The Motley Fool

How to Pick Steady Winning Investments

The name John Neff might not ring a bell, but he is actually one of the true greats in the investment business.

Neff cemented his place in investing folklore while managing the U.S.-based Windsor fund from 1964 to 1995. In those 31 years, each dollar invested in his fund would have become $56, handily outpacing the return of the S&P 500 (a U.S. market index) by two-to-one.

With Neff’s sterling track record, we may want to learn from his investment approach. To do that, we can turn to Neff’s book John Neff on Investing, where he laid out seven principal elements of his investing style.

I’ve looked at Neff’s first principle – fishing in the low price to earnings (PE) ratio pond – in a previous article and today, we’ll look at his second principle: Fundamental growth in excess of seven percent.

Not too hot, not too cold

“Candidates for investments were required to show sturdy track records. Except for cyclical companies that had peaks and troughs, we preferred persistent increments of quarterly earnings. Looking ahead, we sought evidence of reasonable and sustainable growth rates poised to catch investor’s attention in a sober marketplace. Growth rates less than six percent or exceeding 20 percent seldom make the cut. Higher growth rates entailed too much risk for our appetite.”

— John Neff

For Neff, an earnings per share growth rate of between seven percent and 20 percent represents a sweet spot for the kind of company that he prefers. Furthermore, Neff would look at the five year historical growth rate for the company as a sign of the sustainability of the firm’s future growth.

A Singapore-listed firm which hits that growth sweet-spot would be Dairy Farm International Holdings Ltd  (SGX: D01), which has grown its earnings per share by about 7% annually from 2009 to 2014. During that span of time, the pan-Asian retailer (Dairy Farm runs hypermarkets, supermarkets, convenience stores and a variety of other types of stores) had increased its overall outlet count from 5,071 in 2009 to 6,101 in 2014. With an expanding retail landscape in Asia, Dairy Farm arguably has room to run.

But, it should be noted that Dairy Farm’s current trailing PE ratio of 24 would exceed Neff’s criteria of a low PE ratio. It is important to remember that Neff seeks a combination of low expectations in the form of a low PE ratio (his first principle) and sustainable growth (his second principle).

The key to Neff’s second principle can also be found in his careful choice of words: “reasonable” and “sustainable.” A solid historical earnings growth rate alone is not a good reason to invest in a share; all it does is to give a starting point for us to examine the possibility of that growth rate being sustainable in the future.

Foolish takeaway

In my first article on the principal elements of Neff’s investment style, I wrote about where Neff likes to fish: The low PE ratio pond. Within this low PE pond, we now see that Neff prefers a particular type of fish – one that is growing its earnings at a rate of between seven percent and 20 percent. In other words, the stock’s growth must be not too hot and not too cold.

There is more to Neff’s approach than just fishing for a low PE stock with steady growth rates. Like I mentioned earlier, he had another five more principles.

This will be covered in the next few articles. Stay tuned for more on John Neff.

For more (free!) investing tips and tricks and to keep up to date on the latest financial and stock market news, sign up now for a FREE subscription to The Motley Fool's weekly investing newsletter, Take Stock SingaporeIt will teach you how you can grow your wealth in the years ahead.

Also, like us on Facebook to follow our latest hot articles.

The Motley Fool's purpose is to help the world invest, better.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong owns shares in Dairy Farm International Holdings Ltd.