The 5 Principles of Friessology

by Dr. Thomas Carr

In the investing world, there are the “gurus” and there is the rest of us. Gurus manage billion dollar funds and are celebrated as near-divines by the financial media. The rest of us look after whatever funds we can cobble together and are celebrated by none but family members once the will is read.

Many of those in the “rest of us” camp look up to the gurus, ingesting their market philosophies and emulating their investing styles. Some even have favorites. For example, one investor might construct his portfolio according to the rules of “Buffettology” while another might want more of a growth focus like that advocated by Martin Zweig. I’m no different. I build systems based on technical and fundamental analysis, but the gurus always factor into the algorithms, especially when I’m stuck and in need of inspiration.

My favorite guru investor is a man named Foster Friess, founder of Friess Associates and its flagship mutual fund, the Brandywine Fund. Friess has been in the public spotlight in recent years for his ventures into political activism. If that fact knocks him off your personal “favorites” list, you should know that this near-billionaire has done some amazingly cool things with his wealth. Through his family’s foundation, he’s funded mobile hospitals bringing medical aid to the poor. He’s brought clean drinking water to over 70,000 people in Malawi. And he’s poured countless millions into relief efforts following Katrina, the Asian Tsunami, and the Haitian earthquake. One of his secrets to giving is that he doesn’t consider the money he earns as his own. “It belongs to God,” he says. “If it were mine, you’d not get very much of it!”

Kiplinger's listed the Brandywine Fund as one of the top three no-load growth funds in America. Under Friess’ leadership, the Fund boasted of a 10 year record with close to 25% average annual returns. The Wall Street Journal highlighted Brandywine as one of only eight funds with over $1 billion in assets to outpace the Wilshire 5000 Index by at least 15 percentage points in 1999 and 2000. During the dot-com crash, Brandywine strongly outperformed the markets because Friess and his team adhered to their investment disciplines which largely kept them out of the dot-com and tech-stock bubble. Money magazine concluded that, “after the collapse of many high-priced stocks, Friess' caution looks a lot like prescience."

So how does he do it? I’ve scoured what few sources there are out there that discuss Friess’ investing strategies. It seems that much of what makes Friess such a successful investor is non-quantifiable. His partners use the word “intuition” a lot when they describe how he goes about picking stocks. But to be sure, there are some rules he steadfastly lives by as an investor. From what I can determine, there are five such rules – we’ll call them the basic principles of Friessology – which I’ve listed here, in no certain order.

Friessology Principle #1. Never invest in the stock market; invest only in businesses.

This principles states that the benefits of focusing on the strength and promise of individual companies far outweigh the benefits to be gained by trying to predict macro factors like interest rates, currency exchange rates, general market and specific industry trends. Among individual companies, Friess likes to focus on past earnings growth, current bottom-line improvement, and shares that sell for reasonable multiples of forward earnings. The one catalyst he always looks for in a company is the likelihood that it will surprise earnings expectations in the near-term.

Friessology Principle #2. Buy real cash earnings, not future dreams.

According to Friess, there are three things that determine a company's value: the first is past earnings, the second is current earnings, and the third is future earnings! Friess requires at least three years of earnings history – no IPO’s please! – and three years of real, after-tax income before a stock crosses his radar screen. This single principle enabled him to outperform the market during the 2001 – 03 crash by keeping him out of dot-com and high tech stocks, and it is currently keeping his team away from the biotechnology sector which some say is the next bubble to burst. What this principle gets him into are strong money-making companies with a solid past and a bright future.

Friessology Principle #3. Prefer modest P/E ratios over high P/E ratios.

Friess likes to say that if a shoe maker grows earnings 40 percent a year in a mature industry and sells its shares at only 10 times estimates, he’s find that a much more exciting company than an optical semiconductor company that grows earnings at 20 percent with a forward P/E of 50. All things being equal, aim for a real current P/E below 30, a lower forward P/E, and an earnings times P/E valuation that is a good 25% higher than the current share price.

Friessology Principle #4. 'Pigs at the Trough'.

Friess’ Brandywine funds are known for their rapid turnover. If a company sticks around for more than a quarter, it is considered a long-time friend. His flagship fund boasts a turnover rate near 200% per year. Friess calls part of the strategy the “pigs at the trough” idea. The key is to replace good companies with great ones whenever the great ones in the portfolio become merely good. Like a pig that has eaten its fill is displaced by a hungrier pig at the barnyard trough, current holdings must keep their positions in the portfolio by retaining more upside potential than other possible holdings. If they can’t do that, they are replaced. The aim is always to put cash to work in companies with the best earnings strength and potential.

Friessology Principle #5. Don't buy the ‘top-of-the-list market leaders'.

This principle runs counter to many of the growth stock gurus out there – like Zweig, William O’Neil, Louis Navellier – who like to find stocks trading at the top of their industries and relative strength ranks. Friess is not interested in any “top 10” list. What he’s looking for is something further down but with the potential to move much higher. He’s much rather be in a #50 stock that moves to #25 than in the #2 stock that moves to #1. The key here is: discover the growth potential in a company before its gets recognized by the market.

And there you have it. The 5 basic principles guiding the investment strategy of one of the greatest investors of our time. Happy emulating!