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The Unemotional Investor: Simple Systems for Beating the Market

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Investing in Stocks — Without Investing in Time, Tears, or Terror

When Robert Sheard decided to bite the bullet and get into the market, he wasn't the typical Wall Street player, didn't have years of trading experience, and didn't have an M.B.A. What he did have was the know-how. As one of the top stock researchers for The Motley Fool — the widely popular and fiercely irreverent financial site that launched the bestselling The Motley Fool Investment Guide and The Motley Fool's ...

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US 1998 Hard cover New in new dust jacket. Ships today from the USA! Over half off retail. Sewn binding. Paper over boards. 224 p. Contains: Illustrations. Motley Fool Books. ... Audience: General/trade. Simple Systems for Beating the Market for everyone from the absolute beginner to the most experienced investor! Read more Show Less

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Overview

Investing in Stocks — Without Investing in Time, Tears, or Terror

When Robert Sheard decided to bite the bullet and get into the market, he wasn't the typical Wall Street player, didn't have years of trading experience, and didn't have an M.B.A. What he did have was the know-how. As one of the top stock researchers for The Motley Fool — the widely popular and fiercely irreverent financial site that launched the bestselling The Motley Fool Investment Guide and The Motley Fool's You Have More Than You Think — Sheard developed mechanical, emotion-free formulas for analyzing stocks. Now he shares his insights to help you earn gains that will crush market averages. The Unemotional Investor teaches you:

* How to evaluate stocks

* What numbers to look for and how to compare them

* When to buy and when to sell

* How to manage the portfolio you create

* Two investing models you can use — one of which requires no math, no experience, and about fifteen minutes of work per year!

Like other books created by The Motley Fool, The Unemotional Investor presents an easygoing approach to a subject often shrouded in mystery, making it easy for even rank beginners to take the first steps toward reaping the rewards of a low-maintenance, high-profit portfolio.

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Editorial Reviews

Los Angeles Times
Sheard's answer is a tad heretical in an era when stock pickers are exalted, because he turns both choosing stocks and selling them over to a formula that doesn't require a supercomputer the size of Rhode Island to execute. In fact, there's very little math involved. . . . His idea sounds too simple, but perhaps that's the genius.
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Product Details

  • ISBN-13: 9780684845906
  • Publisher: Simon & Schuster
  • Publication date: 4/3/1998
  • Series: Motley Fool Books Series
  • Pages: 239
  • Product dimensions: 6.47 (w) x 9.58 (h) x 1.07 (d)

Meet the Author

Robert Sheard has been a writer and editor for The Motley Fool, Inc., www.fool.com. He now manages money as a director for Sheard and Davey Advisors, Inc., www.sdadvisors.com. He lives in Lexington, Kentucky.

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Read an Excerpt

FROM PART ONE: Stock Market Basics

Let's start with a simple question: Is this book for you? That may sound a little silly, since my editor expected a book suitable for everyone interested in the stock market (and who isn't?), but there are a lot of people for whom this book is not intended. So let's make that clear from the start.

This book is not for people wanting to get rich overnight. While the goal of investing is undoubtedly the creation of wealth — maybe even more wealth than you ever really believed possible — the approaches we'll be working with here are intended for use over a long period. There's no sure prescription for a home run in the financial world, and I won't even try to show you how to swing for one. What we're aiming for is a long investment career with lots of base hits instead of trying for that one lucky swing for the fences.

This book is also not for Wall Street Whiz Kids or financial wizards. Most of what you'll find between these covers will either be old news to them, or they'll assume (wrongly) that because the approaches I'm writing about are simple, they cannot be effective. In other words, sophisticated investors (especially those in thrall to the Wise) will dismiss me and my work out of hand. After all, they've read my introduction, too, and know full well I'm an outsider looking in on the financial world, not an insider with access to the mystical keys to Wall Street. My feeling is that the individual investor has no more need for the Wise than the Wise have for me. Sounds like a pretty healthy arrangement all the way around.

This book is for the Everyman investor. (In these more politically correct times, Irealize that should read "Everyperson," but the fifteenth century was influenced by the Old English and gender-neutral definition of "man.") If you have an interest in managing your own portfolio, in building wealth gradually but effectively, in wresting control of your investments out of the hands of the mediocre mutual fund industry, and in getting better returns than you may have thought possible with an approach simple enough that a seventh grader can use it, this book is for you.

In my experiences with The Motley Fool, I've taught the principles and strategies included here to readers I've never met in person, who span the globe (literally), who range in age from pre-teen to nonagenarian, whose education levels span a similar range, and who have had little or no investing experience or have spent their investment career watching someone else handle their money when they entered the online forum. Like me, they had an interest but no experience, and weren't sure where to turn.

Perhaps the most satisfying aspect of my work with The Fool is hearing from people months or years after I have worked with them to learn the investment strategies included in this book. Most of their e-mails and letters discuss how much they enjoy the feeling of independence that they have now that they're confidently managing their own portfolios. Some even convey a touch of justifiable gloating in their tones as they compare their portfolio returns with those of the mutual funds they abandoned when they began investing in stocks directly. Not enough teachers get that tangible reward. In fact, it was all but absent when I was in academe. Today, it's a fairly common occasion when I hear from a former reader who is proud to report his or her success. Perhaps I'll hear from some of you in the future.

It's time to get to work. I assume that if you are still reading, you are interested in becoming your own investment manager and that what you want now is a little concrete information. The first thing we need to tackle is the definition of a stock itself. Just what is this stock market and how (in basic terms) does it really work?

There are essentially two major types of business structures regarding ownership of a company itself — private and public companies. Privately held companies are those that are owned by an individual or a fixed group of individuals and the ownership only changes according to their own wishes. For example, Irving and Marylou's I. M. Diner is 100 percent owned by Irving and Marylou, making it a private company. If their son decides he wants to be involved in the I. M. Diner, and Irving and Marylou decide to make him a partner, it's still a private company, owned exclusively by Irving, Marylou, and Irving Jr. There is no limitation on the size of a private company or the number of owners. Typically, this type of structure suits smaller businesses, though there are some quite large privately held companies in America.

Ten years down the road, however, the family business has grown. Irving, Marylou, and Junior own six I.M. Diners and all of them are always full of satisfied customers. Their diner is a major hit and now they want to expand into four more states and fifteen new cities. Problem: Virtually all of their financial resources are already wrapped up in the six current diners and they are hesitant to borrow the extra capital they need to start the expansion. What are they to do to capitalize on the craze for Marylou's Heart-Stopper Special Meatloaf? One possible answer is to "go public."

A publicly traded company is one that has raised capital by selling shares of stock, individual shares of ownership in the company itself. The company works with investment bankers who launch what is called an initial public offering (IPO). The owners and their investment bankers decide how many shares they will offer and what percentage of the company those shares will represent, as well as the approximate price per share, which is based on how much the company is worth and how much the company is trying to raise. The investment bankers (called the underwriters of the offering) then seek out interested investors to purchase the available shares of stock. The money raised from the initial offering goes to the company to finance its expansion plans, and then the shares of stock enter the open market.

