Book summary “Investing the Templeton way”: summary

Introduction

You often struggle with emotional market decisions, buying near the top during euphoria and selling in panic near the bottom. Herd behavior tempts you to follow the crowd, which consistently destroys long-term capital and generates poor returns.

Achieve superior investment returns by hunting for bargains globally during moments of maximum pessimism.

Lauren C. Templeton and Scott Phillips decode the timeless principles of legendary investor John Templeton. The book explores how you can master your emotions, apply common sense across global borders, and buy stocks when pessimism reaches its peak.

You will discover answers to the following questions as you read:

• How do you spot bargains during maximum pessimism?
• Why should you look beyond domestic borders for low price-to-earnings stocks?
• How do you recognize the exact moment an asset class hits bottom?

1. The Birth of a Bargain Hunter

You must cultivate radical thrift, emotional fortitude, and independent judgment away from financial herds to spot bargains.

John Templeton observed his father purchasing foreclosed farms at town square auctions for pennies on the dollar because there were no other bidders. This dynamic mirrors the stock market, where extreme price drops cause people to flee rather than buy, creating deep discounts.

Harvey Templeton Sr. acquired six farms by stepping in to bid when auctions failed to attract any other buyers, which were later sold to developers for massive gains.

Aggressive saving and thrift provide the financial security and capital required to launch ventures and capitalize on market opportunities. Templeton and his wife made it an absolute rule to save half of their income and pay everything in cash to avoid paying interest, ensuring they always remained receivers of interest rather than payers.

When moving to New York, John and Judith furnished a five-room apartment for 25 dollars and routinely hunted for 50-cent blue-plate specials and deep discounts like a 200-dollar sofa bed bought for 5 dollars. You can build personal capital by following simple guidelines:

• Set aside and invest 50 cents for every dollar that comes in.
• Pay for everything in cash to avoid becoming a payer of interest.
• Scour newspapers and sales to furnish living spaces at extreme discounts.

Vella and Harvey Templeton practiced a laissez-faire parenting style where they rarely said no and instead encouraged their children to research their own questions by providing books rather than direct answers. At ages 11 and 14, John and his brother built an attic laboratory, channeled 10,000 volts of electricity, and later wired rental properties for tenants after reading library books.

When Templeton discovered his rural high school did not offer the fourth-year math required for Yale admission, he created his own solution by teaching the required class himself to a group of peers. John Templeton convinced his principal to open a math class, recruited eight students to form the mandatory math class, and acted as both student and teacher to fulfill Ivy League prerequisites.

Playing competitive poker from a young age helped Templeton master tracking probabilities, analyzing opponents' motives, and detecting bluffs, which built the emotional discipline required to withstand market manias and panics. Templeton funded up to 25 percent of his Yale education using poker winnings earned during the height of the Great Depression.

After relocating to Nassau in 1968, Templeton achieved the best record as a mutual fund manager by thinking differently than the rest of Wall Street. Physical and mental separation from the financial herd is essential for maintaining independent judgment and beating market consensus.

True investment wisdom requires the fortitude to buy when everyone else is despondently selling, rejecting herd behavior even when market crashes cause widespread panic and destruction of paper wealth. You must master your emotions during crises to secure extraordinary rewards.

2. The First Trade in Maximum Pessimism

Market sentiment moves in a predictable cycle from pessimism to skepticism, optimism, and finally euphoria. When investors panic and sell stocks based on negative news, prices disconnect from the true intrinsic value of the businesses.

You should buy out-of-favor stocks during maximum pessimism, treating volatility as an ally rather than an enemy.

In 1939, following a decade of the Great Depression and the outbreak of World War II, the U.S. stock market fell 49 percent in a 12-month period as investors panicked. Sir John Templeton borrowed $10,000 from his former boss Dick Platt to purchase 104 stocks priced under $1, of which 37 were already bankrupt. Within four years, he turned the investment into $40,000, with only 4 stocks failing, including a massive return on Missouri Pacific Railroad preferred stock bought at an eighth of a dollar.

Brokers push story stocks with high valuation ratios to satisfy demands for hot tips. Fifty years of research confirms that stocks with high price-to-sales, price-to-earnings, or price-to-book ratios consistently produce below-market returns.

You can find better opportunities by following a disciplined screening method:

• Scan the list of stocks ranked from highest to lowest by ratios of price to sales, price to earnings, price to book, and price to cash flow.
• Focus research efforts on the bottom 10 percent of that list to find potential investments.

When evaluating potential bargains, you must separate temporary problems from permanent ones.

Before committing capital, follow these steps:

• Study the business thoroughly before buying, including how it works, what stimulates sales, profit pressures, and competition.
• Assess whether a company's current problem is a temporary operational setback or a permanent structural threat.
• Calculate the stock price divided by its sales per share, earnings per share, or book value per share.
• Compare this calculated number against competitors or relevant stock market indexes.
• Avoid purchasing stocks that return significantly higher ratios than their peers.

