Learn the Templeton Way

8/6/2019 Learn the Templeton Way

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Learn The Templeton Way

One man consistently searched for and bought neglected stocks and made awhole lot of money doing so over and over again in different markets JohnTempleton. His name is now famously associated with Franklin Templeton

Funds (John sold his funds to Franklin Resources in 1992). A hallmark of theTempleton way of investing was foraying into international markets at a timewhen doing so was not common. Constantly searching for markets that weredepressed, and within them buying not the most popular stocks but those thatwere beaten down, was the secret of his outstanding track record spanningdecades.

Point of maximum pessimism

Templeton executed his first trade in 1939 after the start of World War II. The

markets had declined 39 per cent over the preceding 12 months and the outlook

was gloomy. In this pessimistic environment, Templeton took a loan of $10,000

and bought as many stocks for less than $1 as he could lay his hands on. Why did

he buy when the outlook was so depressing, and what was his fascination with the

$1 mark?

Buying when the outlook was negative ensured that stocks were significantly

undervalued. The outcome of the War, and a victory for the Allies, was by no

means assured. Fear and uncertainty combined to produce an environment of

maximum pessimism.

The market did not expect these below-$1 stocks to do well in the prevailing

circumstances. Some even faced bankruptcy. Templeton recognised these

problems. To counter the risk of some of his investments failing, he bought a

large number of stocks: 104 in all.

Templeton was not speculating. His investment rationale was simple: during the

War all companies would be expected to contribute to the War effort. Where

others were pessimistic, Templeton realised that the War, and the massive

expenditure it would entail, was just the kind of stimulus that the economy

needed to pull it out of the Depression. He realised that the prospects and

profitability of at least some of these beaten down stocks would improve and this

would more than compensate for the losses that he would incur on stocks that

failed to turn around. Templeton was proved right. Only four of the companies he

invested in eventually folded up while his $10,000 investment multiplied four-

fold to $40,000.

The concept of buying at maximum pessimism has been immortalised in


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Templetons own words: Bull markets are born on pessimism, grow on

scepticism, mature on optimism and die on euphoria. The time of maximum

pessimism is the best time to buy and the time of maximum optimism is the best

time to sell.

How to identify a good bargain

To identify stocks, Templeton looked at the price that he would have to pay for a

dollar of future earnings today against the companys long-term earnings growth

rate. This concept is today more commonly known as the PEG ratio. A lower PEG

ratio signifies a better bargain. However, dont go buying any stock with a low

PEG ratio. You need to watch out for a few things: check whether the P/E ratio

itself is justified: a bull market inflates the P/E ratios of most stocks. Look up the

stocks historic trading range. Second, consider whether the company can sustain

the growth rate of the last few years.

Take the example of Bata India. The stock is currently trading at a PEG ratio

(calculated using a five-year EPS growth rate) of only 0.4. But is it necessarily a

bargain? The five-year PEG ratio is based on an earnings growth rate of 62 per

cent. But if you look at the three-year EPS growth rate, it dwindles to 21 per cent.

As a result, Batas (three-year) PEG ratio jumps to 1.22. Not such a bargain

anymore!

International foray

Templeton started looking for opportunities in international markets long beforeothers. His rationale? It is commonsense that if you are going to search for these

unusually good bargains, you wouldnt just search in Canada. If you search just in

Canada, you will find some, or if you search just in the United States, you will find

some. But why not search everywhere? Thats what weve been doing for 40

years; we search anywhere in the world, he explained.

Templeton launched the Templeton Growth Fund in 1954 with the objective of

searching for value stocks globally. To illustrate how successful the fund has

been, take a look at these numbers: a $10,000 investment in the fund at itslaunch would be worth $74,61,144 today (as on January 31, 2011).

By looking beyond a single market, an investor can bypass overheated economies

or those with poorer growth prospects in favour of markets that are attractively

valued or offer better growth prospects. For example, global investors who

invested in the Indian markets even as late as in 2006 would have made a 75 per


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cent return by now (BSE Sensex returns). On the other hand, those focusing on a

single economy, say the US, would have made a trifling 10 per cent over the same

period (Dow Jones returns).

