Updated on 02.21.10

Review: Payback Time

Trent Hamm

Every Sunday, The Simple Dollar reviews a personal finance book or other book of interest.

paybackA few years ago, I read and really enjoyed Phil Town’s first investment book, Rule #1 (you can read my review here). Town actually contacted me after reading my review and offered a few thoughts on my comments on the book and we exchanged a few emails over the years. Thus, when he finished his follow-up book, I was quite happy to give it a read.

Town’s basic ideas are pretty straightforward. He believes ardently in value investing, meaning that you look for good, healthy companies that are selling for much less than they should be when compared to similar companies. That requires a great deal of patience to do. In both this book and his last book, he goes over a straightforward formula for finding those companies and identifying whether they’re on sale or not.

So what makes this book different than the earlier book? Let’s dig in and take a look.

How the Wealthy Use Down to Go Up
Town opens the book by explaining the basic strategy Payback Time is focused on, which he calls “stockpiling.” To put it simply, a person buys stock in an individual company that they deeply believe in for whatever reason, then they just keep buying more and more of it. They then use the dividends from the stock to live off of or they reinvest them into more of the stock. So how does this strategy use “down” to go “up”? If you’re owning this for the long haul – basically forever – you actually hope for a down market so that the price of the stock you’re buying is lower. Price does not indicate value in any way – it’s no different than buying the same item at the store when it’s on sale instead of when it’s not on sale.

Mutual Fund Investing Makes No Sense
Here, Town basically writes off every kind of fund that’s not an index fund as junk and a waste of your money. In short, he defines such funds as being the bastion of the investor who really doesn’t have any idea what they’re doing with their money. Sometimes, that’s acceptable if people recognize that they truly don’t have the time to study such things with any detail. For those people, the only real bet is index funds, which are low cost and usually match the market. You can’t hit home runs with them, but you certainly won’t strike out by buying them.

Threee Ms Equal No-Risk Investments
There are a lot of traits that a “perfect” business would have, but there is no perfect business in this world – nobody’s perfect, after all. Instead, Town looks for wonderful businesses to invest in, and wonderful businesses are usually characterized by three criteria – they have great meaning to you (meaning you understand the company and fully approve of their business model), they have a big moat (meaning that it’s protected from competition in some key way, making it both durable and profitable), and they have great management (dedicated, passionate, and honest people running the shop). These are the kinds of businesses you should constantly be looking for and investing in.

Payback Time Means “No Fear”
Once you’ve identified businesses you want to invest in, you should wait until the time is right to buy – in other words, when they’re on sale. How do you know? It has little to do with what the overall market is doing. Instead, you want to watch the P/E ratio (price to earnings) of the stock. You can easily get this information online at pretty much any stock investment website. Just wait until that ratio is noticeably lower than usual without any real changes in how the company is performing (this often happens when it’s not being hyped up at all but is just trucking along, doing its business) and buy in. When the P/E ratio is high, don’t buy (and if you have a reason, it might be a time to sell). He goes quite in depth with this formula, but much of the information is very, very similar to his earlier book Rule #1, which I mentioned earlier and liked.

Eight Baby Steps to Wealth
What are the eight steps? Find it, value it, watch it, buy it, own it, stockpile it, sell it, repeat. In other words, look patiently for companies that meet your criteria (and never rush into buying). When you find the right one, buy it. Keep buying it whenever the P/E ratio (and other indicators) tell you to do so. Sit on the stock and collect dividends. When that ratio gets high, sell the stock. Then repeat. It’s pretty straightforward and actually makes a great deal of sense, particularly to a conservative investor like me.

Just the FACs, Ma’am
Here, Town talks about two methods for determining whether or not you should buy more of a stock once you already own some. He spends most of his time focusing on a method that centers on technical analysis (i.e., looking at charts), which is a method I find to be akin to voodoo. Instead, I prefer the other method, which basically means you pick one day a month to evaluate a stock. If it’s below the P/E ratio (or other similar indicator) you bought the stock at originally, you buy. Otherwise, you stick the money into a savings account and wait until a month when it’s low enough to buy.

A Tale of One Family
All of the information in the previous few chapters is combined together into a real-world look at how a family invests. Basically, it’s a series of real-number examples of the ideas from the book, showing how they all work together and click.

Free Money with a Berky
The final chapter (or at least the last one that’s not functionally an epilogue) contains a brilliant idea that Town calls a “Berky” (short for Berkshire Hathaway) that answers the question of how people come up with the money to actually do this kind of investing. It’s actually simple: automatic savings. You should set up a savings account for the sole purpose of investing according to the ideas in this book (or your own principles). Have your bank put some amount automatically into this account each week (or each month). Then, invest solely from that account. This way, even if the investment tanks, it doesn’t affect your day-to-day personal finances – it’s just an exercise in building wealth. This is absolutely the way people should start investing if they’re tempted.

Is Payback Time Worth Reading?
As with many follow-up books, Town takes the content of his very good earlier book, Rule #1, and places it in a broader context. If you want to know more about the investing part of the book, I’d suggest reading the earlier book as well.