3. The Uncommon Common Sense of Global Investing

Limiting your investments to a single domestic market severely restricts your potential bargains. There are roughly 3,000 stocks available in the United States, but 20,000 stocks available worldwide.

You can dramatically expand your investment opportunities and reduce risk by searching worldwide for low P/E stocks.

John Templeton launched the Templeton Growth Fund in November 1954, expanding his search globally when foreign markets were largely misunderstood and underexploited. Moving beyond domestic borders widens and deepens the pool of potential bargains. Different countries experience varying outlooks, pessimism, and fear, creating pricing asymmetries.

Spreading assets across countries dilutes the pain of long waiting periods. An investment solely in the S&P 500 in 2002 yielded a return of -22.1 percent, whereas spreading money evenly across global markets generated -14.5 percent. When market sentiment changes, it happens very suddenly, and you miss out if you wait for confirmation.

John Templeton derived macroeconomic views from bottom-up analysis rather than top-down economic forecasting. He located concentrations of cheap individual stocks within specific countries instead of starting with forecasts of GDP or employment. His low P/E stock selections led him successfully into Japan in the 1960s, the United States in the 1980s, and South Korea in the late 1990s.

Foreign and emerging markets often lack available research coverage. You can exploit these informational gaps to find undervalued stocks that others avoid. In the mid-1980s, when reported numbers for the Mexican telephone company Telefonos de Mexico were unreliable, John Templeton counted the number of telephones in the country and multiplied it by the user rate to determine the company's true worth.

Valuation should be anchored by long-term earnings potential, seeking stocks trading at low multiples of estimated earnings five years into the future.

John Templeton often looked for stocks trading at no more than five times his estimate of earnings five years out. He occasionally paid only one to two times estimated earnings for the coming year.

To evaluate long-term results properly, follow these rules:

• Forecast long-term results over a five-year cycle encompassing good and bad economic times.
• Apply conservative assumptions, such as historical average net profit margins, unless permanent operational changes justify higher figures.

You must evaluate macro risks such as excessive government borrowing and socialistic policies that endanger currency stability. John Templeton avoided nationalized assets, citing examples like Venezuela under presidential asset nationalizations, the Asian financial crisis of 1997-1998, and Argentina in 2001.

To protect capital from currency and country risks, apply these criteria:

• Focus on companies with over 25 percent of their business performed in countries that export more goods than they import.
• Ensure the target country does not have government debts exceeding 25 percent of its annual gross national product.

4. The First to Spot the Rising Sun

You can uncover hidden value in neglected international markets by analyzing consolidated earnings and practicing comparison shopping.

Search for undervalued assets where negative public sentiment masks strong economic fundamentals.

In the early 1960s, Japanese stocks traded at a P/E ratio of 4x while US stocks traded around 19.5x, even though the Japanese economy was growing at 10 percent annually compared to 4 percent in the US. Japan experienced 10.5 percent annual GDP growth between 1961 and 1970, alongside a 26 percent annual growth rate in Japanese machinery exports from 1955 to 1968. The TOPIX Index experienced a 36 times increase from 80 on December 31, 1959, to 2,881 on December 31, 1989.

John Templeton invested his personal savings in Japan during the 1950s under strict capital controls, waiting until the early 1960s when Japan rescinded restrictions to deploy client funds.

Corporate structures can hide true value behind parent company accounting. Hitachi traded at a stated price/earnings ratio of 16x using only parent earnings, but the price/earnings ratio plummeted to 6x after consolidating subsidiary earnings.

Find superior long-term value by evaluating earnings growth relative to price.

Practice comparison shopping with these steps:

• Take the price/earnings ratio of a stock.
• Divide it by the long-term estimate of growth in earnings to find the PEG ratio.
• Compare the resulting PEG ratios to determine which company offers a better value for its future growth.

Templeton compared the Japanese supermarket chain Ito-Yokado (P/E of 10, estimated growth of 30 percent, PEG of 0.3) with the US supermarket Safeway (P/E of 8, estimated growth of 15 percent, PEG of 0.5), determining Ito-Yokado was a better bargain despite its higher P/E.

Sell holdings using strict replacement criteria to avoid emotional attachment. Apply this discipline:

• Search for a replacement stock that is undervalued by 50 percent or more relative to its estimated worth.
• Replace the current holding whose price has risen to or exceeded its estimated fair value with the newly discovered 50 percent undervalued share.

Templeton reduced his portfolio allocation in Japan from 60 percent down to less than 2 percent as valuations rose and story stocks became subject to the greater fool theorem.

5. The Death of Equities or the Birth of a Bull Market

You should recognize media declarations of an asset class dying as a bullish sign of maximum pessimism and low P/E valuations.

