From Greg Wilson, chief analyst, the Legacy Portfolio: The holiday season is upon us. It’s a time of festivities, being with family, and giving gifts. And what better present to receive than the gift of knowledge…
With that in mind, here are my top four books that would make a great gift for the budding Legacy investor in your family. I’m including the best lesson I learned from each, for your reference.
1. The Warren Buffett Stock Portfolio, by Mary Buffett and David Clark
Comment: This is the book that started it all. Mark Ford read the book during his travels. That’s when it struck him: “This is how I want to invest my money in stocks.” And from that, the Legacy Portfolio was born…
The most powerful idea I learned from the book is the concept of “the expanding equity bond.” It’s one of Warren Buffett’s favorite ways to evaluate a company.
A typical bond pays you a fixed coupon rate. For example, a $1,000 bond with a 5.5% coupon will pay you $55 every year until the bond matures. At that point the bondholder receives a return of his principal ($1,000).
Stocks work in a different way. A company may offer a 5.5% dividend yield… but there’s no guarantee it will keep it there. And the price you paid for the shares can vary over time. It’s why most stocks are viewed as higher risk than bonds.
There is a small segment of companies, however, that are like “bonds in disguise.” These companies are so dominant and gush so much cash, they have track records of increasing their dividends, every year, for decades on end. This helps stabilize their share prices. The result is a type of stock that approaches bond-level security.
Like Buffett, we want to own companies that can always increase their dividends over time… while still staying “bond-like” in terms of safety. This is a foundational Legacy principle.
2. F Wall Street, by Joe Ponzio
Comment: Don’t let the crass name deter you. Joe Ponzio’s book is a must-have for the Legacy investor.
My favorite section is Chapter 7. It focuses on determining a business’ intrinsic value. No matter what price a stock is trading for… its true value is the discounted value of the cash that can be taken out of the business during its lifetime. Now this may sound a little complicated… but Joe takes you through the process, step by step. You’ll emerge with a far better understanding of how to value a business. This is a huge advantage.
Using Joe’s methods would have kept an investor out of Microsoft (NASDAQ: MSFT) at the beginning of 2000. And it’s a good thing, because MSFT has returned only an average of 1.1% per year over 14 years. However, this same knowledge led Joe into MSFT in April of 2006. And since then, an investor would have made a respectable 8.9% per year.
Knowing a company’s intrinsic value gives you a tremendous amount of confidence with your investment decisions. And it works.
3. The Little Book That Builds Wealth, by Pat Dorsey
Comment: Pat Dorsey is the former director of equity research at the independent investment research firm Morningstar. Pat reveals why competitive advantages, or economic “moats,” are good indicators of great long-term investments.
I like the book because Pat discusses competitive advantages from every angle you can imagine. When you’re done, you’ll never think about stocks the same way.
Take the company Stericycle, for example. This relatively unknown company operates in the drab field of medical waste management. Picture a garbage truck service for hospitals. It’s not exciting in the least… until you start learning about its competitive advantages.
Stericycle is 15 times the size of its nearest competitor. It has the most number of routes and the densest routes as well. That means Stericycle can earn a lot more per route than its competitors.
In fact, its advantage is so wide it could potentially underprice competitors and still make more money.
This is just one example among many Pat provides. The book’s list of similar stocks alone is worth the cover price.
Comment: Jeremy Siegel is a professor of finance at the Wharton School of the University of Pennsylvania… one of the highest-ranked business schools in the country. This book is a follow-up to his classic Stocks for the Long Run.
Siegel provides many valuable lessons in this book. The one that has stuck in my mind is Siegel’s analysis on what he calls the “growth trap.”
To illustrate the growth trap, Siegel compared the performance of IBM versus Standard Oil (now Exxon Mobil, XOM) from 1950 to 2003. Before getting to the final return numbers, he shared the growth stats for each company.
From 1950 to 2003, IBM grew faster than XOM when measuring revenues per share, earnings per share, and dividends per share. Not only that, but IBM’s sector expanded over that time while XOM’s contracted.
But XOM still beat out IBM over the five decades. From 1950 to 2003, XOM returned 14.42% versus 13.83% for IBM.
A better valuation and higher dividends made all the difference for XOM. In 1950, XOM traded at half the valuation of IBM, with a dividend more than twice as large. You can’t underestimate the power of fat dividend payouts coupled with a company powerful enough to increase them, relentlessly. These are the hallmark of a genuine Legacy investment.
The ideas discussed in these books are the key concepts behind Legacy investing. With the Legacy Portfolio, we put our money in the highest-quality stocks on the planet. They pay us ever-increasing dividends every year. They buy back shares. And most important of all… they let us sleep well at night.
Happy Holidays from the Legacy Portfolio.