Showing posts with label The Intelligent Investor: The Positive Side to Portfolio Policy for the Enterprising Investor. Show all posts
Showing posts with label The Intelligent Investor: The Positive Side to Portfolio Policy for the Enterprising Investor. Show all posts

Tuesday 27 January 2015

Portfolio Policy for the Enterprising Investor (Benjamin Graham)

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

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

Benjamin Graham
The Intelligent Investor

Quote 
"The purpose of this book is to supply, in a form suitable for laymen, guidance in the adoption of an investment policy.  Comparatively little will be said here about the technique of analysing securities; attention will be paid chiefly to investment principles and investors' attitudes."
"That risk cannot be avoided.  But by bearing it clearly in mind we may succeed in reducing it." 

 Related:

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

Monday 25 March 2013

Benjamin Graham's Intelligent Investor - What the Enterprising Investor should Buy


Portfolio Policy for the Enterprising Investor - the Positive Side
Selection of Bonds 
In addition to the US Bonds described in previous chapters, US guaranteed bonds like “New Housing Authority Bonds” and “New Community Bonds” (both of which were widely available in 1972), as well as tax free municipal bonds serviced by lease payments of A rated corporations, are good investments. 
Selection of Bonds 
Lower quality bonds may be attainable at true bargains in “special situations”, however these have characteristics that are more similar to common stocks.
Selection of Stocks
The enterprising investor usually conducts 4 activities:
1.      Buying in low markets and selling in high markets.
2.      Buying carefully chosen growth stocks.
3.      Buying bargain issues.
4.      Buying into “special situations”.
1.      Market timing - This is a difficult proposition at best.  Market timing is more of a speculative activity.
2.      Growth Stocks – This also is difficult.  These issues are already fully priced.  In fact, their growth may cease at any time.  As a firm grows, its very size inhibits further growth at the same rate.  Therefore, the investor risks not only overpaying for growth stocks, but also choosing the wrong ones.  In fact, the average growth fund does not fair much better than the indexes.  Also, growth stocks fluctuate widely in price over time, which introduces a speculative element.  The more enthusiastic the public becomes, the more speculative the stock becomes as its price rises in comparison to the firm’s earnings.
3.      Special Situations – This is a specialty field that includes workouts in bankruptcy and risk arbitrage arising from mergers and acquisitions.  However, since the 1970s, this field has become increasingly risky with available returns less than were previously realizable.  In addition, this field requires a special mentality as well as special equipment.  Thus, to the common investor, this area is highly speculative.
4.      Bargain Issues – This is the area in which the common investor has the enterprising investor has the greatest chance for long term success. 
The market often undervalues large companies undergoing short-term adversity
The market also will undervalue small firms in similar circumstances. 
Large firms generally possess the capital and intellectual resources necessary to carry the firm through adversity; plus, the market recognizes the recovery of large firms faster than it does for small firms.  
Small firms are more likely to lose profitability that is never to be regained, and when earnings do improve, they may go unnoticed by the market.
One way to profit from this strategy is to purchase those issues of the DJIA that have either the highest dividend yields or the lowest earnings multiples. 
The investment returns using this method should result in a return approximately 50% better than purchasing equal amounts of all 30 DJIA issues.  
This is a sound starting point for the enterprising investor.
Caution must be paid not to purchase companies that are inherently speculative due to economic swings, such as the Big 3 automakers. 
These firms have high prices and low multipliers in their good years, and low prices and high multipliers in their bad years.  
When earnings are significantly low, the P/E is high to adjust for the underlying value of the firm during all economic periods.  
To avoid this mistake, the stock selected should have a low price in reference to past average earnings.  
Bargain issues are defined as those that worth considerably more than their market price based upon a thorough analysis of the facts.  
To be a true bargain, an issue’s price must be at least 50% below its real value. 
This includes bonds and preferred stocks when they sell far under par. 
There are two ways to determine the true value of a stock. 
Both methods rely upon estimating future earnings. 
In the first method, the cumulative future earnings are discounted at an appropriate discount rate, or in the alternative, the earnings are multiplied by an appropriate p/e multiple.  
In the second method, more attention is paid to the realizable value of the assets with particular emphasis on the net current assets or working capital.
