The 3 Investing Rules of a Billionaire Family

During the second half of the 20th century, Larry Tisch and his brother, Bob, turned an investment in a New Jersey resort hotel into a multibillion-dollar conglomerate -- Loews. How did they do it?

Larry, who was the financial mastermind, had a knack for spotting value. In 1960, the brothers took control of Loews, at that time a major movie-theater chain -- but it wasn't the movie theaters they were interested in. Larry understood that the real estate on which they stood had enormous underlying value.

Loews is now a $26 billion company that consists of insurance, hotels, and offshore oil and gas. The stock has returned nearly 1,000% over the past 20 years, an annualized return of 12.6%. Larry's son, James Tisch, the current CEO, recently reflected on the guiding principles on which Loews was built.

"No. 1, don't bet the company."
"First and foremost," says Tisch, "everything we have is fully protected." What does that mean for the individual investor?

For a start, avoid companies that use large amounts of debt to finance their activity. These companies are anything but "fully protected" if their business experiences a downturn. In fact, the shackles of interest and principal payments are the heaviest when a company is least able to shoulder them. Companies in this situation are extremely restricted in their operating flexibility.

What does a "fully protected" company look like? The following companies are among the least leveraged within their sectors:

Source: Capital IQ, a division of Standard & Poor's.

"Second, watch out for the downside."
Tisch argues for businesses with "long-term assets, that are going to be here for a long time and aren't dependent on management." While most investors are single-mindedly focused on expected gains, value investors put capital preservation first. They know that losses are like a punishing series of speed bumps on the road to capital accumulation.

Successful investing boils down to two things: estimating the value of the future cash flows a company will produce, and taking advantage of situations in which there is a significant discrepancy between your estimated value and the price of the company's shares. Insisting on "long-term assets" means excluding businesses whose future is difficult to predict.

If you don't have confidence in the sustainability of a company's business model, you're setting yourself an impossibly high hurdle from the outset. In other words, take technology companies and businesses that depend on a single individual off the table.

That's two strikes against a company like Apple, and rightly so. Ask yourself how much of Apple's value would evaporate if Steve Jobs were hit by a bus. My answer? Too much!

Finally, be patient
Value investors gain from being patient at two different times: while waiting for a current investment to return to its fair value, and while waiting for circumstances in which superior companies become temporarily undervalued. That runs counter to a strong bias toward action, and it requires a level of restraint that is difficult for most investors.

"If there's nothing to do, do nothing," Tisch says. "If you're an action junkie, it's going to get you in trouble." He was commenting on the lending excesses that are now resulting in billions of dollars of bank write-offs, but this point applies to the individual investor as well.

Is successful investing really as easy as following three simple rules? Yes ... and no. Although these rules are simple, they're hard to follow. Doing so requires the intellect and aptitude to analyze and value companies, as well as the temperament to act consistently with the results of one's analysis.

The team at Motley Fool Inside Value recommends two new stocks every month based on the same principles -- excellent but undervalued businesses, strong long-term prospects, and patience -- that James Tisch described. You can find out which stocks it recommended this month, as well as all of the previous picks, with a 30-day free trial. There's no obligation to subscribe.

This article was first published June 26, 2008. It has been updated.

Alex Dumortier, CFA , has a beneficial interest in Microsoft. Microsoft is a Motley Fool Inside Value recommendation. The Motley Fool has a disclosure policy.