John Neff is a life-long contrarian, proving time-and-again over the past three decades that bucking the system can pay off big. During his illustrious career as a money manager, Neff flew in the face of conventional wisdom by consistently passing over the big growth stocks of the moment, in favor of inexpensive, under performing ones-and he usually won. During his thirty-one years as portfolio manager for Vanguard's Windsor and Gemini II Funds, he beat the market twenty-two times, through every imaginable stock market climate, while posting a 57-fold increase in an initial stake. When Windsor closed its doors to new investors in 1986, it was the largest mutual fund in the United States. Now retired from mutual fund management, Neff is finally ready to share the investment strategies that earned him international recognition as the "investor's investor", and made him the one to whom other money managers come to manage their money. In John Neff on Investing, Neff delineates, for the first time, the principles of his phenomenally successful low p/e approach to investing, and he describes the strategies, techniques, and investment decisions that earned him a place alongside Warren Buffett and Peter Lynch in the pantheon of modern investment wizards. Packed with solid advice and guidance for anyone who aspires to using Neff's unique brand of value investing, John Neff on Investing offers invaluable lessons on using price-earnings ratios as a yardstick, to zeroing in on undervalued stocks, interpreting earnings histories and anticipating new market climates. A narrative of Neff's early days-My Road to Windsor-reveals the extraordinary mindset and humble circumstances that shaped his winning investment philosophy. By reproducing excerpts from his personal investment diaries, this book offers a unique opportunity to watch Neff in action over the years. A faithful, quarter-in-quarter-out chronicle of a life on Wall Street, the diaries provide unprecedented insights into the thinking behind some of his best (and worst) investment decisions, while tracing the evolution of his innovative investment style. The first book to fully reveal the long-heralded investment strategies of a Wall Street genius, John Neff on Investing is must reading for investors, brokers, traders, and bankers of every kind. JOHN NEFF, until his retirement in 1995, was Senior Vice President and Managing Partner of the Wellington Management Company, the Windsor Fund's investment advisor. S.L. MINTZ, is New York Bureau Chief of CFO Magazine, a publication of the Economist Group dedicated to the latest financial thinking and how it is being implemented in today's markets. His other books include Beyond Wall Street (Wiley, 1998) and Five Eminent Contrarians.

JOHN NEFF, until his retirement in 1995, was Senior Vice President and Managing Partner of the Wellington Management Company, the Windsor Fund's investment advisor.<br> <br> S. L. MINTZ is New York Bureau Chief of CFO magazine, a publication of the Economist Group dedicated to the latest financial thinking and how it is being implemented in today's markets. His other books include Beyond Wall Street (Wiley, 1998) and Five Eminent Contrarians.

Foreword

xi

Preface

xv

Prologue: Citi Saga

1

(6)

PART ONE MY ROAD TO WINDSOR

Journey East

7

(6)

Grubbing It Out

13

(8)

Basic Training

21

(10)

Banker's Hours

31

(10)

Baptism by Fire

41

(8)

Taking Command at Windsor

49

(12)

PART TWO ENDURING PRINCIPLES

Elements of Style

61

(22)

The Bargain Basement

83

(14)

Care and Maintenance of a Low P/E Portfolio

97

(26)

PART THREE A MARKET JOURNAL

The Silly Season

123

(26)

Four Yards and a Cloud of Dust

149

(26)

The Right Stuff

175

(28)

Good Guys Persevere

203

(26)

Deja Vu

229

(8)

Epilogue: Rivers and Markets

237

(6)

Appendixes

243

(14)

Index

257

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Chapter One

Journey East

A freezing morning, in early January 1955, marked the start of my investment career. Picture a 23-year-old ex-sailor and newly minted college graduate at the Toledo entrance ramp to the just-completed Ohio Turnpike, thumbing a ride to New York City. This uncelebrated debut sounds strange nowadays to legions of job candidates seeking prestige and lavish signing bonuses right out of school. No one offered to pay for a bus ticket, much less airfare and a fancy hotel. I set out with an overnight satchel, a snack, and twenty dollars in my pocket. Hitching was the only way I could afford to get to New York in time for a series of job interviews the following day.

