Got this extremely interesting article to share:
Benjamin Graham, the father of value investing. Graham’s own books are investment classics. Securities Analysis (first published in 1934) and The Intelligent Investor (first published in 1949) continue to sell steadily. In addition to this legacy, he has permanently influenced many successful investors, including Warren Buffett, the wealthiest man in America; William Ruane, founder of the super-successful Sequoia Fund; and well-known investor Walter Schloss.
Ben was a prophet in a very specialized but important realm of life. He preached commandments that any investor can use as stars when navigating the vast and mysterious seas of the investment world. An individual investor, who is not under pressure to shoot comets across the heavens but would like to earn a smart and substantial return, especially can benefit from Ben’s guidance. In greatly simplified terms, here are the 14 points Graham most consistently delivered in his writing and speaking. Some of the counsel is technical, but much of it is aimed at adopting the right attitude:
1. Be an investor, not a speculator
“Let us define the speculator as one who seeks to profit from market movements, without primary regard to intrinsic values; the prudent stock investor is one who (a) buys only at prices amply supported by underlying value and (b) determinedly reduces his stock holdings when the market enters the speculative phase of a sustained advance.”
Speculation, Ben insisted, had its place in the securities markets, but a speculator must do more research and tracking of investments and be prepared for losses if they come.
2. Know the asking price
Multiply the company’s share price by the number of company total shares (undiluted) outstanding. Ask yourself, if I bought the whole company would it be worth this much money?
3. Rake the market for bargains
Graham is best known for using his “net current asset value” (NCAV) rule to decide if the company was worth its market price.
To get the NCAV of a company, subtract all liabilities, including short-term debt and preferred stock, from current assets. By purchasing stocks below the NCAV, the investor buys a bargain because nothing at all is paid for the fixed assets of the company. The 1988 research of Professor Joseph D. Vu shows that buying stocks immediately after their price drop below the NCAV per share and selling two years afterward provides an excess return of more than 24 percent.
Yet even Ben recognized that NCAV stocks are increasingly difficult to find, and when one is located, this measure is only a starting point in the evaluation. “If the investor has occasion to be fearful of the future of such a company,” he explained, “it is perfectly logical for him to obey his fears and pass on from that enterprise to some other security about which he is not so fearful.”
Modern disciples of Graham look for hidden value in additional ways, but still probe the question, “what is this company actually worth?” Buffett modifies the Graham formula by looking at the quality of the business itself. Other apostles use the amount of cash flow generated by the company, the reliability and quality of dividends and other factors.
4. Buy the formula
Ben devised another simple formula to tell if a stock is underpriced. The concept has been tested in many different markets and still works.
It takes into account the company’s earnings per share (E), its expected earnings growth rate (R) and the current yield on AAA rated corporate bonds (Y).
The intrinsic value of a stock equals:
E(2R + 8.5) x Y/4
The number 8.5, Ben believed, was the appropriate price/to/earnings multiple for a company with static growth. P/E ratios have risen, but a conservative investor still will use a low multiplier. At the time this formula was printed, 4.4 percent was the average bond yield, or the Y factor.
5. Regard corporate figures with suspicion
It is a company’s future earnings that will drive its share price higher, but estimates are based on current numbers, of which an investor must be wary. Even with more stringent rules, current earnings can be manipulated by creative accountancy. An investor is urged to pay special attention to reserves, accounting changes and footnotes when reading company documents. As for estimates of future earnings, anything from false expectations to unexpected world events can repaint the picture. Nevertheless, an investor has to do the best evaluation possible and then go with the results.
6. Don’t stress out
Realize that you are unlikely to hit the precise “intrinsic value” of a stock or a stock market right on the mark. A margin of safety provides peace of mind. “Use an old Graham and Dodd guideline that you can’t be that precise about a simple value,” suggested Professor Roger Murray. "Give yourself a band of 20 percent above or below, and say, “that is the range of fair value.”
7. Don’t sweat the math
Ben, who loved mathematics, said so himself: “In 44 years of Wall Street experience and study, I have never seen dependable calculations made about common stock values, or related investment policies, that went beyond simple arithmetic or the most elementary algebra. Whenever calculus is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience, and usually also to give speculation the deceptive guise of investment.”
8. Diversify, rule #1
“My basic rule,” Graham said, “is that the investor should always have a minimum of 25 percent in bonds or bond equivalents, and another minimum of 25 percent in common stocks. He can divide the other 50 percent between the two, according to the varying stock and bond prices.” This is ho-hum advice to anyone in a hurry to get rich, but it helps preserve capital. Remember, earnings cannot compound on money that has evaporated.
