Margin of Safety concept as applied to common stocks, when market is pricy.

1. Under 1972 conditions, the market is overpriced for common-stock. “In a typical case”, the earning power (earning yield) is now much less than 9% on the price paid.
2. Let us assume that by concentrating somewhat on the low-multiplier issues among the large companies a defensive investor may now acquire equities at 12 times recent earnings – i.e., with an earnings return of 8.33% on cost.
3. He may obtain a dividend yield of about 4%, and he will have 4.33% of his cost reinvested in the business for his account.
4. On this basis, the excess of stock earning power over bond interest over a ten-year basis would still be too small to constitute an adequate margin of safety.
5. For that reason, we feel that there are real risks now even in a diversified list of sound common stocks.
6. The risks may be fully offset by the profit possibilities of the list; and indeed the investor may have no choice but to incur them – for otherwise he may run an even greater risk of holding only fixed claims payable in steadily depreciating dollars.
7. Nonetheless, the investor would do well to recognize, and to accept as philosophically as he can, that the old package of good profit possibilities combined with small ultimate risk is no longer available to him.


Ref: Intelligent Investor by Benjamin Graham

Margin of Safety concept as applied to common stocks, under normal market conditions.

1. In common stock bought for investment under normal conditions, the margin of safety lies in an expected earning power considerably above the going rate for bonds.
2. Assume, earning power (earning yield) is 9% on the price, and that the bond rate is 4%; then the stock buyer will have an average annual margin of 5% accruing in his favour. Over a ten-year period the typical excess of stock earning power over bond interest may aggregate 50% of the price paid. This figure is sufficient to provide a very real margin of safety – which, under favourable conditions, will prevent or minimize a loss.
3. In many cases, such reinvested earnings fail to add commensurately to the earning power and value of his stock.
4. If such a margin is present in each of a diversified list of 20 or more stocks, the probability of a favourable result under “fairly normal conditions” becomes very large. That is why the policy of investing in representative common stocks does not require high qualities of insight and foresight to work out successfully.
5. If the purchases are made at the average level of the market over a span of years, the prices paid should carry with them assurance of an adequate margin of safety.
6. The danger to investors lies in concentrating their purchases in the upper levels of the market, or in buying nonrepresentative common stocks that carry more than average risk of diminished earning power.

Ref: Intelligent Investor by Benjamin Graham

Margin of Safety concept as applied to common stocks, under depression conditions

There are instances where a common stock may be considered sound because it enjoys a margin of safety as large as that of a good bond.

1. This will occur, for example, when a company has outstanding only common stock that under depression conditions is selling for less than the amount of bonds that could safely be issued against its property and earning power.
2. That was the position of a host of strongly financed industrial companies at the low price levels of 1932-33.
3. In such instances the investor can obtain the margin of safety associated with a bond, plus all the chances of larger income and principal appreciation inherent in a common stock. (The only thing he lacks is the legal power to insist on dividend payments “or else” – but this is a small drawback as compared with his advantages.)
4. Common stocks bought under such circumstances will supply an ideal, though infrequent, combination of safety and profit opportunity.
5. As a quite recent example of this condition, let us mention once more National Presto Industries stock, which sold for a total enterprise value of $43 million in 1972. With its $16 millions of recent earnings before taxes the company could easily have supported this amount of bonds.

Ref: Intelligent Investor by Benjamin Graham

Margin of Safety concept as applied to “fixed-value investment.”

