Anyone Can Become Rich, Part 2

The Big Money
by Frederick R. Kobrick

(Page 2 of 2)

Those Defining Moments in Life

Most of us can remember a few moments in life that were "defining." That is to say, something set us on a new or different course or made a big difference. This was one of those moments for me, and I have never forgotten it. The seemingly simple stock story that he told me established the basis for a large part of how I came to invest. That one story made a big difference for me.

First, I recognized on that day that I should always try to work in organizations with great people who knew a lot about investing, rather than try to get most of my information from technical journals or texts. I had read about "grand masters" in investing and other areas of life, and it seemed as if one should learn the best and the most from a master. But I had always envisioned this type of person as very famous and had not realized that many masters did not have their name in lights.

Dave was the first person I had ever spoken with at length who had become very wealthy from picking his own stocks, so I was eager to hear more.

He told me that he had invested in a bunch of small, fast-growing companies over time, and some worked better than others. He felt that while everyone should have a portfolio, or group of stocks, that had future growth potential, ones that made sense for him or her, he had always believed that it was smart to also have a few stocks that had the possibility of making one rich.

One day he invested in Xerox. The company, formerly known as Haloid, had a technology that it was perfecting and selling in 1959. The stock went public that year and was trading over the counter, so he bought it. Xerox, the first automatic office copying machine to use regular paper, was listed on the New York Stock Exchange in 1961. Because its price had been appreciating strongly, it became much better known, and the gains accelerated. He went on to say that he read all he could about the new technology and the market reception, the lack of real competition, and the potential for the company. Xerox had been relatively unknown before then, as was the new technology that enabled its machines to make paper copies from printed pages. Back then, everyone used low-tech methods — such as carbon paper, slipped in between sheets in a typewriter — to make copies.

After reading and understanding all about how the company operated, Dave still had not been satisfied, since there was no assurance that this new technology would pay for itself and actually flourish. One of the more important things he did was to talk to other companies' purchasing people, who actually bought the machines; he also spoke with many of the users in some nearby Wall Street offices. He chatted with clerks and secretaries. He asked good questions about their usage patterns, what they liked and did not like, and what would make them buy more copiers. That gave him a real feel for the state of the market and gave him enough relevant information to make his own back-of-the-envelope calculations.

Dave used common sense and estimated how many machines could be sold as technology improved; as prices dropped; and as marketing, distribution, and awareness all were projected to show reasonable expansion. He worked out a weak case, a really strong case, and a middle-of-the-road case. Just from these calculations, it was plain that the potential for earnings growth was huge. Dave had what he needed and wanted in commonsense terms, but he also could look at real numbers on one piece of paper. The simplicity and logic of it all were very impressive, and today I still love so-called models of a company's future earnings that can be made simple, straightforward, and logical.

As much as I benefited from training in my early investment days, it was the practical applications of this commonsense approach that started me on a track that became my personal methodology in most things, including talking to airline pilots, truck drivers, and baseball-card dealers, over the years, to name just a few. In this situation, as the Xerox stock had climbed higher, my lunch partner had known more, had greater confidence, and had bought more. The ups and downs of the market would affect the stock price, of course, but he bought on dips because he had great faith that this company would persevere. He told me that the more knowledge he had, the more money he made; and the more money he made, the more he wanted to know.

I could understand why many investors and businessmen were skeptical about the new product, as they wondered whether buyers were just experimenting with this new toy that seemed to make copies that were so much more expensive than those done with, say, carbon paper. Remember that this great boom period for Xerox occurred before personal computers, and even word processors, appeared in offices. It was just as appropriate to be highly suspicious of brand-new, untested products, services, and markets back then as it is today. Skepticism is a reflection of a healthy sensitivity to risk, and it manifests itself either in staying away from what is feared or unknown or in working to gain the knowledge to clear up some of the doubts and uncertainties, one way or another.

The doubters — there are always plenty of bears for every great idea — felt that the cost of the machine would be far too high for a really broad market to develop, and the copier would not pay for itself in a business that cared about costs and expenses, which is virtually every business. Moreover, the copies came out damp with ink, the machine made noise, and the process was slow. In these early days, nothing at all had been solidly proved. But this company had a product in an early stage and was selling into an immature market, and unlike most of the Internet companies of the 1990s, Haloid Xerox did have some earnings, good management, and a solid business model.

Up to now, Dave had made pretty good money on various investments, like many other investors. But, while many investors over the years held, for example, Xerox, Microsoft, Medtronic, Home Depot, Toys "R" Us, and many others at just the right time in their early years, most investors took a profit and got out way too early, missing the chance to build a fortune with a few stocks, or one stock. Countless investors were shaken out of great stocks because something happened that made the overall market go down, and they just plain bolted for the door.

The difference was that they did not build deep knowledge of the company behind the stock — the kind of deep knowledge that keeps you in the stock when the market fluctuates, the kind of deep knowledge that makes you want to buy more stock, and the kind of knowledge that keeps you in the stock for a very long time.

If you look at an old stock chart from that period, you see that after adjusting for splits, Xerox stock would have sold for about $4 around the time Dave first bought it; some dozen years later, it had hit $160 per share. He had made 40X his money, essentially a lifetime's fortune, and that was that.

