Tuesday, November 11, 2008

The Intelligent Investor: Chapter 15

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

Graham begins with a caveat: It is easy to achieve average returns (just invest in an index fund), and extremely difficult to beat the average with any consistency. Just look at the history of different funds and you will see that most funds, even those with the best security analysts and research departments, failed to beat the market as a whole with any consistency.

“random portfolios of NYSE stocks with equal investment in each stock performed on average better than mutual funds in the same risk class”

So, you’ve been warned.

Graham’s starts by making a list of stocks that, on their face, appear to be cheap based on their P/E (remember to use average historical earnings) and Price to Net (Tangible) Asset Value. This list is easily generated today using a stock screener, like the Google Finance Stock Screener.

Then, apply additional criteria from the list in previous chapters:

  • Financial Condition (Current ratio of at least 1.5 and debt not more than 110% of net current assets),
  • Earnings Stability (No deficit in past 10 years),
  • Dividend Record,
  • Earnings Growth,
  • Price <>

Once you apply these additional criteria, your list of potential candidates will be severely reduced. At this point, you should research the remaining candidates further by reviewing their annual statements and proxy disclosures.

Graham warns against secondary issues - that is, smaller companies in any given industry. Without significant size, these companies lack momentum when the market turns sour and are the first to suffer large price declines. Graham suggests you avoid these in making up your portfolio unless they are bargains sufficient to create wide margins of safety.

Remember: being a bargain issue that satisfies all of the tests is not sufficient to make a good investment. You NEED a portfolio that diversifies away most of your risk.

Zweig suggests enterprising investors start by practicing with hypothetical portfolios of all of their trades, for one year, before investing money. This has clear advantages over jumping in (head-first?) without proving yourself to be a competent stock picker. If, after one year, you enjoyed yourself and earned good returns, then gradually add a small portion of your total portfolio comprised solely of individual stocks you have picked. Over time, increase this portion according to your own success.

Two things successful investing professionals share in common: They are disciplined and consistent, even when their approach falls out of favour with Wall Street; and they focus on what they do, rather than what the market is doing.

Good luck!

1 comment:

passive_indexer said...

One year is an absurdly short time to judge the ability of a value oriented investor and using a time span so short just encourages the worst sort of short-termism. You really need at least 40 years to judge whether above-market returns are due to dumb luck or skill. And therein is the problem. No one has the time to experiment 40 years using a play portfolio to know whether they are able to beat the market or not. So what to do? You have to think carefully about yourself and whether investing is really how you want to spend your life. If so, and if you are intelligent, you'll probably get above average returns. But if not, then you probably won't. Judging intelligence is easy. Judging whether you really like investing enough to stick at it for the next 40 years--that is not so easy.

Follow by Email