One common complaint about Rule #1 that I would anticipate with this book is that people ask where the details are on past results, as Town doesn’t dwell on this for any significant length. My thought is this: past performance is no indication of future results. Much like any other investment strategy book, it’s simply a tool in your arsenal, one you can use in your own investigations to figure out what works. There are lots of investment schemes that have great results for a period in the past but are awful today (that’s why fund managers never have long strings of success). The system that Town espouses is incredibly simple, can be easily tracked over a long period using pretty much any investing website, and is backed by a good idea (value investing). Does it mean it’s the be-all-end-all of investment strategies? No. But it has enough going for it (simplicity, logic, and clarity) that it’s worth at least paying attention to.

All of that being said, I did feel in the end that I learned more (or at least was provoked into more thought) reading Rule #1, but that may have been that the meatiest parts of this book often just rehashed that information. Both books are worthwhile reads, however, and present interesting ideas, which is all I can really ask for in an investment book.

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  1. I listened to Rule #1, and while it was interesting, especially the use of the bollinger bands and other tools to predict the market movement… Most of it can be read in about 10 other financial books. While “Rule #1” was a good read, if you look at most of the stocks that were focused on, I don’t think many are going that well today.

    Still it a good book to read. It definitely has more meat to it versus the other books out there. And I think the author really does a good job of presenting this cases with solid examples.

    I’ll look forward to reading this new book he has!

  2. KC says:

    I need to read these two books because this sounds a lot like the way I already invest. I’ve been an investor for 15 years (I’m 36 and had my first 401k at 21). In those 15 years the stocks I’ve held throughout that time have seen very little growth other than some respectable dividends. However about 10 years ago I figured out a lot of the stocks I own (common companies like MCD and XOM) go up and down. Clearly I should be buying when they are (at least) at 52 week lows (I prefer a 3 yr low if I can get it). But maybe I shouldn’t buy and hold – maybe I should sell when they reach 52 week highs? This strategy is the only reason I have any gains to show over my investing lifetime.

    People will probably want to know “how do you know its at a high or a low?” My answer is you never know for sure, but you get a feeling for it after a while, especially when you pay close attention to your stock and what the sector is doing. You won’t always hit the high or low on the head but you get close.

    I know most people on this blog believe this is nonsense and, yes, I know studies have shown that buy and hold works over the long term. I’ve read everything by and about John Bogle, I respect his opinion, but I’m going with what I know has worked for me – buy low, sell high. There is room in your portfolio for this strategy if you have time – I wouldn’t recommend it for your entire portfolio, but there is room for more active trading if you have the time and inclination.

  3. How the wealthy use down to go up…on “Jimmy Kimmel Live” this week Shia LeBeouf mentioned that he made an investment recently of $20,000 in what he said he was advised were “value stocks” –good companies at low prices. He said to date (during the time he made the new “Wall Street” movie) he is already up $400,000+.

  4. Mule Skinner says:

    How much money has Phil Town made in stocks? As opposed to books about making money in stocks . . .

    Perhaps he is altruistic; or maybe he just likes writing books; but I generally think that if someone has a method that works he probably doesn’t need to write books.

  5. deRuiter says:

    #4 Very clever remark Mule Skinner, you’re correct! I have all my stocks (any discount broker will do this, Schwab, TDAmeritrade, NEVER USE A NON DISCOUTN BROKER) designated as a DRIP account, both the regular brokerage account and the ROTH brokerage account. A DRIP is a “dividend reinvestment program.” It means any dividend a stock throws off is immediately reinvested (at no charge) in more of the same stock. So each quarter, if you have a stock, instead of a bit of cash (the dividend) added to your account, you get a fraction of a the same stock. If you have 10 different stocks, each one has a little bit more each quarter. And you earn dividends on each portion of a stock from then on. Buy 25 shares of a stock which pays dividends. At the end of the quarter you have 25 and a fraction, eventually 26+, 27+. I often buy and sell the same stocks. Not a day trader, but I buy them low and sell them high. To make life easy, if I have accumulated, through DRIP, 1 1/2 shares, my 25 stocks have become 26 1/2. When I sell, I sell the 25 shares. I keep the odd bit, WHICH KEEPS COLLECTING DIVIDENDS, as my place holder. ONLY DO THIS IF YOU ANTICIPATE BUYING THIS STOCK AGAIN! At a glance I know exactly at what price that stock was bought and at what price I sold. because the brokerage company company keeps this record for me on the statement page through the ownership of this one and a fraction stock. When I see that stock has dropped (I sell when high) I investigate and if I still like the stock, I buy it low. If you are happy with a stock and keep it a long time, those DRIPs every quarter give you more of the stock AT NO COMISSION COST, it’s the magic of compound interest! A DRIP account costs nothing to set up or to maintain.

  6. KittyBoarder says:

    I have quite a bit concern with these methods
    1) Sounds like you will have to “time the market” to find the right time to buy when it’s on-sale.
    2) Stock pile on one stock is risky.It’s like putting your eggs in one basket. Stockpile on lots and lots stocks will require a lot of money, so this may not work for a lot of people.

    Call me old fashioned.. I still like the idea of dollar averaging my money into index funds and stay away from stock picking..

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