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Happy New Year from New England, where we are covered with fresh snow. May this be your best yet.

But before we shut the door on 2005, I want to review my investing results to learn what worked and want didn't. Many of you have already done the same on this and other sites (for instance, read BenGrahamMan here: http://boards.fool.com/Message.asp?mid=23491237), and I have learned something from each of you. Thanks for sharing.

Highlights:

1. My Apr. 12, 2004 Business Week picks gained an average of +31% over the next 12 months, versus a +3% gain for the S&P 500. Five of my six picks beat the benchmark index, which means the gains were broad-based, rather in just one or two moon shots. Meanwhile, my two pans--General Motors and Allied Waste--fell an average of –41%. So, 7 out of 8 ideas performed as expected. To learn more, click here: http://www.earningspower.com/performance.html

2. On Sep. 12, 2005, Barron's published my column "Nothing But The Truth," which is about Benjamin Graham and the growth investor. My five picks from the column are up an average of +6% through Dec. 30, versus a +1% gain for the S&P 500. Four of the five picks are beating the market, with Dell being the only laggard, at –14%. (I remain bullish on Dell.) My four pans are down an average of –14%, and each trades below my recommended sell price. So, 8 of 9 ideas performed as expected.

All of the Business Week and Barron's selections was chosen using the Earnings Power Chart. My calculations exclude dividends.

3. Tim Beyers wrote a follow-up to a December 2004 column giving Motley Fools several screens to find earnings power-type companies for further study. My screens were based on a mix of growth and value criteria, as well as low debt loads, insider ownership, and a low short interest ratio. The 9 companies that met these criteria gained +17.5% over the next 12 months, versus +7.7% for the S&P 500. To read Tim's column, click here: http://www.fool.com/Server/printarticle.aspx?file=/news/commentary/2005/commentary05122310.htm

4. Finally, our family portfolio, which includes a heavy dose of earnings power companies, did just fine (although not as well as the Nikkei, which rose about +40%).

It is gratifying to see these strong across-the-board results, for two reasons. First, I do not want to embarrass myself in public. Second, these market-beating returns reinforce my conviction on the soundness of the "measure twice, cut once" philosophy espoused in my book It's Earnings That Count (McGraw-Hill, 2004).

To be sure, the Earnings Power Chart is not the only way to make money on Wall Street. Still, if you are a conservative growth investor, gauging corporate earnings in stereo from the pessimistic view of the defensive investor and optimistic view of the enterprising investor beats the mono sounds of the GAAP-only approach every time.

Given the aforementioned data, you would think that I didn't make any mistakes last year. Well I did, and since confession is good for the soul, here are the gory details:

In Aug. 2004 I read about Sontra Medical (SONT) in the Boston Globe. Sontra was developing a technology that enabled doctors to inject medicine into patients through some kind of high-speed vibration device, rather than the traditional method of using needles. Being squeamish around needles, I wanted Sontra to do well. So even though Sontra's financials were unimpressive and the operating history was slim, I bought shares at $2.47 and held on long enough to suffer a –44% loss, to $1.38. The good news is that I never added to my customary starter position, which I define as 10% of a full position.

Lesson learned: No more venture-type deals; I will leave them for the industry experts.

My second disaster was buying Boston Communications Group (BCGI) in Mar. 2005, at $7.58 a share. Like Sontra, Boston Communications is a local company; in addition, it had an operating history and was a Ben Graham statistically cheap-type stock. Of course, companies are usually cheap for a reason, and Boston Communications was no exception. If I had taken the time to do my normal research, I would have learned that Boston Communications was the defendant in a lawsuit which, if it lost, would wipe-out all the stockholders' equity (corporate net worth). In short, your proverbial Sword of Damocles. After the stock began drifting downward, I took a closer look at this patent infringement case and decided to cash in my chips, resulting in a –22% loss. Good thing I sold, because Boston Communications lost the court case and the stock plunged. Boston Communications recently sold for $1.13 a share.

Lesson learned: Always use my Five-Minute Test, which warns against buying companies facing lawsuits "that could mortally wound the company." You would think I would take my own advice! (n.b., Thanks to Ears for this excellent idea http://boards.fool.com/Message.asp?mid=23476461)

Mistake numero tres was buying First Marblehead (FMD), which had a low PEG ratio and seemed poised for continued rapid growth. Unfortunately, First Marblehead's PEG got even lower, as the stock fell from $56 to $34, handing me a –39% loss.

