Wild Week

Whitney Tilson’s email to investors discussing the wild week


1) What a wild week! The sharpest, fastest bear market in history – the S&P 500 Index was down 35.2% from its closing high on February 19 to its intraday low on Monday – was followed by the sharpest, fastest move back into bull market territory in history, as the index rallied 20% from that point through yesterday's close. Both Tuesday and the past three days were the best for the Dow in 87 years.

I can't recall such a violent upward move in my entire career. I checked the bounces off the bottoms reached on October 10, 2002 and March 6, 2009 (the closing low was March 9, but the intraday low was on March 6) and, in the four days afterward, the S&P 500 rose by "only" 12.5% and 12.3%, respectively. And going back to the Dow's 22.6% plunge on Black Monday on October 19, 1987, while it rose 5.9% the next day, it then trickled downward for another month and a half – going well below its Black Monday close.

I rarely have opinions about where I think the market in general is going, especially in the short term, as this isn't my area of expertise. I find it a far better use of my time to study particular companies and industries to try to develop proprietary insights.



But Monday was one of those rare times. In my e-mail that day, I wrote:

..... why we've come to the firm conclusion that this is the absolute best time to be an investor in more than a decade. To borrow a phrase from one of my friends, "we're trembling with greed" right now.



................



If this doomsday scenario doesn't come to pass, stocks will likely go nuts.

So after the big move in the past three days, what's my thinking? Over the next few months, I no longer have a strong feeling. I think there's a bell curve of possible outcomes, and we're right in middle of it.

But if you ask me where we will be in a year (which is the absolute minimum time horizon I tend to consider) – I think odds are at least 75% that stocks will be higher.




2) In yesterday's e-mail, I wrote:

I just completed a report on [the coronavirus crisis] that I think is the best work I've ever done.

It's broken into three parts:

1. Why I'm Optimistic That We'll Soon Stop the Coronavirus

2. The Five Reasons We're Bullish on Stocks Right Now

3. 10 Stocks to Buy to Profit from the Coming Market Upturn

As it becomes clear that we've controlled the spread of the virus and know exactly where the outbreaks are – which could happen as soon as a couple of weeks from now – we can start bringing our economy back to life.


https://www.valuewalk.com/2020/03/ackmans-greatest-trade/

Warren Buffett: Volatility in the Market

Market Volatility

What should you do?

If you own a farm or an apartment, you do not get a quote on them every day or every week.

The value of a business depends on how much in terms of cash it delivers to its owners between now and judgment day and I don't think it changes in 10% in a 2 months period if you are looking at it as a business.

Anything, I mean, anything can happen in the market; that is why don't borrow money against any securities.  Markets don't have to open tomorrow.  You can have extraordinary events.


You can get some of the instruments that people don't understand very well that has a lot of fire-power.

A sound mental approach towards stock fluctuations (1)

Intelligent investment is more a matter of mental approach than it is of technique.

A sound mental approach towards stock fluctuations is the touchstone of all successful investment under present-day conditions.

Your portfolio should consist of:

(a)  Savings Bonds, which have no price fluctuations, and,

(b)  Common Stocks, which are likely to fluctuate widely in their market price.

Such changes in quoted prices may be significant to the investor in two possible directions:

(A)  As a measure of the success of your investment program.

(B)  As a guide to the selection of your securities and the timing of your transactions.

Benjamin Graham's teachings on Market Fluctuations and your investing

Market Fluctuations

            Fluctuations of Common Stock Prices

Since common stocks are subject to wide price swings, the investor should seek to profit from these opportunities.  However, attempting to time the market usually ends in unsatisfactory results.  Graham believes that market timing is pure speculation and is not an investing activity.  The best an investor can do is the change the bond and stock proportions in his portfolio after major market swings. 

Formulas do not work, although they have been in vogue since the 1950s.  When the market reached new highs in the mid-1950s, many formula investors sold their equities according to formula only to witness the market grow increasingly higher.  Any approach to the market that is easily described is sure to fail (except for Graham’s method). 

