Market Wizard Richard Driehaus

Richard Driehaus

For me, Jack Schwager’s interview with Richard Driehaus in The New Market Wizards was one of the most enjoyable interviews in the entire book. Driehaus begins the interview by discussing how he spend hours doing research in his local library as a kid. This struck an immediate chord with me as I did the exact same thing when I was younger. I was also able to relate with Driehaus because we have very similar trading philosophies, focusing on earnings and sales growth numbers and general chart trends. Needless to say, it was not hard to come up with five great quotes from this interview.

Top Five Quotes From Market Wizard Richard Driehaus

“Many of the best growth stocks have high multiples and are psychologically difficult to buy.” – Driehaus

This quote comes from the section of the interview where Driehaus explains the frustrations he had being an analysts and having traders not follow his recommendations. He would regularly recommend small cap growth stocks capable of explosive growth, and most investors avoid these stocks because they generally command higher PE ratios. This is what he means when he says that these stocks are psychologically difficult to buy.

One of the first things I learned as an investor is to throw PE ratios out the window. If we are going to identify and purchase the leading stocks that are capable of rocketing upward, we are going to have to pay the premium that that growth commands. Whether we buy a powerful, high PE growth stock, or an old, slow, low PE Dow stock, we are going to get what we pay for.

“Most people believe high turnover is risky, but I think just the opposite. High turnover reduces risk when it’s the result of taking a series of small losses in order to avoid larger losses. I don’t hold on to stocks with deteriorating fundamentals or price patterns. For me, this kind of turnover makes sense. It reduces risk; it doesn’t increase it.” – Driehaus

Driehaus addresses another common investing misconception here. He argues that actively trading, when done properly, is actually far less risky than a traditional buy and hold approach. The idea here is that we need to be very active in unloading stocks that are underperforming. This ensures that by taking many small losses we avoid having to take the one big loss that ruins us.

At the same time, Driehaus makes no mention of taking quick profits. When he latches on to a winning position, he becomes a long term investor in that position.

“It had everything I look for in a growth stock: accelerating revenues and earnings and proprietary products in a rapidly expanding market.” – Driehaus

If Driehaus hooked me with his library story, this is where he reeled me in. These are the exact qualities that I look at when I break down stocks every weekend. Earnings and sales growth is the most powerful factor in determining a stock’s price. This is why earnings reports are such a huge event and have such a powerful impact on a stock’s price.

He also looks for companies that have a new factor. There needs to be something powerful that changes the way the world operates. Consider the way AAPL changed our lives with the iPod or how GOOG has revolutionized your internet experience. The companies that are innovating these world changing projects are the most likely to see their stocks rocket upward. One current example of this kind of revolutionary product is the companies building three dimensional printers.

In addition to growth numbers and new products, Driehaus is also looking for companies in industries that are expanding and performing. A significant portion of a stock’s move can be attributed to its industry group. This is the reason that I take the group into consideration when I profile stocks each weekend.

“I would much rather invest in a stock that’s increasing in price and take the risk that it may begin to decline than invest in a stock that’s already in a decline and try to guess when it will turn around.” – Driehaus

This is the classic trend following approach. Driehaus refutes the common belief that the goal is to buy low and sell high. He argues that a much safer approach is to buy high and sell even higher.

I have a friend who often quotes Isaac Newton during these discussions. He reminds us that an object in motion tends to stay in motion.

“You must fully understand, strongly believe in, and be totally committed to your trading philosophy. In order to achieve that mental state, you have to do a great deal of independent research. A trading philosophy is something that cannot just be transferred from one person to another; it’s something that you have to acquire yourself through time and effort.” – Driehaus

At this point for me, that first sentence is a pretty generic comment. Everyone says that you have to be totally convinced that your strategy works. I get it. What is interesting to me here is the second sentence. This is something I haven’t seen before.

It is interesting to me that Driehaus doesn’t believe that an investor can fully grasp and appreciate his trading style without doing his own research. I can give a first hand account that he is right on the money here. I have learned more from the research I have done over the past few months than I did in years of studying other people’s research before that. The more time and effort I put into studying and analyzing, the better understanding I have of why my system will work.