TIP747: John Neff: The Value Investor Who Quietly CRUSHED the S&P 500 w/ Kyle Grieve

24:15So in terms of fundamentals, John looked at a few things. The first thing was that he demanded some sales growth, even if a company was improving margins and therefore improving earnings. At some point, margins can't expand anymore and sales are actually vital to growing those earnings. The second one was to look at cash flow. John's definition of cash flow was retained earnings plus depreciation. Many businesses would have experienced depressed cash flows due to the nature of their operations and incurred larger depreciation expenses which can mask the actual cash flow of a company. And third was return on equity.

24:47He liked it because it showed how skilled management was at delivering returns to the owners of a company's equity. And fourth was margins. He mentioned operating and pre-tax margins, and he used this to help ensure that a business had resilient earning streams. So the next chapter I want to look at is titled The Bargain Basement. And I think it's aptly named, as that is where John really played his entire game. The beautiful part about investing in the bargain basement is that it's not hard to find new opportunities. Today, we can look at apps to find stocks trading at 52-week lows. Now, in John's day, he would have to look at things like public stock tables.

25:24John writes, In the course of my career, few days have passed when the new low list has not included one or two solid companies worth investigating. The goal is to find earnings growth capable of capturing the market's attention once the climate shifts. Now, it's vital to understand that the 52-week low list isn't some giant gold mine. Many of the stocks are at the bottom of the basement because they deserve to be down there. Maybe, you know, earnings have gone negative. Maybe they've lost a large contract. Maybe their IP is becoming public domain. Or maybe they just can't service their debt. These are all pretty bad situations for a business to be in.

26:00But if you look close enough, there may be a handful of companies that don't quite belong there. Those are the ones that you want because those businesses can really turn on a dime once the market understands that things maybe aren't as bleak as what's embedded in the stock price. For many of the examples that John gave in the book, that was what he was looking for, you know, 50 to 200 % returns over a reasonable period of time. Many of these names were boring, misunderstood, and cheap. He'd made his returns based on increases in earnings and accompanying multiple expansion. Neff used what he called the test to see whether a stock was worth looking into when it was down big.

26:38So if there was a big name down big that he was aware of, he might use his total return ratio to see if the business was offering unacceptable upside. Outside of looking at things like 52-week low list, he also just read a lot. Like all good investors, reading opens up just so many opportunities. And similar to someone like a John Templeton or a Warren Buffett, the news would often signal the market's perception of the market as a whole. Neff gives an example here in 1991, when Windsor was featured in Forbes under a story called Tarnished Glory. A few months later, signaling a rebound in the market, another story was written called Stock Picker Returns to Success.

27:16Now, in the 1980s, Neff observed the gloom around the property and casualty insurance industry. So one company that had come on Windsor's radar was called Signacorp. Regarding the industry, nearly every analyst on Wall Street predicted high liabilities in the range of half a trillion dollars. Neff adds, Wall Street's propensity for groupthink fans these dire expectations. Too many sell-side analysts whisper in each other's ears, and few want to stick his or her neck out too far. There's not much of a reason to be a hero if being wrong can cost you your job. You can sum up the street psychology this way.

27:53Hope for the best, expect the worst. Meantime, don't stick your neck out. Now, Cigna had some exposure to this area, but it wasn't the entire business. One of the best parts of the business was its managed care operations. Neff didn't really elaborate on what the segment was, but from some of the research that I did, it appears to be an insurance on services such as medical, dental, and behavioral health, vision, pharmacy, and supplemental benefits. So even with the environmental liabilities looming over Cigna, it didn't actually affect the profits of this part of the business. So Windsor bought shares, and as the environmental consequences abated, Cygnus' share advanced about 54%, while other insurers gained about 45 % on average.

28:37And John noted at this time, the S &P 500 logged about a 29 % gain. So one thing I liked about Neff was that even though he enjoyed his single-digit PE types, he would stray outside that range if the right opportunity arose. Even a high growth company that was hit hard by the market can still present a very good opportunity. One such example was Home Depot. In 1985, Neff found this business trading at a high P.E. by his standards of 20 times earnings. But in his modeling looking forward to 1986, the business was trading at only 10 times normalized earnings. So for a business at the beginning of its growth phase, that's simply incredibly cheap on a forward basis.