The investor also can focus on the price of a security. Graham recommends this practice.  Short-term fluctuations should not matter.  Over a period of 5 years, the investor should not be surprised if the average value of his portfolio increases more than 50% from its low point or decreases 1/3 from its high point.

Market advances and declines tempt investors to make foolish decisions.  Varying the proportion of stocks and bonds between the 25%-75% ratio occupies an investor’s time during turbulent markets and prevents him from making gross errors in judgement.  The true investor takes comfort that his actions are opposite from the actions of the crowd.

The better a firm’s record and its prospects, the less relationship that its price will have to its book value.  The more successful the company, the more likely its share price is to fluctuate.  More often than not, a fast growing firm’s market price will exceed its intrinsic value.  So, the better the quality of the stock, the more speculative it will be.  This explains the erratic price behavior of some of the most successful and impressive enterprises, such as IBM and Xerox.

The investor should purchase issues close to their tangible asset values and at no more than 33% above that figure.  These purchases logically are related to a company’s balance sheet and not to its earnings.  Any premium over book value may be thought of as a fee for liquidity that accompanies any publicly traded stock.   

            Just because a stock sells at or below its net asset value does not warrant that it is a sound purchase.  In addition to below market values, the investor also must demand a strong financial position, a satisfactory p/e ratio, and an assurance that the firm’s earnings will be sustained over the years.  This is not an entirely difficult bill to fill except under dangerously high market conditions.  At the end of 1970 more than half of the DJIA met these investment criteria.  However, the investor will forgo the most brilliant, high growth prospects.

            With a portfolio purchased at close to book value, the investor can take a more detached view of market fluctuations.  In fact, so long as the earning power of the portfolio remains satisfactory, the investor can use these market vagaries to buy low and sell high.

As seen with the stock fluctuations of A & P over many years, the market often goes wrong.  Although the stock market may fall, a true investor is rarely forced to sell his shares.  Rather, the investor is free to disregard the market quotes.  Thus, the investor who allows himself to be unduly worried about the market transforms his basic advantage into a disadvantage.  In fact, the investor who owns common stock owns a piece of these companies as a private owner would, and a private owner would not sell his business when it is undervalued by the market.  A quoted stock provides an option for the investor to sell at a given price and nothing more.  The investor with a diversified portfolio of good stocks should neither worry about sizeable declines nor become excited about sizeable advances.   An investor never should sell a stock just because it has gone down or purchase it because it has gone up.

Graham provides the parable of “Mr. Market”, who like the stock market, quotes you a price for your shares each and every day.  Mr. Market will either buy your shares or sell you his.  The price will depend upon Mr. Market’s mood.  You can ignore his efforts, or you can take advantage of him when he quotes you a price that you believe is priced advantageously.  Finally, one should not forget the effect of management on a firm’s results.  Good management produces acceptable results and bad management does not.

Fluctuation of Bond Prices

            Short-term bonds, defined as those with a duration of less than 7 years, are not significantly affected by changes in the market.  This applies to US Savings Bonds, which can be redeemed at anytime.  Long term bonds, however, may experience wide price swings as a result of fluctuations in the interest rate.  Thus, long term bonds may seem attractive when discounted, but this practice often leads to speculation and losses.

Low yields correspond with high bond prices and vice versa; prices and yields are inversely related.  The period from 1960 to 1975 is marked by reversing swings in the price of bonds so much so that it reminded Graham of Newton’s law: “every action has an opposite and equal reaction.”  Of course, nothing on Wall Street actually occurs the same way twice. 

Graham acknowledges the impossibility of attempting to predict bond prices, even if common stock prices were predictable.  Therefore, the investor must choose between long- term and short-term bonds chiefly on the basis of personal preference.  If the investor wishes to ensure that his market values will not decrease, then the investor is best served by US Savings Bonds.  With higher yield long term bonds, the investor must be prepared to see their market values fluctuate. 

Convertible issues should be avoided.  Their prices fluctuate widely and unpredictably based upon the price of the underlying common stock, the credit standing of the firm, and the market interest rate.  Because convertible issues experience huge swings in market value, they are largely speculative investments.