1. This is essential to the choice of sound bonds and preferred stocks.
2. A railroad should have earned its total fixed charges better than 5 times (before income tax), taking a period of years, for its bonds to qualify as investment-grade issues.
3. This past ability to earn in excess of interest requirements constitutes the margin of safety that is counted on to protect the investor against loss or discomfiture in the event of some future decline in net income.
4. (The margin above charges may be stated in other ways – for example, in the percentage by which revenues or profits may decline before the balance after interest disappears – but the underlying idea remains the same.)
5. The bond investor does not expect future average earnings to work out the same as in the past; if he were sure of that, the margin demanded might be small.
6. Nor does he rely to any controlling extent on his judgment as to whether future earnings will be materially better or poorer than in the past, if he did that, he would have to measure his margin in terms of a carefully projected income account, instead of emphasizing the margin shown in the past record.
7. Here the function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future.
8. If the margin is a large one, then it is enough to assume that future earnings will not fall far below those of the past in order for an investor to feel sufficiently protected against the vicissitudes of time.
9. The margin of safety for bonds may be calculated, alternatively, by comparing the total value of the enterprise with the amount of debt. (A similar calculation may be made for a preferred-stock issue.)
10. If the business owes $10 million and is fairly worth $30 million, there is room for a shrinkage of two-thirds in value – at least theoretically – before the bondholders will suffer loss. The amount of this extra value, or “cushion,” above the debt may be approximated by using the average market price of the junior stock issues over a period of years.
11. Since average stock prices are generally related to average earning powers, the margin of “enterprise value” over debt and the margin of earnings over charges will in most cases yield similar results.


Ref: Intelligent Investor by Benjamin Graham

Performance of iCap Closed Ended Fund (23.7.09)

http://spreadsheets.google.com/pub?key=tLGli-bysuYRLMUAtpdhnGg&output=html

Investing in Investment Funds

Chapter 9 - Investing in Investment Funds
Graham basically says that there are three questions you need to answer before investing in any fund.

1. Is there any way by which the investor can assure himself better than average results by choosing the right funds? [...]

2. If not, how can he avoid choosing funds that will give him worse than average results?

3. Can he make intelligent choices between different types of funds - e.g., balanced versus all-stock, open-end versus closed-end, load versus no-load?

Graham states that in general, individuals who invest in balanced funds tend to do better than individuals who invest in individual common stocks. The reason is simple: a person who is not an expert at picking individual stocks and balancing a portfolio is usually better off in the hands of a professional money manager even after the costs.

However (and this is big), Graham largely seems to suggest that the fees in a typical mutual fund are far too high and the time invested in finding a bargain fund (one with good results with limited costs) is well worth the time. He also believes that you should not expect to ever radically beat the market with a fund, and that funds who have astounding short term gains are usually not playing a healthy long-term gain - something that’s been shown over and over again over the history of investing.

Unsurprisingly, Graham isn’t particularly a big cheerleader of traditional mutual funds. One of Graham’s big requirements for investing is that you know exactly what you’re invested in, and by buying into a fund, you cede that control to someone else.

Of course, even if you’re using an index fund strategy, you still need to pay attention to diversification and should not have all of your eggs in one basket. Just because you’re invested with index funds doesn’t mean you shouldn’t balance your portfolio between stocks, bonds, and cash.

Price volatility is usually a bad sign.

Price volatility is usually a bad sign. If a company is experiencing far greater price fluctuations than the market as a whole is seeing, particularly when it alternates between going up rapidly and going down rapidly, avoid the stock. Such events happen only in companies that are either unstable or are involved in something else going on in the market, both of which are good to avoid.

Everything Buffett Needs to Know, He Learned Right Here

Everything Buffett Needs to Know, He Learned Right Here
By Morgan Housel
July 17, 2009


Millions of investors chase Warren Buffett. Tens of thousands attend Berkshire Hathaway's (NYSE: BRK-A) (NYSE: BRK-B) annual shareholder meetings. Wealthy fans bid millions of dollars to have lunch with him. His appearances on CNBC bring trading floors to a halt. People want to know what he's thinking. Why he's different. What secret has made him so much more successful than anyone else.

What's interesting -- and a little ironic -- is that Buffett has never held back what his secret is. As he recently told PBS:

I read a book, what is it, almost 60 years ago roughly, called The Intelligent Investor and I really learned all I needed to know about investing from that book, and particular chapters 8 and 20 … I haven't changed anything since.

One book. Two chapters. Legendary success.
You'd think such precisely guided advice would draw more attention. Not only has Buffett filtered his success down to one book, he's even listed the two specific chapters on which he built his wisdom. He's making this almost embarrassingly easy for us.

What bits of sage advice do these two chapters -- published in 1949 by Buffett's early mentor Ben Graham -- hold? Here are key points from each one.

Chapter 8: The Investor and Market Fluctuations
Markets go up. Markets go down. Most of us accept this fact until we experience the latter, at which time we throw up our hands and consider the whole thing a sham.

