The Zulu Principle: Making Extraordinary Profits From Ordinary Shares is an investment book first published in 1992 by Jim Slater, a UK-based small-cap investor. Slater is a Chartered Accountant who founded Slater Walker, an investment company famous for corporate raids and the subsequent stripping of company assets.
Though the book has had several updates and republications (latest being in 2008), the author has pretty closely stuck to his key investment principles he had espoused from his initial edition. His philosophy follows GARP investing style that mixes a combination of growth and value, proactively scouting for shares that are expected to register high earnings growth, but are currently valued at prices relatively lower to their forecast earnings.
What the title of the book implies
Unlike Ralph Wanger's Zebra in Lion Country, the book does not draw parallel with the title linked to the African subcontinent and is short of metaphors. While the author was framing his approach, his wife got to read a Reader's Digest article on the Zulu tribe. He was very much captivated by his wife's relative expertise about the Zulu culture and realised that she could become even more knowledgeable by reading every book on the Zulus than she could by living with them. The author uses this anecdote to stress the point that it would be easy to become an expert in a particular subject by narrowly focusing on one area. By doing so, individual investors stand to build an edge and be in a position to compete successfully with investment professionals.
How is the book organized?
The book can be divided into three parts, with the first chapter mainly speaking about the advantages of investing in less tracked smaller companies (compared to larger-cap peers that are parts of the index) and two basic factors that determine stock price growth - EPS growth and multiple expansion - and how they are interlinked.
The second part (from chapters 2 till 10) forms the core, wherein Slater outlines 10 demanding criteria to pick growth stocks with a strong safety net.
The third part provides good strategies for exploiting special scenarios related to cyclical, asset situations and value investing, shells, leading shares and overseas market. There is also a mention about personal investing highlighting details related to brokerage, portfolio management and bull and bear market. What I really like about the book is the simple, easy-to-read format and that each chapter has a quick review and summary at the end that are highlighted and numbered.
What are the Zulu Investing Principles?
Slater has laid down the following 11 criteria for picking growth stocks, ranked by their level of relative importance.
Let start with the Mandatory Criteria:
1. A track record of positive growth in earnings per share in at least four out of the past five years
2. A low price-earnings ratio relative to the growth rate (NYSE:PEG) less than 0.75
3. Optimistic chairman statement
4. Strong financial position characterised by liquidity, low leverage ratio, net cash position, and positive free cash flows. However, he has allowed for minor exceptions if it is cash-generative or has pending asset sales.
5. Superior competitive advantage, characterised by high operating margins and ROCE (relatively to industry) for a long period of time, helped by brands, patents, copyrights, market share, or niche focus.
Now the Highly Desirable criteria:
6. Something relatively new - that could be a major acquisition, change of CEO, or new products launches.
7. Small market capitalisation
8. High relative strength - a technical measure used to confirm investors are begin to appreciate the potential
Finally, the Bonus Criteria:
9. Dividend yield of near 4% and growing in line with earnings growth
10. Reasonable asset position priced below or close to book value
11. Management with significant shareholding and better to avoid companies with dual class shares that allows for special voting rights.
Final thoughts and conclusion
Slater's basic premise is to remain focused on dynamic growth shares that are largely not tracked by sell-side brokerages and are growing at a faster pace than the industry. These mainly include companies in the small-cap and micro-cap space, which are highly under-exploited by the institutional investors and where one could find good bargains.
Further, big investors managing large funds won't have the appetite and time to research these small-cap stocks, as they have to increase their number of holdings with the 100th stock pick being less attractive than the first.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.