Using this rule, an investor would sell stocks when stock prices are high and buy bonds. When the stock market declines, the investor would sell bonds and buy bargain stocks. At all times, however, he or she would hold the minimum 25 percent of the assets either in stocks or bonds — retaining particularly those that offer some contrarian advantage.
As a rule of thumb, an investor should back away from the stock market when the earnings per share on leading indices (such as the Dow Jones Industrial Average or the Standard & Poor’s composite index) is less than the yield on high-quality bonds. When the reverse is true, lean toward bonds.
9. Diversify, rule #2
An investor should have a large number of securities in his or her portfolio, if necessary, with a relatively small number of shares of each stock. While investors such as Buffett may have fewer than a dozen or so carefully chosen companies, Graham usually held 75 or more stocks at any given time. Ben suggested that individual investors try to have at least 30 different holdings, even if it is necessary to buy odd lots. The least expensive way for an individual investor to buy odd lots is through a company’s dividend reinvestment program (DRP).
10. When in doubt, stick to quality
Companies with good earnings, solid dividend histories, low debts and reasonable price/to/earnings ratios serve best. “Investors do not make mistakes, or bad mistakes, in buying good stocks at fair prices,” Ben said. “They make their serious mistakes by buying poor stocks, particularly the ones that are pushed for various reasons. And sometimes — in fact, very frequently — they make mistakes by buying good stocks in the upper reaches of bull markets.”
11. Dividends as a clue
A long record of paying dividends, as long as 20 years, shows that a company has substance and is a limited risk. Chancy growth stocks seldom pay dividends. Furthermore, Ben contended that no dividends or a niggardly dividend policy harms investors in two ways. Not only are shareholders deprived of income from their investment, but when comparable companies are studied, the one with the lower dividend consistently sells for a lower share price. “I believe that Wall Street experience shows clearly that the best treatment for stockholders,” Ben said, “is the payment to them of fair and reasonable dividends in relation to the company’s earnings and in relation to the true value of the security, as measured by any ordinary tests based on earning power or assets.”
12. Defend your shareholder rights
“I want to say a word about disgruntled shareholders,” Ben said. “In my humble opinion, not enough of them are disgruntled. And one of the great troubles with Wall Street is that it cannot distinguish between a mere troublemaker or “strike suitor” in corporate affairs and a stockholder with a legitimate complaint that deserves attention from his management and from his fellow stockholders.” If you object to a dividend policy, executive compensation package or golden parachutes, organize a sharcholder’s offensive.
13. Be Patient
“... every investor should be prepared financially and psychologically for the possibility of poor short-term results. For example, in the 1973-1974 decline the investor would have lost money on paper, but if he’d held on and stuck with the approach, he would have recouped in 1975-1976 and gotten his 15 percent average return for the five-year period.”
14. Think for yourself
Don’t follow the crowd. “There are two requirements for success in Wall Street,” Ben once said. “One, you have to think correctly; and secondly, you have to think independently.”
Finally, continue to search for better ways to ensure safety and maximize growth.
Do not ever stop thinking.
Source: http://sify.com/finance/equity/fullstory.php?id=13418474
Monday, April 02, 2007
The Art Of Value Investing
My Dearest Moo Moo Cow,
Saw this article posted on BTimes written by Mr. Herman Phua.
(http://www.businesstimes.com.sg/sub/campus/story/0,4574,229296,00.html? or you can read it here )
Here is some highlights...
- Together with David Dodd in 1934, Mr Graham published Security Analysis, still in print and considered as the bible for serious investors. Drawing from his personal experience of the devastation caused by the Great Crash of 1929, Mr Graham developed quantitative techniques that expounded the importance of diligent number crunching in the investment decision process. Basically, he developed a rigorous screening methodology.
In fact, it was Mr Graham who popularised the use of many of the financial tools we are familiar with today - price-earnings (PE) ratio, debt-to-equity ratio and book value. While Mr Graham may not be an immediately recognisable name, he is held in the highest esteem by someone who is.
Warren Buffett, a student of Mr Graham and widely regarded as one of the world's greatest investors, attributes much of his success to his mentor. Besides sophisticated screening tools, Mr Graham developed an investment philosophy that has withstood the test of time.
First and foremost, he believed investors have to approach stock investments as though they are seeking to buy or become a partner in the business. Mr Graham published his second book, The Intelligent Investor, in 1949.
POWERFUL CONCEPT
According to Mr Buffett, there are two other essential things all investors will gain from reading it - the concepts of 'Mr Market' and 'Margin of Safety'. The concept behind Mr Market is a simple but powerful idea. It is a story Mr Graham often related to describe how an investor should view market fluctuations.
