General Portfolio Policy (Benjamin Graham)

General Portfolio Policy: The Defensive Investor

Graham opens the chapter defining two different kinds of investors: the “active” investor, which is the kind of investor that actively seeks new investments and invests serious time into studying investments, and the “passive” or “defensive” investor, the kind of investor that wants to invest once (or on a highly regular basis) and just let his or her portfolio run on autopilot.

Regardless of the activity that you apply to your investments, Graham sticks hard with his recommendation from the earlier chapter: 50% stocks, 50% bonds (or a close approximation thereof, with an absolute maximum of 75% in either side). It’s important to remember with a recommendation like that that Graham is very conservative in his investing, dreading the idea of an actual loss in capital. Only in the most dire of down markets (like 2008, for example) would such a portfolio actually deliver a loss to the investor.

Things that enterprising investors should focus on. (Benjamin Graham) 2

Portfolio Policy for the Enterprising Investor: The Positive Side

Graham says that there are four clear areas of activity that an enterprising investor (read: not an ultra-conservative investor) should focus on:

1. Buying in low markets and selling in high markets.
Graham says, in essence, that this is a good strategy in theory, but that it’s essentially impossible to accurately predict (on a mathematical basis) when the market is truly “low” and when it’s truly “high.” Why? Graham says that there’s inadequate data available to be able to accurately predict such situations – he basically believes fifty years of data is needed to make such claims, and as of the book’s writing, he did not believe adequate data was available in the post-1949 modern era. 

2. Buying carefully chosen “growth stocks.”
What about growth stocks – ones that are clearly showing rampant growth? Graham isn’t opposed to buying these, but says that one should look for growth stocks that have a reasonable P/E ratio. He wouldn’t buy a “growth stock” if it had a price-to-earnings ratio higher than 20 over the last year and would avoid stocks that have a price-to-earnings ratio over 25 on average over the last several years. In short, this is a way to filter out “bubble” stocks (one where irrational exuberance is going on) when looking at growth stocks.

3. Buying bargain issues of various types.
Here, Graham finally gets around to the idea of buying so-called “value stocks.” For the most part, Graham focuses on market conditions as they existed in 1959, pointing towards what would constitute value stocks then. A brief bit on page 169, Graham discusses “filtering” the stocks listed by Standard and Poor’s (essentially a 1950s precursor to the S&P 500) and identifying 85 stocks that meet basic value criteria, then buying them and finding that, over the next two years, most of them beat the overall market.

That’s an index fund. Graham had basically conceived of the idea in the 1950s – it worked then, and it works now.

4. Buying into “special situations.”
Graham largely suggests avoiding “topical” news as a reason to buy or sell, mostly because it’s hard for investors to gauge how exactly such news will truly affect the stock’s price. Instead, one should simply file away interesting long-term news for later use if you’re going to evaluate the stock. For example, recalling that a company is still paying off an incurred debt from ten years ago and that debt is about to be paid off might be an indication of an upcoming jump in profit for the company – and a possible sign of a good value.

Things that enterprising investors should focus on. (Benjamin Graham) 1

Ben Graham has a lot of ideas about what you should avoid.  Defensive investors should avoid everything but large, prominent companies with a long history of paying dividends. Even enterprising investors should avoid junk bonds, foreign bonds, preferred stocks, and IPOs.

To put it simply, Graham doesn’t like risk. It comes through time and time again in every chapter of the book – do the footwork, minimize risk, and don’t swing for the fences.

So what kind of real-world investing does that lead to? Graham finally gets down to actual tactics here, finally pointing toward some specific investment choices that he actually supports! At last!

Things that even enterprising investors should avoid. (Benjamin Graham) 2

Portfolio Policy for the Enterprising Investor: Negative Approach

So, what should you avoid?

First, avoid junk bonds. If they have anything less than a stellar bond rating, don’t bother, even if they appear to return very well. Junk bonds put your principal at risk, and the point of buying bonds is to have a safe portion of your portfolio.

Second, avoid foreign bonds. Here, there are stability issues, and it’s often hard to adequately judge the risk of buying bonds from government and private entities operating under rules unfamiliar to you. 

Third, avoid preferred stocks. Preferred stocks are ones that have a higher priority in the event of a liquidation of the business, but often come at a premium price. Almost always, Graham doesn’t feel these are worth any sort of premium. Of course, in the United States, preferred stock is generally not sold directly to individual investors, only to large institutions, so it’s largely a moot point.

