How to Make Real Money in the Stock Market

there are no short cuts to success in the market, but with a little sense and patience, you can reel in the loot without getting hooked

Most people who buy stocks expect to lose money. They may hope that they will beat the market, but their approach to investing in stocks converts odds that are in their favor into a game of chance distinctly inferior to bingo. The first mistake most novice stock-market operators make is to assume that the market is rigged by a mythic group of insiders who allow the little guy to win just often enough to assure a steady supply of players to be fleeced. This illusion persists despite the disastrous record over the past six years of professional investors--those who manage millions or even billions of dollars of mutual-fund, pension-fund, insurance-company and bank assets. To whatever degree he does not subscribe to the conspiratorial theory, the average speculator attributes the remainder of his failure--or someone else's success--to luck. The attraction of these two theories, used singly or in combination, for the typical small investor is that they remove from him any onus of doing some real work and provide a convenient excuse for nis ultimate--and predictable--failure.

As someone who has for years been responsible for investing tens of millions of dollars of other people's money, and, as such, has been able to command the advice of some of the best minds on Wall Street, I do not deny the advantage possessed by very large institutional investors. Their vast flow of brokerage commissions gives them access to a stream of information and ideas unquestionably superior to what the individual with limited capital can expect. All that means, however, is that I, entrusted with the management of someone else's money, can get other people to do some of my work for me. You, concerned only with your own money, must do that work for yourself. It is not impossible. I intend to show you why it is not (continued on page 136)Money in the Stock Market(continued from page 109) and how you should go about it if you, in the words of Bernie Cornfeld, "sincerely want to be rich."

The element of luck can be disposed of simply. It exists; but it exists for everyone and over a period of time will even itself out. The essential difference between the stock market and purer forms of gambling is that it is possible for everyone who buys stocks to be a winner. Between 1962 and 1968, the average stock traded on the New York Stock Exchange doubled. Taking a longer view, during the 15 years from the beginning of 1958 to the end of 1972, the average of all stocks traded on the big board tripled. Clearly, it would have taken real effort, as well as incredibly bad luck, to have lost money during either of those periods. Compare this with roulette or the ponies, where the house percentage guarantees that the entire universe of participants must, on any given day, end up losers, and where any individual player is almost certain, over a lengthy stretch of time, to wind up in the hole. What about commissions, you say? The approximate two-to-three percent cost to buy or sell small amounts of stock is of no real concern to the long-term investor--which is what I will prove you must be.

The stock market is an extremely complex mechanism that at all times reflects two simple emotions--fear and greed. The miserable results obtained by the average small investor derive from greed-motivated purchases and fear-motivated sales. Just as the average N.Y.S.E. stock doubled from 1962 to 1968, from late 1968 to the end of 1974, these stocks fell on average nearly 50 percent, with many individual issues doing far worse. What happened to someone who bought at what later proved to be very close to the top and sold at what has already proved to be the bottom is obvious. Far outweighing the element of luck in the stock market is the element of psychology. Mastery of it would lead to riches far faster than mastery of economic theory. But one need not achieve complete understanding of the pervasive human psychological aspect of the market; just learn to recognize and avoid some of the more egregious examples of the herd instinct. Once you learn to avoid them, you can make their inevitable appearance on the part of others work for you.

A hapless fellow I know once told me the following horror story. In 1966, his brother-in-law gave him a "tip" on a stock called Solitron Devices, then selling at 70. Knowing that this brother-in-law had never made a dime in years of stock-market speculating, he ignored the proffered advice. When, six months later, Solitron was selling at 140, and not being able to stand his brother-in-law's smug satisfaction, he bought 60 shares with $8500 that represented nearly all his liquid assets. Thrilled beyond belief by its subsequent advance in less than a year to 285, he then watched unhappily as, during 1968, it fell back to 200. Convinced by his brother-in-law that this was just a "temporary reaction" and that Solitron Devices, whose earnings were skyrocketing, was ready for another large move upward, he borrowed $5000 and bought another 25 shares. However, it never went up again, it just sank steadily. At 70, the price at which his brother-in-law had originally recommended it, he sold his 85 shares, receiving enough to repay the bank loan but having lost nearly all his original $8500 investment.

