INVESTMENT STRATEGIES OF FAMOUS INVESTMENT GURUS

INTRODUCTION• Becoming a successful investor takes education, patience and maybe even a little

luck.

• Historically, the market has returned a solid 12% per year on average. The icons we'll present here represent the pinnacle of the financial world. Each one has dramatically exceeded market performance. They have all made a fortune off their success and in many cases, they've helped millions of others achieve similar returns.

• These investors differ widely in the strategies and philosophies they applied to their trading; some came up with new and innovative ways to analyze their investments, while others picked securities almost entirely by instinct. Where these investors don't differ is in their ability to consistently beat the market.

• Let’s learn more about these outstanding investors and how they made their fortunes.

BENJAMIN GRAHAM - VALUE INVESTOR• Graham built his fortune and reputation after living through some

extremely difficult times, including both the Great Depression and his own family's financial woes following his father's death when Benjamin was a young man. His investment firm posted per annum returns of about 20 percent from 1936 to 1956,far outpacing the 12.2 percent average return for the market during that time.

• Trendy, hot stocks didn't garner his attention; he was concerned with companies' balance sheets and their fundamentals.

1. How much debt did they carry?

2. How did their stock price compare to the amount of per-share earnings they were generating?

3. Did the firm have strong sales figures?

• This value-centric, company-focused approach may be used by a lot of investors today, but it was Graham who first popularized it.

• A key concept behind his approach was the "margin of safety" -- the difference between a stock's price and the value of its underlying business.

• Graham focused on stocks with high margins of safety (meaning their stocks were selling on the cheap compared to what he believed to be the intrinsic value of their businesses), because their already low prices offered significant downside protection.

PETER LYNCH - P/E/Growth Investor• Lynch's approach centers on a variable that he is famous for

developing: The price/earnings/growth ratio, or "PEG".

• The PEG divides a stock's price/earnings ratio by its historic growth rate to find growth stocks selling on the cheap.

• Lynch's rationale: The faster a firm is growing, the higher the P/E multiple you should be willing to pay for its stock. Lynch is known for saying that investors can get a leg up on Wall Street by "buying what they know", but that's really just a starting point for him; his strategy goes far beyond investing in a restaurant chain you like or a retailer whose clothes you buy.

• Along with the PEG, he focused on fundamental variables like the debt/equity ratio, earnings per share growth rate, inventory/sales ratio, and free cash flow.

• It's important to note that Lynch used different criteria for different categories of stocks, with the three main categories being "fast-growers" (stocks with EPS growth rates of at least 20 percent per year); "stalwarts" (stocks with growth rates between 10 and 20 percent and multi-billion-dollar sales); and "slow-growers" (those with single-digit growth rates and high dividend payouts). He also used special criteria for financial stocks.

WARREN BUFFET – PATIENT INVESTOR • The Buffett-based "Patient Investor" strategy is the only one of our strategies that is not

taken directly from the writings of the guru himself, as Buffett has yet to write about his investment strategies. Our interpretation of Buffett's approach is based on the book Buffettology, written by Buffett's ex daughter-in-law Mary Buffett.

• The Buffett strategy buys stocks with an extremely long-term horizon. In fact, Buffett has held some of his investments for decades, and he's said that Berkshire's favorite holding period is "forever".

• Buffett doesn't try to capitalize on small day-to-day stock market movements; instead, he focuses on a company's business, because he knows that, over time, the stocks of firms with strong businesses and good long-term prospects are likely to rise considerably, regardless of what those stocks are doing today or tomorrow or next week.

• To find those strong businesses, this strategy goes back as far as a decade into a company's history, so only stocks with consistent long-term track records can pass this methodology.

DAVID DREMAN - Contrarian Investor• Dreman believed that investors are prone to overreaction, and, under

certain well-defined circumstances, overreact predictably and systematically.

• They typically overvalue the popular stocks considered the "best", and undervalue those considered the "worst", often going to extremes in these over- and under-valuations. Because of that, he focused on stocks that most investors were shunning -- those with low price/earnings, price/book, price/dividend, and/or price/cash flow ratios.

• To separate stocks that had been beaten down because of investor overreaction from those that were outright dogs, he applied a number of other fundamental tests, looking, for example, for a high current ratio, high return on equity, high pre-tax profit margins, and a low debt/equity ratio.