Maybe I looked unthreatening to drivers in those early days of interstate highways. Cars were somewhat less plentiful, and crime was considerably less on drivers' minds. For whatever reasons, hitchhikers enjoyed more sympathy. I didn't wait long before getting on my way. I don't remember much about the conversation, but, given the Ohio-to-New York route, there naturally were a few comments about the 1954 World Series. The then New York Giants had swept the Cleveland Indians in four games. As a lifelong Detroit Tigers fan, I kept the loss in perspective.

I knew more about baseball than about investing. The meager extent of my accumulated market wisdom at that time came from a couple of college classes on the subject. I was neither prepared nor inclined to preach the merits of investing, which probably was just as well. In those days, for most Americans, October 1929 and the Great Depression still chilled impressions of the stock market. The Dow Jones Industrial Average had finally returned to its 1929 highs--after twenty-six years. When asked about my purpose, I just said I was going to New York to look for a job.

For a portion of the long stretch across Pennsylvania, I rode with a former journalist-turned-truck driver who had spent time in South Texas, near Corpus Christi, where I'd gone to high school. We were both exiles, in a sense, although my exile was self-imposed. He blamed his departure on a run-in with a Texas political boss named George Parr, a man credited with unearthing votes that helped sway the Lyndon Johnson ninety-four-vote election majority against Coke Stevenson in the 1948 U.S. Senate race. That contest was so close that a few hundred votes the other way might have changed the course of Presidential history. As it turned out, pundits tagged the future President with a cynical moniker that stuck: Landslide Lyndon.

After 16 hours and 600 miles, my fifth ride left me at a truck depot in Jersey City close to midnight. My triumphant arrival in the Big Apple required a long dark walk and public transportation, and only the night desk clerk greeted me when I checked into the 34th Street YMCA. The accommodations lacked the charm of the Y in Grand Rapids, Michigan, where I'd lived after high school while working two jobs at a time, but I had made it to New York, more or less on time. I only needed enough sleep to stay sharp through the four job interviews I'd lined up for the following day.

Bombshells and Ticker Tapes

New skyscrapers have altered the financial district, and the Information Age has transformed the floor of the New York Stock Exchange since my job search in early 1955, but the intersection of Wall and Broad looks much the same as it did then. The Exchange still dominates one corner; across from it sits Federal Hall, where George Washington swore the first Presidential oath of office. The third imposing building houses the bank that J. Pierpont Morgan built. Its façade still bears the scars left by an anarchist's bomb that rocked Wall Street one busy Thursday in September 1920.

A subtler but more far-reaching explosion has shaken Wall Street since I embarked on an investment career. For nearly a decade after the Second World War, Wall Street was a sleepy and antiquated business. Negotiated commissions were undreamed of, as were electronic trading accounts that allow individual investors to buy and sell stock in an instant. Stocks changed hands only through orders submitted by cadres of male stockbrokers acting on behalf of wealthy individuals, families, and a few trust departments. Indeed, many of the brokers were members of wealthy families or were connected to them in some way. Barred from owning common stocks by conservative rules enacted in the wake of the 1929 Crash, most pension funds and other institutional investors stuck mainly to bonds and the safest stocks. There was no mutual fund industry to speak of.

Few people had a television set, much less home computers and CNBC with instant access to prices and trading volume. To keep tabs on the stock market in 1955, investors relied on genuine ticker tapes. More often than not, the tapes moved haltingly; they printed out ten characters, then stopped, then printed out ten more characters. At this pace, tapes routinely fell behind trading activity, even though volume seldom exceeded 5 million shares a day--as many shares as might be traded in a single hot or not so hot stock these days. Orders to buy or sell stocks were noted by hand on slips of paper. Pneumatic tubes carried the slips to back rooms for fulfillment. To show price changes on the Exchange floor, reporters adjusted serrated dials fixed to a post. When orders flew, keeping up was a challenge. Off the Exchange, most brokerage firms employed "chalkers" or "posters" who erased the old quotes and chalked in new ones when they changed.

The mighty investment banks of today were not household names outside New York's financial district. To those in the know, so-called "wire houses" dominated Wall Street. These houses had offices in other cities, and they transmitted their buy and sell orders by wire. Merrill Lynch was the largest wire house, and its recommendations always had an impact. If Merrill commanded its troops to advise customers to buy Penn Central Railroad, orders for a half-million shares nearly swamped back-office capacity. In the hinterlands, such as Toledo and Cleveland, strong independently run regional brokerage houses dominated whatever action ensued.

