"John Neff on Investing": Timeless Wisdom of a Value Investing Legend (Part 1)

Introduction

John Neff is considered one of the most successful fund managers in history. From 1964 to 1995, he managed the Vanguard Windsor Fund, achieving an average annual return of 13.7%, which significantly outperformed the S&P 500’s 10.6% return during the same period. Under Neff's management, the Windsor Fund became the highest-performing and largest mutual fund of its time.

Below, I’ve highlighted passages that particularly resonated with me, so this is not a straightforward summary of the book. Please note that I’ve also rearranged, rephrased, or condensed some parts. I’ll mark my thoughts as "Neo" to distinguish them from the book’s content. Let's dive into the key takeaways from the book.

John Neff’s Style: Unyielding Determination

Success in investing isn’t always tied to blue-chip stocks or a bullish market. At the heart of our achievements were wise judgment and unyielding determination. With sound judgment, we seized opportunities, and with unwavering resolve, we stayed the course, even when the majority opposed us.

To succeed in investing, steadfast patience is essential. It's the determination to push forward, even if many around you disagree. Rather than being swayed by market sentiment, the Windsor Fund waited until each company's stock price reached a fair level.

[Neo: Warren Buffett once said that investors should approach investing like the legendary .400 hitter Ted Williams. Wait patiently for the right investment opportunity you’re confident in, and then invest heavily. He also noted that, unlike baseball, there's no “strikeout” in investing, which makes it even more advantageous. To become a successful investor like John Neff or Warren Buffett, it’s crucial to make wise decisions independently and possess the unyielding determination to stick to them.]

John Neff’s Method: Low P/E Stocks

My personal favorite investment strategy is the low P/E (price-to-earnings) approach. No matter the market conditions, we have adhered to the low P/E strategy almost religiously. To successfully invest in low P/E stocks, it's essential to differentiate between those with limited growth potential trading at a low price and those that are genuinely undervalued. However, this distinction is easier said than done.

[Neo: Truly undervalued low P/E stocks are often smaller, unpopular companies with little coverage from brokerage reports, making it difficult to tell if they’re genuinely undervalued. Warren Buffett, for instance, spends hours daily reading numerous companies’ annual reports. He advises investors to read as many annual reports as possible. Even investing geniuses put in substantial time and effort to find undervalued stocks, so it’s no easy task for ordinary investors to identify hidden gems that the market undervalues. However, it’s still worth trying!]

Another advantage of the low P/E strategy is the potential for high dividend yields. While the Windsor Fund invested heavily in high-dividend stocks, it didn’t ignore stocks with strong growth potential, even if they lacked dividends. The approach involved buying high-dividend stocks, selling them when their yield dropped to an average level, and then investing in new stocks.

[Neo: This reminds me of the Dogs of the Dow investment strategy. It involves investing in the 10 highest dividend-yielding stocks among the 30 companies in the DJIA based on the idea that these high-yield stocks are potentially undervalued. At the beginning of each year, identify the 10 DJIA stocks with the highest dividend yields and invest equal amounts. Hold the portfolio for one year until the end of the year and repeat the process.]

In my opinion, a bull market doesn’t weaken the advantages of a low P/E strategy; instead, it highlights its importance even more. Chasing only high P/E stocks can lead to substantial losses when growth slows. In contrast, low P/E stocks reveal their true value during these times, maintaining their worth even in a downtrend.

[Neo: Value and growth stocks seem to cycle endlessly with the market. The key is to solidify your own style. If you just follow trends — growth stocks when they’re hot, value stocks when they’re in vogue — it’s hard to make substantial profits. Of course, combining both in a balanced portfolio is also an option. In fact, the S&P 500 itself is a mix of growth and value stocks, with a stronger emphasis on growth due to their disproportionate aggregate market cap.]

The Windsor Fund maintained a consistent investment style, regardless of market fluctuations. Here are the key characteristics of that style:

• Low Price-to-Earnings Ratio (Low P/E)
• Positive relationship between total return and P/E ratio
• Cyclical exposure adjusted for P/E considerations
• Defensive dividend yields and potential for improvement
• Fundamental growth of 7% or more (strong fundamentals + reliable growth companies)

John Neff’s Method: Growth Stocks

Companies with a low P/E ratio yet promising growth are among the most attractive investment targets. The low P/E stocks favored by the Windsor Fund typically had a P/E ratio that was 40-60% lower than the market’s leading stocks. However, not all low P/E companies make good investments — some have low P/E ratios due to poor management. Neff considered companies with low P/E ratios and an annual growth rate of at least 7% as ideal investments, particularly high-dividend yield stocks.

[Neo: There are portfolios that invest in small-cap, value, and growth stocks, targeting stocks that embody low P/E and low P/B ratios (value), have growing sales and profits (growth), and are often smaller, less popular companies (small-cap). I invest some with this approach.]

Companies with growth rates below 6% or above 20% were excluded from consideration, as extremely high growth often brings significant risks. Companies with overly rapid growth should be approached cautiously for this reason alone.