29:18He noted that the business had gone from about 22 to 50 stores in 1985, and that the costs involved with opening that many new locations had momentarily depressed normalized earnings. After only 9 months, they were up 63 % on their Home Depot investment. One of my favorite John Neffisms is what he calls the silly season. So this occurred at times when the market was selling at exorbitant prices. In John's case, this would be the time when he would just sell some of his winners to increase his cash position. When it wasn't silly season, John was off and buying. And he enjoyed quality stocks about as much as I do.

29:54One quality cyclical that he liked was Gulf Oil back in 1978. So Gulf Oil was undergoing an improvement in its quality as it was increasing its concentration of revenue from US and Canada. So in 1973, earnings from North America were just about 30%. By 1978, they moved up to 85%. So Gulf had been involved in some litigation, and John had a view that they would eventually prevail. While he waited, the business paid a beautiful 8 % yield and was trading at only 5.8 times earnings. He ended up selling over the next two years, posting returns between 42 % and 86%. One category of companies that Windsor Fund liked to look at was those that were miscategorized.

30:35So I like this investment category because you can really find some exceptionally high-quality businesses that are just often overlooked. One of my favorite examples of this is a business that I own called TerraVest Industries. I started researching the business in Q1 of 2024. After speaking with some great investors who had passed on it, I realized that investors were looking at the business the wrong way. If you look at their ticker on Yahoo Finance, they are categorized as an oil and gas equipment and services company. Now, while that is technically true, when you dig a little deeper into TerraVest, the actual exposure to the highly volatile oil and gas industry is a lot less than what you might expect.

31:11Currently, this segment is about 24 % of revenue, but TerraVest has been incredible at smoothing out revenues based on the demand of the industry. Now, while TerraVest is often incorrectly categorized as a pure play oil and gas service company, it generates the majority of its revenue for more stable segments, including HVAC and containment and compressed gas. As a result, I got shares at a decent multiple and now shares trade at what I consider a pretty expensive multiple. One mental model that John Neff used was called critical mass. I like to think of it as a smallest sum, an ingredient, an idea, wealth, anything really, that can create a self-sustaining entity.

31:46So one example he gave of a business that didn't fit this mental model was a business called US Industries. The company experienced impressive growth of about 24 % per year over a five-year period, and yet it was only trading at eight times earnings. John believed they could continue to compound earnings at about 15 % per year going forward. Unfortunately, it wasn't able to create that self-sustenance that critical mass dictates. US Industries was unable to dominate its industry and command any pricing power, and its fundamentals quickly deteriorated. This caused Windsor Fund to lose about half of that investment.

32:21Now, as I've alluded to, John loved yield as a bonus to waiting around for a business's stock to re-rate. But in the absence of yield, John looked for another type of opportunity he titled free plus. This is basically looking for an opportunity with a free call option on additional upside optionality. Or you can think of it as a business where management is just so good that they often outperform expectations. This works very well in low PE world that John was fishing in. Since he searched primarily for low PE businesses, the businesses already had a lot of potential downside priced directly into the stock.

33:00So this meant that if there was some minor positive event that were to happen, you know, something like maybe a nice new contract or maybe cutting costs that could increase margins, or maybe an unexpected boom in the company's industry, could mean very fast and fierce improvements in the company's fundamentals, which would ultimately be shown in the stock price. So similar to Peter Lynch, Neff liked finding ideas outside of referring to just his stockbroker. I think this might be more of a problem for investors during his time as it's much easier to find ideas today. I personally have never gotten one idea from speaking with a stockbroker, but the point is you don't have to peruse professional investors' tips to find ideas.

33:40Neff used the example from retailers, for instance, which are an easy category to search for when you just go shopping. He made a few good points here, which was that Execution separates the best retailers from the average, and don't confuse buzz for a company's products for good execution, as a retailer can actually ride momentum for short bursts before just fizzling out. Now, a notable win for Windsor Fundays, specifically inside of retail, was a business called Pier 1 Imports, which was a specialty retailer of home furnishings. So in the mid-1980s, a new management team took over, which improved their marketing, product mix, and improved the attractiveness of some of their stores.