That kind of behavior is what Chapter 8 is all about: dealing with market movements, and how fundamental they are to investing success.

We have a tendency to become confident and invest the most money after stocks have logged big gains, and vice versa -- selling in panic after big drops. Two seconds of logical thought will tell you this isn't rational. Yet we do it over and over again.

Buffett built his success on exploiting the market's movements, rather than following them with lemming-like obedience. He bought companies like Coca-Cola (NYSE: KO) and Wells Fargo (NYSE: WFC) when the market wanted nothing to do with them. He then sat on his hands and laughed when companies like Microsoft (Nasdaq: MSFT) and Amazon.com (Nasdaq: AMZN) soared during the dot-com boom, ignoring heckles about his technophobic incompetence. It's truly as simple as "being greedy when others are fearful, and fearful when others are greedy."

Here's how Graham puts it in Chapter 8:

The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgment.

Chapter 20: Margin of Safety as the Central Concept of Investment
Graham opens Chapter 20 with a potent message:

In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase, 'This too will pass.' Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.

We have an overwhelming urge to expect certainty, but live in a world that is anything but. Forward-looking projections of a stock's value are based on assumptions, prone to wild miscalculations and unforeseen events. And by prone, I mean 100% assured.

There's only one surefire solution to this: Pay far less for stocks than your estimate of value, leaving room for error. That's a margin of safety. It's giving yourself room to be wrong, knowing that you probably will be. Think a company is worth $50 a share? Great. Don't pay more than $25 for it. Think a company could earn $2 per share next year? Great. Set yourself up so you'll profit if it only makes a buck. There has to be a wide range of acceptance between the projected and the potential.

One stock that might epitomize the opposite of a margin of safety is Visa (NYSE: V). Visa is a great company, to be sure, exploiting a global consumer shifting from paper to plastic transactions. But it currently trades at more than 22 times 2009 earnings. My calculations of growth show this is probably what the company is worth if everything goes according to plan.

But what if everything doesn't? What if growth hits a speed bump? What if management drops the ball? What if consumer spending takes a sustained nosedive? What if, what if, what if -- that's the basis of a margin of safety. There has to be sizable room for error.

Moving on
These lessons might seem basic and dull. They are. Yet too many investors fail to implement them. Buffett obviously isn't the only one who's read The Intelligent Investor -- he's simply put its lessons and theories to work in a habitual manner.

Our Motley Fool Inside Value team strives to put these basic values to work with all of its recommendations, which are currently outperforming the market by an average of four percentage points each. To see what we're recommending right now, you can try the service free for 30 days. Click here to get started. There's no obligation to subscribe.

Fool contributor Morgan Housel owns shares of Berkshire Hathaway. Amazon.com and Berkshire Hathaway are Motley Fool Stock Advisor picks. Berkshire Hathaway, Coca-Cola, and Microsoft are Motley Fool Inside Value selections. Coca-Cola is a Motley Fool Income Investor recommendation. The Fool owns shares of Berkshire Hathaway, and has a disclosure policy.

http://www.fool.com/investing/value/2009/07/17/everything-buffett-needs-to-know-he-learned-right-.aspx

Companies with different EPS GR bought at different prices

Conclusion:

1. Best buy:
High EPS GR companies
Bought at a discount
Held for long haul

2. Good buy:
High EPS GR companies
Bought at a fair price
Held for long haul

3. Good buy:
Low EPS GR companies
Bought at a discount
Held for short haul

5. Do not buy
High EPS GR companies
Bought at high price
Avoid meantime
Be patient

6. Do not buy
Low EPS GR companies
Bought at high price
Avoid



The high CAGR in the early years of the investing period, due to buying at a discount, tended to decline and approach that of the intrinsic EPS GR of the companies over a longer investment time-frame.


http://spreadsheets.google.com/pub?key=thtZJOZYT-iKNP3VPKg9jig&output=html


Chapter 20 - “Margin of Safety” as the Central Concept of Investment
A single quote by Graham on page 516 struck me:

Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.

Basically, Graham is saying that most stock investors lose money because they invest in companies that seem good at a particular point in time, but are lacking the fundamentals of a long-lasting stable company.

