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How to Buy Stocks
by Daniel Brockman
May 6, 2003

If you work hard at it, you can study stocks extensively. The stock market will fully absorb all the time you want to spend on it. Perhaps you will then make pretty good choices, and sometimes even an excellent choice. Of course, sometimes you will lose, as do all persons who trade in the stock market.

On the other hand, you can apply the few simple rules described here to picking your investments and do nearly as well as the experts, or even better, and you need spend only 30 minutes a month doing it. Of course, sometimes you will lose money, as do all persons who trade in the stock market, but long-term investors generally profited from stocks during the last century. These rules won't help you get rich quick, but they can help you get rich slow.

These rules will lead you toward companies with a good track record. These companies tend to be well situated to make money. And while the rules don't protect you from loss in every case, they can make a bear market easier on the nerves. For example, a portfolio holding equal weights of Gillette (G), Clorox (CLX), Colgate (CL) and Procter & Gamble (PG) has both "franchise" and "corner", and it outperformed the broad averages during the third millennium bear market.

The rules provide two strategies: Franchise strategy and Corner strategy.

Plus there is one fundamental qualifying rule, and there are two selling rules.

THE FUNDAMENTAL QUALIFYING RULE: Don't consider buying any stock under any strategy unless it fundamentally qualifies. For each of the five most recent years, the company must have made an accounting profit. That is, it must have positive earnings or net income after taxes, depreciation and extraordinary items and all other cost and revenue items. There's been a recent fashion to ignore taxes, depreciation, amortization and extraordinary items, and maybe a few other things, and use versions of income called "Pro Forma" or "EBITDA". Companies and analysts too often use these versions of earnings to pretend that a company is more profitable than it really is, so these versions aren't good enough. Look at the real bottom line, "Net Income" per GAAP (Generally Accepted Accounting Principles). If some of the relevant data for the last five years is missing, ignore the stock. If it's a 4-year-old stock and doesn't have five years of earnings history, then ignore it. Thus, Microsoft (MSFT) qualifies, but not Sun Microsystems (SUNW). Intel (INTC) qualifies, but not Lucent (LU).

FIRST SELLING RULE: Watch the quarterly reports of net income. Sell the stock if the company has two consecutive quarters of negative earnings, or if the company has negative earnings for a fiscal year. Don't consider buying it again for at least 5 years. The net income figures for current quarters and for each of the preceding five years are public information. They are often available in the "Investor Relations" area of the company website, on brokerage websites, or among CBS Marketwatch (http://cbs.marketwatch.com) investor tools. They are also filed with the SEC on forms 10-K and 10-Q (see http://www.sec.gov).

SECOND SELLING RULE: Watch the market value of your holding. Sell half the stock when your holding has doubled in value.

THE FRANCHISE STRATEGY: Don't buy a stock unless you can do so consistently with either the Franchise Strategy or the Corner Strategy (or both). Provided a company satisfies the Fundamental Qualifying Rule, it is a good investment if it has a franchise. The definition of franchise requires making some subjective judgments. You and someone you regard highly might disagree on whether a particular stock has a franchise. But probably you will find several stocks on which you can agree that they have a franchise. Warren Buffett articulated the following definition of franchise. (See Warren Buffett's letters at http://www.berkshirehathaway.com/.) A franchise is a product (or service) for which three things are true:
1. Customers prefer it to competitors such that they will pay a little more for the franchise product. Customers prefer Disneyland to Knott's Berry Farm, Fedex to UPS.
2. The product is a good and useful product. See's Candy but not Pet Rocks.
3. The product isn't subject to price controls. Wireless phones, but not (in most cases) landlines.

THE CORNER STRATEGY. Don't buy a stock unless you can do so consistently with either the Franchise Strategy or the Corner Strategy (or both). Identify an industry that seems to have a good future and in which a few major competitors divide almost the entire market. Buy all the publicly traded stocks that fundamentally qualify. If you can't buy them all, don't use the Corner Strategy. For example, buy both Fedex and UPS.

Here are some examples of stocks you might choose for franchise and corner strategies, including some mentioned above. (Yes, I own some of these.) The stock market also offers many more choices than these.

FRANCHISE	CORNER
Intel	YUM! Brands
Fedex	McDonald's
Microsoft
Scientific Atlanta	Colgate
J P Morgan Chase	Procter and Gamble
Coca-Cola	Gillette
Ebay	Clorox
Pfizer
American Express	Fedex
IBM	UPS
Citigroup
Walgreens	Royal Dutch
Gillette	Exxon Mobil
Procter and Gamble	Chevron Texaco

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