In retrospect, I'd say that my decision to go to Wall Street mirrors the investment philosophy that ultimately served me well during my whole career. The investment business was undervalued and out of favor in 1955. The best and the brightest job seekers usually headed for great companies like Ford Motor or General Electric, in hopes of becoming captains of industry some day.

I entertained no such ambition. Instead, an article in Barron's guided me to training programs at four national stockbrokerage firms: Merrill Lynch, Blyth & Co., Smith Barney, and Bache & Co. Besides my own confidence in my prospects as a stockbroker, I carried an introduction from a finance professor who had persuaded me to consider an investment career. Had it not been for Professor Sidney Robbins, I would have presumed that success in the investment business required a personal fortune and an Ivy League diploma.

An Auspicious Beginning

I chose an exciting time to launch an investment career. Notwithstanding a tarnished reputation, stocks were starting to recover their luster. Confidence in the growth prospects for such leading stocks as Union Carbide, Dow Chemical, Minnesota Mining & Manufacturing, and Eastman Kodak, propelled their prices to record highs. Restored faith in the soundness of common stocks encouraged investors to surrender sure income for the chance of collecting capital gains, not to mention significant dividend income as well.

The economy was strong and prices were stable as the postwar era took shape. In the year just ended, the U.S. gross national product came in just shy of $400 billion, a new high. As an indication of prosperity, golfers flocked to links in record numbers. According to U.S. golf statistics for 1954, 3.8 million golfers played on approximately 5,000 courses spread over 1.5 million acres. The fourth year in the second half of the 20th century also marked a sixth year in a row without significant price increases. Economists noted the contrast with a 44 percent price decline in the aftermath of World War I. All signs were positive. Shipments of every commodity were strong, and The Wall Street Journal reported, on January 3, corporate executives were planning to expand plants on the strength of optimistic forecasts.

Reflecting these encouraging signs, the first day of trading in 1955 pushed the Dow Jones Industrial Average to 408.89, a new record. Bethlehem Steel, Chrysler, General Motors, Eastman Kodak, and Standard Oil of New Jersey all advanced on January 3. Five million shares changed hands--a mere trickle by today's standards, but, in 1955, the highest volume in almost five years. DuPont jumped 4 points, to 171 1/2. As I reached New York, enthusiasm abounded.

My round of interviews posed no insurmountable hurdles. A two-year hitch in the Navy, a couple of finance courses, and experience as a shoe salesman at a leading men's clothing store in Toledo, Ohio, supplied sufficient preparation, I thought. At each stop, I sat through batteries of tests and interviews aimed, presumably, at learning whether I had the right stuff. I was not intimidated, insulted, or overwhelmed. Afterward, I thought I had done fairly well. I didn't wait around, though, for gilded invitations. Before I learned what impressions I had made in New York, I headed back toward home to interview for a position at the National City Bank of Cleveland. For a more pleasant trip and to make sure I arrived on time, I treated myself to a Greyhound bus ticket. A group of truck drivers on board sang all night long.

I was not a big hit in New York. Instead of extending job offers, Merrill Lynch and Blyth turned me down flat. Smith Barney invited me back for more tests and interviews. Concluding that my voice lacked the requisite authority, Bache offered to consider me for a securities analyst position instead of a stockbroker. Bache's offer did not sit well with me at first, but eventually I realized I was better suited to securities analysis and portfolio management than to pushing stock for a living. Stockbrokers make a good living, if they do things right, but they spend most of their time handholding and less of it plying their trade. Stockbrokers' routine can become stultifying and controlled, and I need to be intrigued. And if I was going to become a securities analyst, Cleveland was just fine with me--and with Lilli, my wife of four months, who had lived in Toledo all her life. I agreed to join the bank.

Whether it was recompense for my chilly reception or not, I can't say. But Wall Street suffered a stiff comeuppance right after I departed for Cleveland. On January 6, a Thursday, following the Federal Reserve's decision to raise margin requirements on stock purchases from 50 percent to 60 percent of the purchase price, the Dow Jones Industrial Average slid 2.2 percent. It was the worst drubbing of shareholders since the outbreak of the Korean War five years earlier, The Wall Street Journal reported the next day. And matters got worse before bottoming out on January 14.

Although these events formed a backdrop to my debut as a professional investor, I scarcely noticed them at the time. My considered opinions and a coherent strategy--and, some might say, a measure of arrogant self-confidence--still lay ahead of me.