34:19This resulted in improvements in the company's volumes and prospects. But it was just too expensive for Neff at that time. So he waited to see if an opportunity might arise in the future. And Black Friday in October of 1987 was just the opportunity that he was looking for. So on that day, the market plunged about 20%. Pier 1 Imports, which John thought could increase EPS by 47 % in 1988, was only trading at 8 times earnings. He gobbled up shares and doubled his investment within a few months. This is an area that most investors should probably try to take more advantage of, and it's also a good reason to keep some cash on hand.

34:55For instance, in early April, the tariff threats caused the market some extreme levels of anxiety. The S &P 500 dropped nearly 11 % over just a two-day period. If you had cash on the sidelines, there's a very good chance that either one, a company that was on your watch list reduced in price enough to become attractive, or two, a company that you already own, which you've wanted more of, becomes attractive to add to. It's important to remember that you don't always need a market sell-off for a good opportunity to present itself. Nearly all companies have just some degree of cyclicality. If you find one that you think has great long-term prospects, but is maybe going through some headwinds that you believe to be temporary in nature, you can make off like an absolute bandit.

35:37You just need to have conviction that you're correct. Now, I find getting this conviction a lot more often in businesses that I already own versus businesses that I'm just starting to research. When I own a business, I become much more attuned to how the business runs and how the market perceives it. Since I'm generally looking for wonderful businesses I can hold for a multi-year time period, it means that I'll have a very good chance that my businesses may undergo some temporary headwinds. And since I know the business so well and have a high level of conviction in the idea, it's a lot easier for me to have a variant perception.

36:08Now, the final interesting lesson here that I took from this chapter was based on a concept known as developing a curbstone opinion. So Neff writes, investing is not a very complicated business. People just make it complicated. You have to learn to go from the general to the particular in a logical, sequential, and rational manner. Curbstone opinions entail informed observations about the general condition of a company or an industry or aspects of the economy that are likely to affect the first two? Ask and get answers to these questions. What is the company's reputation? Is the business likely to grow?

36:43Is it a leader in its industry? What is the growth outlook for that industry? Has management demonstrated sound strategic leadership? So one thing that you learn pretty fast reading this book is just how much attention Neff gives to looking at the economy. With his knowledge and time he spent studying different industries and the economy, in some ways, he was a top-down investor. But in other ways, he was more of a bottoms-up investor, pouring over resources like ValueLine each week, looking for specific stocks trading on the cheap. So the questions posed above help when evaluating an individual business.

37:16If you can answer those five questions, you know probably more about that business than 99 % of investors out there. And if you can maintain your curbstone opinion and update it quarterly, you'll be very well prepared to pounce on the business when it goes through some sort of temporary headwind. Speaking of maintenance, the next theme that I want to cover is a chapter on the care and maintenance of a low PE portfolio. I love this chapter because it deals specifically with how to manage a low PE portfolio, which may differ from other investors who have a medium or high PE portfolio. If John, for instance, were to review my portfolio, he'd probably consider me to be a high PE investor as I have multiple companies that trade at price-to-earnings ratios of more than 30 times.

37:56Nonetheless, I think his principles still stand here. A notable excerpt that he has written discusses the psychological aspects of investing. His point is that many investors claim to adopt a low P strategy, but when reality sets in, they tend to just sit on their hands, waiting for the price to recover before deploying capital into an idea that has already lost its ability to re-rate as multiple. He writes, When shares of a stock change hands for 30 times earnings, who doesn't recall the day when shares fetched only 12 times earnings? But where were the buyers then? Most were cowering in fear of the latest news reports or piling into the speediest growth stock bandwagon, even if its wheels were about to fall off.

38:36This is a great reminder to evaluate just how brave you really are. A straightforward exercise is to just review some of the trades during periods of significant market turmoil. Are you a net buyer or net seller of stocks? You can look up your trades during such times as the COVID-19 crash in March of 2020, the inflation and interest rate fears in the first half of 2022, or the regional bank crisis in March of 2023, or maybe even the most recent tariff sell-off in April of 2025. If you are a net seller during these times, you are acting in accordance with human psychology, which tends to be risk-averse.