Finally, avoid IPOs. To put it simply, new issues do not have any track record upon which to adequately judge the company. The “hype” of an IPO is all you really have to judge the issue on. Instead, let others jump into that feeding frenzy and wait until time has shown which companies swim and which ones sink.

Those are some good rules for anyone to follow, particularly if you’re concerned about not losing the money you invest. Most of these investments have a pretty significant amount of risk and in Graham’s world, one shouldn’t put the principal at undue risk.

Things that even enterprising investors should avoid. (Benjamin Graham) 1

Graham’s view of a conservative investor is very conservative. Focus primarily on big, blue chip stocks that pay a dividend and counterbalance that with roughly an equal amount of bonds. Very conservative, indeed.

But what about those of us who are less conservative and want to seek out other investments? After all, isn’t The Intelligent Investor supposed to be a guide to value investing, not just “buy blue chips and wait”?

Graham starts to head down this path here as he turns his sights from the very conservative investor to the … less conservative investor, the type of person who would actually follow value investing principles and seek out investments that show every sign of being undervalued – and then invest in them.

But first, a chapter of cautionary advice. Graham is nothing if not cautious, after all. The focus here is on things that even enterprising investors should avoid.

The Defensive Investor and Common Stocks (Benjamin Graham)

The Defensive Investor and Common Stocks

Graham’s advice, tends to focus on people who are willing to put in that extra time – and if you’re willing to do that, he has a lot of wisdom to share.

First of all, diversify. You should own at least ten different stocks, but more than thirty might be a mistake, as it becomes difficult to follow all of them carefully and also seek out new potential stock investments.

Second, invest in only large, prominent, and conservatively financed companies. Look for ones with little debt on the books and ones with a large market capitalization.

Third, invest only in companies with a long history of paying dividends. If a company rarely pays dividends, your only way to earn money from that company is if the market deems the stock to be valuable, and you shouldn’t trust that the market will do so.

Graham seems to point strongly towards the thirty stocks that make up the Dow Jones Industrial Average as a good place to start looking, as they usually match all of these criteria. I’d personally stretch that to include stocks that make up the S&P 500, but the Dow is a great place to find very large blue chip companies that are very stable and have paid dividends for a long time.

Other than that, Graham pooh-poohs many other common strategies. Buying growth stocks? Nope. Dollar-cost averaging? Good in theory, not great in practice. Portfolio adjustments? Be very, very careful – and only do annual evaluations. In short, be very, very wary and play it very, very cool.

Remember, this is Graham’s advice for the defensive, very conservative investor.

Strong, thorough research is the most important part about owning stocks. (Benjamin Graham)

The Intelligent Investor by Benjamin Graham

There’s one big underlying theme to this book. Yet, it keeps coming to the forefront again and again. It’s the one point that I believe Graham wants people to take home from this book.

Strong, thorough research is the most important part about owning stocks.

If you can’t – or aren’t willing to – put in a lot of time studying individual stocks, identifying ones that genuinely have potential to return good value to you over time, and keep careful tabs on those individual stocks, then you shouldn’t be investing in stocks.

Over and over again, Graham makes this point, in both obvious and subtle ways. He’s a strong, strong believer in knowing the company. If you don’t have clear, concrete reasons for buying a stock, then you shouldn’t be buying that stock, period.

What if you don’t have that time? This book was written before the advent of index funds, but I tend to think that broad-based index funds can be a reasonable replacement for the stock portion of your portfolio.

Bargain-Issue Pattern in Secondary Companies (1): What led to creating these bargains?

Definition of Secondary Companies

A secondary company is one which is not a leader in a fairly important industry.

It is usually one of the smaller concerns in the field.

It may also equally be the chief unit in an unimportant line.

Any company that has established itself as a growth stock is not ordinarily considered as "secondary" company.



Stock Market's Attitude toward Secondary Companies

(a)  1920

In 1920, relatively little distinction was drawn between industry leaders and other listed issues, provided the latter were of respectable size.

The public felt that a middle-sized company

• was strong enough to weather storms and 
• that it had a better chance for really spectacular expansion than one which was already of major dimension.

(b)  Post 1931 -1933 depression

The 1931 - 1933 depression had a particularly devastating impact on companies below the first rank either in size or inherent stability.