That period in which my new friend Dave made his fortune was the real golden era for Xerox. Later it would see its fortunes get better or worse. Many of those periods in which the challenges were poorly met had to do with its own management. So Xerox in the following decades presents us with other great lessons to learn, and we will be coming back to this company. Clearly, though, I had learned a great lesson from my friend — a lesson that would launch me on a quest early in my professional years. The quest I speak of is with me even now.

This book is about doing what Dave did.

Using stories that are both educational and entertaining, The Big Money reveals the best methods to simplify stock picking and to stop defeating ourselves. You will hear from one of the greatest investors of the 1920s and see how he describes investors beating themselves almost a century ago. This, unfortunately, is still the case with most people today. We are all emotional creatures, and busy and swamped with information and data, but far too many of us have no obvious "navigation chart."

The lessons from each story are universal in the sense that they can be applied to many, many stocks, not just one, and not just in one industry. The theme of simplifying investing is paramount, and this book is not built on numbers or concepts that you need experience to use. This book is for everyone out there willing to spend a few hours a week reading and focusing on a few key factors that can make you the big money from one stock or just a few stocks.

I ask people, "How are you going to recognize the next Microsoft, or the next Home Depot, Dell, Nike, or McDonald's, if you do not really understand how we recognized those companies in the first place?"

McDonald's did not invent either hamburgers or fast food, and Nike did not invent running shoes. Both, however, became the clear leaders of their industries. Microsoft did not invent computer operating systems, word-processing software, or spreadsheet software programs, yet it became the market leader for all of these products.

Home Depot did not invent hardware stores or retailing (though it did pioneer something of its own), and Dell did not invent computers (though it too was a pioneer). Not only that, but in their early years, when these companies were just lifting off, they were not first in their industry. Every one of these companies came from behind. You will be both interested and entertained by these examples, and you will find that the lessons in the following stories can make you rich by helping you to recognize what makes a company and its stock potential sources of great wealth.

All of these companies, and many more that you have heard of — and a long list that you have not heard of — had a few key things in common. These things were ideas that were translated into strategy, business plan, and action.

Over time, companies like Cisco, Dell, Microsoft, Home Depot, Wal-Mart, and others have made investors hundreds of times their money (and in some cases thousands of times, as with Wal-Mart). Yet many more stocks were there for the taking. Some were good gains, some were great gains, and some could make patient investors wealthy for the rest of their lives.

I do feel that most people should have the bulk of their retirement money in mutual funds or with financial advisers or both, so that they are not burdened with managing their retirement account. But I also feel that everyone can use the methods I have developed, own a few stocks, and concentrate all of his or her investment time on the "wealth" stocks, with the objective of becoming truly rich.

It is not just the famous names that can make you rich. You will find a story about a company named Molex in Chapter 2, why I invested in it, and how it did pretty much what Cisco did. You will be witness to the inside battle between Apollo Computer, the leader in work-station computers in the early 1980s; and Sun Microsystems, which replaced Apollo after a tough fight, and went on to make investors over 200X their money.

The battles are endless. Consider what happened when Sears, Roebuck and Co. was king of retail in this country and celebrated its dominance by opening the 110-story Sears Tower in Chicago in 1973. The Sears Tower was the world's tallest building (until 1996), housing the headquarters of America's most successful retail and catalog operation. Analysts back in the seventies projected that Sears would keep its number one spot for a very long time. They were wrong, very wrong. The reasons why Sears fell and Wal-Mart rose are directly related to business model and management, and if one looked hard at the key elements of their stated strategies, what the management was doing, and the main parts of the business model, instead of just extrapolating the momentum of earnings and analysts' estimates, it was all there to see.

Perhaps investors might remember tremendous gains from Zapata Corporation, or Schlumberger, both in the energy business, and perhaps not. Maybe some will know that Quaker Oats and Ralston Purina each had their periods of 700 percent and 800 percent gains in only a few years, or that Rite Aid, the drugstore chain, once went from $4.75 per share to $55 in about twenty-four months. It is easier to remember that Disney went from $4.50 to $120 in one six-year period (1966 to 1972), while McDonald's multiplied investors' money by 50X during that same time. But many will not be aware that MGIC, a good financial company that professionals as well as individuals owned, rose from $1.70 to $96.

The point is that you cannot always predict which business sectors will produce great gains in a given period. Sometimes the gains will come from the technology sector, sometimes from retail or media companies, and at other times from interesting companies that are just doing a great job while other companies in their industry sector are stagnating. Most of the time, it does not matter whether a company is a drugstore or a software company. What does matter is whether it has an open-ended market opportunity and a great BASM to take advantage of that opportunity.

This is not a history book; it is a book of great lessons to teach you to recognize what will make you rich. Nevertheless, history shows us which companies have generated the huge gains for stockholders and why. We all need this perspective in order to recognize great investments in the years ahead. Investors who wonder how Google will fare are far better off if they understand what happened to all the great search-engine companies that came earlier, from Alta Vista and WebCrawler to Lycos and others, concentrating on companies' descriptions of how they would grow and be profitable — the business models.