MARKET FLUCTUATIONS OF INVESTOR'S PORTFOLIO

Note carefully what Graham is saying here. 

It is not just possible, but probable, that most of the stocks you own will gain at least 50% from their lowest price and lose at least 33% ("equivalent one-third") from their highest price -regardless of which stocks you own or whether the market as a whole goes up or down.

If you can't live with that - or you think your portfolio is somehow magically exempt from it - then you are not yet entitled to call yourself an 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%

The case of the market declines and unsuccessful stock investments.

There is a vital difference here between temporary and permanent influences.

A price decline is of no real importance to the bona fide investor unless it is either very substantial - say, more than a third from cost - or unless it reflects a known deterioration of consequence in the company's position.


In a well defined bear market many sound common stocks sell temporarily at extraordinarily low prices.

• It is possible that the investor may then have a paper loss of fully 50 per cent on some of his holdings, without any convincing indication that the underlying values have been permanently affected.

A significant price decline is of importance to the investor.

• He would have been well advised to scrutinize the picture with some care, to see whether he had made any miscalculations.
• But if the results of his study were reassuring - as they should have been - he was entitled then to disregard the market decline as a temporary vagary of finance, unless he had the funds and the courage to take advantage of it by buying more on the bargain basis offered.

Price Changes as Measuring Investment Results

When the general market declines or advances substantially ....
.... nearly all investors will have somewhat similar changes in their portfolio values.

Benjamin Graham, in his book Intelligent Investor, wrote that the investor should not pay serious attention to such price developments unless they fit into a previously established program of buying at low levels and selling at high levels.

The investor is neither a smart investor nor a richer one when he buys in an advancing market and the market continues to rise.

That is true even when the investor cashes in a goodly profit, unless either
(a) he is definitely through with buying stocks - an unlikely story - or
(b) he is determined to reinvest only at considerably lower levels.

In a continuous program no market profit is fully realized until the later reinvestment has actually taken place, and the true measure of the trading profit is the difference between the previous selling level and the new buying level.

The INVESTMENT SUCCESS of the investor may be judged by a long-term or secular rise in market price, without the necessity of sale.

The proof of that achievement lies in the price advances made between successive points of equality in the general market level.

In most cases this favourable price performance will be accompanied by a well-defined improvement in the average earnings, in the dividend, and the balance-sheet position.

Thus in the long run the market test and the ordinary business test of a successful equity commitment tend to be largely identical.



SUMMARY
Most of us are invested for the long run.
Even if you manage to sell your investment for a profit from your previous buying price, no market profit is fully realized until you have reinvested this amount back into the market.
Your trading profit is the difference between the previous selling level and the new buying level.

How worried are you when the stock market goes down 50%? Ask Charlie Munger who reveals the secrets to getting rich.

Published on 13 Jul 2012

http://www.charliemunger.net -- Charlie Munger, the long-time business partner of famed investor Warren Buffett, talks with the BBC. If you know anything about Charlie Munger, he's famous for his quick wit, plain spokeness and absolute genius. He has helped shareholders of Berkshire Hathaway amass untold forunes.

Warren Buffett (1962) talks about a brief stock market drop

Market Fluctuations and Your Emotions

The stock market can fluctuate widely.  Prices of stocks are determined by various factors.  It is better for you to focus on the fundamentals of the stocks.  However, the prices of stocks can be driven very high and pushed very low by sentiments of the players which may not have anything to do with the underlying fundamentals.

As a rational investor, what should you do in such situations?  Let's assume you own good quality companies with durable competitive advantage which you plan to hold for the long term.  You rightly have chosen these companies to be in your portfolio due to their earnings power, mainly gauged from their historical performances. 

Firstly, you should be able to compute the intrinsic values for the companies, using conservative estimates in your valuation.  This ability is important as it is the strength you will have over the other players.  It is not uncommon for your stock prices to fluctuate 50% above or the equivalent 1/3rd below its average market price over a 52 weeks period.  Check these out to confirm this statement in your local press of the listings of the various companies' stock prices.