Had my friend checked a bit before buying, he would have found that Solitron Devices was a third-rate electronic-components company enjoying a temporary vogue. As a result, its price had reached levels unwarranted by even the rosiest of futures. Texas Instruments was then, as it is today, a leader in the electronics industry, strongly financed and extremely well managed. During 1967, while Solitron was going up more than threefold, somewhat sluggish Texas Instruments was advancing "only" 45 percent. In common with many technology stocks, it then proceeded to do rather badly for a number of years. However, Texas Instruments today is worth about two and a half times its late-1966 price, while Solitron Devices, after reporting losses in 1970 and for a number of years since, is now selling for one eighth of its late-1966 price.

Now, my friend made a number of mistakes far more serious than merely picking the wrong horse. He acted on a tip from a dubious source. (Almost all sources of "tips" are dubious.) He bought the stock on emotion, not facts. He put far too large a portion of his net worth into one stock. He knew far too little about the company, its prospects and--most important--what was already known by the market about those prospects and fully discounted in the price of the stock. He regards himself as unlucky. In fact, he was very lucky. Despite the commission of so many stock-market sins, he was offered absolution in the form of more than a double from his original cost. At that point, the stock was selling at 70 times its earnings, an almost unheard-of level. But instead of selling, he bought more, and with borrowed money.

Borrowing money to buy stocks--leveraging, as it's called in the trade--is not always wrong. It can be a successful technique for an aggressive investor who knows intimately the company whose stock he is buying and has carefully assessed the risks involved--criteria certainly not met by my friend. The greatest negative about borrowing--and the reason it should be done only by those practiced and knowledgeable--is that it repeals the most important law of mathematics that the investor seeking large capital gains has going for him: The most he can lose is 100 percent of his investment.

This rule may strike the potential investor as cold comfort, indeed. Obviously, no one embarks on any investment with a total wipe-out in mind. Yet the fact that stocks can--and frequently do--go up far more than 100 percent and cannot go down more than 100 percent is not merely a theoretical point. An attitude I constantly encounter in talking to a wide variety of small investors (small is defined for our purposes as anyone with less than $25,000 to invest) is an excessive concern with risk--and insufficient attention to potential reward. Many individuals with modest-sized portfolios containing the stocks of a few solid, established companies have told me, "I can't afford to take risks; this is all the money I have." Assuming that the person I am talking to has taken the ordinary precautions of having some life insurance and a reasonable emergency fund in a savings account, and assuming that he genuinely wants to build what extra money he has saved into real capital, I point out that he can't afford not to take risks.

Paradoxical as it may sound, someone with $100,000 is less able to risk his money than someone with $10,000. The $100,000 is not money, it is capital. It can safely be invested for yield and produce $8000--$9000 a year without any risk. That amount of income, when added to the investor's regular earnings, can substantially improve his standard of living, as well as give him peace of mind. If this man with $100,000 is relatively young and earning a good income, inflation and the U. S. tax laws still may make it advisable for him to aim for substantial capital growth--but he must be aware of what he is risking.

The individual with $10,000, if he assesses his situation unemotionally, will realize he does not have this choice. The annual income from that sum will produce barely enough for a decent two-week vacation. He is forced to assume the risks that are a necessary concomitant of seeking above-average, long-range growth of capital. The hope of someone with $10,000 is that someday he will have $100,000--a not impossible goal over the very long term, especially if he can add modest sums annually to his pool of investable funds. It is for this individual, with a reasonable amount of money --(continued on page 178)Money in the Stock Market(continued from page 136) anywhere from $5000 to $50,000, with the reasonable hope of being able over the years to put additional money into the market and with what is frequently dismissed as the unreasonable goal of rapid capital gains--that this article is written.

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Most standard investment advice has no relevance to the person described above. The typical writer of a syndicated investment-advice column is a Depression-scarred old man who feels it his sworn duty to warn the neophyte investor of the risks and potential pitfalls of the stock market. The usual suggestion offered is to "stick to quality." By this, the writer means either the solid, old-line industrial companies known as blue chips or what he calls growth stocks. Neither is suitable for someone who wants to see a relatively small amount of money become a much larger sum.