Templetons yardstick for identifying attractive markets was primarily the P/E

ratio. Using this measure, he would zero in on a country that offered the highest

concentration of cheap stocks and start looking for potential investments. Using

this method, he identified Japan as a good investment destination as early as in

the 1960s long before the Japanese markets saw the phenomenal bull run of

the eighties. (Incidentally, Templeton exited the Japanese market with profits

long before the bubble burst).

Investors wanting to emulate Templetons strategy of foraying abroad should,

however, be forewarned. This is one arena where you must do your homework.

While investors from better-developed markets could find the lack of information

and poor disclosure standards (especially in developing markets) frustrating, for

the diligent global investor this could be a source of advantage: these inimical

conditions would drive the casual investor away, thereby presenting him with an

opportunity to scoop up bargains before the crowds discovered them.

By incorporating these tenets of Templetons approach investing at the point of

maximum pessimism and foraying abroad in search of bargains you too can

improve your track record.

Rules for investing the Templeton wayInvest for maximum total return: Investors often make the mistake of

investing too much in fixed-income securities. This is particularly true in todays

environment where many fixed-income securities offer negative returns to

investor after factoring in inflation.

Invest - do not trade or speculate: Investors are people who buy for

fundamental value. Speculators are those who buy in the hope of selling later to

someone at high prices.

Remain flexible and open-minded about types of investments: Neveradopt permanently any type of asset or selection method. Try to stay flexible,

open minded and skeptical. When any method for selecting stocks becomes

popular, then switch to unpopular methods.

Buy low: One of the great ironies of the stock market is that when stocks drop in

price, or go on sale, they attract fewer buyers. Conversely, when stocks become


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more expensive, they attract increasing numbers of buyers because of their

popularity. To get a bargain price, youve got to look for where the public is most

frightened or pessimistic.

When buying stocks search for bargains among quality stocks: The best

bargains are not stocks whose prices are simply down the most, but rather stocks

having the lowest prices in relation to possible earning power of future years.

Look for companies with high profit margins, high returns on capital, and a

sustainable competitive advantage.

Buy value: Not market trends or economic outlook. Too many investors focus

on the market trend or economic outlook. But individual stocks can rise in a bear

market and fall in a bull market. Therefore, more profit is made by focusing on

value.

Diversify: The only investors who shouldnt diversify are those who are right

100 per cent of the time. If you are diversified among different forms of wealth,

nations, industries and companies, you will be safer in the long run.

Do your homework or hire an expert to help you:There is no substitute

for doing your own homework on a company. At the same time, it remains a

tremendous undertaking both from a time and skill standpoint to successfully

purchase individual stocks for ones own brokerage account. For this reason, you

may choose to hire an expert who has a similar investment philosophy to your

own.Dont panic: During a market correction, DO NOT PANIC. Dont rush to sell the

next day. The time to sell is before the crash, not after. Instead, study your

portfolio. If you didnt own these stocks now, would you buy them at current

prices? The only reason to sell stocks after a market sell off is to buy other more

attractive stocks.

Invest for the long term: One of the most common errors in selecting stocks

for purchase, or for sale, is the tendency to emphasise the temporary outlook for

sales and profits for the company. Avoid this temptation and invest with a long-term perspective.

There is NO free lunch: Never invest on sentiment and never invest solely on

a tip. Investing requires an open mind, continuous study, and most of all, critical

judgment. There are no free lunches!

Do not be too negative: Although Sir John M. Templeton coined the phrase


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maximum pessimism to explain the best time to invest, he remains one of the

worlds biggest optimists. Look for bargains and opportunities during times of

market malaise. You will be rewarded in the long run for not following the crowd.

Edited version of rules compiled by Lauren C. Templeton

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Learn the Templeton Way