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on July 24, 2004
I retired at 51 on my investments and have spent much of my time trying to counterbalance the instant-gratification claims of so many of those selling seminars and "help" to the investor.

While few people would be so foolish as to pay $40,000 for a Honda Civic despite that car's solid engineering, many will buy a stock with no concept of what its fair-market value may be. Of this number, some are subscribers to the Greater Fool School of investing. They'll happily overpay for a popular stock in the arrogant belief that they'll be able to unload it for a profit to some Greater Fool. Sometimes, they will indeed make a profit. (At other times, they'll make an excuse.) This book is not for them.

The rest overpay not because they subscribe to the Greater Fool school but because they simply have no idea of how to value a stock. THAT is where this book shines. It will make the investor more conscious of what a stock is worth -- thereby avoiding the payment of $40,000 for a Honda or (in some cases) the payment of $100,000 for a Yugo!

Will the identification of value stocks and the discipline of not overpaying for a stock guarantee a profit? On any given purchase, of course not. However, it is a fool's task to argue that conscious investing based upon some sense of a company's true value will not reward more of its practitioners than Greater Fool speculations will over time.

If you're a serious investor with at least the discipline and patience than you demand of your own children, following this book's counsel should help you to make more money with greater safety. It's more accessible than The Intelligent Investor and a must read both for the novice and for the experienced investor who would like to pick up some distinctions that will improve his or her performance.
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"The Five Rules for Successful Stock Investing" is a guide to value investing by Morningstar's Director of Stock Analysis Pat Dorsey and the folks at Morningstar, Inc. The book's goal is to educate investors in how to "find wonderful businesses and purchase them at reasonable prices." Its title is a little misleading in that the "Five Rules" are a small part of this book. The five principles to which the title refers are: 1. Do your homework, 2. Find companies with strong competitive advantages (or economic moats), 3. Have a margin of safety, 4. Hold for the long term, 5. Know when to sell. Those are vague principles, but most of this book is dedicated to telling you just what homework you need to do and exactly how to do it. Pat Dorsey and Morningstar are advocates of long-term investing who are skeptical of trading and portfolio churning, so this book's intended audience is value investors. No technical analysis here. This is all fundamental analysis, but traders may find the advice on analyzing company finances useful as well.

"The Five Rules for Successful Stock Investing" has 2 parts: Chapters 1-12 are a "how-to" for analyzing companies, their finances, and determining what their stock should be worth. Key points include how to evaluate a company's competitive advantages, what to look for in financial statements, analyzing a company's management, spotting financial chicanery, and how to determine a company's intrinsic value. This is all fairly complex, and there is math involved, but the book takes you through the process, with examples, explaining why and how every step of the way. Chapters 13-26 provide overviews of 13 industries, from banks to software to industrial materials, including information on what the industries do, how they make money, hallmarks of successful companies, and risks to look out for. Each of these chapters concludes with an "Investor's Checklist" for that sector to help you identify key factors when choosing a stock. "The Five Rules for Successful Stock Investing" is among the best books I've seen for learning how to pick apart financial statements, and it packs a great deal of advice on evaluating companies within their sectors into one concise and readable volume. Highly recommended to value investors.
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on October 7, 2005
Have been meaning to put in a good word for this book for a long time. It's a gem. I've read an embarrassingly large number of introductions to investing in equities and this is probably the best. Other books purport to tell you how to identify hot stocks; Dorsey shows how to value companies. This isn't just a matter of understanding PE ratios and other traditional metrics, which most books explain more or less adequately. Instead, it means analyzing balance sheets and cash flow and income statements. _Five Rules_ provides as reader-friendly an introduction to assessing a company's financial statements as I've come across, with plenty of real-world examples. The object in the end is to determine the present value of a company's future cash flows, and Dorsey's explanation of a simplified version of Fisher's and William's discounted cash flow model is lucid and lively. Clorox is the company evaluated in this chapter, and en route there are instructive comparisons of HP and Dell, Best Buy and Circuit City, and, finally, AMD and Biomet. Chapter 8, Avoiding Financial Fakery, is particularly helpful. Obviously, having read this book and nothing else, you're not going to be able to spot something fishy in the footnotes to Microsoft's income statement that has escaped the attention of all the analysts. But for someone without a background in accounting, _Five Rules_ is a godsend.