A young man I know once asked me my opinion of the stocks he owned. I knew he was unmarried and earning a very good salary. I was thus surprised to see that his portfolio consisted of General Motors, DuPont and A.T.&T. I asked him why he had chosen those stocks. He answered he had been advised to stick to quality and that all three paid good dividends. I pointed out that--despite their excellent quality--DuPont and General Motors both were now selling for two thirds their 1965 prices and that A.T.&T. was still today, after a sharp recent advance, below its 1965 level. As for the dividends, they constituted incremental income for him and he was giving 40 percent of them back to the Government in taxes. I went on to say that 20 years ago, the U. S. economy was undergoing a major and rapid expansion and that one then could simply "buy America." For the past three years, real economic growth, after the adjustment for inflation, has been nonexistent and is likely to be modest at best for the foreseeable future. Common sense should tell you that it is difficult, edging on impossible, for the very largest companies in America to have a substantially different long-term rate of growth from that of the over-all economy. Thus, the investor who is in search of outsized profits from his investments must seek out companies that will show rates of growth in sales and earnings far above those of the general economy.

Since we said earlier that what are termed growth stocks are also generally inappropriate choices, this last statement may seem somewhat contradictory. If the definition of a growth stock is one whose earnings, and therefore, by implication, its price, increase rapidly, then, obviously, growth stocks are what everyone wants to buy. There are numerous companies whose past records of steady, above-average growth and strong position in their industries have caused them to be called growth stocks. If it were a simple matter of buying the stocks of such companies and waiting for the profits to roll in, then you wouldn't have to bother reading this article nor would I bother writing it. Clearly, it's not that easy. What everyone who buys stocks, whether with $2000 of his own money or $200,000,000 of someone else's money, must always remember is that in the stock market, you are buying the future. The past is known and is there for everyone to see. What is crucial, and difficult, is to determine what the future of a given company will be and, importantly, how that future will differ from the expectations already built into the price of the stock.

The danger of extrapolating the past into the future can be seen from the fact that among stocks with fabulous 20-year records are Avon Products, Delta Airlines, Tampax and Xerox--all stocks that are accorded the status of growth stocks by those who drive with both eyes squarely on the rearview mirror. As it happens, those four stocks have appreciated to prices anywhere from 25 to 45 times their 1953 level. But they achieved virtually all of their quantum gains before 1966; over the past ten years, three have risen only slightly and one--Xerox--is actually substantially down. There are literally hundreds of stocks that appreciated manyfold during the Fifties and the early Sixties, only to have declined, some by sizable margins, over the past ten years.

So far, I have been assuming that someone who buys stocks, or is considering buying them, is in search of capital gains. There are, of course, other reasons why one buys stocks, or any other form of investment. Stocks, bonds, real estate, gold, silver, art, antiques, stamps, coins--all offer in various combinations just four essential attractions: growth, income, security and liquidity. The first, growth, is never present without risk. Wall Street professionals try to assess the "risk/reward ratio" before buying any stock. In its simplest form, a highly speculative stock, one that may appear to have the potential of advancing tenfold, also offers the possibility, in the event of bankruptcy, of a total loss. But if, after careful examination, you can convince yourself that a rise to ten times the current price over a five-or-ten-year period is possible, then that risk is well worth taking, as a ten-to-one ratio is considered unusually favorable. On the other hand, a stock such as A.T.&T., which clearly has a far lower potential risk, also--it can safely be said--has no chance of selling at ten times its current price ten years hence, even under the most optimistic possible assumptions. It is, thus, quite possible that A.T.&T., with less total risk than a far more speculative stock, has actually a less favorable risk/reward ratio.

As for income, almost all stocks with a potentially high rate of growth will appear to be inferior income vehicles. Companies grow by reinvesting their earnings. To the extent that they pay them out in dividends, those earnings are not available for reinvestment in the future growth of the company. Thus, most stocks that I would select for capital-gains purposes pay little or no dividends. Yet dividends should not be ignored, for ultimately it is the ability of a company to generate a high level of earnings out of which future dividends can be paid that will make its price rise.