As a result of that experience, investors have since developed a pronounced preference for industry leaders and a corresponding lack of interest in the ordinary company of secondary importance.

This has meant that the latter group has usually sold at much lower prices in relation to earnings and assets than have the former.

It has meant further that in many instances the price has fallen so low as to establish the issue in the bargain class.



No sound rational reasons for rejecting stocks of secondary companies

When investors rejected the stocks of secondary companies, even though these sold at a relatively low prices, they were expressing a belief or fear that such companies faced a dismal future.

In fact, at least subconsciously, they calculated that ANY price was too high for them because they were heading for extinction - just as in 1999 the companion theory for the "blue chips" was that no price was too high for them because their future possibilities were limitless.

Both of these views were exaggerations and were productive of serious investment errors.  

Actually, a typical middle-sized listed company is a large one when compared with the average privately-owned business.

There is no sound reason why such companies should not continue indefinitely in operation, undergoing the vicissitudes characteristic of our economy but earning n the whole a fair return on their invested capital.



The stock market's attitude toward secondary companies create instances of major undervaluation.

The stock market's attitude toward secondary companies tends to be unrealistic and consequently to create in normal times innumerable instances of major undervaluation.


As it happens, the war period and the post-war boom were more beneficial to the smaller concerns than to the larger ones, because then the normal competition for sales was suspended and the former could expand sales and profit margins more spectacularly.

• Thus by 1946 the market's pattern had completely reversed itself.  
• Whereas the leading stocks in the Dow-Jones Industrial Average had advanced only 40 percent from the end of 1938 to the 1946 high, Standard & Poor's Index of low-priced stocks had shot up no less than 280 per cent in the same period.  
• Speculators and many self-styled investors - with the proverbial short memories of people in the stock market - were eager to buy both old and new issues of unimportant companies at inflated levels.   

Thus, the pendulum had swung clear to the opposite extreme.

• The very class of secondary issues which had formerly supplied by far the largest proportion of bargain opportunities was now presenting the greatest number of examples of over-enthusiasm and overvaluation.
• If past experience can be relied upon, the post-war bull market will itself prove to have created an enlarged crop of bargain opportunities.
• For in all probability a large proportion of the new common stock offerings of that period will fall into disfavour, and they will join many secondary companies of older vintage in entering the limbo of chronic undervaluation.

The Intelligent Investor
Benjamin Graham

Value of a Business to a Private Owner

Value of a Business to a Private Owner Test

The private-owner test would ordinarily start with the net worth as shown in the balance sheet.


How to search for a bargain opportunity?

1.  Using the net worth as the starting point

The question to ask is:  Is the indicated earnings power sufficient to validate the net worth as a measure of what a private buyer would be justified in paying for the business as a whole?

If the answer is definitely yes, an ordinary investor should find the common stock attractive at a price one-third or more below such a figure.  


2.  Using the working capital as the starting point

If instead of using all the net worth as a starting point, the investor considered only the working capital and applied his test to that, he would have a more convincing demonstration of the existence of a bargain opportunity.

For it is something of an axiom or is self evident, that a business is worth to any private owner AT LEAST the amount of its working capital, since it could ordinarily be sold or liquidated for more than this figure.

If a common stock can be bought at no more than two-thirds of the working capital value alone - disregarding all the other assets - and if the earnings record and prospects are reasonably satisfactory, there is strong reason to believe that the investor is getting substantially more than his money's worth.



An example of how to find a bargain common stock:

[Peculiarly, in 1947, many such opportunities present themselves in ordinary markets.  Benjamin Graham]

National Department Stores as of January 31, 1948, the close of its fiscal year.
The price of the stock was 16 1/2.
The working capital was no less than $26.60 per share.
The total asset value was $33.30.
Deducting contingency reserves - mainly to mark down the inventory to a "LIFO" (last in first out) basis, these figures would be reduced by $2.20 per share.