When the masses exit an asset class and declare its decline permanent, it signals that no sellers remain.

In August 1979, Business Week published a cover story titled 'The Death of Equities' just as pension funds won permission to abandon stocks for real estate, gold, and diamonds. Pundits during the late 1970s commodity boom claimed a new financial age had arrived. They insisted that only elderly investors unable to adjust were sticking with stocks.

In 1979, the Dow Jones Industrial Average hit an average P/E ratio of 6.8. That valuation compared to its long-term historical average of 14.2 going back to the 1920s. This meant the average P/E was 52 percent lower than its historical average.

Relying on a single valuation method causes you to feast or starve. An analyst must maintain numerous perspectives of value to cross-confirm findings.

In 1982, the standard price-to-book ratio for the Dow was 1.0. Asset replacement costs were 70 percent higher than stated book values due to inflation in the late 1970s and early 1980s. Adjusting asset values for inflation placed the true replacement cost ratio at 0.59. This made stocks 40 percent cheaper than casual observers realized, compared to the market crash low point in 1932 where the Dow price/book ratio was 0.79.

You should apply these steps for asset valuation:

• Calculate book value per share by dividing total assets minus total liabilities by shares outstanding.
• Divide stock price by book value per share to find the price/book ratio.
• Adjust asset values upward for inflation to calculate the real replacement value of the assets.

Competitors were willing to pay 50 percent to 100 percent above the market value of target stocks in corporate takeovers during the early 1980s. U.S. pension funds held about $600 billion at the time, with forecasts to reach $3 trillion over 12 years. These figures compared to an entire U.S. stock market value of $1.25 trillion in 1982.

You must also follow these practices for evaluating market signals:

• Spend nearly as much time researching a company's competitors as researching the company itself.
• Calculate enterprise value by taking equity market value plus total debt minus cash.
• Compare enterprise value to EBITDA to evaluate potential takeover costs against industry acquisition levels.

Appearing on Wall Street Week in 1982 when the Dow was in the low 800s, John Templeton forecasted that the Dow would reach 3,000 over the coming 10 years. This prediction materialized by 1991, driven by a long-term average corporate profit growth rate of 7 percent, an expected run rate of inflation of 6 to 7 percent, and a combined annual profit increase of 14 percent.

6. No Trouble to Short the Bubble

You must avoid speculative manias and short overpriced stocks by targeting IPO lockup expirations before bubbles burst.

Sir John Templeton noted that the four most expensive words in the English language are this time its different. Speculative manias consistently share common threads of human behavior, unbridled optimism, and the false assumption of uninterrupted straight-line growth across centuries.

In early 1999, John Templeton recalled townsfolk gathering in Winchester, Tennessee, to watch a house light up with electricity. He noted that while electricity changed the world, the time to get out of those stocks was many years before.

The British parliament made a deal with the South Sea Company to assume national debt in exchange for a trade monopoly in the Spanish Americas and a 6 percent perpetual dividend. Landlords sold ancestral estates, clergymen, philosophers, professors, widows, and ordinary citizens flung all their possessions into South Sea stock, driving the price to a peak of 460 before the crash while Sir Isaac Newton lost substantially.

Short selling is an extremely hazardous strategy because potential losses are unlimited while maximum possible gains are capped at 100 percent. The market can stay irrational longer than you can stay solvent.

You can manage these risks through deliberate steps:

• Establish a preset level at which you will decide to cut your losses and cover the short stock.
• Elect to take profits on a predetermined basis, such as when the stock price falls by a specific percentage or drops below a target P/E ratio.

Company executives and early investors are legally restricted from selling their shares for a six-month period following an IPO. By shorting stocks roughly 11 days before their lockup expiration, you can ride the heavy insider selling pressure that ultimately bursts the bubble.

You can execute this strategy with precise criteria:

• Research incoming technology or high-flying IPOs and identify when their six-month lockup periods expire.
• Focus short selling targets on stocks whose values have increased threefold over their initial offering price to maximize the incentive for insider cashing out.
• Place short positions approximately 11 days before the lockup period expires.

Sir John Templeton selected 84 technology stocks that had tripled in price, invested $2.2 million into each short position totaling $185 million, and profited immensely when the NASDAQ plummeted following its all-time high of 5,132 reached on March 10, 2000.

7. Crisis Equals Opportunity

Market panics driven by crises create the best opportunities for bargain hunters because fear causes aggressive, irrational selling. Panics compress all the ideal conditions for bargain hunting into a very short timeframe.

You can leverage market panics and crises by maintaining a pre-set wish list and open limit orders for deeply discounted stocks.

Following the September 11 terrorist attacks, panicked selling caused major indexes to drop sharply on September 17, 2001, with the Dow falling 7.1 percent.