Crown Cork & Seal, an excellent company with a high past rate of growth, has never paid a dividend on its common stock. Yet its stock has risen over 40fold since 1953. Its level of earnings convinces the market that it has the present ability to pay dividends if it chooses. As long as it finds opportunity for rapid growth in its business, then it is best advised to continue plowing those earnings back into the company rather than pay them out to its shareholders. An argument could be made that when Crown Cork does begin to pay dividends, it will have indicated to the world that it no longer finds its opportunities for future growth equal to what it has found in the past.

An investor who was smart enough--or lucky enough--to buy IBM in 1953, when it was a far smaller and less seasoned company than today, accepted a dividend yield that was little more than a one percent annual return. Yet now, thanks to the company's phenomenal growth in earnings and dividends, that investor is receiving a 129 percent annual return on his original investment. If that same investor had bought American Can in 1953, because it then had a dividend yield of five percent--much better than IBM--he would today be receiving a yield of only seven percent on his original cost and own a stock selling now almost unchanged from its price of over 20 years ago.

As for choosing investments for security, that's fine for those with large amounts of capital to protect, but it is a luxury that must be foregone by someone who wants to build a modest sum into real capital.

The fourth factor an investment can offer is liquidity. Stated simply, this means, "How quickly and easily can I sell?" Here is one major advantage the individual has over the large institutional investor. Small amounts of virtually all stocks can be bought or sold almost instantly, with little or no sacrifice in price. If your mind or your circumstances change at five p.m., you can be out by ten a.m. the following day.

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Except for the unusual periods, such as the first six months of 1975, when the market was reacting from the deep disaster of 1973--1974, it is not likely that stocks in general will experience the kind of broad price rise that marked the great post--World War Two bull market. The achievement of superior performance will likely require far greater selectivity than was necessary from 1949 to 1972, when the average stock traded on the New York Stock Exchange increased sevenfold. Which brings us to the subject of mutual funds. The primary purpose of buying a mutual fund is to secure far greater diversity than otherwise would be practicable with a limited amount of money. An investment in a mutual fund is spread over 50, 100 or even 200 different stocks. Standard investment advice nearly always counsels diversification as a conservative approach. It is the opposite of what I am suggesting. (A very intelligent--and successful--investor I know once summed up his philosophy for me: "Put all your eggs in one basket and watch the basket very closely.") If you take all the money you have set aside for investing and buy three stocks, it requires only one spectacular success for results far better than that of the over-all market. Conversely, if your money, via a mutual fund, is spread over a very large number of companies, it is difficult for the fund's performance over the long run to exceed substantially the appreciation rate for the average of all stocks.

There are, of course, a number of funds that try to identify and invest solely in young, exciting growth companies in the early stages of their development. Some of them have had extremely good records, or at least they did until the past few years, when virtually all stocks were going down. Indeed, the simplicity of picking one fund as your sole investment vehicle, with all future decisions then in the hands of its management, has appeal. But by taking this tack, you miss the chance to gain the knowledge that is the valuable product of teaching yourself to discover and analyze companies. And you miss the fun.

Another alternative to common stocks, and one that in recent years has had great appeal for smaller investors, is any of a variety of fixed-income securities. These include corporate bonds, tax-exempt municipal bonds, Treasury bonds and notes, and savings accounts and certificates. Their current popularity has a simple explanation: Yields had by 1974 risen to record levels and have remained relatively high. At the same time, the stock market has proved an inhospitable place for most investors during the past four or five years. The high interest rates available today are a direct reflection of the high rate of inflation that, despite some improvement, remains the primary problem facing our economy. One can today buy completely safe "Triple-A" corporate bonds with a current yield of nearly nine percent. In 1974, the rise in the Consumer Price Index was over 12 percent. Thus, an investment yielding nine percent meant that its owner that year lost three percent in the purchasing power of his money, even before paying taxes on the interest. The rate of inflation, which came down to about seven percent for the year 1975, would have to decline further and remain at this lower level for a number of years to make a purchase of any long-term, fixed-income security look good.

Let's assume that I have convinced you that any investor with a relatively modest amount of money--who is seeking someday to have a far less modest amount of money--must buy common stocks, particularly those of young, growing companies of the type that has been the source of outsized rewards in the past. Now you must choose a broker. Having dealt over the years with only the very best brokers on Wall Street, the kind who handle multimillion-dollar institutional accounts, I have nonetheless developed a deep cynicism about the breed. Still more vast is my cynicism about the typical customers' man who handles small individual accounts at a branch office of any of the major brokerage firms.