Lesson learned: First Marblehead had a small client base and, more troubling, operating cash flow after deducting stock-based compensation about half of net income. When operating cash flow is half of GAAP profits, this is a sign of poor earnings quality.

(I may regret selling First Marblehead, as Tom Brown, founder of Second Curve Partners, is bullish on the education lender. Brown knows what he is doing; between 1989 and 1997, he was named the top regional-bank analyst in the country eight times by Institutional Investor magazine, according to a February 2004 column in National Review Online by James Glassman. Brown's excellent website is here: http://bankstocks.com/)

Will I make mistakes in 2006? Absolutely. But they won't be the same mistakes that I made in 2005.

If I had stuck to my well-defined process, then I would not have bought these lemons. But I was weak and I deviated from the Earnings Power Playbook. However, when I realized these companies were wrong for me, I sold.

Many investors have trouble selling. Why? Because when we sell, it is a formal admission that we made a mistake. And no one likes to admit they made a mistake.

If you have a problem with selling, here's an idea: Focus on the process, not the results. With Boston Communications, the falling stock did not paralyze me. Instead, I went back to my Ideal Company list. Turns out, between the lawsuit and some other items, Boston Communications lacked many of the qualities that I look for in a stock. So the decision to sell was easy. I was not concerned about trying to get back to break-even, as I think many investors fixate on.

If you find yourself unable to sell, create your own Ideal Company checklist (which I have discussed before.) If the company doesn't earn a high score, cut your losses. There are many fish in the investing sea. If I had let Boston Communications paralyze me, them I would still own it at $1.13, rather then selling at $5.91 a share.

You should also write down the reasons why you are buying the stock, what you think the business is worth, etc. I do. In fact, for each company I have three pages of notes: Quality of Profits/Earnings Power Chart, competitive advantage (plus other information), and estimate of intrinsic value. I carry a printed copy of this file wherever I go, and update the information often.

Looking forward, I intend to reduce the number of stocks in our portfolio. Earlier this year I owned a dozen earnings power-type companies. Now the list is down to 10. But I think this is still a couple of companies too many for me, so I want to get down to 7-8. I can follow 7-8 companies and their competitors, but 10 companies is too much. Under this new "King of the Hill" policy, I must sell a current position before buying a new stock.

My great friend Ted Oglove, author of the excellent book Quality of Earnings, has the opposite view. Ted says he would be "100 times better off" if he had taken smaller positions in a larger number of companies, and then never sold. Ted has lots more investing experience than I do, and he may be right and I may be wrong. (My first mistake of 2006?) Time will tell.

I also hope to do a better job of managing my files in 2006. I read hundreds of columns on which stocks to buy, how to read a financial statement, etc., but I hardly read anything on how to manage all the paper this business generates. If you have any suggestions, please let me know. We can all agree that whether you are a weekend investor or a professional, the amount of material to read and file is daunting.

A third goal is to continue my regular exercise program. As I write on pg. 190 of IETC, "physical activity boosts the oxygen flow to your brain, helping you think more quickly and may even speed the production of new brain cells."

Specifically, I will swim 100 miles, bike 2,000 miles, and run 500 miles in 2006. In 2005, I swam 36 miles, biked 674 miles, and ran 232 miles. (I bought a Cyclops Fluid Trainer in October, so now I can get more indoor miles during the winter months.) I also plan to do 12,500 pushups, versus about 6,000 last year.

Because I sometimes need an incentive to lace up my Asic Gels, I have competed in sprint-length triathlons in the last two years. In Sep. 2004, I finished the Hyannis, MA race in 1 hour 23 minutes and 39 seconds, finishing 351 out of 625 (44% percentile). Then last September I did the same race again and finished in 1 hour 13 minutes and 12 seconds, finishing 184 out of 675 (73rd percentile). Knocking 10 minutes off my previous time was exhilarating.

I find the more I exercise, the more patient I am at work and at home. The natural high from lifting weights and doing cardio makes me a better investor, without question. Try exercising for a month and see what I mean.

Since I am more apt to workout if I keep track of my times and distances, I built a spreadsheet based on an article by Ray Britt, which you can read more about at www.rbritt.com. Double-click the "Inside Triathlon Article-Get Faster Now" column and then go into Word and hit the Cancel button. Ray's column will teach you how he uses Excel's pivot table to track his workouts. If you want my 2005 spreadsheet, send me an e-mail at Hewitt.Heiserman@EarningsPower.com.

Best wishes for a prosperous New Year. Also, thanks for buying IETC.



Hewitt
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