39:10But unfortunately, this is not the way to win in the market. What the best investors do during these times is really deploy as much capital as possible because the upside and the margin of safety during these sell-offs provide them the best possible opportunities. And in today's market, you often need to act very fast or that opportunity vanishes. Speaking of opportunities, let's look at a term that Neff used extensively throughout the book, which is inflection points. So inflection points to Neff are times in the market when there as an excessive sentiment to the highs or to the lows. When an inflection point happened, he viewed it as a signal that the trend had gone too far and he would take appropriate action.

39:49In Neff's case, that meant searching for inflection points to the downside, which allowed him to deploy capital. On inflection points to the upside, John would usually sell off some of his portfolio to free up cash once the market turned. A few other ways that Neff used inflection points to his advantage included being aware that inflection points can be short-lived, such as Black Monday on October 19th, 1987, when the market declined there by over 20%. Being aware that inflection points can be long-duration episodes lasting years, such as the nifty-fifty era of 1971 to 1973. He also came to grips with the fact that if you refuse to take part in inflection points during times of excessive euphoria, you're going to underperform in bull markets.

40:30And lastly was that inflection points are just impossible to predict, but warning signs will be apparent such as excessive IPOs, cheap debt, a lack of good opportunities, and high amounts of speculation. This type of rhetoric always reminds me of Howard Marks and cycles. We don't know when a cycle will turn, but at least we can observe where we are inside of a cycle. You can use that information to help you with decision making. Whenever I read about cycles, I always get a degree of cognitive dissonance. I can see what value investors like John Neff or Howard Marks are saying, act per the cycle.

41:04But how I really act is actually a lot lazier. What many value investors do during exuberant times is to sell stocks that have approached or exceeded intrinsic value. However, this is actually not a strategy that I employ that often. And the reason is simple. I'm not looking for stocks that I can hold for 6 to 12 months, which will quickly re-rate and then never grow again. I'm looking for businesses that can continually improve their intrinsic value. And I don't think I'm smart enough to time when I should be in and out of these names. So my general strategy is to just hold these names, even when the market is euphoric.

41:37When there is a market-wide sell-off, or if one of my businesses goes through headwinds, is when I'm most likely to add to my current positions, which I'm generally more apt to do than pile into new positions that I probably don't understand as well as something that I already own. One area I think I can improve is allowing cash to accumulate more in my brokerage account, which would give me a higher buffer during periods of excess euphoria. Once that euphoria ends, I'll just deploy capital. It sounds easy, but since I tend to stay fully invested, I often have that feeling where excessive amounts of cash doing nothing is just a waste of my capital.

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45:21For the first time ever, you can try NetSuite next for free. If your revenue is at least in the seven figures, go to NetSuite.ai slash TIP. Built for every industry, ready for every boardroom, NetSuite.ai slash TIP. All right, back to the show. So Neff devised a novel approach to investing that I think avoids standard industry classifications that I discussed earlier. He called this measured participation, which I mentioned briefly earlier in this episode. This allowed Windsor to think differently about diversification and portfolio management. Instead, they categorized businesses into four broad investing categories.

46:01The first one was highly recognized growth. The second was less recognized growth. Third, moderate growth. And fourth, cyclical growth. Neff writes, Windsor participated in each of these categories irrespective of industry concentrations. When the best values were available in, say, the moderate growth area, we concentrated our investments there. If financial service providers offered the best values in the moderate growth area, we concentrated in financial services. This structure enabled us to flout the constraints that usually condemn mutual funds to ho-hum performance. So, Neff believed that most investors tend to focus just on that first category, which is highly recognized growth.

46:40This was because since they attempted to copy and index, they actually had to ensure that they had adequate representation. But this act alone is why many funds chronically underperform. They are actively buying stocks that they should probably be trying to sell instead. For Windsor, the well-known blue-chip growth stocks were on the lowest rung. The majority of other funds place these investments on the highest rung. As a result, Windsor constantly held out of favor in less popular stocks, which was a significant reason for their long-term outperformance. Now, as a retail investor myself, I've never actually thought much about having a specific representation of an index.

