I can't recall how I came across John Neff's book. It must have been recommended by one of the Investment Masters, but to be honest, the name John Neff didn't jump out at me, and the book certainly didn't either. With pictures of currency symbols on the front cover, I'd be inclined to think John Neff was a currency trader. And I'm embarrassed by that oversight. During the thirty years that John Neff ran the 'Windsor Fund', he increased the initial stake an incredible fifty-seven times. In the process the Windsor Fund became the largest mutual fund in the United States, and John Neff became an investing legend.
"John Neff is the investment profession's investment professional. Nobody has ever managed a large mutual fund so very well for so very long a time. And no one is likely to do so ever again." Charles Ellis
While the commonalities with Neff and the world's Investment Masters are striking, like each of those Masters, Neff had his own style. While he was a low 'Price to Earnings Ratio' guy in every sense of the word, earnings growth was always front of mind. He hunted for things the crowd disdained. And when the crowd's affections turned, he was always happy to oblige. Neff never fell in love with his stocks; every stock Windsor owned was for sale. Neff continually and tactfully recycled funds into 'behind-the-market', undervalued stocks. He condemned institutional group-think and spent his entire career 'arguing with the market'.
I thoroughly enjoyed John Neff's memoir, 'John Neff on Investing.' While Neff shares his insights into the characteristics that defined him and his investing approach, he does so while taking the reader on a journey through the market action of the 1970's, 80's and 90's. This is such a rare quality to any investment book and can help provide context when looking at markets today. Successful investing, after all, requires an understanding of history. In this regard, Neff's book is an invaluable guide.
"At least a portion of Windsor's critical edge amounted to nothing more mysterious than remembering lessons of the past and how they tend to repeat themselves. You cannot become a captive of historical parallel, but you must be a student of history." John Neff
I've included some of my favourite quotes below ...
Be Curious and Disciplined
"An inventory of my skills on entering college revealed a relentless curiosity, faculty with numbers, an ability to express myself, and firm self-discipline."
Contrarian Nature
"My whole career I have argued with the stock market."
"Windsor's success ultimately flowed from our willingness to step outside the crowd's embrace and be exposed to the risk of embarrassment."
"Taking the unpopular view was how we made our money."
"Savvy contrarians keep their minds open, leavened by a sense of history and a sense of humour."
Low P/E Works
"Carloads of research statistics demonstrate that low p/e investing works, but no evidence I have seen speaks more convincingly than Windsor's track record. During my 31 year tenure, we beat the market 22 times. By the time I retired, each dollar invested in 1964 had returned $56 versus $22 for the S&P500."
"I attribute success not to genius or blinding insights, but to a frugal nature and lessons well learned. Therein rest my enduring principles, stamped indelibly with the merits of low p/e investing."
"The challenge is to foster opportunities for a free plus, and low p/e investing is the most reliable method I know. If you own a stock where negatives are largely known, then good news that comes as a surprise can have outsized effects."
High Flyers Can be Dangerous
"Unlike high-flying growth stocks poised for a fall at the slightest sign of a disappointment, low p/e stocks have little anticipation, no expectation built into them. Indifferent financial performance by low p/e companies seldom exacts a penalty. Hints of improved financial performance trigger fresh interest."
"Accounting practices leave ample wiggle room. Most companies that are close to earnings targets should meet those targets - particularly when the stock price hangs in the balance. In high p/e territory, if lofty growth expectations are missed by an inch, it may mean that a company has really missed by a mile."
"When shares of a stock change hands for 30 times earnings, who doesn't recall the day when shares fetched only 12 times earnings? But where were the buyers then? Most were cowering in fear of the latest news report or piling onto the speediest growth-stock bandwagon, even if its wheels were about to fall off.”
“Investors typically bristle at the notion that the crowd governs their behaviour. Countless self-proclaimed contrarians declare that General Electric is a buy at 40 times earnings because it is such a good company. Hang around long enough and you'll hear variations on that assertion repeatedly. The truth is, General Electric is a very good company - a great company, in fact. But with very few exceptions, markets don't work that way. You can't up the ante forever. Eventually even great stocks run out of gas. So if you bet that GE will go up to 80 times earnings, you're betting against the odds. At Windsor, we tried to keep the odds in our favour."