Besides, just as in military battles, chess, and elsewhere, all the great moves repeat again and again. Business models can be virtually the same, even if the products or services sold are different. That's why Molex taught me things that helped me to recognize and make huge money from Cisco. The key parts of BASM were the same for these two companies.

I listen carefully as debates rage today about Google — the "poster child" for what people hope is the big opportunity stock — and others such as Apple and its iPod, Netflix, TiVo, nanotechnology companies, and more. Debates over Google are most often about its valuation based on price-to-earnings ratio. But for every time investors wish they had sold a "seemingly" expensive stock, there are many instances when they sold stocks that could have made them rich, because they had no guide other than "conventional valuation arithmetic" — they didn't know what to look for.

It is disappointing how many students and investors I talk to do not really understand how Microsoft or Dell or others came from behind to win. They need to know how these things happened if they are to recognize which companies are to be the biggest successes of tomorrow. So picking a winning stock cannot be like a second-rate general trying to fight the last war; it is all about understanding themes that will occur over and over again, in order to recognize how to win the next war. You can be sure that the management of the great companies understands the history of the winners' business models. So do the best investors.

Thus, to spot Google and nanotechnology and stocks of the future, we move away from the conventional — "Red Coat investing" — and use BASM and the Seven Steps.

The most successful managers and strategists are true visionaries who have learned the right lessons from the past and stand by their commitments even when things are tough. Nike's Phil Knight battled against Reebok, and he led Nike to victory in the contest to be number one. The same goes for Microsoft's Bill Gates, who battled Lotus (which had the early spreadsheet lead of 70 percent market share); and Dell, which came along five years after Compaq, when Compaq seemed invincible.

To me, these same stories are going to repeat again and again, with only the names changing. The Internet battles already fought and won were very much decided by the factors of BASM. The Internet is just beginning to transform our lives and how we do business, and successful investing will mean understanding why eBay and Amazon and Yahoo have done what others could not do. New Internet companies will not end with the arrival of Google. There will be many more. The Internet age has only just begun. More new technologies will continue to arrive in this age of science and discovery. Nanotechnology, or the science of the very small, which focuses on things that are the width of a human hair or less, is already finding new ways of doing things. As in any new, exciting area, there will be mania stocks and there will be great investments, and one needs to know how to recognize each.

Some investors ask me how you tell the difference between a stock like Krispy Kreme Doughnuts, which became a mania stock (irrationality prevailing), and Google, which seems to be a solid company so far. There are some good lessons in this book that will answer those questions and many more that are front and center in today's markets and in the markets of every era. These lessons will help you with many stocks in the future.

I enjoy comparing Apple Computer in its early years with TiVo in its early years, since the lesson is a good one. Investors who have no idea of what happened to former great technology companies that "owned" their industries' number one position, including Wang Laboratories, Digital Equipment Corporation, Lotus Development, and Compaq Computer, will find that they will become much stronger tech investors if they know the outcomes of these great battles, and the reasons for victory and defeat.

Finally, there are even simple ways of dealing with potential fraud or financial reporting problems, and using BASM and the Seven Steps in this regard as well.

Have you heard of Sambo's restaurants? Well, just as Molex taught me things that led me to recognize what Cisco really was when Cisco made its public debut, in the 1970s Sambo's taught me to recognize what Enron really was in the 1990s.

Everything repeats. This is a huge plus, and a huge secret to making money with stocks. Learn to recognize things that you will see again and again, and you will be way ahead of many other investors. This is true equally for winners and losers. In this book you will learn how to recognize the themes and the stocks. All of these themes involve BASM and the Seven Steps.

Nonprofessional investors have big advantages over professionals. Among other things, they do not have to provide elaborate reports to committees in order to justify buying or selling and get the votes required to support such decisions. Professionals do have some advantages, but individuals have many more. There is a world of great opportunity if you simplify and focus only on the specific knowledge that you need. This knowledge leads to confidence, and that, with some disciplines, leads to big money.

This book is for people who want a clear, simple way to add to their mutual funds and investments with some stocks that can make them truly wealthy. It is for all of the countless millions more who want to know the stories, the concepts, and the lessons that will guide them to win their own freedom from inertia and from the old ways of investing.

Looking at earnings is important, of course, and I will discuss how one does this, but it is the golden goose that creates those earnings on which we must focus in order to simplify and to understand the great stocks. BASM, or some version of it, worked very well for me in my stock selection and in building a record that was one of the five best in the country for fifteen years. It has also worked for many more of the best stock pickers in the country.

I hope you enjoy the stories, gain from the lessons — and then go out there and, as Phil Knight would say, "Just do it."

Copyright © 2006 by Frederick R. Kobrick

About the Author

Frederick R. Kobrick has managed money for more than thirty years. He spent fourteen years as an investment analyst at Wellington Management Company, then joined State Street Research & Management in 1985. He managed the State Street Research Capital Fund, which was one of the five best-performing funds in the country for fifteen years, according to USA Today. Kobrick's Capital Appreciation Fund was included in Money magazine's "Six Funds of the Decade" in 1996, and cited in USA Today as among the five best funds for the entire bull market.