Once a stock is publicly traded, the original private owners no longer have complete control over the company's ownership; that rests with the current shareholders. (Though many original owners retain enough of the new public stock — at least 50.1 percent of the shares — to keep control of the voting.) Nor does the company control how often or to whom those shares of outstanding stock are bought and sold. That function is taken over by the marketplace. Stocks that are publicly traded act to a large degree like any other publicly traded item in a marketplace. The stock market brings together (through the stockbrokers) individuals and institutions who either own stock and are looking to sell it for the best price possible, or who are looking to invest money in a particular stock and hope to find the best bargain.

The price of the stock for any given company, then, depends on the same market forces of supply and demand that dictate the movement of prices for apples or corn, Reggie Jackson rookie cards, or Joe Montana autographed sweatbands. When there are a lot of buyers clamoring for a small number of shares (or apples or sweatbands), the people who own that supply can command a higher price for the stock. Conversely, if you're trying to sell a stock and there is not a flock of eager buyers, you will probably have to settle for a lower price than you hoped for.

While the actual workings of the stock market can get very complicated, what with all the middlemen involved in the actual buying and selling transactions, the basic functions of the stock market work pretty much like any farmers' market in the country. Visit one and you'll see that Farmer Lotsocare has the best-looking melons you've ever seen because of his special blend of organic fertilizer and the tender attention he gave them. He also has a frantic crowd surrounding his booth trying to get the best melons before they're snatched away. Contrast that to Farmer Quicksale, who cut corners at every opportunity and has a melon crop that seems better suited to doorstop duty than as fare for your buffet table.

As the fair opens, the crowds around Farmer Lotsocare's booth will pay just about any price Farmer Lotsocare asks (within a reasonable range, of course) for fear that they will end up empty-handed if they don't. In the meantime, Farmer Quicksale's booth is deserted. Who would buy an inferior product when a superior one is available right next door? Such is the power of the marketplace. The only buyers Farmer Quicksale will be able to attract as long as Farmer Lotsocare's booth still has melons for sale are ones who simply can't afford the higher prices for the top-grade melons. But that means Farmer Quicksale is already having to mark his prices down to attract buyers. The supply is there, but the demand isn't evident at his original prices.

Once Farmer Lotsocare runs out of melons, though, the few buyers who were too late to get any of his prizewinning crop may then decide to check out the booth next door. With the memory of what could have been, though, those buyers are not going to pay the same price to Farmer Quicksale for his obviously poorer melons. They may buy a few just to have something for their tables, but they won't pay a premium price and they won't buy in the same quantity that they might have if Farmer Lotsocare had not run out of melons. Plain and simple, market forces of supply and demand determine the price for whatever the commodity is. And in this pure sense of the word "commodity," that's how the stock market works as well. (I won't be advising you to look to the commodity markets for your investments, though. Might as well head to Vegas.)

What drives the forces of supply and demand for stocks, however, is not as easy to see as what drives them for our two farmers. On the surface, it's not as easy to see which of two stocks is the better "melon," and that's where the techniques and strategies in this book come into play. You will need a way of thumping the melons to see which farmers are charging too much and which ones are offering you a bargain. Almost everyone who has ever invested has, at some point, run into the cliché "Buy low, sell high." Yet the actual task of determining those values can be extremely complicated. If it were a simple, guaranteed, and well-known process, every investor would be making a fortune in the market on every single investment. Obviously, that is not the case. What, then, drives the forces of supply and demand for stocks?

These forces are driven by many factors, of course, but the crucial distinction we need to make as investors is between long-term and short-term market forces. In the short term, almost anything can affect investor psychology. A rumor that the chairman of the board left his wife, embezzled the company's pension fund, and ran off to South America with his assistant is enough in the short run to knock a stock's price down. Remember that the interplay between buyers and sellers is what determines a stock's price. Would you want your investment strategy to depend on market rumors?

More relevant perhaps is a news story that affects how investors feel about a given stock. Several years ago semiconductor maker Intel was flying high. Everyone loved the company because it was dominating the personal computer market with its microprocessors. The stock was soaring. Then came the announcement that a flaw existed in its new top-of-the-line Pentium chip, which generated false results in certain very complicated mathematical computations. Wham! For a while, the stock price was hammered because of the fears that Intel might lose money on the new product, that a recall would devastate the company, that ... well, you get the picture. A year or so later, with the Pentium problem solved, Intel's stock was again the darling of the market, making great gains and being touted as the one stock you must have in your portfolio by pundits far and wide. For now ...

All of that, however, is in the short run, a period we at The Motley Fool are not nearly as concerned about as what happens over a much longer time frame. Over the long run, there's no doubt what drives the forces at work on a stock's price — the earnings a company records. There is a good reason "the bottom line" has come into our lexicon to mean "what everything boils down to." The bottom line, or how much a company earns in profits, is the factor above all else that will move a stock price up or down over time. Keep in mind, a shareholder is a part owner of the company and, therefore, "owns" a tiny portion of those bottom-line earnings. If the company is making a lot of money, it will take a higher price from a potential buyer to induce a shareholder to sell his share of the business. The stock price rises. The crucial nature of the company's earnings can be seen in a statistic that financial analysts watch constantly — earnings per share (EPS). This is simply a figure derived by taking the total earnings for the company and dividing that number by the number of shares of stock outstanding.

If you look at any of the great stock success stories over the last few decades, you'll find companies whose earnings per share have grown consistently, year after year. Let's just look at two examples from completely different industries: soft-drink giant Coca-Cola and computer software leader Microsoft. Over the last five years, Coca-Cola has had growth in its earnings per share on the average of 18.5 percent a year. That's a total growth rate for the five years of more than 130 percent. For one of the largest companies in the country, that's an impressive achievement in a seemingly stable and mature business. The earnings, though, continue a long-term trend for Coke that has led to terrific gains for shareholders over the years. Over the past decade (from the end of April 1987 to the end of April 1997), Coca-Cola's stock has generated annual returns of more than 30 percent a year. A $10,000 investment in Coke made in 1987 would have grown to more than $145,000 during that decade. Short and sweet: It's earnings, baby!

An even more compelling example is the history of Microsoft, the world leader in personal computer software operating systems. The Windows operating system all but controls the personal computer market today and the company has recorded terrific earnings. Over the last five years, for example, Microsoft's earnings have grown at an annual rate of 35.5 percent — a phenomenal performance for such a behemoth. As with Coca-Cola, shareholders who were a part of that phenomenal earnings growth profited handsomely. A $10,000 investment in Microsoft a decade ago would be worth over $420,000 today. The annual return on the stock during the decade has been better than 45 percent a year — another example of the incredible growth in earnings over a sustained period pushing the stock value to loftier levels.

The trick, of course, is identifying the Coca-Colas and Microsofts before the fact, not after it. I'll come to that later in this book, but, for now, we have some other ground to cover about why you would want to invest in stocks with all of the choices available to today's investors.

