Attractive buying opportunities for the enterprising investor arise through a variety of causes.
The standard or recurrent reasons are
(a) a low level of the general market and
(b) the carrying to an extreme of popular disfavor toward individual issues.
Sometimes, but much more rarely, we have the failure of the market to respond to an important improvement in the company's affairs and in the value of its stock.
Frequently, we find a discrepancy between price and value which arises from the public's failure to realise the true situation of a company - this in turn being due to some complicated aspects of accounting or corporate relationships.
It is the function of competent security analysis to unravel such complexities and to bring the true facts and values to light.
Benjamin Graham
Intelligent Investor
Summary:
Attractive buying opportunities (discrepancy between price and value) due to various causes:
1. low level of the general market
2. extreme of popular disfavour towards individual stocks
3. failure of market to respond to improvement in the company
4. failure to realise hidden value in the company due to some complicated aspects of accounting or corporate relationships
Keep INVESTING Simple and Safe (KISS) ****Investment Philosophy, Strategy and various Valuation Methods**** The same forces that bring risk into investing in the stock market also make possible the large gains many investors enjoy. It’s true that the fluctuations in the market make for losses as well as gains but if you have a proven strategy and stick with it over the long term you will be a winner!****Warren Buffett: Rule No. 1 - Never lose money. Rule No. 2 - Never forget Rule No. 1.
Showing posts with label Intelligent Investor. Show all posts
Showing posts with label Intelligent Investor. Show all posts
Sunday 18 January 2015
Special Situation is where a Definite Corporate Event creates undervalued security in which profits is expected to be realised.
A particular kind of undervalued security in which the profit is expected to be realized from a definite corporate event, rather than from a mere change in the market's attitude is known as a "special situation."
Such events include
A great deal of money has been made by shrewd investors in recent years through the purchase of bonds of railroads in bankruptcy - bonds which they knew would be worth much more than their cost when the railroads were finally reorganized.
Similar large profits have been made in the preferred and common stocks of public-utility holding companies which either were being broken up under the so-called death-sentence clause of the 1935 legislation or were subject to recapitalization plans.
The underlying factor here is the tendency of the security markets to undervalue issues which are involved in any sort of complicated legal proceedings.
An old Wall Street motto has been: "Never buy into a lawsuit."
This may be sound advice to the speculator seeking quick action on his holdings.
But the adoption of this attitude by the general public is bound to create bargain opportunities in the securities affected by it, since the prejudice against them holds their price down to unduly low levels.
"In general, the market undervalues a litigated claim as an asset and overvalues it as a liability. Hence students of these situations often have an opportunity to buy into them at less than their true value, and to realize attractive profits - on the average - when the litigation is disposed off."
The exploitation of special situations is a technical branch of investment which requires a somewhat unusual mentality and equipment. Probably only a small percentage of our enterprising investors are likely to engage in it.
Benjamin Graham
The Intelligent Investor
Such events include
- sale of the business,
- merger,
- recapitalization,
- reorganization, and
- liquidation.
A great deal of money has been made by shrewd investors in recent years through the purchase of bonds of railroads in bankruptcy - bonds which they knew would be worth much more than their cost when the railroads were finally reorganized.
Similar large profits have been made in the preferred and common stocks of public-utility holding companies which either were being broken up under the so-called death-sentence clause of the 1935 legislation or were subject to recapitalization plans.
The underlying factor here is the tendency of the security markets to undervalue issues which are involved in any sort of complicated legal proceedings.
An old Wall Street motto has been: "Never buy into a lawsuit."
This may be sound advice to the speculator seeking quick action on his holdings.
But the adoption of this attitude by the general public is bound to create bargain opportunities in the securities affected by it, since the prejudice against them holds their price down to unduly low levels.
"In general, the market undervalues a litigated claim as an asset and overvalues it as a liability. Hence students of these situations often have an opportunity to buy into them at less than their true value, and to realize attractive profits - on the average - when the litigation is disposed off."
The exploitation of special situations is a technical branch of investment which requires a somewhat unusual mentality and equipment. Probably only a small percentage of our enterprising investors are likely to engage in it.
Benjamin Graham
The Intelligent Investor
Saturday 17 January 2015
Concept of "Risk." Market price fluctuation is NOT risk.
It is conventional to speak of good bonds as less risky than good preferred stocks and of the latter as less risky than good common stocks.
From this is derived the popular prejudice against common stocks because they are not "safe."
The words "risk" and "safety" are applied to securities in two different senses, with a resultant confusion in thought.
A bond is clearly proved unsafe when it defaults its interest or principal payments.
Similarly, if a preferred stock or even a common stock is bought with the expectation that a given rate of dividend will be continued, then a reduction or passing of the dividend means that it is unsafe.
It is also true that an investment contains a risk if there is a fair possibility that the holder may have to sell at a time when the price is well below cost.
Nevertheless, the idea of risk is often extended to apply to a possible decline in the price of a security, even though the decline may be of a cyclical and temporary nature and even though the holder is unlikely to be forced to sell at such times.
These chances are present in all securities, other than United States Savings Bonds, and to a greater extent in the general run of common stocks than in senior issues generally.
But we believe that what is here involved is not a true risk in the useful sense of the term.
$$$$
The man who holds a mortgage on a building might have to take a loss if he were forced to sell it at an unfavourable time. That element is not taken into account in judging the safety or risk of ordinary real-estate mortgages, the only criterion being the certainty of punctual payments.
In the same way the risk attached to an ordinary commercial business is measured by the chance of its losing money, not by what would happen if the owner, were forced to sell.