“Almost routinely, in the aftermath of excessive overvaluation, there is a compensatory penalty on the downside.”
Low P/E and Late Bull Markets
"Aside from late bull markets, in which good low p/e candidates were largely ignored while growth stocks reached strained and dangerous levels, Windsor's edge was usually formidable."
"Ironically, the merits of low p/e ratios are most compelling amid the clamor for hot stocks and hot sectors, but that is when investors are least likely to listen."
"All investing trends seem to go to excess eventually. In the Sixties, the go- go era swept investors in and judgement out. In the early Seventies, the Nifty-Fifty ruled supreme. In 1980, some experts foresaw a $60 barrel of oil, transforming oil companies to gold. These fads clattered to their inevitable conclusions when expectations encountered reality."
"Owing chiefly to the relentless din or experts who fan delusions (with help from the media), the timing and the magnitude of inflection points take most investors by surprise. But some signals are unmistakable. The marketplace always becomes momentum-laden as inflection points draw near, rife with warnings that starry-eyed investors dismiss."
"The capacity of investors to believe in something too good to be true seems almost infinite at times, especially when the market is crying for a sobering inflection point."
When Low P/E is 'Dead'
“Unfavorable news flags my attention. About the time experts declare low p/e has no future and that stocks ‘du jour’ will rule forever, inflection points are drawing near."
Look Forwards Not Backwards
"Adapting to changing circumstances, we try not to be cowed or intimidated by our own lack of success."
"It would be nice to be able to invest yesterday, but investors don't have that option. You can spend your time regretting that you didn't buy Cisco before a tenfold rise, or you can organise for future performance. That's the nature of the daily investment challenge."
Investment Process
"Sufficiently removed from Wall Street's hullabaloo, Windsor applied our low P/E sometimes boring principles in consistent fashion. We weren't fancy, just prudent and consistent. We always took note of prevailing opinion, but we never let it sway our investment decisions."
"I can't think of a better way to start to understand a company's performance than by poring over its results with pencil and paper."
"My motto has not changed: keep it simple."
"Playing the technical or momentum game has always seemed misguided to me."
"We never sought to own market weighting. We concentrated assets in undervalued areas."
"Rather than load up on hot stocks along with the crowd, we took the opposite approach. Our strength always depended on coaxing overlooked, out-of-favour stocks to move from undervalued to fairly valued. We left 'greater-fool' investing to others."
“A wise investor studies the industry, it’s products, and its economic structure. Industry trade magazines supply very valuable information long before it finds its way into the general consensus. Prudent investors always stay abreast of developments, which is why casual investors usually get wind of change after the stock price adjusts.”
Stock Characteristics
"My emphasis was on stocks with a future instead of stocks with a past."
"The stocks Windsor bought usually had had the stuffing beaten out of them. Their p/e ratios were 40 to 60 percent below the market."
"Typical Windsor fare featured good companies with solid market positions and evidence of room to grow."
"I assigned great weight to a judgement about the durability of earnings power under adverse circumstances."
"Absent the ability to dominate markets, products and services cannot command premium prices."
"Growth rates less than 6 percent or exceeding 20 percent (our customary ceiling) seldom made the cut."
“Return on Equity (ROE) furnishes the best single yardstick of what management has accomplished with money that belongs to shareholders.”
"You don't need glamour to make a buck. Indeed, if you can find a dull business that makes money, it is less likely to attract competition."
Source: John Neff on Investing. 1999. John Wiley & Sons Inc..
"What we always tried to do: select the outstanding company in a difficult industry or environment, and fight our way upstream as those qualities became more obvious to the market."
"When areas of the marketplace are under attack, investors can buy the best at little or no premium."
"Dull, ugly stocks found prominence at Windsor, owing to their frequent unpopularity. Insofar, as they were capable of expanding their price-earnings multiples, they fit our profile."
Neff's 'Total Return Ratio'
“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.”
"In Windsor's lexicon, 'total return' described our growth expectations: annual earnings growth plus yield. As a way to measure the bang for our investment buck, total return divided by initial p/e could not have been more succinct. We just never found a catchy name for it other than 'Total Return Ratio'."
"Academicians probably don't celebrate this measure; it's a bit too unsophisticated by their lights. But I never found a better way to express total return relative to what we paid for it."
