A deep-dive book review into the Zulu Principle and what it means for energy investing

What is it? The Zulu Principle, I mean. Have you heard of it?

Or to be more precise, have you read it?

Because it’s a book, or at least the book borrows from the principle for its title.

It’s an investment classic, and I recently finished reading it.

I want to try and draw out some of the key lessons it provides, and apply them to a world which the author, Jim Slater, couldn’t possibly have imagined decades ago when he wrote it.

Slater gave this name to his approach to investment when he observed that after reading a short article on the Zulu people in the Reader’s Digest, his wife was better informed on the subject than he himself was.

He went on to consider that if his wife read all the books she could find on the subject of Zulus, coupled with a visit to South Africa to meet them for herself, then in a relatively short period of time she could become one of the leading authorities on that “clearly defined and narrow area of knowledge”.

The point is, by focusing her energy on a small niche, she could gain an informational advantage over others. She could know more about the Zulus, and understand them better than nearly everyone, because they were so little studied.

And it applies to investment too.

His view was that an investor should seek out a promising niche in the markets – say, renewable energy – and by that means, they could spend a decent amount of time each week studying it until they became an expert relative to most people. This informational advantage, gained by reading plentifully around the subject, and about the companies in the sector, would give an investor a supreme advantage.

If that advantage could be applied to a sector with certain characteristics (high growth, small companies and a unique quality – eg, new technologies) then that advantage would be compounded.

He writes:

First, I look for a tailwind. By this I mean concentrating on an area or sector which has a very favourable outlook. If you are in the wrong business at the wrong time you are bound to lose money. If you are in the right business at the right time it is very difficult not to make a lot of money.

This echoes one of my favourite Howard Marks lines, when he says that in investing you have skill, timing, and aggression, but if you invest with aggression at the right time, then you don’t need a whole lot of skill.

Slater also focuses mainly on small and micro-cap stocks. He writes:

The reasons are obvious – first, they are under-researched so better bargains are available, and second, on average they perform much better than larger-cap stocks. In fact, over the last fifty years, micro-cap stocks have outperformed the market by over eight times.

That was written in the 1980s, but it looks like that fact has remained true since then. Here’s a chart of the smallest 10% of companies in the US vs the largest 10%.

 Source: The Irrelevant investor

Slater will have been looking at charts just like that when he coined the phrase “elephants don’t gallop”. He focuses on growth shares with small market capitalisations, because they do gallop.

It’s also interesting to note his closing remarks from his second edition preface in 2008:

As we go to press the market outlook is very uncertain. The easiest money is to be made is by shorting shares with excessive gearing and diminishing prospects. The multiples on growth shares are falling but this correction is necessary to provide the basis for exceptional future returns. So be of good heart and prepare yourself for the next upswing. May the force be with you!

Aside from the fact that he is a Star Wars fan (legend) he echoes some sentiments from today. We have seen the fastest descent into a bear market in stockmarket history. While we are rebounding now, the forecast decline in earnings suggest we are probably not entirely out of the woods yet.

But it pays to remain dispassionate and think long term. As he says, declines are necessary to provide the basis for exceptional future returns.

It is my firm belief that nowhere is the Zulu Principle more applicable than the nascent clean tech and renewable energy sector. Small companies, with a massive industry tailwind and rapid growth, which are massively understudied by major institutions and most investors.

All the ingredients are there for Slater’s strategy to work.

Large institutions tend to focus on larger companies, leaving nascent industries and small/micro-caps to the retail investors. Slater explains that the reasons for this are obvious:

If a broker can produce a good argument for buying or selling a leading stock, institutions will be able to deal in volume, and a large turnover will deliver hefty commissions for the broker.

Institutions also prefer larger stocks because they are easier to market – people have heard of them. That gives retail investors one area where they can potentially gain a competitive advantage. Competing with the human and computing power of Wall St is tough with the FTSE 100 or the Nasdaq. Much of the competitive advantage has been eroded away in those spaces.

Slater continues:

Investment is essentially the arbitrage of ignorance.