We would emphasize our conviction that the bona fide investor does not lose money merely because the market price of his holdings declines; the fact that a decline may occur does not mean that he is running a true risk of loss.
$$$$$
If a group of well-selected common-stock investments shows a satisfactory over-all return, as measured through a fair number of years, then this group investment has proved to be "safe".
During that period its market value is bound to fluctuate, and as likely as not it will sell for a while under the buyer's cost.
If that fact makes the investment "risky" it would then have to be called both risky and safe at the same time.
$$$$$
This confusion may be avoided if we apply the concept of risk solely to a loss of value which either:
(a) is realized through actual sale or
(b) is ascertained to be caused by a significant deterioration in the company's position.
Many common stocks do involve risks of such deterioration.
But it is our thesis that a properly executed group investment in common stocks does not carry any substantial risk of this sort and that therefore it should not be termed "risk" merely because of the element of price fluctuation.
Benjamin Graham
The Intelligent Investor
From this is derived the popular prejudice against common stocks because they are not "safe."
The words "risk" and "safety" are applied to securities in two different senses, with a resultant confusion in thought.
A bond is clearly proved unsafe when it defaults its interest or principal payments.
Similarly, if a preferred stock or even a common stock is bought with the expectation that a given rate of dividend will be continued, then a reduction or passing of the dividend means that it is unsafe.
It is also true that an investment contains a risk if there is a fair possibility that the holder may have to sell at a time when the price is well below cost.
Nevertheless, the idea of risk is often extended to apply to a possible decline in the price of a security, even though the decline may be of a cyclical and temporary nature and even though the holder is unlikely to be forced to sell at such times.
These chances are present in all securities, other than United States Savings Bonds, and to a greater extent in the general run of common stocks than in senior issues generally.
But we believe that what is here involved is not a true risk in the useful sense of the term.
$$$$
The man who holds a mortgage on a building might have to take a loss if he were forced to sell it at an unfavourable time. That element is not taken into account in judging the safety or risk of ordinary real-estate mortgages, the only criterion being the certainty of punctual payments.
In the same way the risk attached to an ordinary commercial business is measured by the chance of its losing money, not by what would happen if the owner, were forced to sell.
We would emphasize our conviction that the bona fide investor does not lose money merely because the market price of his holdings declines; the fact that a decline may occur does not mean that he is running a true risk of loss.
$$$$$
If a group of well-selected common-stock investments shows a satisfactory over-all return, as measured through a fair number of years, then this group investment has proved to be "safe".
During that period its market value is bound to fluctuate, and as likely as not it will sell for a while under the buyer's cost.
If that fact makes the investment "risky" it would then have to be called both risky and safe at the same time.
$$$$$
This confusion may be avoided if we apply the concept of risk solely to a loss of value which either:
(a) is realized through actual sale or
(b) is ascertained to be caused by a significant deterioration in the company's position.
Many common stocks do involve risks of such deterioration.
But it is our thesis that a properly executed group investment in common stocks does not carry any substantial risk of this sort and that therefore it should not be termed "risk" merely because of the element of price fluctuation.
Benjamin Graham
The Intelligent Investor
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 it 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:
1. The dividend return is high.
2. 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.
3. 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.
4. 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.
Benjamin Graham
The Intelligent Investor
Related:
For if it 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:
1. The dividend return is high.
2. 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.
3. 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.
4. 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.
Benjamin Graham
The Intelligent Investor
Related:
Bargain-issue pattern in Secondary Companies
Friday 16 January 2015
Bargain-issue pattern in Secondary Companies
We have defined a secondary company as one which is not a leader in a fairly important industry.
Thus, it is usually one of the smaller concerns in its field, but it may equally well be the chief unit in an unimportant line.
By way of exception, any company that has established itself as a growth stock is not ordinarily considered as "secondary."
In the 1920's 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 dimensions.
The 1931-33 depression
The 1931-33 depression, however, had a particularly devastating impact on companies below the first rank either in size or in 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 also meant further that in many instances the price has fallen so low as to establish the issue in the bargain class.
When investors rejected the stocks of secondary companies, even though these sold at 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 1929 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, the 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 earnings on the whole a fair return on their invested capital.
This brief review indicates that the stock market's attitude toward secondary companies tends to be unrealistic and consequently to create in normal times innumerable instances of major undervaluation.
Benjamin Graham
The Intelligent Investor
Thus, it is usually one of the smaller concerns in its field, but it may equally well be the chief unit in an unimportant line.
By way of exception, any company that has established itself as a growth stock is not ordinarily considered as "secondary."
In the 1920's 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 dimensions.
The 1931-33 depression
The 1931-33 depression, however, had a particularly devastating impact on companies below the first rank either in size or in 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 also meant further that in many instances the price has fallen so low as to establish the issue in the bargain class.
When investors rejected the stocks of secondary companies, even though these sold at 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 1929 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, the 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 earnings on the whole a fair return on their invested capital.
This brief review indicates that the stock market's attitude toward secondary companies tends to be unrealistic and consequently to create in normal times innumerable instances of major undervaluation.
Benjamin Graham
The Intelligent Investor
Purchase of Bargain Issues
We define a bargain issue as one which, on the basis of facts established by analysis, appears to be worth considerably more than it is selling for.
The genus includes bonds and preferred stocks selling well under par, as well as common stocks.
To be concrete as possible, let us suggest that an issue is not a true "bargain" unless the indicated value is at least 50% more than the price.
What kind of facts would warrant the conclusion that so great a discrepancy exists?
How do bargains come into existence, and how does the investor profit from them?