If you hope to buy and sell to profit from these market fluctuations in the prices of your stocks, believe me that to make money consistently and to grow your portfolio value at a meaningful rate, though possible for a few, is not easy.  Frequent trading incurs costs and expenses, and also your time, which can be better employed to pursue some better, more productive and healthier activities.  Rather than hoping to profit from trading these prices, focus on profiting from the long term returns you can expect with a high degree of probability from holding these stocks with great earning power. 

How then should you approach these market fluctuations of the prices of your stock?

When the price of the stock is higher than your calculated intrinsic value, don't buy to add to your portfolio.  Do you sell based on valuation?  Often, you need not have to.  There are times when you may consider selling some (perhaps 20%), but not all, should the stock be too overpriced  Selling your winners to lock in a gain, may not mean that you will be able to buy the same back at lower prices in the future.  Moreover, the gain that you locked in at the time of selling, you may realise that you have missed out on the even bigger gains that these stocks deliver over the long term.   (Just to emphasize, this is different from stocks which fundamentals have deteriorated permanently.  These should be sold urgently to prevent harm to your portfolio.) 

Great companies can often be bought at fair prices and still be very profitable over the long term in your portfolio.  You should be greedy when such companies are available to you at low prices, especially during a general market correction or a bear market, when even these good stocks are sold down by the less savvy investors, due to fear, during such periods.

Using Market Fluctuations as a guide to making Investment Decisions*

Graham, Chapter 8:

In chapter eight of Graham's book, he brings up the subject of market fluctuation. I think he makes an important point to those people who are monitoring their retirement portfolios almost on a daily basis. 

He states that "the investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances" (p. 206). 

With this in mind, he suggests using these fluctuations in the market as a guide to making investment decisions. 

More precisely, he suggests using the dips in the market as points to acquire more of a quality stock along with finding new opportunities for suitable investments.

The Intelligent Investor by Benjamin Graham

Why I am interested in stocks?

Stock prices fluctuated wildly while the underlying value of the business was far more stable.  

To be a successful investor you need to have the time to stop and contemplate what's going on.  

MARKET FLUCTUATIONS OF INVESTOR'S PORTFOLIO

Note carefully what Graham is saying here. 

It is not just possible, but probable, that most of the stocks you own will gain at least 50% from their lowest price and lose at least 33% ("equivalent one-third") from their highest price -regardless of which stocks you own or whether the market as a whole goes up or down.

If you can't live with that - or you think your portfolio is somehow magically exempt from it - then you are not yet entitled to call yourself an investor.

Any price - and therefore P/E - movements that is not related to the company's earnings is transient.

The stock market is governed by a diverse set of influences.  And just as the sea is, it is predictable over the long term but not over the short term.

Probably the most widely watched reason for the long-term fluctuations of the price and P/E is the rise and fall of the stock market itself.  This can be a function of the economy's volatility.  The economy is battered by the rise and fall of interest rates, by inflation, and by a variety of factors that drive consumer confidence or buying power up or down.  Actual changes in the economy itself will cause longer-term changes in the market and the prices of its individual stocks.  Speculation about such changes has a shorter-term effect.

In the shorter term, there are the ripples and wavelets.  Every little utterance of a government official or company offer, insider buying or selling (which may or may not mean anything), rumour, gossip, and just about anything else can influence the whims of those on the street.  Many people will use these stories to try to make or break a market in the stock.

Over the life of a company, its fair P/E - the "normal" relationship between a company's earnings and its stock's price - is relatively constant.  It does tend to decline slowly as the company's earnings growth declines, which happens with all successful companies.  For all practical purposes, however, that relationship is remarkably stable.  And for that reason, it's also remarkably predictable.

When a company's earnings continue to grow, so will its stock price.  Conversely, when earnings flatten or go down, the price will follow.

The little fluctuations in the P/E ration above and below that constant (fair) value are not so predictable because they are all caused by investor perception and opinion.  Think of them as the winds that blow across the surface of the sea.

The broader moves above and below the norm are the undulations that are typically caused by the continuous rising and falling of analysts' expectations.  When a company first emerges into its explosive growth period, the analysts expect earnings to continue to skyrocket.  Earnings growth estimates in the 50% range or more are not uncommon.

