Bargains in stocks of Secondary Companies
If secondary issues tend NORMALLY to be undervalued, what reason has the investor to hope that he can profit by such a situation?
For if this undervaluation persists indefinitely, will he not always be in the same position market wise as when he bought the issue?
The answer here is somewhat complicated.
Substantial profits from the purchase of secondary companies at bargain prices arise in a variety of ways.
If secondary issues tend NORMALLY to be undervalued, what reason has the investor to hope that he can profit by such a situation?
For if this undervaluation persists indefinitely, will he not always be in the same position market wise as when he bought the issue?
The answer here is somewhat complicated.
Substantial profits from the purchase of secondary companies at bargain prices arise in a variety of ways.
- First, the dividend return is high.
- Second, the reinvested earnings are substantial in relation to the price paid and will ultimately affect the price. In a five- to seven-year period these advantages can bulk quite large in a well-selected list.
- Third, when a bull market appears, it is most generous to low-priced issues; thus it tends to raise the typical bargain issue to at least a reasonable level.
- Fourth, even during relatively featureless market periods a continuous process of price adjustment goes on, under which secondary issues that were undervalued may rise at least to the normal level for their type of security.
An illustration of performance of undervalued securities (bargains companies)
Performance of two groups of undervalued securities selected at the beginning of 1940.
(Reference: pp 689 and 690 of Security Analysis, by Graham and Dodd, 1940 Edition)
(Excluding Dividends Received)
Market Price Market Price
Dec 31, 1939 Dec 31, 1947
Group A
10 Stocks
Total 120 5/8 449
Group B
10 Stocks
Total 115 367 7/8
Total of Both Groups 236 817
INCREASE 246%
INCREASE 246%
Observations and Inferences/Conclusions
This performance is superior not only to that of the Dow-Jones list but to that of the growth-stock list as well.
Allowance should be made for the fact, that nearly all the smaller companies benefited more from the war than did the bigger ones.
The figures, thus, prove without a doubt that under favourable conditions, bargain issues can yield a handsome profit.
His experience over many years led Benjamin Graham to assert that the average results from this area of activity are satisfactory.
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