There are two tests by which a bargain common stock is detected.
The first is by our method of appraisal. This relies largely on estimating future earnings and then multiplying these by a factor appropriate to the particular issue.
The second test is the value of the business to a private owner. This value also is often determined chiefly by expected future earnings - in which case the result may be identical with the first. But in the second test more attention is likely to be paid to the realizable value of the assets, with particular emphasis on the net current assets or working capital.
Courage in depressed markets
At low point in the general market a large proportion of common stocks are bargain issues, as measured by these standards.
It is true that current earnings and the immediate prospects may both be poor, but a level-headed appraisal of average future conditions would indicate values far above ruling prices.
Thus the wisdom of having courage in depressed markets is vindicated not only by the voice of experience but also by application of plausible techniques of value analysis.
The same vagaries of the marketplace which recurrently establish a bargain condition in the general list account for the existence of many individual bargains at almost all market levels.
The market is always making mountains out of molehills and exaggerating ordinary vicissitudes into major setbacks. Even a mere lack of interest or enthusiasm may impel a price decline to absurdly low levels.
Thus we have two major sources of undervaluation: (a) currently disappointing results, and (b) protracted neglect or unpopularity.
The private-owner test
The private-owner test would ordinarily start with the net worth as shown in the balance sheet. The question then arises as to whether the indicated earning power is 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, we suggest that an ordinary investor should find the common stock attractive at a price one-third or more below such a figure.
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 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.
Hence, 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.
Benjamin Graham
The Intelligent Investor
The genus includes bonds and preferred stocks selling well under par, as well as common stocks.
To be concrete as possible, let us suggest that an issue is not a true "bargain" unless the indicated value is at least 50% more than the price.
What kind of facts would warrant the conclusion that so great a discrepancy exists?
How do bargains come into existence, and how does the investor profit from them?
There are two tests by which a bargain common stock is detected.
The first is by our method of appraisal. This relies largely on estimating future earnings and then multiplying these by a factor appropriate to the particular issue.
The second test is the value of the business to a private owner. This value also is often determined chiefly by expected future earnings - in which case the result may be identical with the first. But in the second test more attention is likely to be paid to the realizable value of the assets, with particular emphasis on the net current assets or working capital.
Courage in depressed markets
At low point in the general market a large proportion of common stocks are bargain issues, as measured by these standards.
It is true that current earnings and the immediate prospects may both be poor, but a level-headed appraisal of average future conditions would indicate values far above ruling prices.
Thus the wisdom of having courage in depressed markets is vindicated not only by the voice of experience but also by application of plausible techniques of value analysis.
The same vagaries of the marketplace which recurrently establish a bargain condition in the general list account for the existence of many individual bargains at almost all market levels.
The market is always making mountains out of molehills and exaggerating ordinary vicissitudes into major setbacks. Even a mere lack of interest or enthusiasm may impel a price decline to absurdly low levels.
Thus we have two major sources of undervaluation: (a) currently disappointing results, and (b) protracted neglect or unpopularity.
The private-owner test
The private-owner test would ordinarily start with the net worth as shown in the balance sheet. The question then arises as to whether the indicated earning power is 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, we suggest that an ordinary investor should find the common stock attractive at a price one-third or more below such a figure.
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 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.
Hence, 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.
Benjamin Graham
The Intelligent Investor
Growth Stock Approach
Every investor would like to select a list of securities that will do better than the average over a period of years. A growth stock may be defined as one which has done this in the past and is expected to do so in the future.
(A company with an ordinary record cannot, without confusing the term, be called a growth company or a "growth stock" merely because its proponent expects it to do better than the average in the future. It is just a "promising company.")
Thus it seems only logical that the intelligent investor should concentrate upon the selection of growth stocks.
Actually the matter is more complicated.
The pursue of this aspect of investment policy require more ability and application than most investors can bring to bear on the problem.
The stock of a growing company, if purchasable at a suitable price, is obviously preferable to others.
No matter how enthusiastic the investor may feel about the prospects of a particular company, however, he should set a limit upon the price that he is willing to pay for such prospects.
In the case of a growth company, we should recommended payment of a premium for the growth potential not to exceed about 50% of the value determined without it.
Such a rule would result at times in the missing of an unusually good opportunity.
More often, it would mean the investor's saving himself from "going overboard" on an issue that looked especially good to him and everyone else and consequently was selling much too high.
The choice between the attractive issue that turns out well and the one that does poorly is by no means easy to make in the growth-stock field.
However, superior results may be obtained in this field if the choices are competently made. Even with careful selection, some of the individual issues may fare relatively poorly.
Thus for good results in the growth-stock field there is need not only for skillful analysis but for ample diversification as well.
Summary
The enterprising investor may properly buy growth stocks.
He should beware of paying excessively for them, and he might well limit the price by some practical rule.
A growth-stock program will not be automatically successful; its outcome will depend on the foresight and judgement of the investor or his advisers rather than on any clear-cut methods of analysis.
Benjamin Graham
Intelligent Investor
(A company with an ordinary record cannot, without confusing the term, be called a growth company or a "growth stock" merely because its proponent expects it to do better than the average in the future. It is just a "promising company.")
Thus it seems only logical that the intelligent investor should concentrate upon the selection of growth stocks.
Actually the matter is more complicated.
The pursue of this aspect of investment policy require more ability and application than most investors can bring to bear on the problem.
The stock of a growing company, if purchasable at a suitable price, is obviously preferable to others.
No matter how enthusiastic the investor may feel about the prospects of a particular company, however, he should set a limit upon the price that he is willing to pay for such prospects.