This seems obvious on the surface, but it’s actually a great argument for thinking more carefully about your individual stock investments. If most of your losses come from buying companies that seem healthy but really aren’t, isn’t that a profound argument for carefully studying any company you might invest in?

To map out a course of action and follow it to an end requires courage.

Whatever strategy or strategies you use, the most critical thing in investing is to take a good map with you on your journey and stick to it no matter what. There will be all sorts of distractions along the road to your investment goals. You'll come upon supposed shortcuts that promise to get you where you're going twice as fast. You'll see and hear from all sorts of people who are telling you that they've found a better way to go than the road you're on. Sometimes, you'll even think that your map must be wrong, and that it has you headed in the opposite direction of where you want to go.



But remember, the people who gave you directions - the gurus upon whom some of the strategies are based - are expert mapmakers. They know how to get where you want to go because they've been there before - unlike most of the people who will be telling you to take those shortcuts or alternate routes.



With the map, you have what you need to avoid the obstacles and bad advice along the way, and to do what it takes to beat the market. Remember, while being a good investor is hard, it doesn't have to be complicated. The greatest difficult isn't in the details of stock-picking or portfolio management; you don't have to be a rocket scientist to produce nice returns. No, the hard part will be clearing those psychological and emotional barriers we reviewed, so that you stick to your road map no matter what happens.

If you stick to your roadmap, you should be quite happy with where you end up.

Investing Principle 6: Stick to the Strategy - Not the Stocks

If a stock no longer meets the fundamental criteria that led you to buy it, don't feel obligated to hold on to it.

You're a long-term investor if you stick to a strategy for the long haul - not because you blindly hold on to individual stocks for long periods.

Investing Principle 5: Don't Limit Yourself

Studies show that "style-box" investing can limit your gains by about 300 basis points per year.

Using "strategy-based investing" allows you to pick the best values in the market at any given time, regardless of market cap or growth-value designations.

Investing Principle 4: Diversify, but Don't Own the Market

Diversification is good - to a point. Maintain a focussed portfolio that includes enough stocks to limit stock-specific risk, but don't hold so many that you end up simply mirroring the market's returns.

In a rigid fundamental-based investing system, portfolios as small as 10 stocks can significantly beat the market over the long haul.

While you don't need to hold stocks in every sector or industry, set guidelines to make sure you maintain at least some diversification across those areas within your portfolio.

Investing Principle 3: Stay Disciplined Over the Long Haul

It is essential to stick to your strategy for the long term. Even the best strategies have down periods, and it can sometimes take over a year to reap the benefits of a good method. If you try to time your use of a strategy, you'll likely miss out on some big gains.

Expectations shape reactions: be prepared for short-term 10 to 20% downturns that are inevitable in the stock market - and the less frequent but also inevitable 35 to 50% downturns you'll occasionally experience. You can't predict when they will happen, so you just have to roll with them if you want to reap the market's long-term benefits.

Give the Internet a rest. Checking your portfolio every day, let alone every 10 minutes, can make you want to jump in and out of the market, which hurts your long-term performance.

Investing Principle 2: Stick to the Numbers

Human emotions cloud decision-making, hampering human beings' forecasting abilities.

Using proven, quantitative strategies allows you to make buy and sell decisions solely on the numbers - a stock's fundamentals - helping to remove emotion from the process.

It is best to stick firmly to strategies that are backed up by long, proven track records.

Investing Principle 1: Combining Strategies

Because of compounding, downside volatility costs you money.

If you are looking to smooth out returns, pick stocks with lower degrees of correlation (those that perform differently in the same type of market conditions).

Learn how to combine strategies to limit risk or enhance returns.

To maximise returns, give more weight to those strategies with the best historical track records.

How can investment returns be improved?

How to improve on my returns on my investing?

Always keep cash for emergency use. Also, always have cash for opportunistic investing. This is not a problem for those who have constant stream of cash incomes. For others, keeping cash:stock in the ratio of 25:75, gives a return quite close to those who are 100% invested into stocks.

Next, would be selecting the right stocks. Using my QVM method, we aim to select stocks that will give us good sustainable returns for a long time. We should aim for a return of 15% per year, if possible, and always going for high probability events that give high returns at low risks. Returns can also be sought from badly beaten down stocks (undervalued stocks) that will give great returns when they are repriced at fair values.