Think of Mr Market as one of your partners in a business. He is an eccentric person ruled by his emotions, which can swing from amazing optimism to overpowering depression. Each day, Mr Market will turn up and offer to buy your share or sell you his share in the business at a price that corresponds to his mood, even though there has not been any fundamental change in the business.
On some days, Mr Market feels exhilarated over the prospects of the business and is willing to offer you a very high buy-sell price. On other days, he sees only doom ahead for the business and offers a sharply lower buy-sell price. But temperamental as he is, Mr Market does not seem to mind if you decide not to accept his offer and will be back again the next day with another buy-sell price for you.
The point of Mr Graham's story is that the stock market is there for investors to take advantage of. As investing behaviour is heavily influenced by the emotions of greed and fear, there will be times when you will be presented with opportunities to buy or sell stocks at particularly attractive levels.
Of course, the danger is that you unknowingly fall under the influence of Mr Market and find yourself swayed by the emotions of the herd. While there is the possibility that the herd may be right, Mr Graham's point is that to be successful, an investor has to remain rational and make independent decisions about the value of his investments.
Herein lies the problem as most investors - even professionals - usually will have differing values that they place on the same stock. This largely depends on their methods for calculating intrinsic value.
Acknowledging the possibility that his computations may be flawed, or that an external event could occur to affect the stock valuation, Mr Graham introduced the concept of Margin of Safety. This means making sure you have some room for error in your estimate of a stock's intrinsic value by buying at a sufficiently big discount.
Mr Graham believed that a true margin of safety is one that can be demonstrated by figures, persuasive reasoning and reference to actual experience.
Hope you enjoyed it Moo!!
rgds
Thursday, June 29, 2006
The Intelligent Investor Series
Wallstraits.com has published a series of wonderful articles based on one of my favourite investing book The Intelligent Investor.
Enjoy!
1. INTELLIGENT INVESTOR I
Ben Graham never claimed he could teach anyone how to beat the market, instead he taught three valuable lessons...
2. INTELLIGENT INVESTOR II
Ben Graham, perhaps better than anyone in history, truly understood the distinction between investment and speculation...
3. INTELLIGENT INVESTOR III
Ben Graham offers advice on building a balanced portfolio for the defensive investor...
4. INTELLIGENT INVESTOR IV
Ben Graham offers much wisdom about how a defensive investor should go about buying stocks...
5. INTELLIGENT INVESTOR V
Portfolio policy for the enterprising investor...
6. INTELLIGENT INVESTOR VI
Three Recommendations for the Enterprising Investor...
7. INTELLIGENT INVESTOR VII
Bargain stock price patterns in secondary companies and Special Situation Workout stocks...
8. INTELLIGENT INVESTOR VIII
Stock selection for the defensive investor...
9. INTELLIGENT INVESTOR IX
Stock Selection for the enterprising investor...
10. INTELLIGENT INVESTOR X
Out of favor stocks with investment merit...
11. INTELLIGENT INVESTOR XI
Graham on Managements and Dividend Policy...
12. INTELLIGENT INVESTOR XII
Ben Graham on market psychology...
Ben Graham on Margin of Safety...
Thursday, January 19, 2006
The Intelligent Investor
Should You Buy What You Know?
Do you like this great investing book The Intelligent Investor ?
What is even more interesting is that billionaire investor Warren Buffett still continues to read this great book by Benjamin Graham and yet the great legendary investor still continues to learn from it!
Under the revised edition by Jason Zweig, Chapter 5, pg 125 (commentary on Chapter 5), there is this one interesting commentary:
Should You Buy What You Know?
Another excellent commentary in which Jason commented that the intelligent investor should not simply abuse any famous investment teaching. Take one of Peter Lynch's famous teachings "buy what you know", in which, Lynch teaches that one can outperform the experts if one uses their edge by investing in companies or industries one already understand. The next step is doing the research. In which accordingly to Lynch, no one should invest in a company, no matter how great its products, without studying its financial statements and estimating its business value.
So how does one abuse this great teaching?
Ahhh... according to Jason, many would only remember and adopt the very first part of the teaching, which is "buy what you know". The next part of doing the research is sadly neglected by the investor!!!
How valid is this point? Think about it...
Jason puts it very nicely:
In short, familiarity breeds complacency. On the TV news, isn't always a neighbour or the best friend or the parent of the criminal who says in a shocked voice, "He was such a nice guy". That's because whenever we are too close to someone or something, we take the beliefs for granted, instead of questioning them as we do when we confront something more remote. The more familiar a stock is, the more likely is to turn an investor into a lazy one who thinks there's no need to do any homework. Don't let that happen to you.
Don't you agree?
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