Rule of 72 Rule of Rule of 72 Rule of “ Tom Jacobs and John Del Vecchio are two of the best experts in finding stocks that are hidden, yet offer great potential — on the upside and the downside — with less risk. That is exactly what you need to make money in investment markets that are going to be much more down and far more volatile in the next several years.” 72 — Harry S. Dent, Jr., Founder How to Compound Your Money and Dent Research Uncover Hidden Stock Profits “ Rule of 72 is required reading for investors worldwide who want to reduce the risk in buying U.S. stocks.” — Vincent Tang, Chief Editor Hong Kong Economic Journal “ This book goes far beyond mere stock picking. Tom and John have put together a comprehensive and timeless wealth-building playbook for all seasons and environments. While stock strategies come and go, this work VECCHIO DEL JOHN & JACOBS TOM should be an essential guide for any investor who is serious about building his or her wealth in a sustainable, long-term way.” — Brett Owens, Co-Founder and CEO Chrometa “ Just as important as investing in the best stocks is avoiding the worst ones. Jacobs and Del Vecchio build a stock grading process that allows you to find the good ones and pass on the bad ones.” — Mebane Faber, Chief Investment Officer Cambria Investments ISBN: 978-0-692-72135-3 | 195B001756 TOM JACOBS & JOHN DEL VECCHIO rule of 72 Tom Jacobs John Del Vecchio Ruleof72_all_4p.indd 1 7/19/16 11:26 AM Charles Street Publishing 819 N. Charles Street Baltimore, MD 21201 www.dentresearch.com ISBN: 978-0-692-72135-3 Copyright 2016 Tom Jacobs and John Del Vecchio All Rights Reserved. Protected by copyright laws of the United States and international treaties. Nothing herein should be considered personalized investment advice. Although our employees may answer general customer service questions, they are not licensed under securities laws to address your particular investment situation. Also you should not base investment decisions solely on this document. Charles Street Publishing expressly forbids its writers from having financial interests in securities they recommend to readers. Charles Street Publishing, its affiliated entities, employees and agents must wait 24 hours after an initial trade recommendation is published on the Internet, or 72 hours after a direct mail publication is sent, before acting on that recommendation. Unattributed tables and figures are by Tom Jacobs. Printed in the United States of America Ruleof72_all_4p.indd 2 7/19/16 11:26 AM ABOUT THE AUTHORS Tom Jacobs Co- Author of What’s Behind The Numbers: A Guide To Exposing Financial Chicanery And Avoiding Huge Losses In Your Portfolio, Tom bought his first stock at age 12 and started his first business at 15. Influenced by his Depression- era parents to reduce risk and avoid hype, he employs the value strategies in this book to manage individual accounts for clients of all ages and means. Tom is an Investment Advisor and Portfolio Manager with Huckle- berry Capital Management, www.investhuckleberry.com. He holds degrees from the University of Chicago Law School and Cornell University and lives with his husband in Marfa, Texas. [email protected] @tomjacobsinvest tomjacobsinvests www.linkedin.com/in/tomjacobsinvests John Del Vecchio Co-Author of What’s Behind The Numbers: A Guide To Exposing Financial Chicanery and Avoiding Huge Losses In Your Portfolio, John is a forensic accountant at heart. Standing on the shoulders of the great David Tice, James O’Shaughnessy and Dr. Howard Schilit, he built a framework of algorithms and a multi-factor grading system that has made him one of the more successful short- sellers around. John graduated summa cum laude from Bry- ant College with a B.S. in Finance and was awarded Beta Gamma Sigma hon- ors. He earned the right to use the Chartered Financial Analyst designation in September 2001. [email protected] @delvecchiojd Ruleof72_all_4p.indd 3 7/19/16 11:26 AM Ruleof72_all_4p.indd 4 7/19/16 11:26 AM CONTENTS INTRODUCTION: WHY IT’S ALL ABOUT THE BENJAMIN(S)............ 7 CHECK YOUR KNOWLEDGE ................................. 11 CHAPTER 1: WET SNOW AND A LONG HILL— RULE OF 72 .......... 13 The Golden Rule of 72 .......................................13 Be Real: Don’t Forget Inflation ................................16 Young People: Their Greatest Opportunity and Greatest Impediment ............................................19 FOMO and the $15 Million Deck: Opportunity Cost .............24 Bambi Meets Godzilla........................................27 CHAPTER 2: WHAT IS RISK? ................................. 