Copyright © 1998 by Robert Sheard and the Motley Fool, Inc.

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Table of Contents

Contents

Foreword

by David and Tom Gardner

Introduction

The Birth of a Fool

Part One

Stock Market Basics

Part Two

Getting Started with Value Stocks

Part Three

Diversifying with Growth Stocks

Part Four

Putting It All Together

Part Five

Frequently Asked Questions

Acknowledgments

Index

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First Chapter

Let's start with a simple question: Is this book for you? That may sound a little silly, since my editor expected a book suitable for everyone interested in the stock market (and who isn't?), but there are a lot of people for whom this book is not intended. So let's make that clear from the start.

This book is not for people wanting to get rich overnight. While the goal of investing is undoubtedly the creation of wealth -- maybe even more wealth than you ever really believed possible -- the approaches we'll be working with here are intended for use over a long period. There's no sure prescription for a home run in the financial world, and I won't even try to show you how to swing for one. What we're aiming for is a long investment career with lots of base hits instead of trying for that one lucky swing for the fences.

This book is also not for Wall Street Whiz Kids or financial wizards. Most of what you'll find between these covers will either be old news to them, or they'll assume (wrongly) that because the approaches I'm writing about are simple, they cannot be effective. In other words, sophisticated investors (especially those in thrall to the Wise) will dismiss me and my work out of hand. After all, they've read my introduction, too, and know full well I'm an outsider looking in on the financial world, not an insider with access to the mystical keys to Wall Street. My feeling is that the individual investor has no more need for the Wise than the Wise have for me. Sounds like a pretty healthy arrangement all the way around.

This book is for the Everyman investor. (In these more politically correct times, I realize that should read "Everyperson," but the fifteenth century was influenced by the Old English and gender-neutral definition of "man.") If you have an interest in managing your own portfolio, in building wealth gradually but effectively, in wresting control of your investments out of the hands of the mediocre mutual fund industry, and in getting better returns than you may have thought possible with an approach simple enough that a seventh grader can use it, this book is for you.

In my experiences with The Motley Fool, I've taught the principles and strategies included here to readers I've never met in person, who span the globe (literally), who range in age from preteen to nonagenarian, whose education levels span a similar range, and who have had little or no investing experience or have spent their investment career watching someone else handle their money when they entered the online forum. Like me, they had an interest but no experience, and weren't sure where to turn.

Perhaps the most satisfying aspect of my work with The Fool is hearing from people months or years after I have worked with them to learn the investment strategies included in this book. Most of their e-mails and letters discuss how much they enjoy the feeling of independence that they have now that they're confidently managing their own portfolios. Some even convey a touch of justifiable gloating in their tones as they compare their portfolio returns with those of the mutual funds they abandoned when they began investing in stocks directly. Not enough teachers get that tangible reward. In fact, it was all but absent when I was in academe. Today, it's a fairly common occasion when I hear from a former reader who is proud to report his or her success. Perhaps I'll hear from some of you in the future.

It's time to get to work. I assume that if you are still reading, you are interested in becoming your own investment manager and that what you want now is a little concrete information. The first thing we need to tackle is the definition of a stock itself. Just what is this stock market and how (in basic terms) does it really work?

There are essentially two major types of business structures regarding ownership of a company itself -- private and public companies. Privately held companies are those that are owned by an individual or a fixed group of individuals and the ownership only changes according to their own wishes. For example, Irving and Marylou's I. M. Diner is 100 percent owned by Irving and Marylou, making it a private company. If their son decides he wants to be involved in the I. M. Diner, and Irving and Marylou decide to make him a partner, it's still a private company, owned exclusively by Irving, Marylou, and Irving Jr. There is no limitation on the size of a private company or the number of owners. Typically, this type of structure suits smaller businesses, though there are some quite large privately held companies in America.

Ten years down the road, however, the family business has grown. Irving, Marylou, and Junior own six I. M. Diners and all of them are always full of satisfied customers. Their diner is a major hit and now they want to expand into four more states, and fifteen new cities. Problem: Virtually all of their financial resources are already wrapped up in the six current diners and they are hesitant to borrow the extra capital they need to start the expansion. What are they to do to capitalize on the craze for Marylou's Heart-Stopper Special Meatloaf? One possible answer is to "go public."

A publicly traded company is one that has raised capital by selling shares of stock, individual shares of ownership in the company itself. The company works with investment bankers who launch what is called an initial public offering (IPO). The owners and their investment bankers decide how many shares they will offer and what percentage of the company those shares will represent, as well as the approximate price per share, which is based on how much the company is worth and how much the company is trying to raise. The investment bankers (called the underwriters of the offering) then seek out interested investors to purchase the available shares of stock. The money raised from the initial offering goes to the company to finance its expansion plans, and then the shares of stock enter the open market.

Once a stock is publicly traded, the original private owners no longer have complete control over the company's ownership; that rests with the current shareholders. (Though many original owners retain enough of the new public stock -- at least 50.1 percent of the shares -- to keep control of the voting.) Nor does the company control how often or to whom those shares of outstanding stock are bought and sold. That function is taken over by the marketplace. Stocks that are publicly traded act to a large degree like any other publicly traded item in a marketplace. The stock market brings together (through the stockbrokers) individuals and institutions who either own stock and are looking to sell it for the best price possible, or who are looking to invest money in a particular stock and hope to find the best bargain.

The price of the stock for any given company, then, depends on the same market forces of supply and demand that dictate the movement of prices for apples or corn, Reggie Jackson rookie cards, or Joe Montana autographed sweatbands. When there are a lot of buyers clamoring for a small number of shares (or apples or sweatbands), the people who own that supply can command a higher price for the stock. Conversely, if you're trying to sell a stock and there is not a flock of eager buyers, you will probably have to settle for a lower price than you hoped for.

While the actual workings of the stock market can get very complicated, what with all the middlemen involved in the actual buying and selling transactions, the basic functions of the stock market work pretty much like any farmers' market in the country. Visit one and you'll see that Farmer Lotsocare has the best-looking melons you've ever seen because of his special blend of organic fertilizer and the tender attention he gave them. He also has a frantic crowd surrounding his booth trying to get the best melons before they're snatched away. Contrast that to Farmer Quicksale, who cut corners at every opportunity and has a melon crop that seems better suited to doorstop duty than as fare for your buffet table.

As the fair opens, the crowds around Farmer Lotsocare's booth will pay just about any price Farmer Lotsocare asks (within a reasonable range, of course) for fear that they will end up empty-handed if they don't. In the meantime, Farmer Quicksale's booth is deserted. Who would buy an inferior product when a superior one is available right next door? Such is the power of the marketplace. The only buyers Farmer Quicksale will be able to attract as long as Farmer Lotsocare's booth still has melons for sale are ones who simply can't afford the higher prices for the top-grade melons. But that means Farmer Quicksale is already having to mark his prices down to attract buyers. The supply is there, but the demand isn't evident at his original prices.