The company had earned $4.12 per share in the year just closed.  The seven-year average was $3.43; the twelve-year average was $2.29.  (Growing earnings)
The year's dividend had been $1.50.  (Paying dividends)
Compared with a decade before,
-  the working-capital value had risen from $7.40 per share to $26.60,
-  the sales had doubled and (Increasing sales)
-  the net after taxes had risen from $654,000 to $3,224,000.  (Increasing profits)


Thus, we had a business
-  selling for $13 million,
-  with $25 million of assets, mostly current.  (Price < Net Assets)
-  Its sales were $88 million.  A fair estimate of average future earnings might be $2 million. (earnings record and prospects are reasonably satisfactory  or Not gruesome)

The average earnings prior to 1941 had been unimpressive, and the company was regarded as a "marginal" one in its field - that is, it could earn a reasonably good return only under favourable business conditions.  (Qualitative assessment)

In the past eight years, however, it has improved both in financial strength and in the quality of its management.  (Qualitative assessment - earnings record and prospects are reasonably satisfactory or improving quality of business and management)

Let us grant that Wall Street would still consider the company as belonging in the second rank of department-store enterprises.  (Investor sentiment/Market sentiment/Neglected by market)

Even after proper allowance is made for such an unfavourable factor, we may still conclude that on the basis of the figures the stock is intrinsically worth well above its market price.  (Worse case scenario, still Value > Price)


Conclusion:  At 16 1/2, the conclusion in the case of National Department Stores remains, whether we apply the appraisal test or the test of value to a private owner.  (Undervalued / A bargain)

Avoid buying these securities when available at full prices

In selecting investments, in terms of psychology as well as arithmetic, we are guided by three requirements of:

1. underlying safety,
2. simplicity of choice, and
3. promise of  satisfactory results.

Using these criteria has led to the exclusion from the field of recommended investment a number of security classes which are normally regarded as suitable for various kinds of investors.

INVESTMENTS TO AVOID AT FULL PRICES

Advised against the purchase at FULL PRICES of three important categories of securities:

(a) foreign bonds;

(b) ordinary corporate bonds and preferred stocks, under present conditions of relative yield when the best grade issues yield little more than his US Savings Bonds;

(c) secondary common stocks, including, original offerings of such issues.

By full prices, we mean 

• prices close to par for bonds or preferred stocks, and 
• prices that represent about the fair business value of the enterprise in the case of common stocks.

ADVICE FOR DEFENSIVE INVESTORS

The greater number of defensive investors are to avoid these categories REGARDLESS OF PRICE.

ADVICE FOR ENTERPRISING INVESTORS

Enterprising investors are to buy them only when obtainable at BARGAIN PRICES - which is defined as prices not more than two-thirds of the appraisal value of the securities.

REASONINGS

FOREIGN GOVERNMENT BONDS

Why people buy and why they should avoid purchasing foreign Government bonds?  

• They wanted "just a little more income."  The country seemed like a good risk - and that was enough.  The purchasers of the foreign Government bonds must have told themselves that the bonds are practically riskless, presumably on the ground that the country was a far different kind of debtor than other know riskier countries.  
• At times, the buyer was obtaining just a slight percentage more on his money than the yield on AAA corporate bonds - and this hardly enough to warrant the assumption of a recognized risk.  
• By what process of calculation could the buyers of the foreign Government bonds assure themselves that at no time before their maturity date, would that country suffer severe economic, or internal political, or international problems?  Also, the high interest rates themselves helped to make default inevitable, especially in distressed countries offering by high interest on their foreign Government bonds.

CORPORATE BONDS OR PREFERRED STOCKS

How to entice people to buy corporate bonds or preferred stocks?  

          For corporate bonds and preferred stocks to be bought, these would either 

• have to increase their yields so as to offer a reasonable alternative to US Savings Bonds for individual investors or 
• else would be bought solely by financial institutions - insurance companies, savings banks, commercial banks, and the like,  Such institutions have their own justification for buying corporate securities at current yields.

SECONDARY COMMON STOCKS

How and when to buy secondary common stocks?  

• Secondary issues, for the most part, do fluctuate about a central level which is well below their fair value.  They reach and even surpass that value at times; but this occurs in the upper reaches of bull markets, when the lessons of practical experience would argue against the soundness of paying the prevailing prices for common stocks.  The aggressive investor should accept the central market levels which are normal for that class as their guide in fixing own levels for purchase.  Financial history says clearly that the investor may expect satisfactory results, on the average, from secondary common stocks only if he buys them for less than their value to a private owner, that is, on a bargain basis. 
• [There is a paradox here, nevertheless.  The average well-selected secondary company may be fully as promising as the average industrial leader.  What the smaller concern lacks in inherent stability it may readily make up in superior possibilities of growth.  Consequently, it may appear illogical to many readers to term "unintelligent" the purchase of such secondary issues at their full "enterprise value."  ]

Intelligent Investor

Benjamin Graham

Are you an intelligent investor? What does intelligent means in investing?