47:16I prefer to have none, actually. And as a matter of fact, I've never owned a stock that was in the S &P 500. While I wouldn't say that my portfolio is made of maybe ugly ducklings like Neff's was, I definitely have businesses that are less known to the average person compared to a business inside of the S &P 500 such as, you know, Amazon, Tesla, Microsoft. If I had to say where my focus is on, it's on probably number two, which is less recognized growth. While I love businesses that can grow 25 % or more per year and are trading at single-digit forward multiples, they're pretty tough to find. I see them now and then, but I think another strategy that many investors employ is to search for businesses that have a high likelihood of growth at a higher rate and for a longer time than the market gives them credit for.

47:58These are businesses that are misunderstood, which can hide some potential upside in the opportunity. Businesses that I own like Topicus, Luma, Narizia, and Dino Polska, I think are really good examples of this. They just never appear cheap, but the market always seems to assume growth rates that are below what these companies are capable of producing. This is why having a variant perception is so important. You can buy an optically expensive business, but if you have a view on the growth trajectory of the company that the market just doesn't share with you, then you're buying it at a discount to intrinsic value.

48:30This is something that I think Bill Miller really excelled at. His investment in Amazon was a great example. He knew the business didn't look attractive on a gap basis. But if you made the necessary adjustments, the company was growing incredibly fast. And he felt that Amazon had the DNA to continue doing so for many years into the future. And of course, he was correct. Now, the mention of Amazon is a good transition into another one of Neff's points regarding growth stocks. Don't chase highly recognized growth stocks. This is an area that I mostly agree with Neff, but I think investors like, you know, Terry Smith would probably disagree with him.

49:04So Terry Smith would say that the right growth stock that is also of high quality can be bought and held for an extended period of time and provide tremendous returns. For instance, in his book, Investing for Growth, he mentions two businesses that are highly recognized growth stocks, Coca-Cola and Palmolive. He examined the returns of these businesses over a 30-year period spanning from 1979 to 2009. So in 1979, these businesses were trading actually pretty cheaply at a market multiple of 10 times. However, if you had bought them then, you would have earned a much higher return than the market.

49:37So his question was, okay, how much could you have paid for these businesses and made market-like returns? And the answer is 40 times earnings, which is an absurdly high number. But if you have even a well known company of just superior quality, they can do things that most businesses can't, and they can provide value at a much higher rate for a lot longer than investors can imagine. So while I do think that Neff is mostly right, that you probably shouldn't chase highly recognized growth stocks, it's more of a product of long-term thinking. One of his worst experiences of underperformance was during the Nifty 50 years, and this was when Windsor underperformed the index because it didn't own many of the high-flying stocks that were driving a significant portion of outperformance at that time.

50:21And while Neff did not enjoy the 25 % loss that his fund had in 1973, which coincided with the end of the nifty 50, he also realized that that was the time that was about to breed just enormous opportunity. So in his 1973 letter to shareholders, he wrote, It is my view as Windsor Fund's portfolio manager that there is a period of outstanding potential appreciation on the horizon. As a shareholder with a substantial portion of my family's resources invested into the fund, and one who has personally and financially lived and breathed each good day and each bad day within the fund since mid-1964, I hope you await the inevitable eye-catching appreciation of our fund with the same solid confidence and eager anticipation as I do.

51:03But even during the nifty 50 days, Windsor actually did own a couple more well-known growing businesses. They owned things like IBM, Home Depot, McDonald's, Xerox, and Intel. However, since these businesses tended to trade on expensive multiples, Windsor Fund never really achieved meaningful levels of concentration in those positions inside of the fund. So Neff had a highly amusing joke here on how investors tend to flock to expensive investments, even though they usually end with people losing a lot of money once they tend to re-rate downwards. So here's a joke. Two hunters hire a plane to take them to a remote destination to hunt for moose.

51:42Once at their destination, the pilot warns the hunters that the aircraft can only accommodate one moose per hunter, and any more weight could cause a crash. So the pilot arrives two days later to pick up the hunters. who have each killed two moose apiece. The pilot tells them that they can't take two mooses each because of the added risk. The hunters say, but last year we did the same thing. Remember, we each paid an extra thousand dollars and you took off with all four moose. Reluctantly, the pilot agrees and takes off. After an hour, the plane sputters under the unsafe weight and safely crash lands.