Once Farmer Lotsocare runs out of melons, though, the few buyers who were too late to get any of his prize-winning crop may then decide to check out the booth next door. With the memory of what could have been, though, those buyers are not going to pay the same price to Farmer Quicksale for his obviously poorer melons. They may buy a few just to have something for their tables, but they won't pay a premium price and they won't buy in the same quantity that they might have if Farmer Lotsocare had not run out of melons. Plain and simple, market forces of supply and demand determine the price for whatever the commodity is. And in this pure sense of the word "commodity," that's how the stock market works as well. (I won't be advising you to look to the commodity markets for your investments, though. Might as well head to Vegas.)

What drives the forces of supply and demand for stocks, however, is not as easy to see as what drives them for our two farmers. On the surface, it's not as easy to see which of two stocks is the better "melon," and that's where the techniques and strategies in this book come into play. You will need a way of thumping the melons to see which farmers are charging too much and which ones are offering you a bargain. Almost everyone who has ever invested has, at some point, run into the clichT "Buy low, sell high." Yet the actual task of determining those values can be extremely complicated. If it were a simple, guaranteed, and well-known process, every investor would be making a fortune in the market on every single investment. Obviously, that is not the case. What, then, drives the forces of supply and demand for stocks?

These forces are driven by many factors, of course, but the crucial distinction we need to make as investors is between long-term and short-term market forces. In the short term, almost anything can affect investor psychology. A rumor that the chairman of the board left his wife, embezzled the company's pension fund, and ran off to South America with his assistant is enough in the short run to knock a stock's price down. Remember that the interplay between buyers and sellers is what determines a stock's price. Would you want your investment strategy to depend on market rumors?

More relevant perhaps is a news story that affects how investors feel about a given stock. Several years ago semiconductor maker Intel was flying high. Everyone loved the company because it was dominating the personal computer market with its microprocessors. The stock was soaring. Then came the announcement that a flaw existed in its new top-of-the-line Pentium chip, which generated false results in certain very complicated mathematical computations. Wham! For a while, the stock price was hammered because of the fears that Intel might lose money on the new product, that a recall would devastate the company, that...well, you get the picture. A year or so later, with the Pentium problem solved, Intel's stock was again the darling of the market, making great gains and being touted as the one stock you must have in your portfolio by pundits far and wide. For now...

All of that, however, is in the short run, a period we at The Motley Fool are not nearly as concerned about as what happens over a much longer time frame. Over the long run, there's no doubt what drives the forces at work on a stock's price -- the earnings a company records. There is a good reason "the bottom line" has come into our lexicon to mean "what everything boils down to." The bottom line, or how much a company earns in profits, is the factor above all else that will move a stock price up or down over time. Keep in mind, a shareholder is a part owner of the company and, therefore, "owns" a tiny portion of those bottom-line earnings. If the company is making a lot of money, it will take a higher price from a potential buyer to induce a shareholder to sell his share of the business. The stock price rises. The crucial nature of the company's earnings can be seen in a statistic that financial analysts watch constantly -- earnings per share (EPS). This is simply a figure derived by taking the total earnings for the company and dividing that number by the number of shares of stock outstanding.

If you look at any of the great stock success stories over the last few decades, you'll find companies whose earnings per share have grown consistently, year after year. Let's just look at two examples from completely different industries: soft-drink giant Coca-Cola and computer software leader Microsoft. Over the last five years, Coca-Cola has had growth in its earnings per share on the average of 18.5 percent a year. That's a total growth rate for the five years of more than 130 percent. For one of the largest companies in the country, that's an impressive achievement in a seemingly stable and mature business. The earnings, though, continue a long-term trend for Coke that has led to terrific gains for shareholders over the years. Over the past decade (from the end of April 1987 to the end of April 1997), Coca-Cola's stock has generated annual returns of more than 30 percent a year. A $10,000 investment in Coke made in 1987 would have grown to more than $145,000 during that decade. Short and sweet: It's earnings, baby!

An even more compelling example is the history of Microsoft, the world leader in personal computer software operating systems. The Windows operating system all but controls the personal computer market today and the company has recorded terrific earnings. Over the last five years, for example, Microsoft's earnings have grown at an annual rate of 35.5 percent -- a phenomenal performance for such a behemoth. As with Coca-Cola, shareholders who were a part of that phenomenal earnings growth profited handsomely. A $10,000 investment in Microsoft a decade ago would be worth over $420,000 today. The annual return on the stock during the decade has been better than 45 percent a year -- another example of the incredible growth in earnings over a sustained period pushing the stock value to loftier levels.

The trick, of course, is identifying the Coca-Colas and Microsofts; before the fact, not after it.

Copyright © 1998 by Robert Sheard and The Motley Fool, Inc.

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Introduction

When I decided to embark on this project, I was thrilled to be writing a book, although if you had told me five years ago I'd be writing a book on the stock market, I'd have asked the bartender to start watering down your drinks. My pedigree is anything but typical for Wall Street and my career path five years ago was governed by literary theory rather than price/earnings ratios and dividend yields. I thought my first book was more likely to be a dry-as-dust version of my doctoral dissertation I blackmailed some university press editor into publishing so I could get tenure.

So when I started planning this book, the last thing I wanted to include was personal material about my background. Who was I to be writing about the stock market? And without the typical list of credentials (an M.B.A. from the Wharton School of Business, thirty years as a grizzled Wall Street veteran, or battle scars from the bear market of 1973-74 and the Crash of October 1987), who would listen to what I had to say?

Tom and David Gardner -- the founders of The Motley Fool -- insisted, however, that it is precisely because I come to the world of investing from the outside that I tell my own story. This book, after all, is for people exactly like me, who come from an walks of life, have careers in fields ranging from alfalfa farming to zymology, and who want to take charge of their own investments but are intimidated by the prospects of doing so and want someone to walk them through the entire process, step by step. It's the book I wish someone had written years ago when I was struggling to make sense of investing. So let me back up a few years and tell my own story -- the birth of a Fool.

Six years ago, I was a Ph.D. candidate in English literature at Penn State University. I had just married another graduate student, also in the doctoral program in English, and I was settling in for a year of reading toward my comprehensive exams while my new bride, Cynthia, was recovering from a broken back suffered in an auto accident and writing her dissertation, having already passed her exams.

Over the course of the next two years, our entire world was changed by a series of events no one could have foreseen. In fact, any writer including them in a novel would have had his manuscript rejected for relying on melodrama. Lord Byron was right: "'Tis strange -- but true; for truth is always strange; stranger than fiction" (Don Juan).

In November of 1991, I did manage to pass my exams, but, in retrospect, that was the least crucial event of the next two years. My wife's mother had pancreatic cancer diagnosed earlier that summer and the disease progressed rapidly. She died on Christmas Eve. Enough adjustment for one year, one would think, especially during graduate school. But onward.

In short order, two much happier events propelled our lives forward. In the spring, my wife became pregnant with our son. And, a few months later, she successfully defended her dissertation and graduated. Our next goal was Cynthia's job search.