Benjamin Graham

Intelligent investor:  this is an investor "endowed with the capacity for knowledge and understanding."

Intelligent here is not to be taken to mean "smart" or "shrewd" or gifted with unusual foresight or insight.  

The intelligence here presupposed is a trait more of the character than of the brain.



Defensive investor

For example, a widow who must live on the money left her.

Her chief emphasis will be on the avoidance of any serious mistakes or losses, in the sense of conserving capital.

Her second aim will be freedom from effort, annoyance and the need for frequent decisions.

A woman in this position, with substantial funds, will not be satisfied to leave her financial affairs entirely in the hands of others.

She will want to understand - at least in general terms - what is being done with her money and why.

She will probably want to participate to the extent of approving the broad policy of investment, of keeping track of its results and of judging independently whether or not she is being competently advised.

This will be equally true of men who wish to throw the major burden of their investment operations on the shoulders of others.

For all these defensive investors, intelligent action will mean largely the exercise of firmness in the application of relatively simple principles of sound procedure.



Enterprising investor

These are not distinguished from the others by their willingness to take risks - for in that case they should be called speculators.

Their determining trait is rather their willingness to devote time and care to the selection of sound and attractive investments.  

It is not suggested that the enterprising investor must be a fully-trained expert in the field.

He may derive his information and ideas from others, particularly from security analysts.

But the decisions will be his own and in the last reckoning he must rely upon his own understanding and judgment.

The first rule of intelligent action by the enterprising investor must be that he will never embark on a security purchase which he does not fully comprehend and which he cannot justify by reference to the results of his personal study or experience.

The Intelligent Investor Book Review in 30 Minutes

The Intelligent Investor, by Benjamin Graham, is probably the most important and influential value investing book ever written. Warren Buffet described it as “by far the best book ever written on investing”.

I have provided a summary and book review of The Intelligent Investor, Revised Edition, Updated with New Commentary by Jason Zweig (affiliate link). If you could only buy one investment book in your lifetime, this would probably be the one. By purchasing through the above link, this site will receive a small commission without costing you anything extra.

It had been 8 years since I last read The Intelligent Investor. I have  enjoyed my personal “refresher course” in value investing.

Objective of The Intelligent Investor Book

Benjamin Graham’s objective was to provide an investment policy book for the ordinary investor. He succeeded in putting seemingly hard concepts into terms that could be understood and, more importantly, implemented by the average investor.

The typical investor has a tendency to “follow the market” and learns poor investment habits trying to beat the market. Instead, Graham gives us an alternative based on fundamental valuation.

The goal is to learn how to avoid the pitfalls of allowing our emotions to control our investment decisions. Rather, Graham provides the foundation for making businesslike decisions based on fundamental investing principles .

The Intelligent Investor puts special emphasis on teaching:

1. Risk management through asset allocation and diversification.

2. Maximizing probabilities through valuations analysis and margin of safety.

3. A disciplined approach that will prevent consequential errors to a portfolio.

The Intelligent Investor Book Review Lay Out:

(There is a link at the end of each part so you can read all 8 parts in succession, in less than 30 minutes!)

Investment, Speculation, Inflation, and Market History (Chapters 1, 2, & 3)

The Defensive Investor (Chapters 4, 5, & 14)

The Enterprising Investor (Chapters 6, 7, & 15)

Mr. Market & Fluctuations (Chapter 8)

Investment Funds & Advisors (Chapters 9 & 10)

Investment Selection (Chapters 11, 12, & 13)

Comparisons & Thoughts on Value (Chapters 16, 17, 18, & 19)

Margin of Safety (Chapter 20)

I think you will be excited as we explore the knowledge and wisdom Benjamin Graham left with us. If you have the time, feel free to purchase the book and leave your personal insights and thoughts in the comment section as you progress!

Related Reading: 74 Quotes From The Intelligent Investor, Revised Edition

http://arborinvestmentplanner.com/the-intelligent-investor-book-review-in-30-minutes/

Insist on value when you buy (Buy when EXTREMELY undervalued and Sell when EXTREMELY overvalued; with good resons)

A stock has three prices. It has:

1. a market price, 
2. a book value and 
3. an intrinsic value.

The market price is easy to understand. It is the last traded price at the end of a trading day. 

The book value is simply the net tangible asset (NTA) as shown in its balance sheet. 

