The prevalent approach to investing is first to choose the best industry, and then to invest in the best company in that industry, regardless of the stock's price.
Graham did not think well of this approach because he believed it was too unreliable. Good business does not always translate into good investment returns, and even the experts have difficulty selecting and concentrating on those issues which will become winners. Finally, the application of this method may place an investor in popular, overvalued stocks.
Showing posts with label popular stocks. Show all posts
Showing posts with label popular stocks. Show all posts
Friday, 6 August 2010
How do you find stocks with a margin of safety?
In part, they are found by avoiding stocks which are unlikely to possess this margin. Popular stocks are avoided since they are likely to be fully priced, and growth stocks are avoided since they tend to be popular and since they tend to perform poorly in bad markets. And you follow rules pertaining to low price/earnings ratios, low price/book value ratios, etc., which are designed to exclude stocks without a margin of safety.
Graham's advice to avoid growth stocks may be surprising. The reason is that great wealth is seldom achieved without growth stock investment, and Graham himself apparently amassed much of his fortune, while considerably enhancing his reputation, from a single growth stock. However, when Graham and his investment partners violated this principle, they controlled the firm and thus possessed inside knowledge of its affairs. Graham and partners held on to this stocks, too, because it had become "family business." In this case, they also violated Graham's often -stated admonition to be well diversified ; 20 percent of their funds initially went into this one stock. Still, Graham's disdain for growth stocks - because they are often popular, tend to become overpriced in good markets, and tend to perform poorly in bad markets - is well founded.
Graham's advice to avoid growth stocks may be surprising. The reason is that great wealth is seldom achieved without growth stock investment, and Graham himself apparently amassed much of his fortune, while considerably enhancing his reputation, from a single growth stock. However, when Graham and his investment partners violated this principle, they controlled the firm and thus possessed inside knowledge of its affairs. Graham and partners held on to this stocks, too, because it had become "family business." In this case, they also violated Graham's often -stated admonition to be well diversified ; 20 percent of their funds initially went into this one stock. Still, Graham's disdain for growth stocks - because they are often popular, tend to become overpriced in good markets, and tend to perform poorly in bad markets - is well founded.
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