During bear markets, many issues are bargains by this definition. 
Courage to purchase these issues in depressed markets often is later vindicated. 
In any case, bargains can be found in almost all market conditions (except for the highest) due to the market’s vagaries. 
The market often makes mountains out of molehills. 
In addition to currently disappointing results, a lack of interest also can cause an issue to plummet.
Many stocks, however, never recover. 
Determining which stocks have temporary problems from those that have chronic woes is not easy. 
Earnings should be proximately stable for a minimum of 10 years with no earnings deficit in any year
In addition, the firm should have sufficient financial strength to meet future possible setbacks.
Ideally, the large and prominent company should be selling below both its average price and its past average price/earnings multiple. 
This rule usually disqualifies from investment companies like Chrysler, whose low price years are accompanied by high price earnings ratios.  The Chrysler type of roller coaster is not a suitable investment activity.
The easiest value to recognize is one where the firm sells for the price of its net working capital after all long-term obligations.  This means that the buyer pays nothing for fixed assets like buildings and machinery. 
In 1957, 150 common stocks were considered bargain issues.  Of these, 85 issues appeared in the S & P Monthly Guide.  The gain for these issues in two years was 75%, compared to 50% for the S & P industrials.  This constitutes a good investment operation.  During market advances bargain issues are difficult to find.    
Secondary issues, those that are not the largest firms in the most important industries, but that otherwise possess large market positions, may be purchased profitably under the conditions that follow. 
Secondary issues should have a high dividend yield, their reinvested earnings should be substantial compared to their price, and the issues should purchased well below their market highs. 
Regardless of the circumstance, purchasing a firm’s issue prior to its acquisition usually results in a realized gain for the investor.
General Rules for Investment  
The aggressive investor must have a considerable knowledge of security values and must devote enough time to the pursuit as to consider it a business enterprise.  
Those who place themselves in an intermediate category between defensive and aggressive are likely to produce only disappointment.  There is no middle ground. 
Thus, a majority of security owners should position themselves as defensive investors who seek safety, simplicity, and satisfactory results.         
General Rules for Investment
As stated earlier, all investors should avoid purchase at full price of all foreign bonds, ordinary preferred stocks, and secondary issues. 
Full price” is defined to be the fair value of a common stock or the par value of a bond.         
General Rules for Investment
Most secondary issues fluctuate below fair value and only surpass their value in the upper reaches of a bull market. 
Thus, the only logic for owning common secondary issues is that they are purchased far below their worth to a private owner, that is, on a bargain basis. 
In secondary companies, the average common share is worth much less to an outside investor than the share is worth to a controlling owner. 
In any case, the distinction between a primary and secondary issue often is difficult to determine.

Thursday 2 July 2009

The Intelligent Investor: The Positive Side to Portfolio Policy for the Enterprising Investor

Chapter 7 - Portfolio Policy for the Enterprising Investor: The Positive Side
Graham says that there are four clear areas of activity that an enterprising investor (read: not an ultra-conservative investor) should focus on:

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

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

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

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

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


Commentary on Chapter 7
Zweig provides a ton of supporting evidence that market timing doesn’t really work, and that “examples” of market timing that are often used to show how good it can be are cherry picked using the amazing power of hindsight.

He makes a similar argument about growth stocks, saying that there are often periods where growth stocks appear to be taking off like a rocket, but that it’s impossible to know where the top of that rocket ride is. He provides several examples of this and largely seems to agree with Graham that the only growth stocks a person should invest in are ones that are truly sound as a business and not merely the beneficiaries of a lot of hype. How can you do this? Keep a very close eye on the real business numbers of any growth stock you own.

In the end, Zweig argues that the best solution for most investors is pretty simple: diversify, diversify, diversify. Don’t put all your eggs in one basket, ever. Instead, buy lots of different stocks from lots of different industries and from lots of different markets (foreign and domestic).


Ref: The Intelligent Investor: The Positive Side to Portfolio Policy for the Enterprising Investor