FOOL SCHOOL
Stock Market Greats - Sir John Templeton

October 7, 2005

"The time of maximum pessimism is the best time to buy"

So said Sir John Templeton, the legendary stock picker who became the first to spot the potential of 'emerging markets'. Having seen it all, done it all, long-term investors can always find solace with Sir John and his contrarian beliefs, especially at the present time when the markets are filled with gloom and doom.

At 92 years of age, Sir John's efforts are now largely devoted to philanthropy and the funding of various scientific studies and theological pursuits. Yet he remains an investor whose record and thoughts have survived the test of time. Anybody who'd invested $10,000 in the Templeton Growth fund at its inception in 1954 would have seen it turn into $4m by 1992, at which point Sir John sold his investment business to Franklin for $440m.

Common sense

How did Templeton invest so successfully? When asked once about where and when to invest, he responded: "I would look around for opportunities and be open minded. Try to look widely, especially where others are not looking... Common sense tells you that there is only one thing that allows a share to go down to a very low level and that is other people selling. There is absolutely no other influence. So if you want to buy shares when they are depressed, you look for a point when everybody is trying to sell.... Where in the world are people extremely pessimistic, then if there is a change, you can make a lot of money...I would spend some time asking myself which industry, which nation is almost everyone trying to get out of."

Templeton's first break came just after the Second World War had started in 1939. He gave this order to his broker: "I want you to buy me a hundred dollars' worth of every single stock on both major [US] exchanges that is selling for no more than one dollar a share."

Templeton ended up with 104 companies, of which 34 were bankrupt. However, after holding each for an average of four years, he registered a profit on all but four of the shares and made about five times his money. This passage from the book The Money Masters outlines Templeton's conviction:

"A singular aspect of this transaction was that Templeton didn't have the $10,000 in cash. He was convinced stocks were dirt cheap, and that of them all, the neglected cats and dogs selling for less than $1 were the best value. When the [Second World] War started, he reasoned that, if anything, [it] was going to pull America out of its economic slump, and virtually all stocks would rise. So he went to his boss and borrowed the entire amount".

Turning Japanese

Templeton's status as pioneer of international investing came in the early 1960s, by which time he had started his own investment management business. He turned his attention to Japan, at a time when the country's economy was reeling and the phrase 'made in Japan' was considered a joke.

Templeton noted many Japanese shares were selling on price to earnings (P/E) ratios as low as 3, and bet 60% of his fund's assets on growth firms such as Hitachi and Fuji Film. In fact, when Templeton started buying, the whole Japanese market was worth less than IBM (NYSE: IBM), then seen by his contemporaries as a 'safe blue chip' on a P/E of 33.

When market exuberance eventually took hold in Japan during the 1980s, Templeton cashed in a Far Eastern fortune. Indeed, during the early 1980s, he'd become interested in the US. During an interview with Newsmax, Templeton recalled his optimism for shares during what was quite a pessimistic time for the markets: "I was invited to appear on Louis Rukeyser's programme in 1982 when the Dow Jones was below 1,000. I said chances were good that within 10 years the Dow Jones might march above 3,000..."

Even though he no longer runs an investment business, Templeton still keeps an eye on the markets. In May 2001, an article in Business Week revealed Templeton had made $86m by shorting 84 Nasdaq shares at an average $2.2m per position. Needless to say, Templeton felt 'new economy' dotcoms had reached absurd valuations but, significantly, had commenced his trades in the first quarter of 2000 when the shares were still on the up.

And the latest Templeton market prediction (made in 2001)? "Before this century is over, the Dow Jones Industrial Average will probably be over one million versus around 10,000 now. So for the long term, the outlook is tremendously bullish if you buy stocks blindly to keep for a century."

Maxims

Templeton boiled down his philosophy into ten maxims, which are still followed today by the fund managers at Franklin Templeton:

1. Invest for real returns.
The true objective for any long-term investor is maximum total real return after taxes.

2. Keep an open mind.
Never adopt permanently any type of asset or any selection method. Try to stay flexible, open minded and sceptical. Long-term top results are achieved only by changing from popular to unpopular the types of securities you favour and your methods of selection.

3. Never follow the crowd.
If you buy the same securities as other people, you will have the same results as other people. It is impossible to produce a superior performance unless you do something different from the majority. To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude and pays the greatest reward.

4. Everything changes.
Bear markets have always been temporary. And so have bull markets. Share prices usually turn upward from one to twelve months before the bottom of the business cycle and vice versa. If a particular industry or type of security becomes popular with investors, that popularity will always prove temporary and, when lost, may not return for many years.

5. Avoid the popular.
When any method for selecting stocks becomes popular, then switch to unpopular methods. Too many investors can spoil any share selection method or any market timing formula.

6. Learn from your mistakes.
"This time is different" are among the most costly four words in market history.

7. Buy during times of pessimism.
Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

8. Hunt for value and bargains.
Too many investors focus on outlook and trend. Therefore, more profit is made by focusing on value. In the stock market the only way to get a bargain is to buy what most investors are selling.

9. Search worldwide.
To avoid having all your eggs in the wrong basket at the wrong time, every investor should diversify. If you search worldwide, you will find more bargains and better bargains than by studying only one nation. You also gain the safety of diversification.

10. No-one knows everything.
An investor who has all the answers doesn't even understand the questions.

(What's not clear though is whether Franklin fund managers continue Templeton's tradition of starting annual meetings with a prayer. Templeton once explained the words were not pleas for divine market intervention, but meditations to calm and clear the minds of managers and shareholders!)