The intrinsic value is the most difficult to calculate. I do not know of any formula for this. At most, it is only an estimation. 

You have to factor in many metrics such as barrier of entry, calibre of management, earnings potentials (present and future) growth prospects, patents, etc.


So, what should we do? 

For me, I make it simply. I look at the track record relative to its earnings, earnings growth and dividend yields. The higher these are, the higher the value. 

Buying a stock at high earnings per share (PE) is risky. Unless the forward PE is  expected be much lower, avoid stocks trading with high PE. (A PE of over 16 is too high for me.) 

To value a stock, here are some metrics or key ratios to consider: 

• EPS( earnings per share); 
• D/Y (dividend yield); 
• NTA (net tangible assets); 
• PEG (price to earnings growth); 
• NPM (net profit margin); 
• ROE (return on equity); 
• D/E (debt to equity ratio) 
• C/R (current ratio); 
• PCF (price to cash flow). 

One other thing to carefully consider is the core business of the company. Here, you need to think about barrier of entry, patents and competition.






When is the best time to sell a stock

Close to 100% of all stocks will at one time or another be selling at extremely high valuation that they should be sold. 

At other times, they will be selling at overly undervalued prices that they should be bought. 

We want to sell a stock when it is very much overvalued.

Understanding the value of a stock is crucial in this respect, and with the help of technical analysis, you have the advantage of the competitive edge.





Control your emotion

Taking action for action sake is a weakness that many people fail to control. Some people need to move in and out of the market often enough to overcome boredom.

They forget that transaction costs eat into their earnings.

Buy and sell with good reasons and not simply with intuition and the need for action.

Following the guidelines mention above will go a long way to help you to invest intelligently

The Intelligent Investor Benjamin Graham Audiobook

https://www.youtube.com/watch?v=SOZL99qriLE

Portfolio Policy for the Enterprising Investor (Benjamin Graham)

The activities characteristics of the enterprising investor may be classified under four heads:

1.  Buying in low market and selling in high markets
2.  Buying carefully chosen "growth stocks"
3.  Buying bargain issues of various types
4.  Buying into "special situations"

Benjamin Graham
The Intelligent Investor

Quote 

"The purpose of this book is to supply, in a form suitable for laymen, guidance in the adoption of an investment policy.  Comparatively little will be said here about the technique of analysing securities; attention will be paid chiefly to investment principles and investors' attitudes."

"That risk cannot be avoided.  But by bearing it clearly in mind we may succeed in reducing it." 

 Related:

### Attractive Buying Opportunities arise through a Variety of Causes

Approach to Convertible Issues

An illustration on convertible issue

The fine balance between what is given and what is withheld in a standard-type convertible issue is well illustrated by the extensive use of this type of security in the financing of American Telephone & Telegraph Company.

Since 1913 the company has sold at least seven separate issues of convertible bonds, most of them through subscription rights to stockholders.

The convertible bonds had the important advantage to the company of bringing in a much wider class of buyers than would have been available for a stock offering, since the bonds are popular with many financial institutions which possess huge resources but some of which are not permitted to buy stocks.

The interest return on the bonds has generally been less than half the corresponding dividend yield on the stock - a factor which was calculated to offset the prior claim of the bondholders.

Since the company has been able to maintain its dividend without change for many years, the result has been the eventual conversion of all the older convertible issues into stock.  

Thus the buyers of these convertibles have fared well through the years - but not quite so well as if they had bought the capital stock in the first place.

This example establishes the soundness of American Telephone & Telegraph, but not the intrinsic attractiveness of convertible bonds.

To prove them sound in practice we should need to have a number of instances in which the convertible worked out well even though the common stock proved disappointing.  

Such instances are not easy to find.


$$$$$


Advice by Benjamin Graham on convertibles

Our general attitude toward new convertible issues is thus a mistrustful one.

We mean here, as in other similar observations, that the investor should look more than twice before he buys them.

After such hostile scrutiny he may find some exceptional offerings that are too good to refuse.

The ideal combination, of course, is a strongly secured convertible, exchangeable for a common stock which itself is attractive, and at a price only slightly higher than the current market.  

Every now and then a new offering appears that meets these requirements.

By the nature of the securities markets, however, you are more likely to find such an opportunity in some older issue which has developed into a favorable position rather than in a new flotation.

(If a new issue is a really strong one, it is not likely to have a good conversion privilege.)