52:16The hunters exit the plane and one asks, do you know where we are? The other responds with, not sure, but it sure looks a lot like the place we crashed last year. This anecdote illustrates how investors will just continually chase assets out of greed, even after having a bad experience in the past. This is why it's crucial to identify and just learn from your mistakes. If you just identify mistakes, but continue to make them, then you're making a very grave error. The sad fact is that most investors just don't learn from their mistakes, which is why if you go back four centuries, you can see bubbles forming repeatedly, and they will again and again into the future.

52:56You can try to protect yourself from participating by adopting a value investing mindset. If something is now trading at two times its average multiple over the last decade, the multiple is probably unsustainable. Let's get back to the importance that Neff put on less recognized growth stocks, because it's a segment of his portfolio that was pretty large, at about 25 % of his career at Windsor Fund. So one advantage he saw in these lesser known names was that the well-known names would receive most of the attention. This meant that certain businesses, which might have been too small or maybe lacked visibility, wouldn't receive that same amount of attention.

53:32An example in the book was a business that was called Edison Brothers. So Edison Brothers was a specialty retailer of women's shoes. Earnings had improved in the industry at a steady rate in 1974. But But since the market was obsessed with just these larger growth companies, it just didn't pay that much attention to the improvements that were being made at Edison. One year after the Windsor Fund purchased it, Edison's share price increased by 137%. The process of discovery in stocks is truly powerful. So Neff had some very interesting warnings for investors looking at the less recognized bargain bin.

54:06He noted that one in five of these businesses tended to fail each year. Now, by failure, he's not saying that they file for, you know, chapter 11, but rather that they will see things like their growth rates decline along with a corresponding PE contraction. So here are some of the specific attributes that he looked for. 12 to 20 % growth rate with high visibility, high single digit P multiples of six to nine, dominant or large market share and well-defined growth areas in an easy to understand industry, an unblemished record of double-digit historical earnings growth, a high ROE, high enough market cap and profitability to qualify for institutional ownership, a minimal but present Wall Street coverage, and a 2-3.5 % yield.

54:49Next is the third part of measured participation in which Windsor Fund invested, which was moderate growers. So these are your blue chip companies, which are relatively boring investments, but offer high yields that Neff really loved. Think of businesses like phone companies, electric utilities, and banks. These businesses have dividend yields that often exceed 7 % and are expected to grow at rates similar to GDP growth. Add that all up, along with the fact that they generally trade for mid-single GDP multiples, and John felt that he could get a very good return from some of those names. Another bonus was that since these names were boring, they would often remain attractive even in heated markets.

55:28So he mentions a few names from the tech bubble of 1999 that were still trading at yields of 48%. The other interesting trait that he noted about moderate growers was that they provided liquidity during inflection points. For instance, during the tech bubble, it would have been challenging to find good opportunities where you weren't taking part in speculation. However, since the bubble would eventually burst at some point, these moderate growers allowed Windsor Fund to accumulate extra cash through the yields, which could then be deployed during any potential market sell-offs. Now, the final category of measured participation was in cyclicals.

56:02Ness meant a significant amount of time on cyclicals and frequently mentions them in his investing career. He understood cyclicals very well, especially the timing part. Here's how he breaks down cyclicals. So, earnings pick up and investors flock to them. Earnings peak and investors abandon them. Ness' strategy was just to buy cyclicals six to nine months before earnings would swing upwards and then sell them into rising demand. The key was to understand and anticipate the fluctuations in commodity pricing. So he presents an interesting case study in the book on a business called Newmont Mining.

56:34So this was a company that was very well diversified across, you know, copper, gold, oil and gas, and coal. But he bought it specifically due to the copper part of the business. So in 1981, Windsor's view on copper was that it was due for a rebound in pricing from current depressed levels. The copper capacity wasn't really growing very fast at a rate of only 3%. So Neff liked Newmont because they were a low cost provider and their customers were all domestic. So here's what happened after Windsor purchased it. There was a quick run-up in price. The price then slid by 40%, dropping 15 % below Windsor's initial buy price.

