Phil Town’s upcoming book Rule #1 is sure to become an investment classic. I had the pleasure of reading the book after receiving an advanced copy from Crown Publishers, the distributor of the book which is scheduled to be released in March. What I found was a practical, no-nonsense approach to stocks that will do for investing what David Bach’s The Automatic Millionaire did for personal finance. While Town himself admits that the techniques he describes have been used for years, his true genius lies in his ability to translate classic investing principles into a straight-forward approach that can achieve at least 15% returns a year with little risk.

The true joy I took in Rule #1 was Phil’s humility, something that is immediately evident in all his writing, both in print and on his weblog. It not only made me immediately comfortable with him as a teacher but also removed any possible anxiety from learning about this huge subject of stock investing. He patiently lays out his technique, constantly reinforcing each principle throughout each chapter, and then in the last section walks the reader through an example first investment. This is the clearest and most easy to follow book on investing I’ve read to date, and was able to put its principles into practice before even finishing the book!

About Phil Town

Originally a rebellious, white water river guide, Town became a successful investor and public speaker after being mentored by a financially astute client who he had rescued from a particularly dangerous run down the Colorado River. (find out more about Phil Town’s background). Within five years he turned his first $1,000 of borrowed money into $1,000,000. He is a sought after public speaker and currently works with the Get Motivated tour appearing on stage with Robert Kiyosaki, Rudy Giuliani, Bill Clinton and others. Town’s generating a good amount of buzz in the publishing world as the next big thing, and apparently received one of the largest book advances in history.

The 4 M’s

Town’s first priority in Rule #1 is to help new investors find excellent companies — companies that we believe in and that have a proven track record of producing strong growth and investment returns. He teaches a research method he calls the “4M’s” which uses 4 tests to determine whether a company is in good financial condition and will produce strong long-term growth.

Meaning: Finding a company that an investor understands and believes in is essential. Does the investor understand the business? If not, how could he reasonably assume he is not being duped by management? As Peter Lynch admonishes, “Buy what you know.” One must have a basic understanding of a company’s industry and business before he should buy it.

Moat: Companies with strong competitive advantages achieve the most predictable returns. If competition is so fierce that a company is struggling to keep ahead, then an investor could not reasonably trust long-term growth estimates. Town’s method teaches how to recognize what Warren Buffett calls a company’s “moat” and use financial statistics such as Return on Capital, Earnings growth and Revenue Growth to build evidence of a strong competitive advantage.

Margin of Safety: Buying dollars for 50 cents is the name of the game in Rule #1. If a company has passed the first two M’s then it’s time to see if it’s selling at a “50% discount”. Town teaches a simple method for determining a stock’s true “sticker price” by estimating the future earnings growth and price/earnings ratio. If a company is selling for 50% of this computed price then it may be time to buy — but only if it passes the final M.

Management: The most time-consuming of all the tests, this M focuses on the people running the company, and seeks to answer the question “Does management have the best interest of the owners at heart?” To find out, the CEO of the company must be carefully reviewed by reading articles and letters to shareholders, and the company’s annual and quarterly reports must be analyzed to determine if the company is being open and honest with its owners. Town covers what to look for and what to avoid.

The Tools

While the majority of the book tries to build and reinforce the skills necessary to find great companies, Town devotes an entire chapter to teach readers how to use what he calls his “Three Tools.” This excellent lesson covers how these tools, which are actually charts, tell investors when to move in and out of stocks. These are the basics of what is known to investors as “Technical Analysis” which is using market data to determine when to buy and sell a stock. His most important point is that institutional investors account for the vast majority of stock trading and these large investors can move prices up and down. Using the tools he describes, small investors like us can buy and sell before the big guys affect the price too much.

Perhaps Some Overselling

I can offer some warning to those who think, as the book’s subtitle suggests, that successfully investing in stocks using Rule #1 can be done in 15 minutes a day. Despite the claim, logically this is too good to be true, and in fact it is. In the book Town admits that after the initial research to pick your favorite companies, maintaining your portfolio only needs to take 15 minutes a day. However, to build that watch list of companies takes any number of hours, days or weeks. It is absolutely worth it, but don’t be fooled into thinking that the process isn’t time consuming. Rule #1 only works if you’re willing to do your homework upfront, and check up on the company’s condition every so often. The important thing to remember is find companies that you’re passionate about, and learning more about them can really be fascinating.

Wrapping it Up

This book is by no means the be-all and end-all of investing. Some have already criticized the book as covering material that other investors have been talking about for years. This fact is true, but Rule #1 was not meant to be a compendium of all things investing! Investing in stocks can be overwhelming, especially for new investors, and this book lays out the basic principles a new investor must know to purchase their first stock.

After reading this book and purchasing your first stock, you should absolutely pick up more great books by authors like Graham, Lynch and Collins — but this is a wonderful place to start! I wholeheartedly recommend that you reserve a copy of this book for your own personal investment library.

Rating: 5 out of 5 stars
Best Suited For: New investors interested in learning how to invest in companies, not speculate in stocks, and those who want to learn the difference.

Additional Reading
Phil Town and INVESTools. Chris Welch. InvestorGeeks.
The Intelligent Investor. Benjamin Graham.
The Essays of Warren Buffett. Lawrence Cunningham.
One Up On Wall Street. Peter Lynch.
Good to Great. Jim Collins.