Investment Book - The Five Rules For Successful Stock Investing

“The Five Rules For Successful Stock Investing” by Pat Dorsey is a book I strongly recommend, especially for stock investing beginner that is lack of financial knowledge. The book is packed with so much knowledge about stock investing, but described in an easily understandable manner.

Table of Contents

Introduction

The book was originally published in 2004. In 2012, I stumbled upon this book in bookstore. After reading it for a while, without hesitation I decided to buy this book. I would say, this is a perfect text book for stock investing beginners. Looking at my book, it is fully of highlights and notes that I made while reading the book. Even until today, occasionally I still refer back to the book for information or to refresh my mind.

While the name of the book is called “the five rules for successful stock investing”, the actual content of the book is much more than that. In fact the book contains 26 chapters, and “the five rules for successful stock investing” is only content of chapter 1.

In this article, I will share what are the five rules for successful stock investing according to Author Pat Dorsey. In addition, I will also tell what other knowledge readers can expect to learn from this book.

The Five Rules For Successful Stock Investing

Rule No.1: Do Your Homework

The simplest but most important rule. This rule has also been stated by many successful investors. For instance, Warren Buffet has said that “Risk comes from not knowing what you’re doing“.

It is always very tempting to hear that there is a way to make money quick and easy. Unfortunately there is just no free lunch in the world. Otherwise everyone would have been millionaire in the world, right?

Homework required before making a stock investment includes reading financial reports from page to page and understanding how the business works.

For most of the people, the biggest challenge of doing is time. Undoubtedly, it is very time consuming to thoroughly investigate a company and their business. But rewards always go to those who actually putting in the effort.

Don’t know how to do the homework? This book has 4 chapters to assist readers in this regard. By reading the 4 chapters, readers should be able to understand the basics of three financial statements (balance sheet, income statement and cash flow statement), to analysis the basics of a company and to evaluate management of a company.

Rule No.2: Find Economic Moats

Economic moat is a term to describe long-term competitive advantage of a company. To a greater or less extent, all companies face competition. How to decide whether it is better to invest in one company over the others doing similar business? Economic moat plays a vital role.

Quoted the statement from author Pat Dorsey in the book, “How does a company manage to keep competitors at bay and earn consistently fat profits?” Unlock answer to this question is the key to find economic moat of a company.

Rule No.3: Have a Margin of Safety

One difficult thing about stock investing is, investors need to use past data to predict the future. Because of this feature, no matter how much homework is done, there is always a possibility that something goes wrong in the future. This is where margin of safety kicks in.

Margin of safety is basically difference between share price and estimated valuation done. There is magic number on how much margin the safety should be. It should be higher for riskier firms and lower for solid firms.

Wonder how to calculate estimated value of a company so that comparison can be made with share price in the market? This book has a chapter to teach how to calculate intrinsic value of a company based on discounted cash flow model.

Rule No.4: Hold for the Long Haul

All successful stock investors understand the power of time and know how to make use of it. Power of time comes from compound interest. Albert Einstein has said “Compound interest is the eighth wonder of the world”.

In addition, all transaction required commission fee and tax to be paid. If trade frequently, those are the money that can’t compound in the future.

Rule No.5: Know When to Sell

Warren Buffet has said “our favorite holding time is forever“. But did Warren Buffet sell shares? Yes. The book has given five reasons below when investors should consider to sell a stock.

Did you make a mistake?
Have the fundamentals deteriorated?
Has the stock risen too far above intrinsic value?
Is there something better you can do with the money?
Do you have too much money in one stock?

Stock investing knowledge taught in the book

Besides the five rules of stock investing described above, below are readers a list of knowledge readers can gain from this book.

Basic investing terms (revenue, cost, depreciation, receivable, payable etc)
How to read financial statements (income statement, balance sheet and cash flow statement)
Analysis and valuation of a company. The valuation method taught in the book is based on discounted cash flow model, i.e. value of a stock is equal to sum of present value of all of its future cash flow that can be generated.
10-minute check list before making a stock investment
Understanding how different business sectors work

My thoughts on this book

For myself, this book is like a textbook for stock investing, and title of this book “The five rules for successful stock investing” does not reveal how much valuable knowledge is contained in the 300+ pages.

To assist readers, I’ve decided to list down the table of content of this book in this article. The table of content serves just like a syllabus of this text book.

Although this book was originally published in 2004, I sincerely think value of knowledge taught in the book does not change with time. I do still refer to the book until today. If you are interested in this book, it can be purchased through Kinokuniya online bookstore here.

Chapter 1: The five rules for successful stock investing
Chapter 2: Seven mistakes to avoid
Chapter 3: Economic moats
Chapter 4: The language of investing
Chapter 5: Financial statements explains
Chapter 6: Analyzing a company – The basics
Chapter 7: Analyzing a company – Management
Chapter 8: Avoid financial fakery
Chapter 9: Valuation – The basics
Chapter 10: Valuation – Intrinsic Value
Chapter 11: Putting it together
Chapter 12: The 10-minute test
Chapter 13: A guided tour of the market
Chapter 14: Health care
Chapter 15: Consumer services
Chapter 16: Business services
Chapter 17: Banks
Chapter 18: Asset management and insurance
Chapter 19: Software
Chapter 20: Hardware
Chapter 21: Media
Chapter 22: Telecom
Chapter 23: Consumer goods
Chapter 24: Industrial materials
Chapter 25: Energy
Chapter 26: Utilities

Click here to purchase from Kinokuniya online bookstore

For other books on stock investment and personal finance that I recommend, see more here.

This Post Has 2 Comments

James August 25, 2020 Reply

This is indeed a great recommendation. The Five Rules is a down to earth, step-by-step guide that ordinary readers like me can follow and apply. The DCF valuation approach it recommends has been a great tool for me. I can perform quick valuation exercises just based on the free Morningstar data. The book offers many practical insights, like instead of relying on agonizing over the cost of equity which changes as beta changes, just apply a simple discount rate based on the understanding of the investment risk.

I came across this book later than you do. I actually started with his other book The Little Book That Builds Wealth which is a simpler read and beautifully explains the concept of moats.

For those who don’t read books, I usually recommend them to start with Pat Dorsey’s talk at Google
1. CK August 25, 2020 Reply
  
  Thank you for sharing the video James !