Focus on under-the-radar growth stocks. Windsor’s criteria included:

• Single-digit P/E ratios around 6-9 times
• Impressive growth rates of 12-20%, with consistent double-digit earnings growth over time
• Active participation in sectors with clear growth potential
• Dividend yields in the range of 2.0-3.5% under all conditions
• Industries that are straightforward to analyze
• High return on equity achieved through capital expansion and strong management performance
• Market cap and net income substantial enough to be considered by the broader market

[Neo: Investing legends such as Warren Buffett, Peter Lynch, and John Neff emphasize the importance of investing in easily analyzable companies and sectors. This gives us a good reason (or excuse..) to avoid complex industries that demand extensive specialized knowledge.]

John Neff’s Mthod: Contrarian Investing

While the majority flocked to popular stocks, we took the opposite route. At Windsor, we capitalized on the market's trend toward trending stocks, buying neglected, undervalued stocks at low prices and holding them until they reached fair value. This approach was relatively low-risk and straightforward, yet many people dismissed us as the "great fools" of the market.

[Neo: Warren Buffett, known as "the Oracle of Obama," faced similar criticism during the late 1990s dot-com bubble. While others rushed into tech stocks, he focused on traditional value stocks, leading some to label him as an outdated investor. During this time, Buffett famously said, "Only when the tide goes out do you discover who’s been swimming naked."]

Look for hidden gems in the discount section. Pay attention to stocks hitting new lows, but avoid buying indiscriminately just because prices are down — some may fall further. Yet, among stocks at daily lows, there are always one or two companies worth investing in. The key is to select those with growth potential that the market will recognize when sentiment shifts.

[Neo: Some experts advise avoiding stocks hitting new lows or those dipping below the 240-day moving average. But John Neff suggests looking for investment opportunities in these low-price lists. I believe both views have merit. Ultimately, finding a method aligned with your personality and investment horizon — and sticking with it — is what really matters.]

John Neff’s Method: Calculated Participation

The Windsor Fund’s portfolio was composed through a strategy known as "calculated participation." Each stock was categorized into four main groups: cyclical growth stocks, moderate growth stocks, unpopular growth stocks, and popular growth stocks. Notably, the share of popular growth stocks — the type most investors favored — was kept minimal. Only four popular growth stocks were included, making up less than one-tenth of the entire Windsor portfolio.

[Neo: Peter Lynch also classified stocks into categories like growth, blue-chip, cyclical, turnaround stocks, etc., applying a distinct selection and management strategy for each category. When I invest in individual stocks, I try to categorize them similarly before purchasing.]

To assess the potential of cyclical stocks, we closely analyzed their earnings trends over economic cycles, using five-year average returns rather than growth rates. Given cyclical volatility, average returns provided the most reliable indicator for future earnings potential.

Windsor allocated over one-third of its investment capital to cyclical stocks. With a deep understanding of cyclical industries, we consistently bought shares of the same companies at market lows and sold at peaks when demand rose. The low P/E strategy typically yielded the best returns on cyclical stocks 6–9 months before they reported improved earnings.

[Neo: Both John Neff and Peter Lynch favored cyclical stocks. To seize opportunities well, it seems crucial to focus on a few specific cyclical industries and thoroughly understand them.]

On average, the Windsor Fund held about 60 stocks, with the top 10 stocks accounting for around 40% of the portfolio — a highly focused investment strategy.

John Neff’s Method: Selling Timing

There were clear reasons behind every stock sale we made, typically for one of two reasons: (1) the fundamentals were seriously deteriorating, or (2) the stock price had reached our estimate. When the fundamentals were strong, we often held the same stock for 3, 4, or even 5 years. However, sometimes we sold a stock less than a month after buying it.

[Neo: It’s interesting that John Neff mentions holding a stock for “even 5 years,” which implies Windsor rarely held stocks beyond that period. He also admitted that there were times he sold stocks within a month of purchase. Warren Buffett, on the other hand, is known for holding quality stocks like Coca-Cola and American Express indefinitely. However, he has also adjusted or sold many other stocks when fundamentals changed, when stock prices far exceeded their intrinsic values, or when initial misjudgments were realized later. This serves as a reminder that even investment legends with a long-term approach occasionally adjust their stock holdings quickly.]

Ordinary investors often sell when a stock reaches their target price, but this approach may be unwise, as profit estimates can change over time along with market conditions.

When you feel the urge to brag about your holdings, it’s likely a sign that the time to sell is near.

[Neo: Whenever I proudly shared a high-performing investment holding with others, it almost inevitably dropped soon after, even if it rebounded later. These days, I make a point not to boast about good returns!]

There’s so much to cover that I will divide my review into two parts. Part 2 will be posted soon. Thanks for reading. I wish you grow rich slowly and surely!

This blog post includes excerpts from the book “John Neff on Investing”, published by Wiley, quoted under fair use as permitted by copyright laws in relevant jurisdictions. The content includes both direct excerpts from the original work and my personal thoughts, rephrasings, and interpretations. All original text and images from the book are the property of the respective author and publisher, and are not to be used for commercial purposes.