Beating the Street (5 page)

One of the companies the students at St. Agnes knew about was Pentech International, a maker of colored pens and markers. Their favorite Pentech product, with a marker on one end and a highlighter on the other, was introduced into the class by Ms. Morrissey. This pen was very popular, and some of the kids even used it to highlight their stock selections. It wasn't long before they were investigating Pentech itself.

The stock was selling for $5 at the time, and the students discovered that the company had no long-term debt. They were also impressed by the fact that Pentech made a superior product, which, judging by its popularity in house, was likely to be just as popular in classrooms nationwide. Another positive, from their point of view, was that Pentech was a relatively unknown company, as compared, say, to Gillette, the maker of Paper Mate pens and the Good News razors they saw in their fathers' bathrooms.

Trying to come to the aid of a colleague, the St. Agnes fund managers sent me a Pentech pen and suggested I look into this wonderful company. This advice I wish I had taken. After I received the research tip and neglected to act on it, the stock nearly doubled, from 5⅛ to a high of 9½.

This same kid's-eye approach to stockpicking led the 1990 St. Agnes fund managers to the Walt Disney Company, two sneaker manufacturers (Nike and L. A. Gear), the Gap (where most of them buy their clothes), PepsiCo (which they know four different ways via Pepsi-Cola, Pizza Hut, Kentucky Fried Chicken, and Frito-Lay), and Topps (a maker of baseball cards). “We were very much into trading cards within the seventh grade,” Ms. Morrissey says, “so there was no question about whether to own Topps. Again, Topps produced something the kids could actually buy. In doing so, they felt they were contributing to the revenues of one of their companies.”

They got to the others as follows: Wal-Mart because they were shown a videotaped segment of “Lifestyles of the Rich and Famous” that featured Wal-Mart's founder, Sam Walton, talking about how investing benefits the economy; NYNEX and Mobil because of their excellent dividends; Food Lion, Inc., because it was a well-run
company with a high return on equity and also because it was featured in the same video segment that introduced them to Sam Walton. Ms. Morrissey explains:

“The focus was on eighty-eight citizens of Salisbury, North Carolina, who each bought ten shares of Food Lion stock for one hundred dollars when the company went public back in 1957. A thousand dollars invested then had become fourteen million dollars. Do you believe it? All of these eighty-eight people became millionaires. These facts impressed all the kids, to say the least. By the end of the year they had forgotten a lot of things, but not the story of Food Lion.”

The only clunker in the model portfolio is IBM, which I don't have to tell you has been the favorite of professional adult money managers for 20 years (yours truly included—grown-ups keep buying it and keep wishing they hadn't). The reason for this destructive obsession is not hard to find: IBM is an approved stock that everybody knows about and a fund manager can't get into trouble for losing money on it. The St. Agnes kids can be forgiven this one foolish attempt to imitate their elders on Wall Street.

Let me anticipate some of the criticisms of the St. Agnes results that are sure to come from the professional ranks. (1) “This isn't real money.” True, but so what? Anyway, the pros ought to be relieved that St. Agnes isn't working with real money—otherwise, based on St. Agnes's performance, billions of dollars might be pulled from the regular mutual funds and turned over to the kids. (2) “Anybody could have picked those stocks.” If so, why didn't anybody? (3) “The kids got lucky with a bunch of their favorite picks.” Perhaps, but some of the smaller portfolios chosen by the fourperson teams in Ms. Morrissey's class did as well as or better than the model portfolio selected by the class at large. The winning foursome in 1990 (Andrew Castiglioni, Greg Bialach, Paul Knisell, and Matt Keating) picked the following stocks for the reasons noted:

100 shares of Disney (“Every kid can explain this one.”)

100 shares of Kellogg (“They liked the product.”)

300 shares of Topps (“Who doesn't trade baseball cards?”)

200 shares of McDonald's (“People have to eat.”)

100 shares of Wal-Mart (“A remarkable growth spurt.”)

100 shares of Savannah Foods (“They got it from
Investor's Daily.”)

5,000 shares of Jiffy Lube (“Cheap at the time.”)

600 shares of Hasbro (“It's a toy company, isn't it?”)

