. Take a look at it if you have some time.
So, what exactly does Phil’s Rule 1 system involve and what made me intrigued enough to give it a try?
The thing that made me try Phil’s system was that it is the only individual stock picking strategy that is actually 1) systematic, 2) repeatable, 3) formulaic, and 4) most importantly, has a way to block emotions from coming in to investing. In a way, it is the most similar approach to dollar value averaging and index mutual fund asset allocation I could find.
Description of Rule 1 System:
1) Search for and identify stocks to invest in – These should only be companies that you would be proud to own, trade for > $1 per share, and have > 500,000 average daily trading volume. Ok – good. I agree with this approach. The type of companies you should invest in should be at the intersection of what you love to do, what you are good at doing, and what you can earn money doing.
2) Next, identify if the company has a “moat” – What he explains we are looking for here is >10% growth rate over 10 years for the following things: Return on investment capital, sales revenue, EPS growth, Equity per share, and free cash flow growth. He does a very nice job explaining exactly how to calculate these numbers, and Phil also offers a very good free calculator on his website (www.ruleoneinvestor.com) that I have used and would highly recommend. We also make sure that the company has enough current free cash flow to be able to pay back it’s long term debt in 3 years or less. OK – I agree with this as well.
3) Research the management and make sure the CEO is good and that no insider selling is happening – OK I agree with this.
4) Calculate the appropriate sticker price, or what the stock should be selling at given it’s current EPS and EPS growth rate. We then calculate the Margin of Safety price (MOS) to make sure that we buy the stock a significant enough discount to shield ourselves from mistakes and be able to achieve higher returns.
5) Once you ID a company that fulfills all of these fundamental requirements, it is then time to use technical analysis tools to make sure you are either buying or selling at the right time. Phil recommends using three technical tools to make sure of this – 1) MACD indicator, 2) Stochostics, and 3) 10 day moving average. Without going in to all of the details of these (Phil does in his book), Phil recommends that you only buy when all 3 of the tech. indicators say “buy” and that you only sell when all 3 indicators say, “sell.” I felt like this was really good because it eliminates the emotionally urges investors have to sell off at the wrong time and buy when prices are too high. Remember, you only buy the stock if 1) all technical indicators say to, and 2) it is trading below the MOS price. If a stock doesn’t fit these requirements, we put it on our watch list and review the current price each week to see if it has been discounted enough by the market to be under our MOS price.
So, that’s Phil’s system at a high level! How did I fare using it?
Since I wasn’t ready to commit my own real money to using his system before trying it out, I did 6 months of simulated trading/investing with this system using an Excel spreadsheet and my Google Finance watch list.
The companies listed below were ones that I found that fit the fundamental criteria above and were placed on my watch list. However, there were only two stocks during the 6 month period that came in below my MOS price that I calculated, Apollo and Research in Motion. I took this as a good sign because I didn’t want to be investing in just any company.
During the period that I tested out this system (August 2009 – January 2010), the S&P500 index return was 11.2%.
The returns for my trading activity for Apollo and Research in Motion were as follows (not included trading commissions or taxes):
Apollo – 2% gain, 1.4% gain, 6% gain, 0.3% loss
Research in Motion – 12.4% gain, 3% loss, 6.25% loss
If you sum up the returns, you get a total return of 12.85%. However, if you subtract 1% from each return for commissions, it is easy to see how the total return dips below the return of the market (and you haven’t considered taxes yet).
ITT Educational Services
Vasco Data Security
Research In Motion
Factset Research Systems
Mobile Telesystems MBT
America movil amx
Western Digital Corp WDC
EOG resources EOG
China Mobile CHL
murphy oil MUR
Gildan Activwear GIL
Endo pharma ENDP
Compania de bebidas ABV
Pharm Product Development PPDI
American Oriental Bioengineering AOB
China Automotive Systems CAAS
Ross Stores ROST
Best Buy BBY
So, to summarize, Phil’s system is very interesting, and I feel that I learned a lot from it. However, I still do not believe that it beats portfolio theory, asset allocation, and investing in index mutual funds. The link below is to Amazon if you all want to pick up a copy. I feel it is worth the read!
Keep on learning!