 | The Investment U E-Letter: Issue # 111
Monday, February 11, 2002 Charles Dow: 100 Years of Investing Wisdom
By Dr. Steve Sjuggerud, Chairman, Investment U
"The man who begins to speculate in stocks with the intention of making a fortune usually goes broke, whereas the man who trades with a view of getting good interest on his money sometimes gets rich." ~ Charles Dow, 1901
One hundred years ago, Charles Dow wrote about how to make money in the stock market in his publication: The Wall Street Journal. Amazingly, the same rules for making money that he outlined 100 years ago apply today.
I recently went back and read many of Dow's columns…and I was reminded that we will always have booms and busts - as well as fear and greed - in the markets. Human nature doesn't change - and by realizing that simple fact, we'll always be able to bring home profits in the stock market.
With that, allow me to share a few of Charles Dow's remarkably clear - and still entirely appropriate - lessons from a CENTURY ago. Timeless Investing Lessons from Charles Dow: - "The public, as a whole, buys at the wrong time and sells at the wrong time. The average operator, when he sees two or three points profit, takes it; but, if a stock goes against him two or three points, he holds on waiting for the price to recover, with oftentimes, the result of seeing a loss of two or three points run into a loss of ten points."
- "The [best] rule is to cut losses short but let profits run. It sounds very easy to follow, but is in reality difficult to observe. The difficulty arises from the unwillingness of an operator to take a small loss when experience shows him that in many cases such a loss need not have been taken."
[Investors in Enron would have been well served to learn this lesson from Charles Dow, which is the oldest rule in the investing book. But even as the oldest - and perhaps simplest - rule in the book, most investors can't follow it. Wouldn't it have been nice to take profits two years ago from the Nasdaq when it was at 4000? That's over 100% higher than the Nasdaq is right now…] - Value is determined by the margin of safety over dividends, the size and tendency of earnings, the soundness of the balance sheet and of operating methods, and general prospects for the future. This sounds rather complicated, but is not especially difficult to work out. It can now (remember - this was 1902) be said that most stocks are dear on their earnings. It is true that earnings have increased somewhat over last year, but prices of many stocks have advanced from 50 - 100%. In the long run, the prices of stocks adjust themselves to the return on the investment, and this should never be laid aside or overlooked. The tendency of prices over a considerable period of time will always be toward values."
[Bringing up Enron again, how sound was its balance sheet? As for value, the stock market is now trading at over 28-times earnings - one of the worst "values" in history. Stocks would need to fall in half (roughly) to return to their historical values. Dow's words are worth paying attention to.] - There are two general methods of trading. One is to deal in active stocks relying for protection upon stop orders. In this method of trading, it is not necessary to know much about the values. The operator guesses which way the stock will move. If he guesses right, he lets his profits run. If he guesses wrong, he goes out on the stop order. If he can guess right as often as he can guess wrong, he is fairly sure of profits. The other system is an entirely different proposition. It starts out with the assumption that the operator knows approximately the value of the stock. It assumes that he has considered the tendency of the general market; that he realizes whether the stock is relatively up or down; and that he feels sure of its value for at least months to come."
[These are the same trading methods employed today. You've got momentum players and value players - your hedge funds and your Warren Buffetts. Personally, a mix of both works best for me - buying a company that's both a good value and that has just started moving up in price. If I don't have both good value and price action in my favor, I don't do nearly as well.] So there you have it: timeless, classic investing rules from the master, Charles Dow. Asking for too much from the market will often leave you with nothing. The best policy is to cut your losers and let your losers win. As Charles Dow said so eloquently, sometimes we as investors are unwilling to take a small loss…even though our experience might tell us that we should. TODAY'S IU CRIB SHEET - There's nothing new on Wall Street. The more things change, the more they stay the same. Greed and fear will rule the markets in the short run, but stocks will return toward their values in the long run.
- Many of Wall Street's most important - and valuable - lessons were learned long ago. Do not be afraid to allow history to guide you. Re-read Charles Dow's quotes and see how you can avoid making - or repeating - many of the mistakes that investors have been making for over 100 years.
Good investing,
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