In quick succession, Cynthia's father died suddenly, our son, Brenden, was born, and Cynthia was offered a position at the University of Kentucky. Dazed, we left Pennsylvania for the Bluegrass State. The plan was that I would try to teach part-time at either the University of Kentucky or another local college while writing my dissertation, and then we would do another job search if I couldn't secure a tenure-track position locally.

What does any of this have to do with investing? Not much, actually, other than to explain that in 1993 and 1994, I was on the treadmill toward a Ph.D. and a career in talking and writing about British novels. Because of the premature deaths of Cynthia's parents, we were also faced with deciding what to do with her parents' modest estate -- a topic neither of us was prepared for, emotionally or financially.

We did what most young couples do when faced with a new job, home, and baby -- we went house hunting. Interest rates were very low at the time and the housing market in Lexington was far more reasonable than the property values we had seen in Pennsylvania. For roughly what we were shelling out in rent for a tiny student apartment in Happy Valley, Pa., we could buy a house big enough to afford us both offices at home. So we invested a healthy amount of Cynthia's inheritance into the house and put the rest in three or four mutual funds. We didn't know anything about investing and weren't particularly interested in learning at the time. The logical alternative, or so we thought at the time, was to let a professional manage the money from the inheritance and we'd live out our lives in an ivory-tower paradise.

Over the next year or so, I taught part time at both the University of Kentucky and Georgetown College, but I was rapidly losing my enthusiasm for the profession. Between the miserable job prospects for new Ph.D.'s, the "publish-or-perish" mentality driving the humanities in silly directions, the students who would rather suffer unanesthetized root canals than read or write, and the hyperpolitical atmosphere that infects the profession, my reason for getting into higher education in the first place (my love of reading literature) was rapidly becoming a mirage. Enter The Motley Fool.

About the time I was getting despondent about my future in academe, I plugged one of those ubiquitous America Online promotional floppy disks into my computer. When I plugged the disk in, I fully intended to little more than fritter away the ten free hours and then cancel the service.

Call it chance, call it free will, what have you (appropriately, my master's thesis focused on chance, free will, and fate in the novels of Margaret Drabble, so perhaps it was a bit of each), but the first time I loaded the software and signed on to America Online, an icon with a Renaissance jester's face and a blurb linking Shakespeare and finance together appeared in one of the three slots where AOL highlights different forums. Not knowing my way around the service and being attracted to both Shakespeare and finance, I naturally clicked the button.

I still haven't recovered.

In those days (the summer of 1994), The Motley Fool was almost brand-new. What was once a print newsletter published by David and Tom Gardner, with their longtime friend Erik Rydholm, had evolved into a public message folder on Prodigy, then a message folder on America Online, and eventually a full-fledged forum on America Online. I stumbled across it shortly after its birth as an autonomous forum.

In those days, the forum consisted of only a handful of articles, a message folder or two, and a chat once a week, hosted by the Gardners. They were still running the business out of the back of David's home and were working insane hours as the forum exploded in popularity. But what hooked me almost immediately, before I even chatted with the Gardners or any other readers, was the original series of articles called "How to Invest What You Have: From $1 to $1 Million." The articles were short, irreverent, literate, hilarious, all the qualities I admired in writing and tried to convey to my writing students.

The entertainment value wasn't all that kept me enthralled, though. The information in those articles -- straightforward, honest, practical information that anyone could use to start learning about investing -- was the real hook. Nowhere else had I found information I knew I could use. I had glanced through a handful of the classic investing texts, those by Peter Lynch (of mutual fund fame as the manager of Fidelity Magellan), a few about Warren Buffett (one of the two richest men in America and a brilliant investor), and others, and while they were inspiring, I never felt that what I had learned helped me as an individual investor with a job outside professional money management. No companies are going to knock on my door and pitch me their success stories as they did for Peter Lynch.

The articles in The Motley Fool, though, launched me on an educational journey that continues today. After printing out those articles and poring over them again and again, I began to find other books to flesh out the approaches the Fools taught online. I attended every chat the Gardners hosted, until you could hear them groan all the way through cyberspace: "That Sheard pest is back. Quick, lock the door." I posted endless questions, seeking clarification about points I still didn't understand, and the Fools were gracious again and again with their all-too-precious time and their desire to teach.

In the end, it was the Fools' spirit of education and their ax to grind about the misinformation spread by the traditional money management industry that kept me coming back again and again, long after my ten free hours vaporized and I was "on the clock" at AOL's subscriber rates.

I obviously wasn't alone in my race to become Foolish. (In Folly, to be Foolish is the goal rather than to be Wise. The Foolish theme comes from Shakespeare's use of the Fool as the only character at court who could tell the king the truth without losing his head. As La Rochefoucauld put it, "Who lives without folly is not so wise as he thinks.") The forum was growing so rapidly as more and more Fools began participating that the Gardners couldn't keep up with the requests for information and the demands of a growing readership.

As the forum expanded, the Fools asked some of the earliest participants who were still around and had absorbed a certain measure of Folly if they'd join the staff on a volunteer basis and host a chat occasionally, or host a message-board discussion. The goal was simply to spread the message to as many readers as possible that, hey, if you can take a little time to learn the basics of investing, you can manage your own money and put the professional Wall Street Wisemen to shame with your returns. In October of 1994, then, my AOL bill threatening to outpace my salary as a lecturer, I gladly accepted the Gardners' offer of a volunteer position and became MF DowMan, my America Online screen name (for reasons that will become apparent later in the book).

Over the next seven months, I found I was spending more time on Folly than I was writing my dissertation, and having a great deal more fun. I learned as much as I could while hosting a chat for beginning investors to help them discover what I had learned. Interestingly, the hardest challenge in the early days of The Motley Fool was to get people to realize that under the facade of jesters' hats and Shakespearean punning, we were deadly serious in our message. Many new readers who would pop into one of our chat rooms would spend the greatest portion of their time trying to figure out when our sales pitch was coming. When they finally discovered the information we were providing was free (except for whatever they paid to America Online for their connection time), they went away thinking we might well be fools (little f ).

After all, most people have precious little sense of humor when it comes to money matters, and here we were, clowning around, calling ourselves Fools and explicating the merits of being un-Wise. If nothing else, we were (and are) opinionated and out to put fun back into the dusty museum most people picture as the hallowed halls of finance.

As the end of the spring 1995 semester rolled around, I was in despair at the thought of another year of teaching for peanuts and having little or no hope of seeing my efforts pay off in the form of a tenure-track job after graduation. At precisely the same time, the Gardners contacted me to see if I'd be willing to give up academe to work for them as an editor and writer. It was an agonizing decision and I spent the better part of two minutes making it. Sew that belled cap to my forehead, boys, I'm a Fool!

