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The key to great investing lies here: Tiger Woods, Ben Hogan and a crowbar. Can you identify the key? Is it obvious? Or do you think it is nuts to tie these three to great investing? In deference to those that think it is nuts, let’s toss a nutcracker into the mix. The secret to great investing lies here: Woods, Hogan, a crowbar and a nutcracker.

Tiger Woods, the greatest golfer in the world, will make about $80m this year. In 1950, the then-greatest golfer in the world, Ben Hogan, made slightly more than $20,000. You cannot attribute the staggering difference in annual income to inflation. Adjusting Hogan’s income for historical inflation would lift his income level to about $200,000.

Woods and Hogan’s income differential is not due to their energy expenditure. The energy expended to play a professional golf tournament in 2008 is identical to the energy expended in 1950. It requires about 280 strokes over a four-day period. Other variables such as the popularity of golf, the number of golf courses, population size and growth in the economy are insufficient to account for the massive income disparity between Woods and Hogan.

What is the important differentiating factor between Woods and Hogan, between $80m in income and an inflation-adjusted $200,000 income? For the answer, we can look to the crowbar and nutcracker. The startling gap in income can be traced to a single magical word: lever.

Employ the appropriate lever and the resulting effect is dramatically greater than if no lever is used. It is much easier to remove a hubcap when you employ a lever called a crowbar. Compare squeezing a walnut in your bare hand to squeezing a walnut using a nutcracker. With the right lever, the resulting effect is dramatic and it requires no increase in effort.

The reason why Woods makes exponentially more money than Hogan is because of a lever called television. Whether they admit it or not, sports figures make money because they provide entertainment. The number of people Hogan entertained was limited to the few thousand people who actually attended his events. By contrast, because of the lever called television, Woods can expend the same energy (about 280 strokes over four days) and entertain far more than 10m people. On a per capita basis (per viewer), adjusted for inflation, it is interesting to note Hogan made about 50 times more income than Woods.

How does the lever concept apply to investing? Since the objective of every investor is to make money, the lever concept has utility only if it facilitates identification of stocks poised to increase in value. Here are a few examples of how the lever concept can be applied to investing in stocks:

The valuation lever.

A powerful lever is available to investors that can identify and measure the spread between price and value. Because the purpose of the stock market is to provide liquidity – not to provide valuation appraisals – the gap between price and value for many stocks can be enormous. While the value of most publicly traded businesses changes less than 1 per cent a month, the change in stockprice for many companies is 50-100 per cent a year. For the adroit analyst, capable of measuring value with a reasonable level of precision, that presents an arbitrage situation with enormous profit potential.

The sales lever.

If internal metrics (such as operating margins) and external influences (such as inflation and interest rates) stay the same, companies that increase sales by 12, 15, and 18 per cent a year will double in value in six, five and four years, respectively. At first blush, it seems simple enough: find fast-growing companies and buy their stock! But the sales lever is problematic for a couple of reasons. Too many investors chase this lever, causing the stocks of companies with impressive sales growth to be bid up to unreasonable levels. If an investor buys a company that grows by 15 per cent a year over five years, doubling in value, he will not make a profit if he pays two times value for the company at the outset. The other problem is structural forces make it all but impossible for companies to grow fast in the long term. Fewer than 1 per cent of all publicly traded companies increase 15 per cent or more every year for 10 years consecutively.

The margin lever.

This oft-overlooked lever provides a rich vein of stock ideas for investors. If you can identify a company whose net margins oscillate between 2 per cent and 4 per cent, for example, consider buying the stock when margins are at a cyclical low, when net margins approach 2 per cent. When margins revert to the mean, company profitability soars – a cyclical move in net margins, from 2 to 3 per cent, means nominal profits will increase by 50 per cent. Note that cyclical operating nadirs tend to correlate to the historically wide price-to-value gaps, so investors that employ the margin lever also reap a windfall from the valuation lever.