57:08But the fundamentals held, so they ended up buying more shares a year later. And in 1983, they made about a 61 % return and sold into strength. So I personally find cyclicals to be just too complicated. My one obvious cyclical play that I no longer own is a business called Natural Resource Partners. I actually still love the business and if you want my full pitch, I'll have it linked in the show notes below. So NRP is simply just a royalty play on a commodity. In this case, the commodity is coal. So they own land that mines use to extract thermal and coal from. Then they have another piece of a mine that deals with soda ash.

57:42So their customers pay a percentage of revenues back to NRP for use of their land. The thing I liked most about NRP was that I didn't have to worry much about cycles. The business just gushed cash. Whether the cycle was up, whether it was down, they're always cash flow positive. But it's a different story at the mines where when supply is highest, it then lowers the price that they can charge for their commodity, yet input prices remain the exact same. So the reason NRP was interesting was that it was inexpensive and had a very high pro forma cash flow yield in the high teens. It had paid down a ton of debt to get near debt-free.

58:17And since it was seen as a coal business, many hedge funds just weren't interested in the name. If I had to bet, NEF would have been all over a company like this. So even though NRP was involved in cyclical businesses, they didn't participate in the margin compression that plagued cyclical industries. I liked that because it meant that I could lazily just hold onto my position. For those wondering, I sold purely based on non-investing reasons. The business is a master limited partnership, meaning that I would have to hire someone to handle all my taxes and it just became a little bit too much of a headache.

58:48If I didn't have to worry about any of that, I would still gladly be a shareholder of the company. Now back to cyclicals. Neff noted that the market is knowledgeable about one aspect of cyclicals, specifically the application of non-peak PEE ratios when these businesses are at the top of their cycle. The typical growth stock will have a PEE that generally expands as earnings growth expands, but this is a death sentence in a cyclical business. So what happens typically in cyclicals is that the PE will decline as the cycle moves towards its apex. Windsor's strategy was to gauge what normalized earnings would be at some point during the upcycle.

59:24That way, he knew that when the business reached that normalized earnings number, he admitted that this did sometimes result in selling out too early, but it also prevented him from having to ride back down when the cycle was over and sell at a loss, or locking up capital waiting for the next up cycle. Now, one twist on cyclicals is just to find a business that is becoming less cyclical. One business I think that has executed on this flawlessly is Apple. So Apple, up until 2015, was primarily engaged in hardware sales. However, the sales numbers and margins were somewhat volatile, depending on consumer demand and peak cycles of Apple's specific products, such as the iPod.

1:00:03As a result, Apple's operating margins fluctuated wildly between 2 % and 10 % in the early 2000s. However, as the business scaled and diversified its products, its cyclicality decreased and now Apple boasts rising operating margins all the way up in the low 30s. I mentioned a little earlier that Neff was both a top-down and bottoms-up investor, so let's expand a little bit on that. While Neff liked looking at individual businesses, I think he got a lot of his ideas from a top-down approach as well. When you understand just an industry and its various subtleties, you begin to really separate yourself from others.

1:00:36If you know that a positive or negative catalyst is likely to happen in an industry by understanding it, you can find a business inside of that particular industry that might benefit the most, that the market isn't pricing properly. So if you want to understand an industry better, Neff mentions a few simple questions to ask. Are the industry's prices headed up or down? What about costs? Who are the market leaders? Do any competitors dominate the market? Can the industry capacity meet demand? Are new plants under construction? What will be the effect on profitability? And when it comes to macro, which Neff paid very close attention to, he was looking at just three signs of excess, capital expenditures, inventories, and consumer credit.

1:01:17Since Windsor Fund was pretty widely diversified into 50 plus stocks, Neff built fact sheets for all of his businesses to keep track of them. They had pertinent information like the number of shares owned, their average cost basis, the current price, historical and projected price earnings ratios, historical and projected earnings per share, historical and projected growth rates, historical and projected PE ratios, yield, returns on equity, price projections based on earnings expectations and upside potential. I think this is a really good idea to hold on to, even if you keep a more concentrated portfolio.