As the company continues to meet these expectations, investor confidence booms along with it, and more investors pay a higher and higher price for the stock.  The P/E rises as a meteor right along with the price.  The faster the growth, the higher the P/E.  This does nothing to alter the value of the "reasonable or fair" P/E multiple.  It just means that investor confidence has risen well above that norm and that there will eventually be an adjustment.

Sure enough, one fine day when the analysts' consensus called for growth of 45%, the company turns in a "disappointing" earnings growth of only 38%.  The analysts start wringing their hands because the company has not met their expectations, and some fund manger sells.  Next, all of the lemmings on Wall Street follow suit.  And not long thereafter you get a call from your broker telling you that you've had a nice ride, you've made a lot of money on the stock, and it's time to take your profit and get out.  In the meantime, the broker has made a commission on your purchase and is hoping to make it on your sale as well.

After a while, after the price and the P/E have plummeted and then sat there for a while, some analyst wakes up to the fact that a 34% earning growth rate is still pretty darn good and jumps back in.   Soon the cycle is reversed.  The market starts showing the company some respect again.  And you get a call from your broker.

Of course, as a smart intelligent investor you didn't sell it in the first place!  Because you were watching the fine earnings growth all along, you knew better than to sell.  And you chose the opportunity to buy some more.  In the meantime, your brokers'; clients who were not so savvy has taken their profits (and, had paid the taxes on them, by the way) and are now wishing that they had stayed in with you.  By the time their broker called them again, the price had already climbed past the point where it made good sense for them to jump in again.

It is best to assume that any price - and therefore P/E - movements that is not related to the company's earnings is transient.  If the stories - not the numbers - cause the price to move, the change won't last.  What goes up will come down, and what goes down will come up.,  You have to be concerned only when the sales, pretax profits, or earnings cause the change, and then only if you find that the performance decay is related to a major long-term problem that is beyond the management's ability to resolve.

Remember also that a sizable segment of Wall Street doesn't make its money investing as you do; it makes its money on the "ocean motion."  Buy or sell, it makes little difference to them what you do.  They make their money either way.  But it sure makes a big difference to you!

Benjamin Graham on Market Behavior

In Security Analysis, Benjamin Graham emphasizes the importance of not only focusing on a firm’s potential and accounting statements, but to also pay great attention to the business cycle. Individual investors should research and create their own one year outlook for the market.

Almost any security may be a sound purchase at some real or prospective price and an indicated sale at another price.
- Benjamin Graham, Security Analysis

Think Long-Term

However, Graham also stresses that day-to-day and month-to-month fluctuations of the market should be ignored. Instead, investors should focus on the major shifts in market sentiment and estimating what stage of the business cylce we are in. Clearly today we are in a brutal bear market that has brought down the S&P 500 over 40% year to date. But we have to ask ourselves, what inning of this bear market are we in? Where do we see the strongest values in the market?

Benjamin Graham on Investing in Bear Markets

In a typical case of bear-market hysteria or pessimism the investor would be better off if he were not able to sell out so readily; in fact, he is often better off if he does not even know what changes are taking place in the market price of his securities.
- Benjamin Graham, Security Analysis

Graham’s sentiment on holding onto securities in a bear market could have taken a huge chunk out of someone’s portfolio this year, I know holding onto crashing stocks has severly hurt my portfolio. However at this state of the bear market I believe the above quote is appropriate.

It is ill-advised at this moment in time to liquidate investments into weakness. Your portfolio may depreciate in the coming months, but sometimes you have to take a 3 month deep breath and try your best to not follow your stock prices on a daily basis and just enjoy your dividend yields! To do this you have to be sure that your portfolio is filled with strong, value stocks with years of consistent earnings growth. Ignoring equity prices does not mean you should ignore the latest news from stocks you own. Shares should be sold if there is a fundamental shift in the companies’ long-term outlook.

Even though Warren Buffet’s 2 month-old investment in Goldman Sachs (GS) at $115 a share has fallen almost in half to $65 a share, I’m willing to bet he is sleeping well at night knowing he is invested in a first-in class company (although the investment banking class may be gone forever) and enjoying a 10% dividend yield from his preferred stock.

