*** “The stock market is a study in cycles; when it changes direction, it remains in that new trend until the momentum weakens — a body in motion tends to stay in motion. Remember, don’t buck the trend. Don’t fight the tape.”

That quote is from Jesse Livermore: World’s Greatest Stock Trader by Richard Smitten. It is a fantastic book. I just finished it last weekend.

In case you don’t know, Jesse Livermore is regarded as the best trader ever to walk the Earth. He made (and lost) millions of dollars time and time again in the early 1900s. But his largest win came on Black Tuesday.

When the U.S. markets came crashing down in October 1929, in what turned out to be the start of the Great Depression, Livermore was prepared. Weeks before, he went short the biggest-name stocks of the day. His indicators told him the market trend was changing from bull to bear. And he was right.

While everyone else lost the farm — many literally — Livermore walked away with over $100 million in earnings. It was such an amazing feat that people literally blamed him for the crash. They were jealous with rage. So…

How did he do it?

Livermore studied the markets like you wouldn’t believe. And over the years, he
developed a set of rules — rules he lived by each and every day. One of his most important rules was, “Don’t fight the tape.” What he meant by that was simple…

As a trader, or an investor, your best bet to make money is to invest in the direction of the major trend. For instance, if you are in a bear market (when the indexes are in a sustained downtrend), your easiest money will be made going short. This is what Livermore did in 1929. Likewise, when the market is in an uptrend, like it is now, your best bet is to stay long…and let your winners ride. This is important to remember.

It’s so easy to overthink situations. For instance…

Is the small-cap market overbought right now? It may well be. But you know what? People are still buying. And until the tape says to get out, there’s no reason you should. Right now the “easy money” is being made by being long on small caps. Period.

When that changes, I’ll let you know. But for now, everything is sunny in the small-cap world…

*** The Russell 2000 is trading for 639.03 — just a shade under its all-time high (which it recently made, on Friday of last week).

*** Big hedge funds and financial institutions are buying into small-cap funds (ETFs) quicker than you can imagine. As Dan Denning showed us last week, funds that track the Russell 2000 and S&P 600 are being flooded with more “smart money” in the last month than in all of the second and, in some cases, third quarters COMBINED! In other words…

The major players on Wall Street are just now buying into the small-cap rally. Logically, that says small-cap stocks still have momentum on their side. In fact…

*** As I type, all 10 of the best performing stocks on Wall Street (that trade for at least $5) are small-cap stocks with market caps under $1 billion. Stocks like Sola Intl., Inc. (SOL:NYSE), Applied Digital Solutions (ADSX:NASDAQ) and 724 Solutions, Inc. (SVNX:NASDAQ) are leading the way with gains of 24.5%, 22.4% and 21.2%, respectively. Not too shabby.

By the way, if you want to learn to trade like Jesse Livermore, check out this report I put together for potential traders:

www.agora-inc.com/reports/MST/liverC00

In the spirit of Wall Street legends, Irwin writes this week about how Phil Fisher got in early on a certain car radio company. Although Fisher isn’t a household name like Warren Buffett or T. Rowe Price, he started one of the most successful money management firms ever, Fisher Investments. Read Irwin’s story to see how Fisher’s buy-and-hold strategy made him a fortune in a company that went on to revolutionize the electronics industry.

Irwin, crank it up…

Why the Galvins Rule

This American electronics giant built by the Galvin dynasty helped make necking in cars a national pastime…while empowering the police who cruised Lovers Lane with the first walkie-talkie. Forty years later, when Japan, Inc. had this company in its crosshairs, the Galvins dug in for the heavyweight match…and the company’s stock had climbed 1,400% when it was over.

In fact, it was the Galvins’ enormous strength of character that impressed one of the greatest investors of all time to buy stock in this company for the long haul…giving him a profit over 23,000%.

That company is Motorola — the name derived from its popular car radio that served as a backdrop to romantic interludes on Lovers Lane. But legendary investor Phil Fisher saw a more profitable opportunity with Motorola. It happened during a meeting with then-CEO and co-founder Paul Galvin…and cemented a relationship that would last half a century.

It was the late 1950s. Paul had rescued Motorola from bankruptcy by successfully mass-producing high-quality car radios. Fisher was interested in investing in Motorola (despite Wall Street’s negative outlook on the company), and he arranged a meeting with Paul. Fisher found Galvin forthright, competent and inventive — the kind of executive that a long-term investor knows could lead a company through good times and bad.