Maintain a concentrated portfolio. Bet big on those stocks you have conviction in. Do not over-diversify. The company specific risks are fully diversified when you have 6 stocks in your portfolio. An additional stock added to the portfolio after the sixth may lead to lower returns without the benefit of reducing further the risks. The market risks cannot be diversified, but can be partially managed through asset allocation.

It is important to manage the portfolio actively. This also incorporates asset allocation. There will be time when the market is bubbly, when one may need to pare down exposure to stocks, though, never completely. There will be times, when one's exposure to stock will be relatively high, especially at the end of a severe and prolonged bear market.

Always monitor the business of the stocks in the portfolio in your readings of the papers, business magazines, etc. Track their business performance every quarter through their regular financial releases.

Two active strategies are employed to improve on the returns of our portfolio. Firstly, the defensive strategy. This is to prevent harm to our portfolio. This occurs when the fundamentals of the business of the stock have deteriorated, sometimes suddenly, for various reasons. Another reason maybe "creative" accounting. In these situations, sell the related stocks quickly. Do not hesistate. Speed in selling is important in reducing severe damage to your portfolio, by limiting the losses.

The next is termed offensive strategy. Of 5 stocks one invest into, expect 1 to perform exceptionally well, 3 to be fairly well and 1 to do "not so well or badly". You have time to apply this strategy leisurely. There is no urgency as like the situation previously described.

Review and rebalance your portfolio at regular intervals. Perhaps, once per month or even less frequent than this. You may wish to sell or trim the stocks where the prices are too high, reducing the upside potential and increasing the downside risk. You may also wish to sell or trim those stocks where the potential for upside gain is assessed to be low. (Remember you aim for 15% return on an annual basis.) The cash derived from their disposals should be re-deployed into those stocks which have a higher potential for gain.

Sounds simple, but trust me, active investing and active management of portfolio are both challenging and take effort. However, the returns can be good for those employing a disciplined investing philosophy and strategy.

Risk comes from misjudgement of a company's prospects, not price volatility

Academics define risk as price volatility, and to counter that risk, they recommend holding a diversified portfolio.

But to value investors, like Warren Buffett, risk is the intrinsic value risk of a business, not the price behaviour of its stock. And intrinsic value risk, he says, comes from misjudgement of a company's prospects. He has extreme confidence in his ability to pick fundamentally strong companies which are trading at prices below their intrinsic value, and thus favours placing big bets on these companies.

You should have the courage and conviction to put at least 10 percent of your net worth into each investment you make, he says. "We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort level he must feel with its economic characteristics before buying into it," he explains.

Ptui

MCA: Dr M’s remarks not helping racial unity
PETALING JAYA: Tun Dr Mahathir Moha-mad’s claim that the Chinese are the masters in the country will not help foster racial harmony, said the MCA.

Thursday July 23, 2009

http://thestar.com.my/news/story.asp?file=/2009/7/23/nation/4375350&sec=nation

iCap Portfolios of 2008 and 2009

http://spreadsheets.google.com/pub?key=tC9bD59Bg2AKPA3Bgfyo8qA&output=html


There are 17 stocks in iCap Portfolio for the financial year ended 31 May 2009. This is the same number of stocks as for the previous financial year ended 31 May 2008.

iCap sold:

• AirAsia,
• Axiata and
• VADS.

2 new stocks were included in the present portfolio at the cost of $ 42.95 million, namely,

• Astro (31% gain), and,
  
• KLKepong (30.16% gain).
  

During the last financial year, iCap added more shares at the cost of $ 6.1 million, in 4 pre-existing stocks:

• Boustead (average cost of newly bought shares 3.64, giving 8.17% gain)
  
• Parkson (average cost of newly bought shares 4.84, giving 13.62% gain)
  
• PohKong (average cost of newly bought shares 0.36, giving 6.73% gain)
  
• HaiO (HaiO shares are probably from share dividends).

iCap NAV fell from $1.95 per share on 31 May 2008 to RM 1.77 per share by 31 May 2009 or a loss of 9%. The KLCI declined 18% in the same period.