Who is Phil Town, and what is the Rule #1 Investing Screen?
The Rule #1 Investing Screen is adapted from Phil Town's 2006 book "Rule #1" (Crown Publishers). The title comes from Warren Buffett's line that investing has only two rules: Rule #1 is don't lose money, and Rule #2 is don't forget Rule #1. Town is a former Green Beret turned river guide who says a client introduced him to value investing on one of his trips, and that he turned $1,000 into $1 million in five years applying it. His pitch is that an individual investor can beat the market in about 15 minutes a week by buying a "wonderful business" at an attractive price. The screen puts numbers on that idea.
The Four Ms
Town judges a business against four tests he calls the Four Ms. Meaning asks whether you understand the company and would happily own it for the long haul — he suggests starting with businesses tied to your work or interests.Moat is a durable competitive advantage that fends off rivals and makes future results easier to predict; the wider and more defensible the moat, the safer the business. Management is about owner-oriented leaders who are candid with shareholders about what went wrong, not only what went right. Margin of safety is the discipline of paying well below what the business is worth, so that even a mistaken read on the first three Ms need not cost you money. The first three find a great company; the fourth insists you buy it cheap.
The Big Five numbers and the sticker price
Town measures moat and management with five figures he calls the Big Five: return on invested capital (ROIC), plus the growth rates of equity (book value), sales, earnings per share, and free cash flow. He treats ROIC — operating profit after tax over debt plus equity — as the most important, because a high return on the money a business reinvests in itself signals that management is working for its owners. Town ideally wants each of the Big Five running at 10% or more a year for ten years; because most data services only reach back five, this screen uses a five-year window.
The margin of safety is where the pricing happens. Town estimates a company's "sticker price" — his fair value — from four inputs: current earnings per share, a conservative growth rate (the lower of historical equity growth and analysts' forecast), an estimated future price-earnings ratio, and a required annual return of 15%. He projects earnings ten years out, applies the future P/E, then discounts back at 15% to reach the sticker price. The margin-of-safety price is simply half of that. In other words, he wants to buy a dollar of value for no more than fifty cents — pure Graham logic, applied to companies that have also cleared a high bar for growth and returns.
What the Rule #1 Investing Screen looks for
- Average return on invested capital over the last five years of at least 10%.
- Average annual growth in equity (book value) over the last five years of at least 10%.
- Average annual growth in earnings per share from continuing operations over the last five years of at least 10%.
- Average annual growth in sales over the last five years of at least 10%.
- Average annual growth in free cash flow over the last five years of at least 10%.
- Current long-term debt per share no more than three times current annual free cash flow per share — a company that could clear its long-term debt in roughly three years.
- Current stock price no more than 50% of the estimated sticker price, the margin-of-safety test.
- Only companies listed on the New York, American, or NASDAQ exchanges; foreign companies trading as ADRs are excluded.
What to keep in mind
The sticker-price math is only as reliable as its inputs. Fair value swings hard on the assumed growth rate and future P/E, so "half of sticker price" protects you only if that sticker price is honest — a 50% discount to an inflated estimate is no discount at all. The full set of hurdles is demanding: 10% growth across five different measures, low debt, and a half-price entry rarely line up at once, so the screen tends to pass few names and lean toward smaller, faster-growing companies. Town's headline claims — the 15-minutes-a-week ease and the thousandfold return — are self-reported and deserve a healthy dose of skepticism. Use the screen to find candidates, then do the work the Four Ms actually demand.
Sources
Rule #1: The Simple Strategy for Successful Investing in Only 15 Minutes a Week, Phil Town, Crown Publishers, 2006.
American Association of Individual Investors (AAII) — Stock Investor Pro screen definition and commentary.