John Neff

Investment style
Hard-core value investment, based on buying good companies with moderate growth and high dividends while out of favour, and selling once they rise to fair value.

Profile
Neff is known as 'the professional's professional', because many fund managers entrusted their money to him in the belief that it would be in safe hands. That view was justified by his remarkably consistent performance. For more than 30 years, the Windsor Fund routinely featured in the top 5 percent of all US mutual funds.

Neff studied industrial marketing at college, but attended night classes to get a degree in banking and finance. In 1954, he became a securities analyst with the National City Bank of Cleveland. Both there and at his next firm, Wellington Management, he pursued a value style of investment modelled on the writings of Ben Graham. He went on to apply this to three equity-and-income funds - Windsor, Gemini and Qualified Dividend - with spectacular results until his retirement in 1995.

An unassuming man, who always encouraged his colleagues to collaborate in his decisions, Neff never sought to publicize himself during his career in the same way as many star fund managers. But with the recent publication of his memoirs, John Neff on Investing, he is at last achieving the wider recognition he deserves.

Long-term returns
The average annual total return from the Windsor Fund during Neff's 32-year tenure was 13.7%, against a return from the S&P500 index of 10.6%.

Biggest success
Neff invested a huge proportion of his fund in Ford in 1984, when everyone feared it might go bust and the P/E ratio had sunk to 2.5! He paid an average price of under $14. Within 3 years, the price had climbed to $50, making Windsor profits of $500m.

Method and guidelines
Neff describes himself as 'a low price-earnings investor'. He hunts for stocks that are cheaply priced in relation to the total return indicated by the sum of their earnings growth plus their dividend yield. He calls this the 'terminal relationship' or, more colloquially, 'what you pay for what you get'. You might also think of it as the GYP (Growth & Yield:P/E) ratio:

(Earnings Growth + Dividend Yield) ÷ P/E ratio

Neff recommends comparing the GYP ratio on your stocks and on your whole portfolio with that on the market.

Example

Average forecast portfolio EPS growth (%)
plus average forecast portfolio dividend yield
divided by average forecast portfolio P/E
= (7 + 5) ÷ 10
= a GYP of 1.2
Average forecast market EPS growth (%)
plus average forecast market dividend yield
divided by average forecast market P/E
= (15 + 2) ÷ 28
= a GYP of 0.6

On the above figures, your portfolio would be twice as attractive as the market. (This is only an example. The actual relationship would usually be much closer.)

Consider avoiding, putting into your portfolio stocks that significantly reduce its overall attractiveness. Instead, set a target buying price that represents the GYP you are after and wait for the price to fall to that level.

If two companies offer a prospective 14% return, but Company A's consists of 14% earnings growth and no dividend, whereas Company B's consists of 7% growth plus a 7% dividend, it is better to choose Company B, because the dividend makes the outcome more certain.

Following this principle, Neff has always stuck to a simple investment style based on the following 7 selection criteria:

Low P/E ratio.
Fundamental earnings growth above 7%.
A solid, and ideally rising, dividend.
A much-better-than-average total return in relation to the P/E ratio.
No exposure to cyclical downturns without a compensatory low P/E.
Solid companies in growing fields.
A strong fundamental case for investment.
Source: John Neff on Investing, J Neff, 1999

A good place to look for ideas is the New Lows column in the back pages of the FT. Many, if not most, of the companies mentioned are generally bad investments. But shares in surprisingly good companies sometimes slide to new lows on bad news. Test these to see if they meet the 7 selection criteria. (Neff calls this the 'Hmmmph' test: "Some names I would not have expected to see on this list elicit an audible 'Hmmmph'.")

Don't chase highly recognized growth stocks. Their P/E ratios are invariably pushed up to ridiculously expensive levels. This greatly increases the risk of a sudden collapse in the share price.

Stick to a firm selling strategy, or you risk losing your profits. There are two basic reasons to sell:

Fundamentals deteriorate
The price approaches or matches your expectations.
The main fundamentals to keep an eye on are earnings estimates and 5-year growth rates. If these start to slip, sell at once.

Pay more attention to the GYP ratio of your portfolio than to the market. But if the market becomes very expensive and it is hard to find worthwhile purchases, it is permissible to hold up to 20% of your funds in cash until new opportunities emerge.

The best profits are usually made after market panics.

Key sayings

"Absent stunning growth rates, low P/E stocks can capture the wonders of P/E expansion with less risk than skittish growth stocks."

"As a low P/E investor, you have to distinguish misunderstood and overlooked stocks selling at bargain prices from many more stocks with lacklustre prospects."

"A dividend increase is one kind of 'free plus'. A free plus is the return investors enjoy over and above initial expectations. One of Ben Franklin's wise observations offers a parallel: 'He who waits upon Fortune is never sure of a dinner.' As I see it, a superior yield at least lets you snack on hors d'oeuvres while waiting for the main meal."

"An awful lot of people keep a stock too long because it gives them warm fuzzies - particularly when a contrarian stance has been vindicated. If they sell it, they lose bragging rights."