JOHN NEFF - Low PE Investor• Neff's approach was "relatively prosaic" and "dull" because it focused on the

market's unloved.

• Neff identified these stocks using the price/earnings ratio, seeking stocks with P/Es that were between 40 to 60 percent of the market average.

• From this group, he looked for firms with steady, sustainable EPS growth (between 7 percent and 20 percent per year, and driven by sales growth), as well as positive free cash flows.

• He also used what he called the "total return/PE" ratio, which combined a stock's growth rate and dividend yield and divided that by its P/E ratio to find good values.

• The variable underscored Neff's belief that strong dividends were an often-overlooked part of how investors could beat the market.

KENNETH FISHER - Price/Sales Investor• Fisher found that earnings -- even the earnings of good firms -- could vary

from year to year based on things (accounting changes, decisions to upgrade facilities, increased research costs that will lead to bigger profits down the line) that had little to do with the prospects of the company's underlying business.

• Sales, however, were far more stable and thus a better indicator of the strength of a company's business, making the PSR a very useful tool.

• Fisher wanted stocks with low PSRs, and he used different standards for different types of companies. He also wanted to see strong earnings growth, high profit margins, and low debt.

• In addition, for technology and medical companies, Fisher viewed research as a commodity. When analyzing these firms, he used the "price/research" ratio (PRR), which divides a firm's market cap by the amount it is spending on research. Fisher has changed his strategy today, but his PSR-focused approach has continued to produce strong results for us.

MARTIN ZWEIG - Growth Investor• Zweig is a growth investor with a serious conservative streak.• To pass his strategy, a stock must meet a slew of earnings-related criteria,

showing that its earnings growth is: 1. At a high rate over the long haul2. Persistent over several years in a row3. Accelerating in more recent quarters; and sustainable, i.e. driven by sales

growth4. Not cost-cutting measures. • In addition, Zweig wanted to make sure he wasn't paying too much for a

company's growth. If a stock was selling at a price/earnings multiple that was more than three times the market average, or greater than 43 regardless of the market P/E, he avoided it. Another part of his conservative streak: Zweig wanted a firm's debt/equity ratio to be low compared to its industry average.

JOEL GREENBLATT - Earnings Yield Investor• Greenblatt's approach looks only at the return a company generates

on its capital, and at the firm's earnings yield (which is similar, but not identical to, the inverse of its price-earnings ratio).

• The Greenblatt strategy ranks all stocks in both of those categories, and then adds their numerical rankings together. The lower the combined numerical ranking, the better. (Our Greenblatt strategy invests in the 30 stocks with the best combined ranking.)

• Greenblatt's research shows that while beating the market is hard, it doesn't have to be complicated. The hard part comes not in developing a complex strategy, but instead in finding a proven approach and sticking with it through good times and bad. He stresses discipline as much as any of the gurus we follow.

JOSEPH PIOTROSKI - Book/Market Investor• Piotroski's methodology starts by narrowing stock choices to those trading

in the top 20 percent of the market based on their book/market ratios (or, conversely, the bottom 20 percent of the market based on price/book ratios).

• He found that just buying low price/book stocks does not produce excess returns over the long term, because many low price/book companies are trading at a discount because they deserve to -- they're dogs with poor prospects. When he applied a series of additional tests of financial strength to these low price/book stocks, however, Piotroski was able to separate the dogs from the good prospects.

• Among the variables he examined: return on assets, current ratio, cash flow from operations, change in gross margin, and change in asset turnover. The strategy usually finds smaller companies whose stocks are flying under Wall Street's radar.

James O'Shaughnessy - Growth/Value Investor• J O'Shaughnessy developed two key investment strategies:

"Cornerstone Growth" and "Cornerstone Value."

• Cornerstone Growth favors companies with a market capitalization of at least $150 million and a price/sales ratio below 1.5. It also looks for companies with persistent earnings growth over a five-year period, and shares that have been among the market's best performers over the prior 12 months. This strategy makes sense for value-oriented growth investors who have the patience and personality to stick with a purely quantitative investment approach.

• Cornerstone Value looks for large companies with strong sales and cash flows, and solid dividend yields. It is appropriate for income-oriented investors.