In the case of a growth company, we should recommended payment of a premium for the growth potential not to exceed about 50% of the value determined without it.
Such a rule would result at times in the missing of an unusually good opportunity.
More often, it would mean the investor's saving himself from "going overboard" on an issue that looked especially good to him and everyone else and consequently was selling much too high.
The choice between the attractive issue that turns out well and the one that does poorly is by no means easy to make in the growth-stock field.
However, superior results may be obtained in this field if the choices are competently made. Even with careful selection, some of the individual issues may fare relatively poorly.
Thus for good results in the growth-stock field there is need not only for skillful analysis but for ample diversification as well.
Summary
The enterprising investor may properly buy growth stocks.
He should beware of paying excessively for them, and he might well limit the price by some practical rule.
A growth-stock program will not be automatically successful; its outcome will depend on the foresight and judgement of the investor or his advisers rather than on any clear-cut methods of analysis.
Benjamin Graham
Intelligent Investor
Thursday 15 January 2015
Broader implications of adopting a sound investment policy
Investment policy, as it has been developed and taught by Benjamin Graham, depends in the first place upon a choice by the investor of either the defensive (passive) or aggressive (enterprising) role.
The aggressive investor must have a considerable knowledge of security values - enough, in fact, to warrant viewing his security operations as equivalent to a business enterprise.
There is no room in this philosophy for a middle ground, or a series of gradations, between the passive and aggressive status.
Many, perhaps most, investors seek to place themselves in such an intermediate category; in our opinion that is a compromise that is more likely to produce disappointment than achievement.
It follows from this reasoning that the majority of security owners should elect the defensive classification.
The enterprising investor may properly embark upon any security operation for which his training and judgement are adequate and which appears sufficiently promising when measured by established business standards.
Benjamin Graham
The Intelligent Investor
The aggressive investor must have a considerable knowledge of security values - enough, in fact, to warrant viewing his security operations as equivalent to a business enterprise.
There is no room in this philosophy for a middle ground, or a series of gradations, between the passive and aggressive status.
Many, perhaps most, investors seek to place themselves in such an intermediate category; in our opinion that is a compromise that is more likely to produce disappointment than achievement.
It follows from this reasoning that the majority of security owners should elect the defensive classification.
- They do not have the time, or the determination, or the mental equipment to embark upon investing as a quasi business.
- They should therefore be satisfied with the reasonably good return obtainable from a defensive portfolio, and they should stoutly resist the recurrent temptation to increase this return by deviating into other paths.
The enterprising investor may properly embark upon any security operation for which his training and judgement are adequate and which appears sufficiently promising when measured by established business standards.
Benjamin Graham
The Intelligent Investor
Practical suggestions on switching stocks
Let us summarize our practical suggestions in the matter of security switches as follows:
The investor who begins with a list of standard, first-grade common stocks can expect some of them to lose quality through the years.
His aim should be to replace these, with a minimum sacrifice of dividend return and with a fair chance of recouping any loss of principal value resulting from their sale.
The best means of accomplishing this is by seeking out attractive issues in the secondary group. A competent security analyst is usually in a position to recommend a number of such issues which by objective tests appear to be worth substantially above their selling price.
The fundamental principle of every security replacement should be the following:
Each dollar paid for the issue bought should appear to obtain more intrinsic value than was represented by a dollar's worth of the issue sold.
We believe, in sum, that quality may be approached soundly by way of value. If the value is abundant, the quality may be deemed sufficient.
Benjamin Graham
The investor who begins with a list of standard, first-grade common stocks can expect some of them to lose quality through the years.
His aim should be to replace these, with a minimum sacrifice of dividend return and with a fair chance of recouping any loss of principal value resulting from their sale.
The best means of accomplishing this is by seeking out attractive issues in the secondary group. A competent security analyst is usually in a position to recommend a number of such issues which by objective tests appear to be worth substantially above their selling price.
The fundamental principle of every security replacement should be the following:
Each dollar paid for the issue bought should appear to obtain more intrinsic value than was represented by a dollar's worth of the issue sold.
We believe, in sum, that quality may be approached soundly by way of value. If the value is abundant, the quality may be deemed sufficient.
Benjamin Graham
Saturday 30 November 2013
Margin of safety
Margin of safety (safety margin) is the difference between the intrinsic value of a stock and its market price.
Another definition: In Break even analysis (accounting), margin of safety is how much output or sales level can fall before a business reaches its breakeven point.
History
Benjamin Graham and David Dodd, founders of value investing, coined the term margin of safety in their seminal 1934 book, Security Analysis. The term is also described in Graham's The Intelligent Investor. Graham said that "the margin of safety is always dependent on the price paid" (The Intelligent Investor, Benjamin Graham, Harper Business Essentials, 2003).
Application to investing
Using margin of safety, one should buy a stock when it is worth more than its price on the market. This is the central thesis of value investing philosophy which espouses preservation of capital as its first rule of investing. Benjamin Graham suggested to look at unpopular or neglected companies with low P/E and P/B ratios. One should also analyze financial statements and footnotes to understand whether companies have hidden assets (e.g., investments in other companies) that are potentially unnoticed by the market.
The margin of safety protects the investor from both poor decisions and downturns in the market. Because fair value is difficult to accurately compute, the margin of safety gives the investor room for investing.
A common interpretation of margin of safety is how far below intrinsic value one is paying for a stock. For high quality issues, value investors typically want to pay 90 cents for a dollar (90% of intrinsic value) while more speculative stocks should be purchased for up to a 50 percent discount to intrinsic value (pay 50 cents for a dollar).