Benjamin Graham
The Intelligent Investor

Formula Timing - Buying in low markets and selling in high markets. No simple and fool-proof formula. Select a ins and outs formula timing plan that is simple and convenient .

Let's look at the possibilities and limitations of a policy of entering the market when it is depressed and selling out in the advanced stages of a boom.

This bright idea appeared feasible from a first inspection of the market chart covering the gyrations of the past fifty years.

But closer study indicated that no simple and fool-proof formula could be counted upon to work out in the future.  

For example, the history of the Dow-Jones Industrial Average suggests that it should be possible to buy at 140 during the next few years and sell out at 280 later.

But this is only an indication and not a true prediction.

Nor can we tell whether the probability of its working out is good enough to justify the basing of an investment policy upon it.

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The various formula timing plans, which have come into prominence in recent years, all represent a compromise attempt to deal with this probability.

Instead of planning to do all the buying at 140 - or some similar price - and all the selling at 280, the formula user buys at various stages on the downside and sells in installments on the upside.

By this means he can obtain some benefit from market fluctuations, even if they do not fall precisely within the range suggested by the chart.

Thus his formula assures him at least some profit if the future performance of the market is only reasonably close to that of the past.

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A simple application of this idea would be to sell 10 percent of your holdings when the market advances 10 per cent above a chosen base or central level; then to sell 20 per cent of the remainder when it advances another 10 per cent and so on.

Repurchases would be made after the market had declined to the central level, and on some similar schedule.
Following this plan, you would have sold all your stocks if and when the market level reached double the base figure, and you would then have realized a profit of 37 per cent above the base.

You can apply these ins and outs of formula timing plans, using various types of plans, to calculate their possible results, using the record of your own actual operations and also applied to hypothetical or imaginary funds.

$$$$$

There is some danger here for both writers and investors to lose themselves in a maze of alternative procedures.  

It is well to bear certain basic facts in mind.  No one plan has a priori or guaranteed advantage over any other.

The relative results of various plans will depend on how well each happens to fit the market fluctuations of the future.

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1.  The more certain the investor is that the range of future fluctuations will duplicate the past, the more justified he is in concentrating his buying close to the bottom line of the Dow-Jones performance chart and his selling not much below the top line.  

2.  But since we lack any proof that the past range must determine that of the future, most of us will prefer a compromise formula by which buying and selling is done in various stages below and above the indicated median level.

3.  So too, there is no assured advantage as between a plan to sell 100 per cent of our stock holdings by the time a designated high point is reached and a plan that assures retention of some stocks under all circumstances.  The latter in some measure protects against an inflationary breakout of a permanent character into a much higher band of fluctuation than we have experienced hitherto.

But like all the other choices in formula timing plans the wisdom of this one depends not on reasoning but on results.

$$$$$

The sovereign virtue of all formula plans lies in the compulsion they bring upon the investor to sell when the crowd is buying and to buy when the crowd lacks confidence.  

If the reader adopts a formula plan today and it happens to turn out badly - because the market chances to soar upwards to unexpected heights and does not return - it will still prove to have been worth while.

For the principle and the psychology will remain sound and applicable to the markets of the future, however far removed their middle range may be from the line of the past.

$$$$$

Since all the rest is a matter of detail or of guesswork, we strongly advice to "formula investors" that they select a plan that is simple and convenient in their circumstance.



Benjamin Graham
Intelligent Investor

Timing is of no value, unless it coincides with pricing, enabling repurchase at substantially under previous selling price.

The investor can scarcely take seriously the innumerable predictions which appear almost daily and are his for the asking.

Yet in many cases he pays attention to them and even acts on them.  Why?

Because he has been persuaded that it is important for him to form some opinion of the future course of the stock market, and because he feels that the brokerage or service forecast is at least more dependable than his own.

This attitude will bring the typical investor nothing but regrets.

Without realizing it, he is likely to find himself transformed into a market trader.  

During a sustained bull movement, when it is easy to make money by simply swimming with the speculative tide, he will gradually lose interest in the quality and the value of the securities he is buying and become more and more engrossed in the fascinating game of beating the market.

But "beating the market" really means beating himself - for he and his fellows constitute the market.

Thus he begins by studying market movements as a "commonsense investment precaution" or a "desirable supplement to his study of security values"; he ends as a stock-market speculator, indistinguishable from all the rest.