Don’t Purchase a Stock at Any Price

Finding the strongest values is no easy task, and Benjamin Graham gives some bull market advice that is worth remembering once this cycle changes gears. “Don’t purchase stocks atany price.” He writes that great companies don’t necessarily indicate a great investment if their stock price is comparatively high. Be a patient investor and wait until the company drops to an attractive level. For instance during a bull market in 2006 you could have bought Microsoft (MSFT) at a high of $30.19 or a low of $21.92 (or today at $19.15!) - a 27% variation. If a stock price of a company you have been watching continues to soar far above the intristic value (you can use my post on the Dividend Growth Model to estimate intrinsic value) you give the company, don’t feel like you missed the boat, in the long-term the price very well will come down to levels you like or their earnings will improve to increase your valutation.

When to Invest In Small Cap Stocks

Graham also notes that small cap stocks are more sensitive to swings in the overall market. Your position in small caps should be minimized in your portfolio if you have a weak outlook for the coming year and your small cap positions should be increased in bull markets. This sentiment is supported decades after Graham’s writing, consider comparing SPDR DJ Wilshire Small Cap Growth (DSG) which retreated 49% YTD vs. SPDR DJ Wilshire Large Cap Growth (ELG) which declined only (only!?) 43% YTD.

Beware of Bull Markets

Beware of “bargains” when most stock prices are high. An undervalued, neglected stock may continue to be neglected through the end of the bull market and may potential be one of the hardest hit stocks in the following bear market.

Market Environment, Potential Value, and Intristic Value Produce Market Price

Post written by Max Asciutto

http://www.theintelligentinvestor.net/benjamin-graham-on-market-behavior

The Investor and Market Fluctuations: The story of the Great Atlantic & Pacific Tea Company Shares (1)

The A. & P. Example

At this point we shall introduce one of our original examples, which dates back many years but which has a certain fascination for us because it combines so many aspects of corporate and investment experience. It involves the Great Atlantic & Pacific Tea Co. Here is the story:

A. & P. shares  were introduced to trading on the “Curb” market, now the American Stock Exchange, in 1929 and sold as high as 494.  

• By 1932 they had declined to 104, although the company’s earnings were nearly as large in that generally catastrophic year as previously. 
• In 1936 the range was between 111 and 131. 
• Then in the business recession and bear market of 1938 the shares fell to a new low of 36.

That price was extraordinary.

• It meant that the preferred and common were together selling for $126 million, although the company had just reported that it held $85 million in cash alone and a working capital (or net current assets) of $134 million. 
• A. & P. was the largest retail enterprise in America, if not in the world, with a continuous and impressive record of large earnings for many years. 
• Yet in 1938 this outstanding business was considered on Wall Street to be worth less than its current assets alone—which means less as a going concern than if it were liquidated. 

Why? 

• First, because there were threats of special taxes on chain stores; 
• second, because net profits had fallen off in the previous year; and, 
• third, because the general market was depressed. 
• The first of these reasons was an exaggerated and eventually groundless fear; the other two were typical of temporary influences.

Let us assume that the investor had bought A. & P. common in 1937 at, say, 12 times its five-year average earnings, or about 80.  We are far from asserting that the ensuing decline to 36 was of no importance to him.

• He would have been well advised to scrutinize the picture with some care, to see whether he had made any miscalculations. 
• But if the results of his study were reassuring—as they should have been—he was entitled then to disregard the market decline as a temporary vagary of finance, unless he had the funds and the courage to take advantage of it by buying more on the bargain basis offered.

Ref; Intelligent Investor by Benjamin Graham

The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements.

The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements.  

The speculator’s primary interest lies in anticipating and profiting from market fluctuations. 

The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices.

Market movements are important to him in a practical sense, because they alternately create 

• low price levels at which he would be wise to buy and 
• high price levels at which he certainly should refrain from buying and probably would be wise to sell.