Needless to say, there was some hand-wringing behind the scenes. I was asking my wife to have faith in me as I abandoned a professional goal I had held for a decade in favor of a new job where I sit at home (most of the time in what could hardly be called "professional" attire) and write and talk online about the stock market with people I can't see, employed by two guys who, at that time, were still in their twenties, and whom I had never met in person. And the real leap of faith? My checks were going to be deposited electronically! She saw a future episode of 60 Minutes written all over this scenario. But she saw where I was heading emotionally in academics and supported me in my decision to follow a radically different path. It's been an incredible learning experience for me, not only in terms of investing and financial analysis, but also in the electronic medium that's revolutionizing how people communicate and share information that previously had simply not been available outside of an institutional context.

Since beginning with The Motley Fool, my focus has changed a number of times as the forum has evolved and my own interests and financial research have carried me down new avenues. Much of what you'll read about in this book grew out of some interactive collaboration between me, The Fool staff, and our ever-changing and growing community of readers.

To many of you, this rather personal story may seem entirely irrelevant in a book purportedly about investing in the stock market. My point in relating it, though, is that the knowledge one needs to invest well isn't highly specialized. It doesn't require an M.B.A. and professional grooming, courtesy of a Wall Street firm. In a very direct way, I'm living proof of that. My professional training was in how to interpret literature and how to interpret those interpretations, a spiral that can be as daunting as wading through financial statements to the uninitiated. Yet with some very pointed instruction and a minimal amount of independent study, I soon learned enough to manage my own investments well. From there, my personal research and model building (the subject of this book) blossomed out of some very basic principles.

Most new investors, and I still feel I'm a new investor at heart, fear uncertainty more than anything when it comes to investing. It's the single most powerful force keeping the professional fund managers in business. If investors can get over that fear of the unknown (and if you read this book, I guarantee you'll know enough that the basic uncertainty of managing your own portfolio will be removed), the actual act of managing one's own stock portfolio will be as unthreatening to you as balancing your checkbook each month. (Maybe less so; I've seen the way some people keep track of their checkbooks.)

Regardless of your experience with investing, then, know that you can do it yourself without having to become a professional in a daunting and completely foreign discipline -- high finance. When you start to doubt whether you can do it -- and if you are anything like the thousands of readers I've chatted with in e-mail and in online seminars (or chats), you will -- just recall my own personal odyssey into the investment world. When the Gardners insisted I tell my story, I think the comment I heard was, Your readers need to know that if you can do it, anyone can. After pulling the darts out of my neck, I realized they had a very good point. I came to investing with no special training, no special gifts for financial analysis, only the desire to learn more and the excitement of finding an interactive forum that afforded me the opportunity to pursue my interests, both as a novice, and now as a writer and researcher.

If you ever need a personal cheerleader, read these introductory pages again and realize that building wealth is possible for all of us, no matter how much education you have, how much experience you've had, or how much money you start with. If you can look at two numbers and can tell which of them is larger, you've got the basic skills necessary to manage your own stock portfolio. The rest is just learning where to look for the right numbers to compare. That's precisely what I'll tell you, step-by-step, number-by-number, throughout this book. I'll walk you through the first day of your learning process, clear through to your first set of trades and beyond. If you're a complete tyro at investing, I've been there. And I've talked with thousands of other investors just like you and have answered the vast majority of questions you'll probably have along the way. I'll do my best to anticipate them throughout this book and cover the bases crucial to get you started in stocks. Congratulations are already in order, in fact. Simply by reading a book like this one, you've taken the first step toward financial independence. In short order, you'll be wearing a jester's cap and proudly boasting that you're a Fool. "I met a fool i' the forest, A motley fool" (Shakespeare, As You Like It).

A Note on How to Use This Text

I'm working from the assumption that you are likely to have had little or no experience at all in the stock market before reading this book. If that's not the case, please bear with me during sections that may seem obvious to you. One thing I've learned in the last two years, writing about these subjects online and chatting with readers in e-mail, is that each individual will bring to investing a range of experiences. For me, it's better to err on the side of repetition and take too basic a path than to assume the reader has already worked through certain issues and doesn't need help.

The outline of this book, then, is geared toward a first-time stock investor, or even someone one step earlier in the process than that, someone who is just trying to find out whether or not stocks are even the right way to invest. To that end, I've tried to lay out the information in a sequence that new investors may find helpful.

Even though I've arranged the book to follow what I think is a logical pattern for new investors, feel free to skip around in it or even omit parts you feel don't apply to you. While I'd like you to think of me guiding you as if I were your personal investing coach, I'm not going to be looking over your shoulder along the way. Take what you can and need from the book and make it your own. There may be several places in the book where you feel as if you've learned all you need to know to be comfortable with your investments. Feel free to stop right there and be content with that. There's no rule that says you must learn or attempt everything you'll find in this book. Incorporate what you need into your own world. That's the real goal of education. I have no doubt that one of you reading this will take what I've built here and expand on it or improve it to make it more useful. The only thing I ask of you in return is that you then share what you've discovered with other investors.

We've got the greatest investment club in history going in The Motley Fool, and a lot of the ideas in this book were fired in the flames of that communal kiln because of the remarkable ease of communication in that interactive medium. By sharing our ideas, working to test possibilities, banging into dead ends only to discover another avenue, we've been able to help hundreds of thousands of individual investors improve their returns and wrest control of their investments back from the Wall Street. This book can get you started on the same journey I began not too terribly long ago. And even though Tom Gardner was joking (I think) when he said that if I can do this, anyone can, to some degree, that's the idea behind this book. I've learned how to manage my portfolio well in a short time; so can you, no matter where you're starting from or what you have to invest. You can build your own wealth. Fool on!

Copyright © 1998 by Robert Sheard and The Motley Fool, Inc.

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Interviews & Essays

On Wednesday, May 13th, barnesandnoble.com welcomed Robert Sheard to discuss THE UNEMOTIONAL INVESTOR.


Moderator: Good evening, Robert Sheard, and thank you for joining us tonight. Welcome to the Auditorium. How are you this evening?

Robert Sheard: Fine. It's good to be here.


martinis from LA: Why the "unemotional" in the title of your book?"

Robert Sheard: I think for most people, investing their life savings can be very emotional, and the key to any long-term investing plan is to have a strategy you can stick with when things don't look so good as well as when things are great. It's too easy to fall in love with a stock that's been wonderful over the last year, and it's too easy to get scared out of a stock that might just be going through a normal correction. So it's important to have a set of guidelines you can fall back on that takes the emotional response out of the equation.


Phil Herbert from Eugene, OR: I have four Dogs of the Dow stocks, and one small-cap stock, also one great investment stock. Total 15,000. Where do I go from here?

Robert Sheard: Well, one of the things I've been telling a lot of readers lately is that for protection it's often better to have 15 or 20 stocks rather than 5 or 6, and the reason for that is that the stock might blow up overnight and you can't do anything about it. A recent example of that is Cendant, which lost 46 percent overnight because of an accounting error. And if you are holding that as one of only 5 or 6 stocks, 8-10 percent of your portfolio disappears overnight. If it's only one of 20 stocks, your total loss is only 2.5 percent. So in your case, I'd look to add some more large-cap stocks, perhaps, using something like Tom Gardner's Cash King Stocks or my Keystone model, and then maybe pick up some more growth stocks using the screens we feature in the workshop area.