You will develop a more proper attitude toward a broker if you start by thinking of him as a salesman, which he is. He might have become a used-car salesman or a life-insurance salesman, but. instead, he is a stock salesman. By some strange quirk of American social history, stockbrokers are accorded a high degree of social status and earning power. It is completely unwarranted by what they actually do, and don't be taken in by this or by the plush offices most maintain. The normal training course for a stockbroker runs from 90 days to six months. Such a course is obviously no substitute for a Ph.D. in economics, a degree in accountancy and advanced training in psychology--all of which would be necessary to allow anyone to speak with the certainty I have heard many brokers express.

There are, of course, many good stockbrokers. They have become so by virtue of years of experience with the vagaries of the stock market. Unfortunately, such are not likely to be available to you. It stands to reason that those who really know what they are doing will attract and hold as customers institutions or individuals with very large accounts, particularly those oriented toward trading. A broker makes his money from customers who buy and sell stocks, who trade. You will make money in the market if you buy stocks and hold them as long as they continue to do well. If you do what is best for you, you will soon come to be regarded by your broker as a nuisance. Don't let it bother you.

The worst mistake people make when walking into a brokerage office is to allow themselves to be talked into something totally unsuited to their needs. As soon as you tell the smiling young broker you've been assigned that you are in search of rapid capital gains, his eyes will light up. Even a fairly small amount of money, if he can persuade you to become an active buyer and seller with it, can produce a quite handsome flow of commissions for him. Resist his blandishments. To be a successful trader, you must be right about the stocks you select and about the market. To be a successful long-term investor, you need only be right in your stock selection, and not even every time. One spectacular winner can more than offset a few soso performers.

Armed with the proper attitude toward stock salesmen, you will avoid the trap of letting your broker pick your stocks for you. It always amazes me that the same person who will read Consumer Reports and check the prices at four stores before investing $250 in an air conditioner will take the word of some broker he has just met as to the correct disposition of his life's savings. Brokers, in addition to carrying out the mechanical function of handling orders to buy or sell stocks, provide something they call research. There are two things to remember about this research: It is a selling tool and it is generally wrong.

Most brokerage firms that deal with individual investors spew forth a stream of reports recommending purchase of a variety of stocks, these reports usually being no more than three or four pages long. Perhaps I am being unfair, but I have been greatly impressed by some ancient brokerage studies I have unearthed: the 1929 report suggesting a switch out of General Motors and into Moon Motors; the 1937 study that counseled against investment in Eastman Kodak because "photography is a luxury item and will, of course, never attain a mass market"; the 1956 write-up on Haloid Corporation (the predecessor of Xerox) that drew negative conclusions about the company's chances of ever implementing its ambitious plans; or, to bring it more up to date, the 1968 studies--and they were numerous--recommending Penn Central at 70 or 80 as "an asset play."

The above reports, by no means chosen at random, are examples of analytical thinking that completely missed the boat. The analysts who write these reports are, with rare exceptions, not analysts but reporters. They visit the management of companies and almost invariably produce "research" that presents the company's viewpoint. Aside from the obvious fact that this builds in a bias toward the optimistic, it also forces the analyst/reporter to deal with the near-term outlook, as that is all even the head of a company can discuss with any certainty. The stocks most firms choose to recommend are those in which there is already a high degree of interest. These companies, generally the largest and best known, are the very ones least likely to present a significant opportunity to purchase an unrecognized future superstar.

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How, then, does one go about finding those "unrecognized future superstars"? First, you should formulate your own broad view of the type of economy we are likely to experience over the next five or ten years. Will inflation subside from its current level, remain at today's historically high level or become still more virulent? Will consumer spending grow at the rapid rate of the Sixties? Will the Government continue to expand its role in determining the direction of the economy via regulation and tax legislation? Will the domestic market present the best opportunity for growth, or will foreign markets, as in the Sixties, show superior rates of expansion? If you can reach just a few extremely general conclusions about such questions, then you will have narrowed down your field of choice by a substantial degree.