Mr. Steady invested $100,000 in General Electric right before the 1987 crash and earned an 11.8 percent annualized return over 19 years, growing to $832,519. Ms. Wise bought during the Black Monday panic and earned a 13.0 percent annualized return, growing her $100,000 to $1,011,203.

To avoid second-guessing oneself during a chaotic market sell-off, you should decide on target valuation prices and place standing orders with brokers beforehand.

• Make your decision to buy when you are thinking clearly and your judgment is not affected by current events.
• Maintain your strict discipline of purchasing only stocks that you believe to be a bargain.

When a crisis threatens to cause a recession, you must examine balance sheets to ensure businesses can survive.

• Calculate the debt-to-equity ratio by dividing short-term debt plus long-term debt by shareholder's equity.
• Calculate the net-debt-to-equity ratio by taking total debt minus cash, divided by shareholder's equity.
• Calculate the EBITDA coverage ratio by dividing earnings before interest, taxes, and depreciation by interest expense.
• Calculate the total-debt-to-trailing-12-months EBITDA ratio by dividing total debt by EBITDA for the last 12 months.

Following the September 11 attacks, John Templeton placed limit orders on eight airline stocks to buy any that fell by 50 percent on September 17, 2001. Three orders filled for AMR, Continental, and US Airways, yielding returns of 61 percent, 72 percent, and 24 percent respectively within six months.

8. History Rhymes and When Bonds Are Not Boring

Severe currency crises and panics create extraordinary bargain-hunting opportunities in countries with strong long-term economic fundamentals. When the Asian financial crisis triggered currency devaluations and a stock market collapse in 1997, South Korea was hit hard by excessive leverage in its major conglomerates. Templeton recognized that South Korea's underlying economic trajectory mirrored Japan's post-WWII rise, characterized by high domestic savings and export-led industrialization. Despite widespread panic and an impending recession, he bought heavily depressed Korean stocks at the point of maximum pessimism.

You should exploit currency and debt crises abroad while deploying alternative assets like zero coupon bonds during stock market bubbles.

In January 1998, Templeton invested millions into the Matthews Korea Fund after its shares plummeted by 64 percent in 1997. By 1999, the fund achieved a staggering 267 to 278.5 percent return, transforming from the worst-performing U.S. fund into the top-performing market winner.

When equity markets reach extreme overvaluation during historic manias, high-grade long-term bonds serve as a superior alternative that provides capital protection and attractive fixed yields. In March 2000, just before the NASDAQ collapsed, Templeton publicly advised readers of Equities magazine to buy bonds, noting that the internet bubble was the biggest in history and that long-term zero coupon bonds were the best buy available.

A carry trade involves borrowing at a low interest rate and lending or investing the funds at a higher rate to pocket the spread. Templeton borrowed Japanese yen at 0.1 percent interest, purchased Canadian 30-year zero coupon bonds yielding 5.3 percent, and applied 2x leverage. This trade generated an 86.8 percent total return in U.S. dollars over a three-year bear market.

You can execute similar strategies by following specific steps:

• Locate fund managers who are like-minded and act as agents on your behalf.
• Investigate the methods and processes employed by fund managers rather than chasing recent performance.
• Examine holding periods to see if the manager waits patiently for returns over several years.
• Calculate the average P/E ratio of a mutual fund using its list of holdings if the manager claims to buy low P/E stocks.
• Use third-party research resources like Morningstar to study fund managers and follow up with direct questions.
• Secure low-cost borrowing in a currency with depressed interest rates such as the Japanese yen.
• Convert the borrowed funds into a stronger foreign currency with positive trade balances and small budget deficits.
• Purchase long-term risk-free zero coupon bonds from stable governments such as Canada, Australia, or New Zealand.
• Apply calculated leverage to multiply the yield spread while hedging against domestic currency depreciation.

10 Key Ideas

1. Cultivate radical thrift, emotional fortitude, and independent judgment away from financial herds to spot market bargains.
2. Buy out-of-favor stocks during maximum pessimism, treating volatility as an ally rather than an enemy.
3. Dramatically expand your investment opportunities and reduce risk by searching worldwide for low P/E stocks.
4. Search for undervalued assets where negative public sentiment masks strong economic fundamentals.
5. Recognize media declarations of an asset class dying as a bullish sign of maximum pessimism and low P/E valuations.
6. Avoid speculative manias and short overpriced stocks by targeting IPO lockup expirations before bubbles burst.
7. Leverage market panics and crises by maintaining a pre-set wish list and open limit orders for deeply discounted stocks.
8. Exploit currency and debt crises abroad while deploying alternative assets like zero coupon bonds during stock market bubbles.
9. Spot bargains by evaluating earnings growth relative to price using the PEG ratio to compare global alternatives.
10. Anchor valuation by long-term earnings potential, seeking stocks trading at low multiples of estimated earnings five years into the future.