Bruce from Atlanta, GA: I recently inherited some money for which I feel very responsible. Scared might be a better word. I can't seem to make myself pull the trigger to buy the Foolish Four at these valuations. And of course, I missed GM's spike. Is the bear growling???

Robert Sheard: That's a great question, and it's one that I've been asked almost every day since I began working for the Fool in 1994. The great problem is that no one knows what's going to happen in the short run. So if you are waiting for a correction, think back to the people who were waiting for the same correction in 1994. They are still waiting, and in the meantime, the Dow has gone from 4,000 to 9,000. That's not to say the market's not going to crash the day after you invest -- it might. But 10 or 20 years from now it's likely to be so much higher than it is today. What happens this year or next year is not going to be that important in the long run. In fact, if you take the long-term growth rate for the stock market since 1928, which is 11 percent a year, and project that out over 20 years from now, the Dow could well be over 70,000, so whether we go to 8,000 or 10,000 next really isn't that important.


Steve from Pittsburgh, PA: Hi, Robert! Will TMF Sandy's data concerning the 12-month versus 18-month holding period be out soon? Thanks.

Robert Sheard: I don't have a date on that, but I know they are planning to release it in some version through FoolMart.


Brian from Greenwich, CT: What lies behind your methods that make them the most effective for beating the Dow Jones?

Robert Sheard: Well, I'm not going to claim that my methods are the most effective, but they are effective in that they take some strategies that have worked well under a variety of conditions, and they force you into a discipline that keeps you from getting in your own way. There are lots of good strategies out there -- these just happen to be two that work really well and are easy to implement.


Gary Gist from Woodland Hills, CA: Robert, for my growth portfolio I started a Keystone Dozen. On February 17th I purchased PFE, on March 17th I purchased SGP, on April 17th I purchased AOL, all in equal dollar amounts. I can't complain, as I am up 222.20 percent annualized. If things don't change too much by Friday, it looks like I should purchase Dell. What are your thoughts about Dell's high valuation?

Robert Sheard: I wrote a column just this week about Dell, in fact. Intuitively it's very hard to buy a stock that's up nearly 3,000 percent in the last four years, but Dell has consistently outgrown its competition. It still has all of the signs of a strong stock in the near future, and it's still showing up quite highly in a number of the ranking systems we follow in the workshop, so in a case like that, I try to ignore my intuition and do what the rankings say.


gwnc59a from Brockton, MA: I am switching from the Foolish Four to the UV4. What is your position on the UV4+?

Robert Sheard: This year the Fools switched officially to adopt the Unemotional Value 4 as the Motley Fool Foolish Four, so those two are synonymous now. The UV4+ requires you to overweight some positions in your portfolio, which is something I'm not really a big fan of. I prefer to see people use the UV 4 as a core around which they'll add more growth stocks. That way, no one stock gets extra weighting in your portfolio.


MSH from Dallas, TX: Does this book discuss your Keystone Portfolio approach?

Robert Sheard: No, it doesn't. In fact, the testing on that wasn't completed until after I finished the manuscript. I considered working on a second book, and Keystone will definitely be included there.


Shane Shepherd from San Francisco, CA: I love the refreshing approach and humor you bring to the investing world -- keep it up! My question involves options. As an investor experienced in stocks but just learning about options, I am wondering why The Motley Fool makes no mention of them on the web site. Do you see an allocation of, say, 10 percent of one's portfolio in relatively conservative options (covered calls, straddles, combinations) to be a Foolish idea? Why or why not?

Robert Sheard: I don't like options at all, and the reason is simple. When you invest in a stock, all you have to do is be right about the direction it's going to go in, whether that's up or down. With options you have to be right about the direction, how much the stock is going to move, and the day by which it will make that move. If you are wrong about any of those three elements, you lose your money. It just requires you to be right about too many things for it to be a successful strategy for most people.


Mike O'Neill from Washington, DC: 1) Why do you recommend "juicing" the Foolish Four in your book, but then retreat from that position in the On-Line Motley Fool? 2) Given the data thus assembled, do you think it better to go with the Unemotional Growth Strategy, or the Keystone strategy? 3) As between the two, and taking tax and transaction costs into account, do you still advocate a monthly trading program, or do you think it better to do it quarterly or (as the On-Line Fool Guides track) annually?

Robert Sheard: 1) The statistics on the UV4+ were really more a demonstration that the famous PPP approach isn't necessarily the world-beater everybody thought it was. But in real life, I don't like overweighting positions, even though theoretically the returns might be higher, because I don't see the Foolish Four or the Unemotional Value Four as an end in itself, but more of a starting point for a larger portfolio. 2) and 3) Unemotional growth is a very aggressive strategy, and because of the tax ramifications of short-term trades, it's really only useful for many investors in a tax-deferred account. Keystone is still a growth strategy, but it focuses on much more conservative stocks and because the holding period is one year, it's much more tax-efficient, so it's really not an either/or question as much as which one fits your situation best.


Randy from Staten Island, NY: Robert, I really enjoy your workshop! How do you feel about investing in O'Shaunessy Cornerstone Fund as opposed to individual stocks?

Robert Sheard: O'Shaunessy's work is great. He and I have a lot of the same philosophies and strategies, and if you are not interested in picking your own stocks, you're probably going to be hard-pressed to find a better fund. That said, I think you can do better choosing your own stocks, because you won't have to buy 50 of them at a time.


G. Curley from New York: Because of my 401(k)s, I have much more invested in mutuals than in stock. Does it make sense to limit my contributions to the savings plans and start to pick up stocks slowly?

Robert Sheard: That's a tough call. A lot of it depends in what investment opportunities you have in your 401(k). For most people, an index fund is probably their best 401(k) option. So my usual advice is to put money in your 401(k) at least to the extent that your employer matches your contribution. After that, you may well be better off putting money into a regular account and investing in your own stocks.


Tony from San Jose, CA: I still don't see why "high yield" works so well for identifying which are the "dogs"...aren't there better metrics for which are the out-of-favor stocks?

Robert Sheard: The way the high-yield approach works is within a culture that really favors the dividend. Dividends are almost sacred to the Dow stocks. So when a stock price falls and the dividend remains the same, the dividend yield rises. By focusing on those stocks with the highest yields, you are finding those stocks within that group of 30 that have fallen out of favor. It's a relative rather than a wrong measure.


Ross from Arkansas: Great Book! What do you think about buying top five or ten RS 26-week stocks and switching out quarterly? Should this not reduce some volatility in a portfolio?

Robert Sheard: I wouldn't buy just five or ten stocks from that screen by themselves, but it's a very good component of a larger portfolio. As for switching every quarter, the research I've read suggests that a one-year period is better. And it's also better from a tax point of view.


Phil from Needham, MA: Many of your screens require timeliness rankings from ValueLine. What benefit does this give? Are there other, more objective measures that one can use as a screen? Most computer screens I've seen don't have timeliness as a factor.