Dorsey then conducts a very informative tour d'horizon of 13 industries. It should go without saying that before you invest in a company, you'd want to find out something about the economics of its industry, so you can compare apples with apples. The chapter on health care is especially good, but I found them all excellent.

In an Ameritrade ad that aired this week, a teenager asks her dad for $80 for a pair of jeans. The dad is nonplused, but the girl assures him that everyone is buying these jeans. He asks her who the manufacturer is, promptly logs onto Ameritrade, checks a chart, and buys the company's stock. The guy then gives his daughter the $80, a reward for the hot tip, presumably. He might do OK this time, but you have to figure he'd be a lot better off in the long run investing a fraction of that $80 in _Five Rules_.

Bottom line: there are a ton of books on trading strategies, but if you're looking for a practical book on value investing, this is the best.
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on June 16, 2004
There are many books on financial statement analysis, and I've bought most of them...being a liberal arts major who is working toward an MBA in Finance, I've found mastering ratios and concepts related to reading company annual reports frustrating and challeging: my brain seemed not to be wired to be competent in this subject matter. However, I find Pat Dorsey's treatment effective in that he uses the concepts in a less intimidating context than other books might, without watering down the content. Can someone read this book and decipher GE's annual statement to the last footnote? Not hardly. It is often said that it's knowing the essential 20% of a subject that is responsible for 80% of one's success, and this book fills this role in understanding that 20%. Further, the chapters breaking out how to modify analyis of different sectors and industries in the market is also helpful to avoid comparing apples to oranges when evaluating stocks and companies. Beyond this book, the next step up from this would be "Analysis for Financial Management" by Higgins.
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on July 10, 2012
Morningstar's guide is an excellent reference tool for any beginner investor. In detail, he explains financial statements and what to look for as a value investor. One section takes a step-by-step analysis of each sector of the market: typical breakdown of the businesses, trends & comparables, and what to look for in the sector. This book is dense with relevant information!

My only critism is that the book is out of date I.e. written in 2004. The reason it is an issue is because the analysis of financials, technology, and housing have a pre-resession vibe that is disconnected with current views on the sectors. However, the vast majority of the book is timeless, and an excellent guide for understanding corporations in the context of their sectors.
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The best investing principles, as clearly reiterated here, are stable and evergreen. As an investor, you'll welcome author Pat Dorsey's unambiguous, straightforward presentation of the always valid wisdom of the markets. This conveniently organized book offers several chapters of general relevance to investors in all markets and industries, including an industry-by-industry examination of the determinants of value. The title is cute, but the content isn't about the title's rules - it is about learning and obeying the basics of stock investing. We recommend the author's long term perspective. Many of the directions he sets for potential investments could still be valid years hence.
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on January 12, 2013
When I think of Morningstar I picture something similar to Moody's or Standard & Poor's, a correct, slow and slightly bureaucratic organization. This book gives a totally different insight. It takes a clear stance for the Warren Buffett "buy wonderful businesses at reasonable prices"-type of value investing (as opposed to the "Graham low multiple, cigar butt"-type). It's clear that the author Pat Dorsey, Director of Stock Analysis for Morningstar, but also Joe Mansueto the founder of the same firm, are great admirers of Mr Buffett.

If you choose this type of franchise investment you also per necessity have to focus your research effort on finding that wonderful business and securing that it stays that way. This is what Dorsey tries to do through this book's five rules. In short they are:
1. Do your homework - engage in the fundamental bottom-up analysis that has been the hallmark of most successful investors, but that has been less profitable the last few risk-on-risk-off-years.
2. Find economic moats - unravel the sustainable competitive advantages that hinder competitors to catch up and force a reversal to the mean of the wonderful business.
3. Have a margin of safety - to have the discipline to only buy the great company if its stock sells for less than its estimated worth.
4. Hold for the long haul - minimize trading costs and taxes and instead have the money to compound over time. And yet...
5. Know when to sell - if you have made a mistake in the estimation of value (and there is no margin of safety), if fundamentals deteriorates so that value is less than you estimated (no margins of safety), the stock rises above its intrinsic value (no margin of safety) or you have found a stock with a larger margin of safety.

