Sunday, 4 March 2012

Do Not Overpay to Own a Company with Brilliant Prospects; Use the Vagaries of the Market to Play the Master Game of Buying Low and Selling High

Growth Stock Paradox: The more successful the company, the greater are likely to be the fluctuations in the price of its shares.

This leads us to a conclusion of practical importance to the conservative investor in common stocks.
  • If he is to pay some special attention to the selection of his portfolio, it might be best for him to concentrate on issues selling at a reasonably close approximation to their tangible-asset value—say, at not more than one-third above that figure. 
  • Purchases made at such  levels, or lower, may with logic be regarded as related to the company’s balance sheet, and as having a justification or support independent of the fluctuating market prices. 
  • The premium over book value that may be involved can be considered as a kind of extra fee paid for the advantage of stock-exchange listing and the marketability that goes with it.

A caution is needed here.
  • A stock does not become a sound investment merely because it can be bought at close to its asset value. 
  • The investor should demand, in addition, a satisfactory ratio of earnings to price, a sufficiently strong financial position, and the prospect that its earnings will at least be maintained over the years. 
This may appear like demanding a lot from a modestly priced stock, but the prescription is not hard to fill under all but dangerously high market conditions. 

Once the investor is willing to forgo brilliant prospects—i.e., better than average expected growth—he will have no difficulty in finding a wide selection of issues meeting these criteria.

More than half of the DJIA issues met our asset-value criterion at the end of 1970.

  • The most widely held investment of all—American Tel. & Tel.—actually sells below its tangible-asset value as we write. 
  • Most of the light-and power shares, in addition to their other advantages, are now (early 1972) available at prices reasonably close to their asset values. 

The investor with a stock portfolio having such book values behind it can take a much more independent and detached view of stock-market fluctuations than those who have paid high multipliers of both earnings and tangible assets.

As long as the earning power of his holdings remains satisfactory, he can give as little attention as he pleases to the vagaries of the stock market. 

More than that, at times he can use these vagaries to play the master game of buying low and selling high.

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