A great deal of brain power goes into this field, and undoubtedly, some people can make money by being good stock-market analysts.

But it is absurd to think that the general public can ever make money out of market forecasts.

For who will buy when the general public, at a given signal, rushes to sell out at a profit?

If you, the reader, expect to get rich over the years by following some system or leadership in market forecasting, you must be expecting:

(a) to try to do what countless others are aiming at and
(b) to be able to do it better than your numerous competitors in the market.

There is no basis either in logic or in experience for assuming that any typical or average investor can anticipate market movements more successfully that the general public, of which he is himself a part.


$$$$$$$$$$


Timing is of great psychological importance to the speculator because he wants to make his profit in a hurry.

The idea of waiting a year before his stock moves up is repugnant to him.  

But a waiting period, as such, is of no consequence to the investor.

What advantage is there to him in having his money un-invested until he receives some (presumably) trustworthy signal that the time has come to buy?

He enjoys an advantage only if by waiting he succeeds in buying later at a sufficiently lower price to offset his loss of dividend income.

What this means is that timing is of no real value to the investor unless it coincides with pricing - that is, unless it enables him to repurchase his shares at substantially under his previous selling price.


Benjamin Graham
Intelligent Investor

A creditable, if unspectacular, result can be achieved by the lay investor with a minimum of effort and capability.

One thing badly needed by investors - and a quality they rarely seem to have - is a sense of financial history.  In nine companies out of ten the factor of fluctuation has been a more dominant and important consideration in the matter of investment than has the factor of long-term growth or decline.

Yet the market tends to greet each upsurge as if it were the beginning of an endless growth and each decline in earnings as if it presaged ultimate extinction.

Investments may be soundly made with either of two alternative intentions:

(a)  to carry them determinedly through the fluctuations that are reasonably to be expected in the future, or
(b) to take advantage of such fluctuations by buying when confidence and prices are low and by selling when both are high.

Neither policy can be followed with intelligence unless the investor, or his adviser, has a broad comprehension of the effects of the economic alternations of the past, and unless he takes them fully into account in planning to meet the future.

The art of investment has one characteristic which is not generally appreciated.  A creditable, if unspectacular, result can be achieved by the lay investor with a minimum of effort and capability, but to improve this easily attainable standard requires much application and more than a trace of wisdom.  If you merely try to bring just a little extra knowledge and cleverness to bear upon your investment program, instead of realizing a little better than normal results, you may well find that you have done worse.

Since anyone - by just buying and holding a representative list - can equal the performance of the market averages, it would seem a comparatively simple matter to "beat the averages"' but as a matter of fact the proportion of smart people who try this and fail is surprisingly large.

Even many of the investment funds, with all their experienced personnel, have not performed as well over the years as has the general market.

Allied to the foregoing is the record of the published stock-market predictions of the brokerage houses, for there is strong evidence that their calculated forecasts have been somewhat less reliable than the simple tossing of a coin.


Benjamin Graham
Intelligent Investor

Judged by past history, you always had a chance to buy them back at substantially lower levels at some time later.

Another encouraging element for the preceptor is found in the strong warp of continuity that seems to underlie the pattern of financial change.

Important developments affecting broad groups of security values do not come suddenly or in one piece.

An excellent example is found in the long term course of the stock market; this has never moved to permanently higher levels without retreating at least once to former territory.

Hence, investors who sold out representative stocks at what seemed a high price as judged by past history have always had a chance to buy them back at substantially lower levels at some later time.

This proved true in spite of the inflationary effects of the First World War and again of the Second World War, and it also was notoriously true after the extreme market advance of 1928 - 29.


Benjamin Graham
The Intelligent Investor


Comments:

Here are the charts of KLSE and the annual returns of KLSE.

Observe for yourself whether the statement by Benjamin Graham above holds true.

It generally is so but how can you hope to profit from this strategy?

Annual Stock Market Returns in KLSE

2005      -0.84%   
2006      21.83%   
2007      31.82%   
2008     -39.33%   
2009      45.17%   
2010      19.34%   
2011        0.78%   
2012       10.34%   
2013       10.54%   
2014      -5.66%



MSCI Malaysia (price) index

2005      -1.52%
2006      33.11%
2007      41.54%
2008      -43.39%
2009      47.79%
2010      32.51%
2011      -2.92%
2012      10.76%
2013      4.17%
2014      -13.41%