Explanations for the Erratic Price Behaviour of some of the Most Successful and Impressive Enterprises

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

The argument made above should explain the often erratic price behavior of our most successful and impressive enterprises. 

• Our favorite example is the monarch of them all—International Business Machines. The price of its shares fell from 607 to 300 in seven months in 1962–63; after two splits its price fell from 387 to 219 in 1970. 
• Similarly, Xerox—an even more impressive earnings gainer in recent decades—fell from 171 to 87 in 1962–63, and from 116 to 65 in 1970. 

These striking losses 

• did not indicate any doubt about the future long-term growth of IBM or Xerox; 
• they reflected instead a lack of confidence in the premium valuation that the stock market itself had placed on these excellent prospects.

Every investor who owns common stocks must expect to see them fluctuate in value over the years.

Market Fluctuations of the Investor’s Portfolio

Every investor who owns common stocks must expect to see them fluctuate in value over the years. 

The behavior of the DJIA since our last edition was written in 1964 probably reflects pretty well what has happened to the stock portfolio of a conservative investor who limited his stock holdings to those of large, prominent, and conservatively financed corporations.

• The overall value advanced from an average level of about 890 to a high of 995 in 1966 (and 985 again in 1968), fell to 631 in 1970, and made an almost full recovery to 940 in early 1971. 
• (Since the individual issues set their high and low marks at different times, the fluctuations in the Dow Jones group as a whole are less severe than those in the separate components.) 
• We have traced through the price fluctuations of other types of diversified and conservative common-stock portfolios and we find that the overall results are not likely to be markedly different from the above. 
• In general, the shares of second-line companies* fluctuate more widely than the major ones, but this does not necessarily mean that a group of well established but smaller companies will make a poorer showing over a fairly long period. 

In any case the investor may as well resign himself in advance to the probability rather than the mere possibility that most of his holdings will advance, say, 50% or more from their low point and decline the equivalent one-third or more from their high point at various periods in the next five years.†




* Today’s equivalent of what Graham calls “second-line companies” would be any of the thousands of stocks not included in the Standard & Poor’s 500-stock index. A regularly revised list of the 500 stocks in the S & P index is available at www.standardandpoors.com.

† Note carefully what Graham is saying here. It is not just possible, but probable, that most of the stocks you own will gain at least 50% from their lowest price and lose at least 33% from their highest price—regardless of which stocks you own or whether the market as a whole goes up or down. 

• If you can’t live with that—or you think your portfolio is somehow magically exempt from it—then you are not yet entitled to call yourself an investor. 
• (Graham refers to a 33% decline as the “equivalent one-third” because a 50% gain takes a $10 stock to $15. From $15, a 33% loss [or $5 drop] takes it right back to $10, where it started.

Ref:  Intelligent Investor by Benjamin Graham

The Investor and Market Fluctuations

To the extent that the investor’s funds are placed

• in high-grade bonds of relatively short maturity—say, of seven years or less—he will not be affected significantly by changes in market prices and need not take them into account. 
• (This applies also to his holdings of U.S. savings bonds, which he can always turn in at his cost price or more.) 
• His longer-term bonds may have relatively wide price swings during their lifetimes, and 
• his common-stock portfolio is almost certain to fluctuate in value over any period of several years.

The investor should know about these possibilities and should be prepared for them both financially and psychologically.  He will want to benefit from changes in market levels—

• certainly through an advance in the value of his stock holdings as time goes on, and 
• perhaps also by making purchases and sales at advantageous prices. 

This interest on his part is inevitable, and legitimate enough. But it involves the very real danger that it will lead him into speculative attitudes and activities. 

• It is easy for us to tell you not to speculate; the hard thing will be for you to follow this advice. 
• Let us repeat what we said at the outset: If you want to speculate do so with your eyes open, knowing that you will probably lose money in the end; be sure to limit the amount at risk and to separate it completely from your investment program.

What can the past record of the market actions promises the investor—

• in either the form of long-term appreciation of a portfolio held relatively unchanged through successive rises and declines, 
• or in the possibilities of buying near bear-market lows and selling not too far below bull-market highs?

Ref:  Intelligent Investor by Benjamin Graham.