It seems that Lefty Gomez, who played for the Yankees in the 1930s, gets credit for having said “I’d rather be lucky than good.” Charles Rotblut turns this around in his book title: Better Good Than Lucky: How Savvy Investors Create Fortune with the Risk-Reward Ratio (W&A Publishing, 2010). His central tenet is that being a successful investor is about making good decisions, not about being lucky.
In this slight book Rotblut introduces the beginning investor (as well as the investor who is trying to rejigger his portfolio in a more thoughtful way) to the rationale for value investing and to some of its basic principles.
“One reason,” he writes, “why stock prices rose too much in the 1920s and the 1990s—as well as other periods—was that forecasts were given more weight than valuations.” (p. 9) Analyst forecasts usually have about as much predictive value as the divination that comes from reading entrails. “Placing an emphasis on valuation provides a margin of safety against making mistakes.” (p. 10)
Rotblut takes the reader through the fundamentals of corporate analysis: business models, the balance sheet, income statement, and cash flow statement. He then cuts to the chase and offers what he considers the two most profitable measures of valuation (price-to-book and price-to-earnings) and “a sanity check to ensure you are not overpaying for a stock” (discounted cash flow).
Book value, the theoretical value of a company’s net assets or equity, is according to many studies the best valuation measure of a stock’s performance because “no quality company should sell for a price equivalent to or less than its theoretical liquidation value.” (p. 123) But the P/E multiple should not be ignored, since a high P/E increases the possibility of downside risk whereas a low P/E increases the potential for upside reward. DCF, a mathematical model that calculates the current worth of a company’s future cash flows and that is most often invoked to calculate a stock’s price target, should be used not “to determine a stock’s worth, but whether a stock is undervalued or overvalued relative to its projected future cash flows.” (p. 166) As rules of thumb Rotblut recommends looking for stocks trading at a P/B multiple of 2.0 or lower, a P/E of 12 or lower, and a discount of 10% or more to their DCF-calculated value.
Better Good Than Lucky is an entry-level book. In addition to its discussion of value investing it explains where to get investment advice, how to apply modern portfolio theory, and how to own stocks and still sleep at night. Rotblut, by the way, makes one recommendation that should be followed by everyone, quite independent of investment style: keeping an investing journal, writing down the reasons you bought each stock as well as the factors that would cause you to sell it.
Investors who want a meaty book would be better served with John Price’s The Conscious Investor. But for those who want a quick and easy introduction to value investing, Rotblut’s Better Good Than Lucky is an excellent choice.