Shortly afterwards, Fisher paid $43 per share in 1,000-share blocks. By 1997, Fisher had turned that $43,000 investment into an INCREDIBLE $10 million…proving that it pays to HOLD great small-cap stocks.

Admittedly, that kind of commitment is not for everyone. You can’t cut your losses when the stock drops. Or cash in on a rush of good news. You really have to stick to your guns. But it’s the kind of investment strategy that works for Wall Street legends like Phil Fisher…and for captains of industry like the Galvin family.

For the Galvins, it started when brothers Paul and Joe bought a run-down electronics shop on the outskirts of Chicago in 1928. At the time, the company was called Galvin Manufacturing. The brothers were completely bootstrapped. Their only assets were $565 in cash and $750 in tools. The company’s first week’s payroll was $63.

The Galvins’ extraordinary perseverance and courage turned that dingy little shop into a $27 billion conglomerate…and changed the way people live. The company that became Motorola brought mobile radios to police departments, rectangular TV picture tubes into living rooms and cell phones, well…just about everywhere. Within 76 years (three generations of Galvins), Motorola had matured into a global leader in wireless, broadband and automotive communications technologies

But the Galvins’ innovations weren’t restricted to technology. They had amazing
foresight when it came to employee relations. Before there was ever such a thing as a benefit plan, Paul helped Motorola workers with medical bills and college tuition. Under his management, Motorola was a pioneer in profit-sharing.

After Paul’s son Bob moved into the executive ranks, in 1948, he started Motorola University – the company’s training and education center. Bob knew that Motorola’s long-term success depended on employees who could think ahead…and not repeat past mistakes. It was that kind of thinking that saved the company in the mid-1980s.

At the time, Sony had penetrated the U.S. market with innovations such as the Walkman, Trinitron color TVs and VCRs. Panasonic had achieved global domination in consumer electronics through advanced product development, manufacturing, marketing…and low-ball pricing. By the time they had set their sights on Motorola, both companies had already laid to rest major competitors in the United States and Europe.

Bob acted quickly. He enforced a world-class quality-assurance program that dramatically cut semiconductor defects…while speeding up production lines. He was now able to produce more products, at lower prices…successfully fending off a frontal assault by the Japanese.

Bob’s lasting faith in superior quality and shorter manufacturing times produced miraculous results. From 1980-1997, Motorola’s sales climbed from $3.3 billion to $29.8 billion…and earnings jumped from $192 million to $1.2 billion. Wall Street was impressed. The stock soared from $6 per share in 1980 to more than $90 in 1997 — an increase of 1,400%

But what if Bob had just focused on quarter-to-quarter results, like so many investors today? Chances are the name Motorola would have been changed to…Panasonic? And consider that if the company had gotten into the hands of offshore management, Chris Galvin would never have taken over the reins as CEO…and rescued the company in the true Galvin spirit.

Because when Chris moved into the corner office, in 1997, the company was once again facing a crisis. A glut of chips and pagers was collecting dust in warehouses. And by 1998, Motorola’s worldwide markets were in fierce decline.

All at a time when Asian competitors embarked on another wave of cutthroat pricing tactics.

As his father and grandfather before him, Chris made the tough decisions. Plants were sold, divisions reorganized and…he INCREASED R&D. Chris’ aim was to strengthen leadership through long-term innovation.

By taking the long view, Chris managed to reverse the company’s slide. The stock jumped from a 1998 low of $38 per share to $149 in 1999.

Through it all, the generations of Galvins remained levelheaded. They never panicked when the stock tanked. Or kicked back during the peaks. Instead, they always charted a course that would add long-term value to the company and its shareholders.

For the Galvins and for celebrated investors like Phil Fisher business is much more than a quarter-to-quarter roller-coaster ride. Making big returns in small-cap stocks, like Fisher did with Motorola in the 1950s, takes real stamina and determination.

That’s why for some small-cap investors, a buy-and-hold strategy can often turn a few hundred dollars into tens of thousands. They have what it takes to ride out the tough times and wait for the big payoffs. Not everyone can become the next Phil Fisher or Paul Galvin, but one way to think about having a great ride in the small-cap market is to cruise your way to profitability.

Happy investing,
Irwin Greenstein

December 07, 2004

Why the Galvins Rule was originally featured in the Penny Sleuth.