Suppose you had asked yourself those questions ten years ago. Had you anticipated the extreme inflationary bias of the past decade, you would have known enough to avoid companies that are heavily dependent on purchased raw materials or whose labor costs are a large percentage of their total expenses. Since both of these facts are particularly true of automobile companies, you would have shunned altogether the four U. S. car manufacturers, whose stocks today on average are well below their prices of ten years ago, without any adjustment for inflation. (Remember, the ravages of inflation must be calculated when comparing a past price with today's: If you bought a stock at 20 in 1966, it would have to be selling at 37 today just to maintain the same purchasing power that $20 had in 1966.) This same conclusion about inflation that ruled out automobile stocks might have led you to seek an investment vehicle from among the drug stocks, as a constant flow of new products, an unusual degree of pricing freedom and the highest profit margins of any industry make them relatively impervious to inflation. Or you might have chosen a forest-products company, as their ownership of their basic raw material, timber, gives them a built-in hedge against inflation. Had you done so, you would have been rewarded. The stocks of the leading companies in the drug industry have on average doubled in price, while those of the major forest-products companies have increased threefold over the past ten years, with many individual companies doing far better.

A list of the best-performing companies over the past decade would indicate how an understanding of certain broad trends within the economy will lead you to the more promising sectors for investment. Nearly every stock that has appreciated fivefold or more since 1966 could be placed in one of four basic categories: companies that sell directly to consumers, companies in the medical and health field, technology companies and those directly or indirectly involved in the production of energy. My own view is that only the last of these sectors presents truly attractive opportunities for the next ten years. The average consumer is now struggling to keep abreast of inflation, and the huge expansion in discretionary income for such things as second homes, expensive leisure-time activities, etc., will not be present. The increasing likelihood of some form of Government health insurance suggests that the medical/drug field--and its very high profit margins--will come under much tougher Government scrutiny. And the stock-market magic that was attached during the Sixties and early Seventies to anything connected with new technology has, I believe, worn off. However, the announced commitment of the Government to expand our domestic energy industry, be it oil, gas, coal or nuclear fuel, makes this area one of immense promise.

Assuming that you share my conviction that energy remains a promising area of investment, don't rush out and buy simply anything to do with its production. The six "international oils," so called because of their vast global oil activities, proved a relatively poor investment over the past ten years. Their average price has risen only slightly, which means that the purchaser of these stocks has lost over one third of his investment's value after deducting the effects of inflation, although the dividends he has received have to a great extent offset his loss of purchasing power. On the other hand, the perspicacious individual who foresaw a decade ago the phenomenal growth in demand for oil-well drilling services and related equipment on average would have increased his capital eight times had he invested in the six companies that are today the leaders in this area.

Does this mean that those companies whose stock prices rose eightfold since 1966 are still the most promising sector among energy investments? Perhaps; but both common sense and mathematics make it unlikely that the next ten years will prove equally enriching for the owners of these stocks. These stocks have been "discovered." You, in your search for investment performance out of the ordinary, must discover your own stocks. It's far easier said than done, though by no means impossible. You have two basic choices: Decide what field you think has unusual promise and then learn everything possible about it; or stick to something you already know well--most likely an area related to your work, hobby or specialized field of interest.

The first road is tougher but reasonably self-explanatory. The source of the original idea can be as accidental as a newspaper or magazine article or an offhand remark by a friend who is knowledgeable about a particular field; or it can be the outgrowth of a dedicated search for that sector of the economy with the most dazzling potential. A very savvy friend of mine manages over $100,000,000 and, for that reason, has access to the best "research" available on Wall Street. He considers the daily newspaper, of which he reads eight from all over the world, his best source of investment ideas. One day in 1965, he read an article in a Chicago paper that told of increasing Government concern about industry-caused air pollution. (Yes, that was a new idea 11 years ago.) He immediately sought the names of leading companies that manufactured air-pollution equipment. The first was easy, as he came across a company called American Air Filter. He then simply telephoned that company and asked who were its most prominent competitors, which yielded two names: Buffalo Forge and Joy Manufacturing. A very quick review of the public financial data on all three revealed that they were sound, adequately financed companies, so he took sizable positions in each. By 1972, when air-pollution control had become a magic phrase on Wall Street, he had sold all three positions for more than triple his original investment.