31 Conservative, Moderate or Aggressive? .........................31 The Glide Path: A Contrarian View of the Bond- Stock- Age Equation ...............................................36 Time Wounds All Heels ......................................39 A Checking Account That Pays 12%?...........................41 Act at Leisure, Repent Never ..................................44 Dividends as Shock Absorbers ................................46 The Elephant in the Bathtub ..................................48 Absolutist or Relativist: The Right Tool for the Job ...............52 The Problem with All Benchmarks.............................54 Lynched: Your Circle of Competence...........................60 Living (and Dying) on the Margin .............................62 CHAPTER 3: FORTUNE FAVORS THE PREPARED MIND.............. 66 Mental Accounting ..........................................66 The Heebner Jeebies: Buying High, Selling Low..................70 Agree to Disagree ...........................................73 The Unpopularity Contest ....................................75 Ruleof72_all_4p.indd 5 7/19/16 11:26 AM 6 | Contents Recency Bias................................................78 Percentages, Not Points ......................................82 Manage Emotions Through DCA..............................85 Don’t Let the Anchor Sink You ................................89 CHAPTER 4: Grading Stocks From A+ TO F ...................... 92 The Six Tests................................................92 Test #1: Revenue Recognition— $#%! Flows Downhill ............97 Test #2: Cash Flow Quality— Mama Needs a New Pair of Shoes...............................................103 Test #3: Earnings Quality— Levers on a One- Armed Bandit ......108 Test #4: Expectations Analysis— Getting Ahead of the Wall Street Herd........................................112 Test #5: Valuation— Paying 50 Cents for a Dollar................115 Valuation Example: How to Value Your House..................117 Valuation: Determines Future Returns.........................119 Valuation: To Value, Think Like a Buyer .......................121 CHAPTER 5: The Final Exam: Putting Shareholders First............ 126 Test #6: Shareholder Yield ...................................126 Bad Shareholder Yield ......................................131 Dividends— The Good and the Bad ...........................134 Buybacks— The Good and the Bad............................140 Paying Down High Interest Debt .............................150 CLOSING ......................................................161 BIBLIOGRAPHY ................................................167 EQUATIONS ...................................................169 GLOSSARY TERMS..............................................171 INDEX ........................................................179 Ruleof72_all_4p.indd 6 7/19/16 11:26 AM INTRODUCTION: Why It’s All About the Benjamin(s) ost of us want not only to do well, but also do good. There Mis no better example than this man: Ben Franklin’s will included an unusual gift— 1,000 pounds sterling each to the cities of Boston and Philadelphia. That’s equivalent to about $122,000 today— good money, but hardly riches. The bequests came with strings. For the first 100 years, the money could only be used to loan to help young tradesmen starting out— just as others Ruleof72_all_4p.indd 7 7/19/16 11:26 AM 8 | RULE OF 72 had loaned money to him. Franklin chose to invest his estate in the future of America, apprentices who would grow businesses and form the backbone of his favored cities. The interest paid on the loans would grow the entire amount over time. At 100 years, the cities could withdraw 75% of the money to use for “public works, which may be judged of most general utility to the inhabit- ants, such as fortifications, bridges, aqueducts, public buildings, baths, pavements, or whatever may make living in the town more convenient to its people, and render it more agreeable to strangers resorting thither for health or a tem- porary residence,” as well as water systems to bring water to and re- duce water waste in Philadelphia. In another 100 years, all the money would go to the cities. Here is what this great believer in compound interest willed: I have considered that, among artisans, good apprentices are most likely to make good citizens, and, having myself been bred to a manual art, printing, in my native town, and after- wards assisted to set up my business in Philadelphia by kind loans of money from two friends there, which was the foun- dation of my fortune, and all the utility in life that may be ascribed to me, I wish to be useful even after my death, if pos- sible, in forming and advancing other young men, that may be serviceable to their country in both these towns. To this end, I devote two thousand pounds sterling, of which I give one thousand thereof to the inhabitants of the town of Boston, in Massachusetts, and