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  1. Home
  2. / Investing
  3. / U.S. Equity

Mr. Phelps: Finding '100 to 1' Stocks Is a Mission Possible

Thomas Phelps' '100 to 1 in the Stock Market' provides valuable lessons for any type of investor.
By TIM MELVIN Sep 17, 2015 | 12:00 PM EDT

I am just about finished reading "100 to 1 in the Stock Market" by Thomas Phelps. Phelps passed away back in 1992 after spending decades working as a broker, advisor and investor. He wrote the book in 1972 and it should be on your "must read" list.

Phelps talks about finding those stocks that can grow and reinvesting earnings over decades and multiplying your investment by 100 times or more. He cites numerous examples of companies that did exactly that for those with the patience and fortitude to hold stocks for decades, instead of a few months.

The book focuses more on growth then a deep-value approach, but there are many lessons for any type of investor. I like that he focuses on growth in book value as the best measure of growth. I have always maintained that everything that happens ends up being reflected in book value. If you find a company is growing reported earnings at a much higher rate than book value, there is a lot of cash disappearing between the top and bottom line. If management is successfully reinvesting profits then book value should be growing at around the same rate as earnings. It is a huge red flag if it is not.

Additionally, I really like that Phelps stresses owning stocks for decades. He suggests that most investors would be better off concentrating on finding and owning decent companies and letting time and compounding do all the heavy lifting. He talks about earning 100 to 1 returns over decades rather than trying to trade in and out of the hot stocks of the day. The key is to focus on the business results and not the current quote.

In the book, Phelps tells the story of a businessman who sold his companies and put the proceeds in the stock market. He found it incredibly stressful. Owning stocks was keeping him awake at night. Phelps asked how he tracked his holdings when he owned several operating companies. The businessman said that he didn't. As long as business was good and cost controls were sufficient to protect his margins he didn't worry about them at all. Phelps suggested he start viewing his stocks the same way and focus only on the operating conditions of the companies and not the price in the Wall Street Journal every day.

But Phelps is not purely a growth investor either. He notes several times in the book that the easiest way to achieve outsized gains is to benefit from both long-term earnings growth and earnings multiple expansion. He counsels buying stocks at lower multiples of earnings and then holding on, calling this "buy right and hold tight."

If you are lucky enough to find a company that can grow by 15% a year on average over a long period of time and the multiple stays the same you will do OK.. Let's say you pay 10x earnings for the stock and three decades later it trades at the same multiple. With earnings of $1 in year one your money will go from $10 per share to about $660. That's not too bad, but if the multiple expands because of investors paying up for the sustained growth rate then you do even better. If the P/E expands to 20x then your stake is now worth $1,320. Multiple expansion is as big a part of the equation as earnings growth.

Phelps also mentions in the book that one of the other ways to find 100 to 1 winners is to be a buyer of quality stocks at major market bottoms. This is a sound suggestion that is very hard for most of us to put into practice. As Charlie Munger has noted, while it takes a lot of character to sit around with lots of cash while waiting for an extraordinary opportunity, the ability to do so is why he is so rich. The older I get the more convinced I am that while holding some portion of your portfolio in cash may be a short-term drag on performance in rising markets the ability to buy great companies on the cheap in severe corrections will make a significant improvement  in long-term performance.

This is a fantastic book that belongs with "The Intelligent Investor," "The Aggressive Conservative Investor," "Quantitative Value," "Where Are All the Customers' Yachts?" and other classics. Having said that, finding stocks that are capable of the sustained long-term growth needed to produce 100 to 1 returns is not an easy or simple task.

The past few days, I have spent some time talking with friends with substantial market and business experience about where we might look for potential 100 to 1 returns. I will talk about that tomorrow.

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At the time of publication, Melvin had no positions in the securities mentioned.

TAGS: Investing | U.S. Equity

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