1,000 shares of Tyco Toys (Ditto.)

100 shares of IBM (“Premature adulthood.”)

600 shares of National Pizza (“Nobody can turn down a pizza.”)

1,000 shares of Bank of New England (“How low could it go?”)

This last stock I owned myself and lost money on, so I can appreciate the mistake. It was more than counteracted by the boys' two best picks, National Pizza and Tyco Toys. These four-baggers would have done wonders for any portfolio. Andrew Castiglioni discovered National Pizza by scanning the NASDAQ list, and then he followed up on his discovery by doing some research on the company—the crucial second step that many adult investors continue to omit.

The winning foursome in 1991 (Kevin Spinale, Brian Hough, David Cardillo, and Terence Kiernan) divided their pretend money among Philip Morris, Coca-Cola, Texaco, Raytheon, Nike, Merck, Blockbuster Entertainment, and Playboy Enterprises. Merck and Texaco got their attention because of the good dividends. Playboy got their attention for reasons that had nothing to do with the fundamentals of the company, although they did notice that the magazine had a large circulation and that Playboy owned a cable channel.

The entire class was introduced to Raytheon during the Gulf War, when Ms. Morrissey's students sent letters to the troops in Saudi Arabia. They developed a regular correspondence with Major Robert Swisher, who described how a Scud missile hit within a couple of miles of his camp. When the portfolio managers learned that Raytheon made the Patriot missile, they couldn't wait to research the stock. “It was a good feeling,” Ms. Morrissey says, “knowing we had a theoretical financial interest in the weapon that was keeping Major Swisher alive.”

After visiting Fidelity, eating pizza in the executive dining room, and giving me the Pentech advice I wish I had taken, the St. Agnes stock experts returned the favor by inviting me to address the school and to visit their portfolio department, a.k.a. the classroom. In
response to my visit to this 100-year-old institution, which offers classes from kindergarten through eighth grade, I received a cassette tape the students had recorded.

This remarkable tape included some of their own stockpicking ideas and stratagems, as well as a few that I'd suggested and they decided to repeat back to me, if only to make certain that I wouldn't forget them myself. Here are some of their comments:

Hi, this is Lori. One thing I remember you telling us is over the last seventy years the market has declined forty times, so an investor has to be willing to be in the market for the long term.… If I ever invest money in the market I will be sure to keep the money in.

Hi, this is Felicity. I remember you telling us the story about Sears and how when the first shopping malls were built, Sears was in ninety-five percent of them.… Now when I invest in a stock, I'll know to invest in a company that has room to grow.

Hi, this is Kim. I remember talking to you and you said that while K mart went into all the big towns, Wal-Mart was doing even better because it went into all the small towns where there was no competition, and I remember you said you were the guest speaker at Sam Walton's award ceremony, and just yesterday Wal-Mart was sixty dollars and they announced a two-for-one split.

This is Willy. I just want to say that all the kids were relieved when we had pizza for lunch.

Hi, this is Steve. I just want to tell you that I convinced my group to buy a lot of shares of Nike. We bought at fifty-six dollars a share; it is currently at seventy-six dollars a share. I own a lot of pairs of sneakers and they are comfortable shoes.

Hi, this is Kim, Maureen, and Jackie. We remember you were telling us that Coke was an OK company until five years ago when they came out with diet Coke and the adults went from drinking coffee and tea to diet Coke. Recently, Coke just split its stock at eighty-four dollars and is doing quite well.

At the end of the tape, the entire seventh-grade portfolio department repeated the following maxims in unison. This is a chorus that we should all memorize and repeat in the shower, to save ourselves from making future mistakes:

A good company usually increases its dividend every year.

You can lose money in a very short time but it takes a long time to make money.

The stock market really isn't a gamble, as long as you pick good companies that you think will do well, and not just because of the stock price.

You can make a lot of money from the stock market, but then again you can also lose money, as we proved.

You have to research the company before you put your money into it.

When you invest in the stock market you should always diversify.

You should invest in several stocks because out of every five you pick one will be very great, one will be really bad, and three will be OK.

Never fall in love with a stock; always have an open mind.