And that is one of the best quotes on investment I’ve ever come across, truly. That’s why I put it in bold, on its own line, you see?

There is very little that isn’t known about the leading stocks, so there is hardly any ignorance to arbitrage. Small and micro caps offer potential niches for the retail investor.

And small companies with high growth, especially those which are undervalued by the market, have a two-fold route to pretty chunky profits for investors.

A company with 25% earnings growth valued at 15x profits (price/earnings ratio, or P/E ratio) will look quite different a few years down the line.

Its earnings have grown from 100 to 195 in three years. If the P/E ratio remains constant, then you’ve nearly doubled your money.

But in such a scenario, you’re very likely to see an increased appreciation from investors, and maybe the entrance of a few larger players, so let’s say the P/E ratio climbs to 25x.

Instead of a share price of 1,500 (15 x100), it’s now 25 times 195, which is 4,882 apparently. You’ve more than tripled your holding in just three years.

That’s the dream scenario, and one which Slater says is almost impossible to find in the major large-cap indices, as elephants don’t run.

Bah! You might exclaim. That never happens.

Well in one particular sector – green energy – it’s been happening quite a bit of late.

In fact, our very own James Allen, my boss and editor of Exponential Energy Fortunes, has been applying what in essence amounts to his own adaptation of the Zulu Principle.

By focusing on the best technologies and business models in the clean technology and renewable energy sectors, he has the benefit of rapid growth in sales or earnings, a broad-based tailwind, backed by politicians and societies the world over.

It’s truly the most perfect sector for applying Slater’s Zulu principle, and James is the proof of that. His readers have certainly benefited, both up to and during this latest calamity and crash.

I shall offer only one example, but there are genuinely so many more which James and I look at on a daily basis.

Powercell Sweden, a leading company in the hydrogen space, could have been picked up at 30 krona when its revenues (not earnings, I’m being lazy) were 12,185 million krona.

In 2019, that had grown to 66,850 million krona, a 448% increase.

Partly because of this, its P/E ratio also grew, as investor confidence built up. From (1.57b market cap/12.85 million sales) = 12.3 to (13.69 billion mkt cap/66.8 million sales) = 20.5.

These are very back-of-the-envelope calculations from Yahoo Finance data by the way – not precise or even double checked, but you get the idea. Rapid sales increases plus a multiple expansion of share price relative to those sales, reflecting greater investor confidence, have resulted in epic gains.

So, the share prices went from KR30 to KR260, which is roughly where it is today. That’s an 800% gain, give or take. Even the latest crash at its lowest would have left you with a ridiculously large gain for just a three- or four-year investment.

Source: Yahoo Finance

I wonder if Slater himself foresaw what’s been happening in the green energy space.

But whether he did or not, I cannot see any other sector which shows more perfect characteristics for his Zulu Principle.

Small companies. Rapid growth. Widely underappreciated (make sure to see my podcast with Charlie Morris to see what institutions still think of this incredible sector).

James and I spend every day of every week becoming the energy equivalents of Zulu experts. Well, I’m still learning; James has been on this for a long time, which is why he’s been helping advise people on the best stocks in the sector for almost two years now.

The final point I’ll make from Slater’s book is this.

He writes:

There is a way to win, but unless you are prepared to dedicate a few hours per week to your investments, you will have no hope of succeeding. I suggest an average of half an hour a day – thirty minutes that I hope you will look forward to and enjoy.

Which is an appropriate note to end on, because I want to finish by reminding you to sign up to our Beyond Oil summit next week, for investors looking to apply the Zulu Principle to the burgeoning green energy sector.

It’s completely free to view, and just a smidge over half an hour of your day is required. You’ll also get some extra research documents to read.

James has brilliantly organised the whole thing, and I myself interviewed some of the biggest names in the industry to help you become Zulu experts of this market niche too. Each day of the summit, you’ll get a new interview to watch, and if you’re lucky, James himself might pop in to turn the context into actionable investment advice.

You can sign up here.

I look forward to you joining us then.

Best wishes,

Kit Winder
Editor, UK Uncensored

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