Application to accounting
In accounting parlance, margin of safety is the difference between the expected (or actual) sales level and the breakeven sales level. It can be expressed in the equation form as follows:
Margin of Safety = Expected (or) Actual Sales Level (quantity or dollar amount) - Breakeven sales Level (quantity or dollar amount)
The measure is especially useful in situations where large portions of a company's sales are at risk, such as when they are tied up in a single customer contract that may be canceled.
Formula
Margin of Safety = Actual Sales - Breakeven Sales
Another definition: In Break even analysis (accounting), margin of safety is how much output or sales level can fall before a business reaches its breakeven point.
History
Benjamin Graham and David Dodd, founders of value investing, coined the term margin of safety in their seminal 1934 book, Security Analysis. The term is also described in Graham's The Intelligent Investor. Graham said that "the margin of safety is always dependent on the price paid" (The Intelligent Investor, Benjamin Graham, Harper Business Essentials, 2003).
Application to investing
Using margin of safety, one should buy a stock when it is worth more than its price on the market. This is the central thesis of value investing philosophy which espouses preservation of capital as its first rule of investing. Benjamin Graham suggested to look at unpopular or neglected companies with low P/E and P/B ratios. One should also analyze financial statements and footnotes to understand whether companies have hidden assets (e.g., investments in other companies) that are potentially unnoticed by the market.
The margin of safety protects the investor from both poor decisions and downturns in the market. Because fair value is difficult to accurately compute, the margin of safety gives the investor room for investing.
A common interpretation of margin of safety is how far below intrinsic value one is paying for a stock. For high quality issues, value investors typically want to pay 90 cents for a dollar (90% of intrinsic value) while more speculative stocks should be purchased for up to a 50 percent discount to intrinsic value (pay 50 cents for a dollar).
Application to accounting
In accounting parlance, margin of safety is the difference between the expected (or actual) sales level and the breakeven sales level. It can be expressed in the equation form as follows:
Margin of Safety = Expected (or) Actual Sales Level (quantity or dollar amount) - Breakeven sales Level (quantity or dollar amount)
The measure is especially useful in situations where large portions of a company's sales are at risk, such as when they are tied up in a single customer contract that may be canceled.
Formula
Margin of Safety = Actual Sales - Breakeven Sales
Reference
- Graham, Benjamin. Dodd, David. Security Analysis: The Classic 1934 Edition. McGraw-Hill. 1996. ISBN 0-07-024496-0.
- http://www.businessweek.com/magazine/content/06_32/b3996085.htm
- http://www.worldfinancialblog.com/investing/ben-grahams-margin-of-safety/26/
Notes
- ^ Yee, Kenton K. (2008). "Deep-Value Investing, Fundamental Risks, and the Margin of Safety". Journal of Investing 17 (3): 35–46. doi:10.3905/JOI.2009.18.1.027.
- ^ http://www.accountingtools.com/article-metric-margin-of-safet
External links
From Wikipedia, the free encyclopedia
Monday 25 November 2013
How Emotional Intelligence Can Improve Decision-Making
The secret to making smarter decisions that aren't swayed by your current emotions -- particularly when your emotions are unrelated to the decision at hand -- could lie in emotional intelligence, according to a new study.
For instance, "people are driving and it's frustrating. They get to work and the emotions they felt in their car influences what they do in their offices. Or they invest money based on emotions that stem from things unrelated to their investments," study researcher Stéphane Côté, a professor in the Rotman School of Management at the University of Toronto, said in a statement. "But our investigation reveals that if they have emotional intelligence, they are protected from these biases."
Emotional intelligence is a term used in psychology to signal the ability to identify and control both your and others' emotions, and to apply that ability to certain tasks, according to Psychology Today.
For the study, published in the journal Psychological Science, researchers conducted several experiments to evaluate how different levels of emotional intelligence influence decision-making. In one experiment, researchers found that anxiety's effect on a decision involving risk -- when that anxiety was unrelated to the decision at hand -- seemed to be blocked in people with high emotional intelligence. For people with low emotional intelligence, on the other hand, anxiety seemed to influence the decision-making.
The researchers said that emotional intelligence can likely help you stop any emotions -- not just negative ones, like stress and anxiety, but also good ones, like excitement -- from influencing unrelated decisions.
"People who are emotionally intelligent don't remove all emotions from their decision-making," Côté said in the statement. "They remove emotions that have nothing to do with the decision."
Indeed, a 2008 study published in the Journal of Consumer Research also showed that emotional intelligence could play a role in decision-making by helping people realize their emotions can sway the choices they make.
Monday 11 November 2013
Saturday 25 May 2013
The Intelligent Investor is likely to need considerable willpower to keep from following the crowd - Benjamin Graham
Have the Discipline to Say No
Arming yourself with a sound investment philosophy and search strategy puts you on the path to selecting businesses suitable for investment. Once a business is valued, the most difficult determinants of whether to invest or not come into play.
Unlike valuation, which primarily relies on quantitative measures, investors now must rely on qualitative factors:
These factors are exceedingly important because the probability of suffering investment loss is significantly higher due to the emotional underpinnings of these factors.
Most investors are smart; few, however, are disciplined enough to say no and move on or, more important, be patient. Very few activities in life can be practiced successfully without some degree of discipline. Being disciplined requires you to think independently and ignore crowd psychology. Discipline requires investors to be confident in their research and analysis and be prepared to receive criticism from all angles.
Yet disciplined investors clearly realize that investment success comes from sticking to their methods and not participating in crowd folly.