Stock-market success is not, however, solely the result of picking the right industry. The right company can be in the wrong industry. Here is where your own personal knowledge comes in. Someone I know whose hobby is making things in his well-equipped basement shop became convinced that Black & Decker made a superior product. Today, in addition to the satisfaction he derives from his pastime, he has made an 800 percent profit on his purchase of Black & Decker stock a dozen years ago. During this same period, other companies in this industry have been lackluster performers. The single best-performing major stock of the past 20 or so years has been Masco Corp. One dollar invested in 1953 in this manufacturer of plumbing fixtures, particularly single-handle water faucets, is worth $325 today. How many professional plumbers, contractors and amateur handy men might have capitalized on their knowledge of this company's specialty to have made the investment of a lifetime? (By comparison, the largest company in the plumbing-supply business, American Standard, is today selling at its price of 20 years ago.) A further example of the potential usefulness of hobbies: Had those collectors of commemorative plates and medals issued by Franklin Mint bought instead its stock when it first went public in 1968, they would today have a 900 percent profit on their investment. The space left on their wall by the absence of Washington kneeling to pray at Valley Forge in bas-relief silver could now be filled by those lovely, valuable stock certificates.

Perhaps the most classic form the quest for gargantuan stock-market profits takes is what Wall Street calls "the search for the new Xerox." A word of caution. For every Xerox or Polaroid that comes along with a new product that revolutionizes its industry or creates a new market, there are literally hundreds of would-be corporate revolutionizes whose ships sink with all investment hands aboard. Beware of patents. Polaroid assigns its patents a balance-sheet valuation of one dollar, admittedly an understatement. But it is its marketing, financial and manufacturing know-how that has made it a great enterprise, not the Government-granted protection implied by a patent.

Yet the search continues, abetted not by the probability of success but by the lotterylike payoffs to the occasional winner. At a recent lunch with the managing partners of two respected Wall Street firms, I asked each to name his favorite stock to put away and hold for ten years. One supplied the name of a company whose future is based on a patented process that would "revolutionize surgical procedure in every hospital in America." The other man's choice was a small company with still more ambitious plans: to develop and license a patented scientific breakthrough, the offspring of its scientist-founder, that would allow the synthesis of far more complex molecules than heretofore possible, with wide application throughout the chemical industry. (Sorry, no names.) Will both of them, or even either one, make it? The history of similar ventures offers little comfort, and I myself would not buy either stock without the most exhaustive inquiry into the technological and business pitfalls that abound. But I just may make that inquiry. I'd hate to find myself, 15 years from now, ordering my second vodka martini in the club car on the 5:27 to Westport and boring my fellow commuters with the story of how I passed up the greatest investment idea since Xerox.

A revolutionary idea need not be a new product. It can be a new marketing technique or just a better way of doing something that a lot of other companies do less well. McDonald's didn't invent the hamburger, it wasn't the first to franchise fast-food restaurants nor the first to create a low-priced, limited-menu operation. However, one needed only to take a couple of kids to McDonald's to know that those guys were doing it a lot better than anyone else. It still would have taken some foresight to buy the stock in 1965, its first year as a public company. (Had you done so, your investment would have appreciated more than 25fold since then.) Even a late-comer who bought the stock in 1970--by which time they were well onto their six-billionth Big Mac, while a host of competitors offering hamburgers, roast-beef sandwiches, pizza and fish and chips were already falling by the wayside--would have since quintupled his money. But this kind of company puts a terrible premium on the investor's being right: New wrinkles in marketing are notoriously easy to imitate. The stockholders of Levitz Furniture found this out during 1972--1974, when warehouse furniture retailers sprang up on every vacant lot, and the stock of this erstwhile highflier fell from 60 to one and a half.