After stating the rules Dorsey goes on to present a number of chapters to complement them. Topics like commonly made mistakes, descriptions of various types of economic moats, financial expressions, accounting, analysing companies and their management, how to avoid financial tricksters and valuation. I like the chapter on moats and there are a number of nuggets like "the bottom line about financial health is that when a company increases its debt, it increases its fixed cost as a percentage of total costs." That's why high financial and operational gearing combined with volatile sales is such a potential corporate killer.

Yet this is only half of the book. The second half is a one after another review of the economic characteristics of various corporate sectors. As this book is written about 10 years ago it's interesting to see which sectors that have changed the most during these years. Care to guess? Financials - naturally - but also media. Ten years ago we hadn't started to understand the effect that digitalization and Internet would come to have.

It's really hard to grade this book. It gives a sound, comprehensive and logically consistent investment strategy. But, this is a book for the retail investor. It will take the novel investor a long way, but as the book is so comprehensive the coverage of each topic is quite shallow. If you have some investment experience you will learn very little.

A practice where you buy undervalued stocks that you can own long term will serve the right person well if you got the stomach to stand the short term movement of markets. Above all this book reinforces the importance of being able to articulate ones investment strategy. If not, it's very easy to get frustrated when the markets move against you, this will make you move outside your core competence and will unavoidably lead to trouble. This book gets you started.

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on November 30, 2004
This book is the best book on fundamental investing that I have ever read. It is clear, concise and filled with simply stated useful information. For anyone interested in value investing this is a perfect place to start. Financial information is demystified, and the worth and usefulness of each financial statement is explained methodically and completely enabling any investor to analyse a company in a logical and competent manner. Financial ratios and the importance of each is covered.

Additionally, and unusually, a number of industries are discussed, giving the salient factors to consider in each.

There is also an excellent bibliography for additional reading.

All in all, this is a superb book.
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on February 15, 2016
Where do you start when you want to begin learning about securities and stock investing? This book.

I've read and studied this book for about 2 or 3-months now and I gotta say that I've learned so much from it. I'm fairly new to securities investing and this book gives a great start for beginners and I'm sure helps sharpen the whits of seasoned professionals.

It touches base on how to analyze different companies based on different industries; different KPIs based on the financial statements; how to analyze companies in general; and more! Not every company is the same and there are many indicators of strong companies and weak companies. These indicators also vary by industry and time has proven that there is not any one indicator that proves a company is better than another - you must fully research each company before making a purchasing decision.

I've recommended this book to some friends of mine and would highly suggest anyone to give this book a shot. Plenty of information in this that will keep me busy for the next year or so.
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on October 31, 2011
I was quite eager to read Dorsey's book on analyzing stocks. Since this was the guy who founded the well known website I thought he would know a great deal on analyzing companies. I wasn't disappointed while reading his book.

The first chapters of the book were not really useful for readers already familiar with fundamental analysis. Further in the book he tells how to valuate companies on well known ratio's such as P/E, P/B, P/S, and were you have to be careful about for each company. Later on he starts on explaining the ROA, with a very helpful distinction between Sales turnover en Net Margin (for the real fans: he uses the Dupont formula to make this split). Then we get some examples on how to interpret this ROA over a certain number of years, before he makes the link to ROE and how to interpret that.

There is also a full chapter on how to calculate the price we should pay for a stock, based on a the present value of the expected free cash flows in the future. This might be helpful for some investors, and academics also like to put a lot of value to these FCF models, but I'm not that big a fan of them. These calculations assume you can make estimations for the next 10 years, and more dangerously you have to make an estimation of each growth and discount rate. The final present value you get by this calculation is very sensitive to mistakes you make in the parameters. I prefer to use the approach presented in Graham his classic book: The Intelligent Investor. He offers a simpler more robust approach (imo).

Also helpful was the chapter on analyzing a companies management. Although most value investors agree the management of a company is of huge importance for the future of the company, you don't find a lot of information in most of the financial literature. Dorsey gives us here a full chapter and how to do this in a practical way.

The real meat of the book still comes after this information, though. He gives a full overview of the most known stock industries (especially the one on banks was useful for me with the low prices bank stocks are selling at these days). These chapters are concluded with Checklists for each investor to make sure the stock were analyzing has good fundamentals. Really nice, these checklists.

In short: recommended!
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