Arming yourself with a sound investment philosophy and search strategy puts you on the path to selecting businesses suitable for investment. Once a business is valued, the most difficult determinants of whether to invest or not come into play.
Unlike valuation, which primarily relies on quantitative measures, investors now must rely on qualitative factors:
- Having the discipline to say no.
- Being patient.
- Having the courage to make a significant investment at a maximum point of pessimism.
These factors are exceedingly important because the probability of suffering investment loss is significantly higher due to the emotional underpinnings of these factors.
Most investors are smart; few, however, are disciplined enough to say no and move on or, more important, be patient. Very few activities in life can be practiced successfully without some degree of discipline. Being disciplined requires you to think independently and ignore crowd psychology. Discipline requires investors to be confident in their research and analysis and be prepared to receive criticism from all angles.
Yet disciplined investors clearly realize that investment success comes from sticking to their methods and not participating in crowd folly.
Tuesday 26 March 2013
Benjamin Graham's Writings over time
Year 1934 1st Edition Security Analysis
Year 1940 2nd Edition Security Analysis
Year 1949 1st Edition The Intelligent Investor
Year 1951 3rd Edition Security Analysis
Year 1954 2nd Edition The Intelligent Investor
Year 1959 3rd Edition The Intelligent Investor
Year 1962 4th Edition Security Analysis
Year 1973 4th Edition The Intelligent Investor
Monday 25 March 2013
The Intelligent Investor by Benjamin Graham: What the Enterprising Investor should Avoid.
Portfolio Policy for the Enterprising Investor – the Negative Side
•
•What to Avoid
•The
aggressive investor should start with the same base as the defensive investor,
dividing the portfolio more or less equally between stocks and bonds.
•
•What to Avoid
•To
avoid losses or
returns lower than that of the defensive investor, the aggressive investor
should steer clear of the following pitfalls:
1. Avoid
all preferred stocks.
Preferred stock rarely possesses upside component that is the basis for owning
common stock. Yet compared to debt, preferred stock affords little
protection. Since dividends can be suspended at anytime, unlike debt, why
not just own debt instead?
2. Avoid
inferior (“high yield” or “junk”) bonds unless such bonds are purchased at least 30% below their par
value for high coupon issues, or 50% below par value for other
issues. The risk of these issues is rarely worth the interest premium
that they offer.
3. Avoid
all new issues.
4. Avoid
firms with “excellent” earnings limited to the recent past.
•
•Quality
bonds should have “Times Interest Earned” ratio, that is EBIT/net interest, of
at least 5x.
•
•
•Preferred stocks, convertible bonds, and other high yield or
“junk” bonds often trade significantly below par during their issue, so
purchasing them at par is unwise.
•
•During
economic downturns, lower quality bonds and preferred stocks often experience
“severe sinking spells” where they trade below 70% of their par value.
•
•For
the minor advantage
in annual income of 1%-2%, the buyer risks losing a substantial amount of
capital, which is bad business.
•Yet
purchasing these
issues at par value provides no ability to achieve capital gains.
•
•Therefore, unless
second grade bonds can be purchased at a substantial discount, they are bad
deals!
•
•
•Foreign Government Bonds are worse than domestic
high yield junk, for the owner of foreign obligations has no legal or other
means of enforcing their claims.
•This
has been true since 1914.
•Foreign bonds should be avoided at all costs.
•
•Investors
should be wary of all new issues.
•New issues are best left for speculators.
•In
addition to the usual risks, new issues have salesmanship behind them, which
artificially raises the price and requires an additional level of
resistance.
•Aversion
becomes paramount as the quality of these issues decrease.
•
•During
favorable periods,
many firms trade in their debt for new bonds with lower coupons.
•This
inevitably results in
too high a price paid for these new issues, which then experience significant
declines in principal value.
•
•
•Common
stock issues take two forms - - those that are already traded publicly
(secondary issues) and those that are not already traded publicly (IPOs).
•
•Stock
that is already publicly traded does not ordinarily call for active selling by
investment houses, whereas the issue of new stock requires an active selling
effort.
•
•Most
new issues are sold for account of the controlling interests, which allows them
to cash-in their equity during the next several years and to diversify their
own finances.
•
•Not only does danger arise from the poor character of
businesses brought public, but also from the favorable market conditions that permit
initial public offerings.
•
•
•New
issues during a bull market usually follow the same cycle.
•As
a bull market is established, new issues are brought public at reasonable
prices, from which adequate profits may be made.
•As
the market rise continues, the quality of new issues wanes.
•In
fact, one important signal of a market downturn is that new common stocks of
small, nondescript firms are offered at prices higher than the current level
for those of medium sizes with long market histories.
•
•In many cases, new issues of common stock lose 75% or more of
their initial value.
•Thus, the investor should
avoid new issues and their salespeople.
•These issues may be excellent values
several years after their initial offering, but that will be when nobody else
wants them.
•
•
Tuesday 19 March 2013
Ten signs your stock will double
Date March 16, 2013
Nathan Bell
Everyone loves the idea of buying stocks that double in price. But how do you spot them? Here are 10 quick pointers:
1. Out of favour
A stock that's out of favour – hated even – is potentially an investor's most rewarding opportunity.
Intelligent Investor recommended News Corp in July 2011 at the height of the phone-hacking scandal when the price had fallen to $14.58. Since then it's more than doubled.
What most investors missed was the fact that the company's newspaper businesses were insignificant compared with its pay TV and movie operations, which were travelling along nicely. It was the quintessential out-of-favour stock.