All of the above advice will only get you to the starting gate. Dozens of extremely good books have been written on how to run the race, with the possible approaches far from exhausted. If your goal is creating genuine capital from a modest sum of money, if you are willing to endure the risks this goal necessarily involves and if you will do the essential preliminary spadework before you buy a single share, then there are some brief guidelines I can offer, mainly the product of my own--and others'--mistakes. (Sadly, mistakes are more instructive than successes.) First, analyze companies, not the market. If you're in for the long pull--and you should be--periods of market weakness, even two-year ones such as 1973-1974, should be seen as unusually attractive opportunities to buy stocks of companies you believe in when everyone else is convinced the world is coming to an end. Find out everything you can about the company. Write the corporate secretary and ask for the past few years' annual reports; look at the earlier ones to see if the company lived up to its targets for the ensuing year, generally set forth in the president's letter. Also, ask for a very valuable document called a Form 10-K. Every public company must file one with the Securities and Exchange Commission, and it contains a lot of information often kept out of the annual report--information that may not put the company in the best light. You can even ask your broker for any information or research reports he may have on a company that intrigues you--but use him just for information, not advice.

After you have bought a stock, judge its future performance by how well it lives up to your expectations of its growth in sales and earnings and to the goals spelled out by its management. Although Wall Street firmly believes that a good stock is one whose price goes up (and a bad one, one whose price declines), this should not be your rule. Someone who bought Archer-Daniels-Midland, the largest soybean-processing company in America, at its high in 1969 would have paid $68 for one share. Six months later, that share was trading at 43. Not a well-timed purchase, but today--after numerous stock splits--Archer-Daniels is selling at nearly five times its 1969 high. Now the guy who was clever enough to buy it at its 1969 low may be somewhat happier with his eightfold gain. But I am sure both buyers, regardless of whether they got in at the 1969 high or the low, are a lot happier than the fellow who panicked and sold out at what proved to be the bottom of a sharp upward climb. This does not mean all stocks should be held forever once purchased, just that the stock market over the short term can fluctuate widely, based on its psychology of the moment, and you should sell a stock only when its fundamental performance diverges noticeably from what your original research led you to expect.

The hardest rule to follow, but clearly an essential precept if you ever wish to multiply your investment in a single stock manyfold, is, Ignore the double. The guy who never tires of telling you how he owns Xerox at a cost of one dollar per share, after adjustment for multiple stock splits, owns it today only because he didn't sell it when it reached two dollars. The second smartest thing he ever did was to buy Xerox; the first smartest was not to sell it for two--or three or four. One last actual case history: A friend of mine came to me in 1963, seeking advice on how to invest $10,000 he had saved. He said he didn't expect to have any immediate need for the money and wanted to take a chance on seeing it grow into real capital. I gave him a list of half a dozen stocks and told him why I thought all had elements of great long-term interest. We settled on three of them and divided the money equally among those three. Today, 13 years later, two of the stocks have advanced modestly, less than the subsequent rate of inflation. The other third of his $10,000 went into 150 shares of Baxter Labs, then selling at 22 1/2. By 1973, after various stock splits, he had 1200 shares of Baxter Labs with a market value of $66,000. All because he didn't sell when it doubled, or even tripled. His total portfolio, counting the two laggards, was worth $74,000. Baxter, when my friend bought it, was a rather small company with sales of less than $50,000,000, earnings of less than $3,000,000, and was already selling at a rich relationship to its earnings. It was--in a word--speculative. By 1973, it had grown to sales of $356,000,000, earnings of over $27,000,000, and was now considered a growth stock by those who probably would have rejected it ten years earlier as too risky.

When my friend called me up in 1973, after being out of touch for years, I was delighted to learn he still owned all three stocks--especially Baxter Labs. He asked what he should do and I told him it was his decision. His good sense in holding on despite numerous opportunities to sell at a handsome profit had been far more crucial to his ultimate success than my original good fortune in lighting on Baxter as one of a number of possible vehicles. He decided to sell 15 percent of his Baxter stock, take a one-year sabbatical from his teaching post and go around the world with his wife. (The point of investing is, after all, to enable you to acquire the financial freedom to do things that would not otherwise be possible--not just pile up paper profits.)

I believe the stock market to be ultimately rational. Surprisingly, this is a view not universally shared on Wall Street. But if you take an initially rational approach to it, ignore its interim gyrations and have the guts to stick with your choices until you are proved right--or wrong--you may come to share my view of the stock market. The process isn't painful and the end results can be downright delightful.