Rule #1

1. Rule #1: Don't Lose Money - Invest with Certainty

There are only two rules of investing: Rule #1: Don't lose money … and Rule #2: Don't forget Rule #1.

Invest with certainty. The core principle of Rule #1 investing is to avoid losing money by investing with certainty. This approach challenges conventional wisdom that higher returns necessarily mean higher risk. Instead, it focuses on buying high-quality businesses at discounted prices, providing a margin of safety that reduces risk while potentially increasing returns.

Advantages over traditional investing:

• Aims for 15% annual returns or higher
• Requires only 15 minutes per week
• Protects against market downturns
• Suitable for investors of all experience levels

Rule #1 investing empowers individual investors to outperform professional fund managers by leveraging their size advantage and utilizing readily available online tools and information.

2. Buy Wonderful Businesses at Attractive Prices

The basic ideas of investing are to look at stocks as businesses, use market fluctuations to your advantage and seek a Margin of Safety.

Think like a business owner. Rule #1 investors view stocks as partial ownership in real businesses, not just pieces of paper to be traded. This mindset shift helps investors focus on the intrinsic value of companies rather than short-term price fluctuations.

Key principles:

• Buy businesses you understand and would be proud to own
• Look for companies with durable competitive advantages
• Seek businesses with strong, consistent financial performance
• Wait patiently for market inefficiencies to create buying opportunities

By treating stock purchases as buying entire businesses, investors can make more informed decisions and avoid speculative behavior that often leads to losses.

3. The Four Ms: Meaning, Moat, Management, and Margin of Safety

Knowing you will make money comes from buying a wonderful business at an attractive price.

The Four Ms framework guides investors in identifying and evaluating potential investments:

1. Meaning: Understand the business and be proud to own it
2. Moat: Identify a durable competitive advantage
3. Management: Ensure competent and trustworthy leadership
4. Margin of Safety: Buy at a significant discount to intrinsic value

This systematic approach helps investors:

• Filter out risky or overvalued companies
• Focus on high-quality businesses with predictable futures
• Align investments with personal values and understanding
• Reduce the likelihood of permanent capital loss

By adhering to the Four Ms, investors can build a portfolio of exceptional businesses purchased at attractive prices, increasing their chances of long-term success.

4. Understand and Calculate the Big Five Numbers

The Big Five numbers are so important that I never buy a business that has a bad Big Five.

The Big Five numbers are critical indicators of a company's financial health and competitive position:

1. Return on Invested Capital (ROIC)
2. Sales growth rate
3. Earnings per Share (EPS) growth rate
4. Equity (Book Value per Share) growth rate
5. Free Cash Flow growth rate

Key points:

• All Big Five numbers should be ≥10% per year for the last 10 years
• Consistency and upward trends are crucial
• Prioritize equity growth as the best indicator of intrinsic value growth

By analyzing these numbers, investors can:

• Confirm the existence and strength of a company's competitive moat
• Assess the predictability of future performance
• Make more informed decisions about valuation and potential returns

5. Determine the Sticker Price and Margin of Safety

The Sticker Price is the maximum amount we can pay and still get that 15-percent return on our money over the next ten years.

Calculate intrinsic value. The Sticker Price represents a company's fair value, while the Margin of Safety (MOS) Price is typically set at 50% of the Sticker Price. This approach ensures a significant cushion against valuation errors and market volatility.

Steps to determine Sticker Price:

1. Estimate future earnings per share (EPS) growth rate
2. Project EPS 10 years into the future
3. Apply an appropriate future PE ratio
4. Calculate the future market price
5. Discount back to present value at 15% per year

Benefits of using Sticker Price and MOS:

• Provides a clear buy/sell target
• Reduces emotional decision-making
• Increases potential returns by buying at a discount
• Protects against permanent capital loss

6. Use Three Tools to Time Market Entry and Exit

These Tools are fantastic at keeping you from losing money if you are buying businesses at prices below their value, the Sticker Price.

Leverage technical indicators. Rule #1 investors use three primary tools to time their entries and exits:

1. MACD (Moving Average Convergence Divergence)
2. Stochastics
3. Moving Averages

Key points:

• These tools help identify institutional money flows
• Wait for all three tools to align before buying or selling
• Use in conjunction with fundamental analysis, not in isolation

Benefits of using these tools:

• Reduces the risk of buying too early or selling too late
• Helps capture larger portions of price moves
• Provides objective signals to overcome emotional biases
• Allows investors to take advantage of market inefficiencies

7. Overcome Barriers and Start Investing with Confidence

The reason I want you to start with $1,000 no matter how much you have to invest is that I want you to see for yourself that you're investing with real money with the same success you had paper trading.

Start small and build confidence. Overcoming common barriers to successful investing is crucial for long-term success. Key steps include:

1. Eliminate bad debt before investing
2. Utilize tax-advantaged accounts when possible
3. Avoid over-diversification; focus on your best ideas
4. Take control of your investments rather than relying on fund managers
5. Overcome fear through education and paper trading

Practical steps to get started:

• Open an online brokerage account
• Begin with paper trading to practice and build confidence
• Start with a small amount of real money ($1,000) to gain experience
• Gradually increase your investment as you become more comfortable
• Continuously educate yourself and refine your approach

By following these steps and applying Rule #1 principles, investors can build the knowledge and confidence needed to achieve long-term financial success.

Last updated: October 2, 2024