You shouldn't just pick a stock—you should do your homework.

Buying stocks in utility companies is good because it gives you a higher dividend, but you'll make money in growth stocks.

Just because a stock goes down doesn't mean it can't go lower.

Over the long term, it's better to buy stocks in small companies.

You should not buy a stock because it's cheap but because you know a lot about it.

Ms. Morrissey continues to do her best to promote amateur stockpicking, not only with students but with her fellow teachers, whom she inspired to start their own investment club, the Wall Street Wonders. There are twenty-two members, including me (honorary) and also Major Swisher.

The Wall Street Wonders have had a decent record, but not as good as the students'. “Wait until I tell the other teachers,” Ms. Morrissey said after we had gone over the numbers, “that the kids' stocks have done better than ours.”

Evidence that adults as well as children can beat the market averages with a disciplined approach to picking stocks comes from the
National Association of Investors Corporation, based in Royal Oak, Michigan. This organization represents 10,000 stockpicking clubs, and publishes a guidebook and a monthly magazine to help them.

Over the decade of the 1980s, the majority of NAIC chapters outperformed the S&P 500 index, and three-quarters of all equity mutual funds to boot. The NAIC also reports that in 1991, 61.9 percent of its chapters did as well as or better than the S&P 500. Sixty-nine percent beat that average again in 1992. The key to the success of these investment clubs is that they invest on a regular timetable, which takes the guesswork out of whether the market is headed up or down, and does not allow for the impulse buying and impulse selling that spoil so many nest eggs. People who invest in stocks automatically, the same amount every month, through their retirement accounts or other pension plans, will profit from their self-discipline just as the clubs have.

The following calculations, made at my request by Fidelity's technical department, have strengthened the argument for investing on a schedule. If you had put $1,000 in the S&P 500 index on January 31, 1940, and left it there for 52 years, you'd now have $333,793.30 in your account. This is only a theoretical exercise, since there were no index funds in 1940, but it gives you an idea of the value of sticking with a broad range of stocks.

If you'd added $1,000 to your initial outlay every January 31 throughout those same 52 years, your $52,000 investment would now be worth $3,554,227. Finally, if you had the courage to add another $1,000 every time the market dropped 10 percent or more (this has happened 31 times in 52 years), your $83,000 investment would now be worth $6,295,000. Thus, there are substantial rewards for adopting a regular routine of investing and following it no matter what, and additional rewards for buying more shares when most investors are scared into selling.

All 10,000 clubs in the NAIC held to their timetables during and after the Great Correction of October 1987, when the end of the world and the end of the banking system were widely predicted. They ignored the scary rhetoric and kept on buying stocks.

An individual might be scared out of stocks and later regret it, but in the clubs nothing can be accomplished without a majority vote. Rule by committee is not always a good thing, but in this case it helps ensure that no foolish proposal to sell everything will be
carried out by the group. Collective decision making is one of the principal reasons that club members tend to do better with the money they invest with the group than with the money they invest in their private accounts on the side.

The clubs meet once a month, either in members' houses or in rented conference rooms at local hotels, where they trade ideas and decide what to buy next. Each person is responsible for researching one or two companies and keeping tabs on the latest developments. This takes the whimsy out of stockpicking. Nobody is going to get up and announce: “We've got to buy Home Shopping Network. I overheard a taxicab driver say it's a sure thing.” When you know your recommendations will affect the pocketbooks of your friends, you tend to do your homework.

For the most part, the NAIC groups buy stocks in well-managed growth companies with a history of prosperity, and in which earnings are on the rise. This is the land of the many-bagger, where it's not unusual to make 10, 20, or even 30 times your original investment in a decade.

In 40 years of experience, the NAIC has learned many of the same lessons I learned at Magellan, beginning with the fact that if you pick stocks in five different growth companies, you'll find that three will perform as expected, one will run into unforeseen trouble and will disappoint you, and the fifth will do better than you could have imagined and will surprise you with a phenomenal return. Since it's impossible to predict which companies will do better than expected and which will do worse, the organization advises that your portfolio should include no fewer than five stocks. The NAIC calls this the Rule of Five.