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Revisiting the Templeton Trade

This column originally appeared on Real Money at 5:00 p.m. EDT on May 4.

NEW YORK ( Real Money) -- The clan gathered at Chez Melvin yesterday evening for a little wine and cake in celebration of the old man getting older.

It was a gorgeous night, so we sat out on the patio enjoying some conversation, and my son and I got onto the subject of stocks and the stock market.

I am teaching him how to use some basic value techniques and to focus on long shots that can offer dramatic returns over time. He is young enough that he can be much more aggressive in his approach to the markets and focus more on distressed equities with the potential for recovery.

During our conversation, I told him one of my favorite stock market stories. Sir John Templeton borrowed $10,000 before World War II and bought every stock priced at less than $1 on the NYSE. Over the next four years, the portfolio of cheap stocks quadrupled in value. It was the beginning of his fortune and spectacular investing career.

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This investment strategy can still be employed today.

I adjust the $1 to $3 to capture more opportunities in low-priced NYSE-listed issues. Listed stocks trading for less than $1 today are often in danger of losing their listing and moving to the Nasdaq or even the pink sheets.

I add an additional rule to the screening process: no Chinese stocks. I do not trust one single number issued by a Chinese company, government agency or other source when it comes to the markets.

I assembled a portfolio of stocks that were trading for less than $3 on the NYSE back in 2008 when the world was thought to be ending.

I have kept track of how it performed, and it has actually done a little better than Sir John did with his low-priced speculation.

The portfolio has seen a few bankruptcies, several takeovers and mergers but most of the stocks are still listed today. The return is a nice multiple of 5 times the original capital rather than a paltry percentage. It is a high-risk and very volatile trade, but if I were a young man, this fertile arena would be the staple of my investing efforts.

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