2. Hidden progress
Computershare, the world's largest share registry, last year completed the purchase of BNY Mellon. As a result, it now controls about 60 per cent of the US registry market. That has huge potential to deliver cost savings and higher earnings when corporate activity recovers. The company has made hidden progress but the market is yet to catch up.
3. New technology
Sirtex owns an innovative treatment for liver cancer that costs $US14,000 ($13,500) per dose. When Intelligent Investor recommended it as a "speculative buy" in November 2010 at a price of $5.90, the company was involved in litigation with a major shareholder, directors owned very few shares and profitability was declining.
But new clinical trials were underway that could increase the market size for Sirtex's product tenfold.
The results of the trials aren't due until next year but the share price has almost doubled since late 2010 in anticipation of the potential financial rewards.
4. Investment in R&D
In his book, Common Stocks and Uncommon Profits, Philip A. Fisher suggests that the best companies to buy are those investing heavily in research and development to provide future profits.
After recommending blood products manufacturer CSL in March 2011 at $33.97, its share price surpassed $60 recently. This year the company will invest more than $400 million in research and development – more than its entire revenue in 1997.
5. Industry tailwinds
Air travel tends to grow at about twice GDP growth. That's a lovely tailwind for an airport business (less so for airlines where the benefits get competed away). At the bottom of the market in 2009, Sydney Airport stock hit a low of $1.45. With passenger growth recovering, the stock price is now $3.16 and it has paid handsome distributions along the way.
6. Changes to industry structure
The internet has all but destroyed traditional newspaper companies. In their place have arisen online classifieds sites such as Realestate.com.au, Carsales and Seek. All trade at multiples of their float price while companies such as Fairfax struggle. The structural shift has destroyed some businesses and created others.
7. Owner-managers
When owner-managers put their money on the line, pay close attention. Investors in four-wheel-drive accessories manufacturer ARB Corporation and Flight Centre would understand the benefits. Stocks that double tend to have exceptional management with a vested interest in maximising the value of their shareholding.
8. Insider buying
Directors buying stock is another indicator of a potentially cheap stock. Flight Centre's Graham Turner last purchased shares on market at a price of $3.84 on March 16, 2009. Now, the company's share price is well over $30. Directors know their businesses well. It pays to watch their activity.
9. Financial strength
The strong financial position of serviced office provider Servcorp meant it could purchase cheap leases during the GFC and reap the benefits when the market recovered. That's one of the reasons why the stock has increased more than 40 per cent since the middle of last year.
10. Unrecognised by the market
When the stock price fell below $20 a year-and-a-half ago, complaints about Macquarie Group's return on equity failed to recognise the value of its large capital cushion, and investors ignored its more stable businesses such as funds management, which were growing, and supported a decent dividend. The market is now catching on, with its share price more than doubling since the 2009 market lows.
Genuinely independent thinking and a thorough understanding of the facts increase your chances of buying stocks that will double in price. Next time you're considering a stock purchase, use this checklist.
The more factors you can tick off, the greater the chance of your next purchase doubling in price.
This article contains general investment advice only (under AFSL 282288).
Nathan Bell is the Research Director at Intelligent Investor Share Advisor, shares.intelligentinvestor.com.au.
Read more: http://www.smh.com.au/money/investing/ten-signs-your-stock-will-double-20130316-2g72h.html#ixzz2NvyYjZln
Wednesday 15 August 2012
The three most important words in the books of Benjamin Graham
Yes, these are the three most important words in the books of Benjamin Graham.
If you have to take home a message from his thick books, it is knowing everything about "Margin of Safety".
Better still, tattoo these three words to your body, so that you can be reminded every minute of the day.
If you have to take home a message from his thick books, it is knowing everything about "Margin of Safety".
Better still, tattoo these three words to your body, so that you can be reminded every minute of the day.
Monday 13 August 2012
Diversification and fear of risk
Fear of risk is a legitimate fear - it is the fear of losing money.
Master investors don't fear risk, because they passionately and actively avoid it. Fear results from uncertainty about the outcome, and a master investor only makes an investment when he has strong reasons to believe he'll achieve the result he wants.
Those who follow the conventional advice to diversify simply don't understand the nature of risk, and they don't believe it is possible to avoid risk AND make money at the same time.
While diversification is certainly a method for minimizing risk, it has one unfortunate side-effect: it also minimizes profit.
Master investors don't fear risk, because they passionately and actively avoid it. Fear results from uncertainty about the outcome, and a master investor only makes an investment when he has strong reasons to believe he'll achieve the result he wants.
Those who follow the conventional advice to diversify simply don't understand the nature of risk, and they don't believe it is possible to avoid risk AND make money at the same time.
While diversification is certainly a method for minimizing risk, it has one unfortunate side-effect: it also minimizes profit.
Wednesday 18 July 2012
Benjamin Graham: The Intelligent Investor (audiobook)
1Benjamin Graham The Intelligent Investor 24 of 24by flodemonn
Security Analysis by Benjamin Graham and David Dodd
Security Analysis, the revolutionary book on fundamental analysis and investing, was first published in 1934, following unprecedented losses on Wall Street.
Benjamin Graham and David Dodd chided Wall Street for its myopic focus on a company's reported earnings per share (eps), and were particularly harsh on the favored "earnings trends." They encouraged investors to take an entirely different approach by estimating the rough value of the operating business that lay behind the security. They have given actual examples of the market's tendency to irrationally under-value certain out-of-favor stocks.
The book is must read for any Stock Market Investor, fundamental analyst or equity research professional.