1:01:53It's nice to have this information handy in case you want to share some of this information with others so you can quickly provide them with important numbers. Next, I want to discuss an area that I always enjoy breaking down in different investors that I get to examine, and that's their selling framework. So NEFS was pretty simple. Windsor sold for just two reasons. The first one was if fundamentals deteriorated, and the second one was when price approached expectations. So the first point is pretty simple. I think any half-decent investor is likely to sell once they realize that the businesses fundamentals have deteriorated.

1:02:26Unless investors are short a stock, there is just no money to be made holding a stock that is likely to drop in value. What I always find interesting is why investors sell their winners. And in true value investor fashion, Neff's strategy didn't really surprise me. He would hold onto some winners for three, four, five years if the fundamentals remained intact or they improved. However, he also mentioned that Windsor Fund had periods where they'd hold stocks for a month or less. So, similar to this strategy of selling on the way up with cyclicals, he employed the same approach with non-cyclicals.

1:02:59Since he was very well aware of the price appreciation potential of all of his holdings, he preferred to sell into strength. He was not into the buy and hold strategy seen in investors who focus more on high-quality assets that can compound for a long period. He also admitted to not trying to capture market tops. If a company became fully valued, then there was a good chance it would not stay in the portfolio. The final thing I want to discuss today is some of Neff's blunders. We all make them, and the beauty of being a good investor like Neff is that when you make a blunder or commit an error of omission, it doesn't harm your investing results.

1:03:34For instance, in a 1999 roundtable discussion with Barron's, Neff said, it's the valuation, stupid, when referring to Amazon. He warned investors of the perils of Amazon, since its market cap exceeded the retail sales of all bookstores in the entire world. It's easy to look back now and see that this remark clearly shows a misunderstanding of the business. But when you hear most of the stories surrounding Amazon at this time, there was no value investors outside of Bill Miller or Nick Sleep and Case Acaria that thought that Amazon was a value stock. Then there are other stocks where when I was reading this book, I just thought, why didn't you just hold on to these for a longer period of time?

1:04:11time. For instance, ABC. So Windsor bought the stock around 1978 for five times earnings. This was a business that he believed could grow earnings at about 11 % and offer about a 4 % yield, resulting in a total return of about 15%. Now over the next year, he ended up selling and his gains ranged as high as 85%. Now that's great, but I decided that I wanted to dig a little deeper. So I asked myself, okay, what would have happened if just held ABC from then until ABC was acquired by Cap Cities in 1985. The numbers were hard to come by, but I used perplexity to look them up. So it shows an EPS of about$4.89 in 1978, which was approximately when Windsor purchased it.

1:04:53By 1974, before merging with Cap Cities, ABC grew EPS to $6.71. Now at a PE of five times, Windsor would have purchased ABC for about$25. Had they held onto until the merger in 1985, they would have sold their shares for about$118 a share or nearly a 5x. So full disclosure, I couldn't find any data on share splits. So my assumption is that there weren't any during this time. But this example is just an issue that I think I have with some of the really, really good value investors that I've researched. They're just, they're so obsessed with price and value that their ability to value quality becomes completely negated.

1:05:29However, as with many things, this could very well be a result of my own biases. A part of me truly appreciates the nomad partnership style of investing, which involves just finding a few incredible compounders to hold onto and ride off into the sunset with. But when it comes to Neff, the results just speak for themselves. What he did clearly works. And even though he went through periods where the strategy underperformed, he never lost his way of searching for value. Another thing I really appreciated about Neff was that he wasn't afraid to look at growthier type stocks, trading above market multiples, if the opportunity was right.

1:06:01Even though it was a smaller part of investing strategy, he knew that growth, even when priced where he wasn't typically comfortable, could provide value if he had high conviction in the company's abilities to continue growing at high rates. That's all I have for you today on John Neff, a no-nonsense, dividend-loving, PE-skeptical investor who quietly beat the market for 30 years. Want to keep the conversation going? Follow me on Twitter at IrrationalMRKTS or connect with me on LinkedIn. just search for Kyle Grieve. I'm always open to feedback, so feel free to share how I can make this podcast even better for you.

1:06:37Thanks for listening and see you next time.

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