Book Summary: Five Rules for Successful Stock Investing

Book: Five Rules for Successful Stock Investing

Author: Pat Dorsey

Quick takeaway: This book is useful for an intermediate or advanced investor only if (s)he is looking to build/add to his/her checklist for investing. I found it to be an excellent book for simple company analysis. I learned a lot. A lot of the notes that I took from the book have been made a part of the existing pages under the Single-stock Research section on this website, and I will not repeat them below.

It’s an okay book for beginners, but only if they recognize one thing: this is a great book for company analysis, but not a good book for learning investing. This may seem a little harsh, but I have a simple rule for good books on investing: the book should teach you at least one good thing, and not teach you anything even bordering incorrect. I believe that this book fails the second test, as there are some bad examples in here.

There are sentences such as  “assume that earnings grow at 6 percent per year, and the initial P/E ratio of 20 doesn’t change. After five years… the shares would theoretically trade for new earnings x 20..”, which just seems like a really bad example. First of all, for a stock to trade at 20x with 6% earnings growth, it will need to have cost of equity of 7%, which is absurd for most companies, as cost of equity of the whole market is usually higher than that; but let’s just say that cost of equity is really 7%, but then why should the multiple of 20 not change over five years? The multiple of 20, when it began, counted in the growth for the next five years, so how come the the exact same growth of 6% is expect going ahead? why is the growth not moderating after five years? Is it because this is a company that will keep on growing at 6% per year? Very very few companies in the world can do this.  It’s an example, but a very bad one, to teach a basic concept. Then, at some point it talks about the ratio of Price / Sales, which is again absurd, because it presumes that the company is unlevered and has ZERO cash (or in other words, at least assumes that the Enterprise value equals the Equity Value, while discounting other assets and off-b/s liabilities that the company may have had). If not, why would anyone compare the value of a company’s equity holders’ ownership with the sales that will generate return for all the company’s holders-debt, equity and others?

All in all, an okay book if (a) you’re at an intermediate/expert, and are looking to build a checklist, or (b) a beginner but use it only to learn company analysis, and skip everything said about investing.

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