"Windsor hunted for stocks with a cheapo profile; their total return divided by the p/e ratio was notably out of line with industry or market benchmarks. To put it differently, we preferred stocks whose total return, divided by the p/e, exceeded the market average by 2 to 1."
"For many years, Windsor routinely snatched stocks whose P/E equaled half of the total returns. As the Nineties progressed, this target became tougher to realize. By early 1999, S&P500 earnings were growing long-term at an 8% clip. This plus a 1.1% average yield pegged total return at 9.1%. Meantime, the going p/e hovered around 27 times."
"A stock whose 'total return ratio' exceeds 0.7 matches Windsor's traditional edge."
[Note: While John Neff utilized quantitative data he also focused heavily on qualitative information. In John Train's book, 'Money Masters of our Time', a chapter dedicated to John Neff discusses his investment in Ford which netted Windsor almost $500m in profit. You'll notice similar cultural characteristics which also contributed to the astonishing returns of Home Depot and Walmart..
“Explaining the investment merit of Ford, Neff pointed out that the company had little debt and $9 billion cash. The difference betweeen Ford's management and GM's, he says, is night and day. GM is arrogant, while the men who run Ford are 'home folks' who know how to hold down costs and avoid delusions of grandeur. The president eats with the men from the assembly line, so he knows what they are thinking. A Ford assembly-line worker makes several thousand dollars a year in bonuses, while a GM worker gets next to none. Neff began buying Ford heavily in 1984, when popular disillusionment with the automobile manufacturers had driven the stock down to $12 a share, two and half times earnings! Within a year he had accumulated 12.3 million shares at an average price under $14. Three years later the stock had reached $50 a share and had brought Windsor a profit of almost $500 million.]”
Stock Market Predictions Aren't Necessary
"We were not skilled at predicting the path of the market."
"It is always hard to be too penetrating or too precise about the outlook for the market in general."
Don't Fall in Love
"Falling in love with stocks in a portfolio is very easy to do and, I might add, very perilous. Every stock Windsor owned was for sale."
Don't Just Own your Company's Stock
"Be wary, however, of investing exclusively in the company that writes your paycheck. You may like your employer's prospects, but if business goes awry, you don't want to see your nest egg vanish along with your salary."
Three Areas of The Economy to Watch
“I always watch three areas of the economy for signs of excess: (1) capital expenditures, (2) inventories, (3) consumer credit.”
Summary
John Neff allocated his clients assets into areas of the market that were out-of-favour and cheap in a rational and disciplined manner. And while Neff's strategy outperformed, it didn't always. At times when markets were momentum-laden and valuations were stretched, Neff tended to under-perform. An imminent inflection point was usually at hand.
It's ironic that at the time time Neff published his book in 1999, one of the greatest investment bubbles in history was approaching its climactic end point. In the book's final chapter titled 'De Ja Vu', Neff noted the S&P500 was trading at 28 times offering just a 1% yield. And although, Neff could not see the typical warning signs he looked for, [capital expenditures, inventories and consumer debt] he recognized the risks...
"With no signs of excess visible in the [typical areas of excess] ... we always have to remain alert to other excesses that are not measured as acutely. The market itself suggests excess."
"Red-hot Nasdaq stocks seem most exposed to reality checks, particularly because five stocks command almost 40 percent of the market capital of the Nasdaq 100 Index. Four of these five stocks advanced more than 140 percent in 1998. This growth is quite unsustainable. Even if growth had been less than 140%, that's impressive, to be sure. My point is: They have enjoyed superlative growth for several straight years. Does the market believe they'll grow in excess of 30 percent for the several straight years? I don't...
If there is any classic lesson in the market place, it's that at some point reversion to the mean occurs. Sooner or later, something happens and growth, particularly high-magnitude growth, is diminished."
Neff's lessons remain timeless: History has a tendency to repeat. While most people forget the lessons of the past, Neff's book is a great reminder of many of those lessons, particularly in light of today's momentum driven market. De ja vu, indeed.
"All things considered, if I started again in January 2000, I'd follow the identical course." John Neff
Further Reading:
'John Neff on Investing', by John Neff. 1999. John Wiley & Sons.
'Money Masters of Our Time' by John Train. 2000. HarperCollins [Chapter 9 'John Neff - Systematic Bargain Hunter']
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