Robert Sheard: The Valueline ranking system is an objective ranking system based on long-term and short-term earnings trends. And it's been around and very successful since 1965, so for the individual investor it provides a very quick filtering tool to narrow the choices down to a manageable number.


Paul from Dothan: I'm currently running with the UV4, Keystone 5, and Unemotional Growth. Is this too many portfolios, or do you suggest more? If so, where to next?

Robert Sheard: I would say it's a pretty good mix. You are probably holding about 15 stocks, some are large-cap value stocks, some are large-cap growth, and some are aggressive growth, so I think it 's a fine mix if the tax implications of the UG stocks aren't going to hurt you.


Dawn from Youngwood, PA: I have the Foolish Four and a few other "emotional" stock picks, and about half of my portfolio in three mutual funds...large-cap, small-cap, international.... I'm still somewhat hesitant to go 100 percent into stocks, but that would seem to be in my best interest. Is there any time that mutual funds are the way to go...does it help protect investments in a downturn? Thanks...(I love the book!)

Robert Sheard: Some people think mutual funds are somehow safer than individual stocks. But they are just big collections of individual stocks and subject to the same ups and downs as your own stock picks. Given that 82 percent of all stock funds lost to the S&P 500 over the last decade, I don't see them as a better option for the individual investor. I think you are better off setting up a well-diversified stock portfolio, which puts the odds in your corner of outperforming the market.


Ken Kellerman from Cary, NC: Robert -- are you going to update the book, or write another based on the dozens concept -- which I consider brilliant, BTW -- so that those not familiar with, or who can't access, your online columns can learn about it?

Robert Sheard: I would love to. And in fact if I do write a second book, that is one of the sections I'm going to develop fully.


Ron Impeyan from Oregon: Robert, I just want to thank you for bringing this strategy to the level it is today.... I have successfully followed both you and the Dow strategy for four years now.... Thank you.

Robert Sheard: Thanks. I recognized your name right away. You've been there as long as I have, and it's been really interesting.


Samuel from New York: Your book just came in the mail today, will read it this weekend, I hope! We just started the RS dozens this month with a buy of COF. Can you talk about this approach a bit, it seems all the interest is Keystone.

Robert Sheard: I think the same philosophy can be used with Keystone and the regularly relative strength approach. The real difference is that Keystone focuses only on the largest stocks in America, whereas the regular relative strength approach is much more aggressive and can be much more volatile. But if you can stick with it, it might even provide better returns.


Ken from Mountain View, CA: Have you run this year's UV4 dropping MO and adding DuPont instead? What is the return on that UV4?

Robert Sheard: I don't have those figures right off the top of my head, but DuPont has been so strong lately that it's been a pretty good return already, just after five months. But there's no way around the fact that we didn't pick Phillip Morris at the beginning of the year. We are stuck with it.


Bob Rosen from Monmouth County, NJ: Hi. I truly enjoy your comments on the Motley Fool boards, etc. My portfolio consists of roughly 25 percent each of Keystone 10, FF, and a basket of a dozen "hold-em-forever" stocks (G, MSFT, KO, JNJ, LU, that sort of stuff). I also have a small IFG portfolio based mostly on the classic method. This gives me about 40 different stocks. First, any suggestions on the best way to whittle down the total number of companies to 25-30? Or should I do that? And second, what are your current thoughts about the Investing for Growth ports? How would they do in a significant market downturn compared to Keystone or the FF, for instance? Thanks.

Robert Sheard: I think 40 stocks is probably more than you need. And it sounds like you've primarily focused on larger stocks, so you might want to get down to around 20 by choosing, say, five stocks from each of your four favorite strategies. And you can make this transition gradually as your regular update cycle comes around again. As for which models are likely to hold up the best in a bad market, I think the Foolish Four model has the best record in bear markets and the Keystone model has a very good record, but it hasn't gone back as far. So we don't know what will happen to it in a really ugly bear market.


L. W. from San Francisco, CA: What do you think the recent merger craze means for investors, for example, Daimler-Benz and Chrysler; Traveler's Group and Citibank?

Robert Sheard: I frankly don't worry about the mergers that much. These go through cycles, just like stocks go through cycles, and these larger issues don't affect the way I invest. I just focus on letting the strategies pick the best stocks that are available now and try to blot out other issues that will just confuse the picture.


Paul Aughey (Caveguy on Fool web site) from Atlanta, GA: Hi, Robert. Besides your book, and the other three Fool books, what books and authors do you think are great reads for investors?

Robert Sheard: One of the first books I recommend, especially for new investors, isn't really an investment book but more of a finance book: THE WEALTHY BARBER by David Chilton. I also think all three of Jim O'Shaunessy's books are very good resources. And two recent books that are very popular and worth reading are BUFFETTOLOGY and THE MILLIONAIRE NEXT DOOR. I like Peter Lynch's books, but I've always had a hard time taking practical things away from them. They are inspirational but not very practical.


Aaron from Bellingham, WA: What do you think about the Roth IRA? Will it live up to its hype?

Robert Sheard: I think for young investors especially, it's terrific. If you are 30 years old and you put $2,000 away every year at a return of 17 percent a year, at age 65 you can retire with over $3.3 million completely tax-free. So as long as Congress keeps its hands off of it, it's wonderful.


Fletch from Harrison, NJ: Is it smart for people who are retired to invest in stocks? What sort of advice would you give to a retired couple? Thanks for taking my question.

Robert Sheard: That's a great question. I actually believe that retired investors should still be fully invested in stocks. If you are able to limit your withdrawals to 5 percent of your total portfolio each year, you're reasonably protected against bear markets, and you should be able to live off of normal portfolio growth indefinitely. So set up a fully diversified conservative portfolio of 20 stocks, and the long-term averages are on your side.


J. Sewell from Richmond, VA: Do you have any strategies for beating the S&P 500?

Robert Sheard: One of our regular readers, Ethan Haskel, uses the same strategy for the S&P stocks that we use for the Dow Jones Industrial stocks, and it works as well. So you can use those strategies together to get even more stocks of the strategy that you like.


Steve from Pittsburgh, PA: Nice to talk to you live! So what's your current thought: Foolish Four or RP-4, 12- or 18-month holding? Thanks again...

Robert Sheard: The RP variation appears to have done better than any of the other straight variations in our recent tests. But all of the Dow variations are market beaters. As for the holding period, there are lots of variables and they all come out very similar in the long run, so chose 12 or 18 months based on how conveniently it fits in your larger portfolio plans. That's my way of sitting on the fence.


John from da Bronx: I always watch on CNBC the market rising and falling before trading hours open at 9:30. Who is allowed to make these trades?

Robert Sheard: There are a number of after-hours markets that are primarily by subscription only, which means that the people making these trades are generally institutional investors trading with each other.


Moderator: Thank you for joining us tonight, Robert Sheard, and for taking the time to dispense your expertise to all of our online guests! Before you go, any last bit of advice for your audience?

Robert Sheard: Come visit us free online at www.fools.com or on America Online at keyword: Fools, and there are plenty of message boards where you can post your questions and talk to us directly.


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