Benjamin Graham and David Dodd chided Wall Street for its myopic focus on a company's reported earnings per share (eps), and were particularly harsh on the favored "earnings trends." They encouraged investors to take an entirely different approach by estimating the rough value of the operating business that lay behind the security. They have given actual examples of the market's tendency to irrationally under-value certain out-of-favor stocks.
The book is must read for any Stock Market Investor, fundamental analyst or equity research professional.
Investment Policies (Based on Benjamin Graham)
Summary of Investment Policies
A. INVESTMENT FOR FIXED INCOME:
US Savings Bonds (FDs)
B. INVESTMENT FOR INCOME, MODERATE LONG-TERM APPRECIATION AND PROTECTION AGAINST INFLATION:
(1) INVESTMENT FUNDS bought at reasonable price.
(2) Diversified list of primary common stocks (BLUE CHIPS) bought at reasonable price.
C. INVESTMENT CHIEFLY FOR PROFIT: 4 approaches are open to both the small and the large investors:
(1) Representative common stocks bought when the MARKET level is clearly LOW.
(2) GROWTH STOCKS, when these can be obtained at reasonable prices in relation to actual accomplishment – GROWTH INVESTING.
(3) Purchase of securities selling well BELOW INTRINSIC VALUE – VALUE INVESTING.
(4) Purchase of WELL-SECURED PRIVILEGED SENIOR ISSUES (bonds and preferred shares).
(5) SPECIAL SITUATIONS: Mergers, arbitrages, cash pay-outs.
D. SPECULATION:
(1) Buying stock in new or virtually new ventures (IPOs) .(2) TRADING in the market.
(3) Purchase of "GROWTH STOCKS" at GENEROUS PRICES.
_______________
For DEFENSIVE INVESTORS: Portfolio A & B
(Portfolio A: Cash, FDs, Bonds Portfolio B: Mutual funds, Blue chips)
For ENTERPRISING INVESTORS: Portfolio A & B & C
(Portfolio C: Buy in Low Market, Buy Growth stocks at fair value, Buy value stocks i.e. bargains, High grade bonds and preferred shares, Arbitrages)
For SPECULATORS: Portfolio D
(Should set aside a sum for this separate from their money in investing.)
________________
________________
Types of Investors
Graham felt that individual investors fell into two camps : "defensive" investorsand "aggressive" or "enterprising" investors.
These two groups are distinguished not by the amount of risk they are willing to take, but rather by the amount of "intelligent effort" they are "willing and able to bring to bear on the task."
Thus, for instance, he included in the defensive investor category professionals (his example--a doctor) unable to devote much time to the process and young investors (his example--a sharp young executive interested in finance) who are as-yet unfamiliar and inexperienced with investing.
Graham felt that the defensive investor should confine his holdings to the shares of important companies with a long record of profitable operations and that are in strong financial condition. By "important," he meant one of substantial size and with a leading position in the industry, ranking among the first quarter or first third in size within its industry group.
Aggressive investors, Graham felt, could expand their universe substantially,but purchases should be attractively priced as established by intelligent analysis. He also suggested that aggressive investors avoid new issues.
Click and read also:
A. INVESTMENT FOR FIXED INCOME:
US Savings Bonds (FDs)
B. INVESTMENT FOR INCOME, MODERATE LONG-TERM APPRECIATION AND PROTECTION AGAINST INFLATION:
(1) INVESTMENT FUNDS bought at reasonable price.
(2) Diversified list of primary common stocks (BLUE CHIPS) bought at reasonable price.
C. INVESTMENT CHIEFLY FOR PROFIT: 4 approaches are open to both the small and the large investors:
(1) Representative common stocks bought when the MARKET level is clearly LOW.
(2) GROWTH STOCKS, when these can be obtained at reasonable prices in relation to actual accomplishment – GROWTH INVESTING.
(3) Purchase of securities selling well BELOW INTRINSIC VALUE – VALUE INVESTING.
(4) Purchase of WELL-SECURED PRIVILEGED SENIOR ISSUES (bonds and preferred shares).
(5) SPECIAL SITUATIONS: Mergers, arbitrages, cash pay-outs.
D. SPECULATION:
(1) Buying stock in new or virtually new ventures (IPOs) .(2) TRADING in the market.
(3) Purchase of "GROWTH STOCKS" at GENEROUS PRICES.
_______________
For DEFENSIVE INVESTORS: Portfolio A & B
(Portfolio A: Cash, FDs, Bonds Portfolio B: Mutual funds, Blue chips)
For ENTERPRISING INVESTORS: Portfolio A & B & C
(Portfolio C: Buy in Low Market, Buy Growth stocks at fair value, Buy value stocks i.e. bargains, High grade bonds and preferred shares, Arbitrages)
For SPECULATORS: Portfolio D
(Should set aside a sum for this separate from their money in investing.)
________________
________________
Types of Investors
Graham felt that individual investors fell into two camps : "defensive" investorsand "aggressive" or "enterprising" investors.
These two groups are distinguished not by the amount of risk they are willing to take, but rather by the amount of "intelligent effort" they are "willing and able to bring to bear on the task."
Thus, for instance, he included in the defensive investor category professionals (his example--a doctor) unable to devote much time to the process and young investors (his example--a sharp young executive interested in finance) who are as-yet unfamiliar and inexperienced with investing.
Graham felt that the defensive investor should confine his holdings to the shares of important companies with a long record of profitable operations and that are in strong financial condition. By "important," he meant one of substantial size and with a leading position in the industry, ranking among the first quarter or first third in size within its industry group.
Aggressive investors, Graham felt, could expand their universe substantially,but purchases should be attractively priced as established by intelligent analysis. He also suggested that aggressive investors avoid new issues.
Click and read also:
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