The enterprising investor, by definition, will devote a fair amount of his attention and efforts toward obtaining a better than run-of-the-mill investment result.
Below are some suggestion regarding bond investments and common stock investments to the enterprising investor.
Buying in low markets and selling in high markets
In an ideal world, the intelligent investor would hold stocks only when they are cheap and sell them when they become overpriced, then duck into the bunker of bonds and cash untill stocks again become cheap enough to buy.
TIMING IS NOTHING
As the Danish philosopher Soren Kierkegaard noted, life can only be understood backwards-but it must be lived forwards.
Looking back, you can always see exactly when you should have bought and sold your stocks. But don't let that fool you into thinking you can see, in real time, just when to get in and out.
In financial markets, hindsight is forever 20/20, but foresight is legally blind. And thus, for most investor, market timing is a practical and emotional impossibility.
Buying carefully chosen “growth stocks”
Let's look at the trajectories of three of the hottest growth stocks of the 1990s: General Electric, Home Depot, and Sun Microsystems.
In every year from 1995 through 1999, each grew bigger and more profitable. Revenues doubled at Sun and more than doubled at Home Depot. According to Value Line, GE's revenues grew 29%; its earnings rose 65%. At Home Depot and Sun, earning per share roughly tripled.
But something else was happening-and it wouldn't have surprised Graham one bit. The faster these companies grew, the more expensive their stocks became. And when stocks grow faster than companies, investor always end up sorry.
A great company is not a great investment if you pay too much for the stock.
The more a stock has gone up, the more it seems likely to keep going up. But that instinctive belief is flatly contradicted by a fundamental low of financial physics: The bigger they get, the slower they grow.
Growth stocks are worth buying when their prices are reasonable, but when their price/earnings ratios go much above 25 or 30 the odds get ugly.
The intelligent investor, however, gets interested in big growth stocks not when they are at their most popular-but when something goes wrong.
In July 2002, Johnson & Johnson annouched that Federal regulators were investigating accusations of false record keeping at one of its drug factories, and the stock lost 16% in a single day. That took J&J's share price down from 24 times the previous 12 months' earnings to just 20 times. At that lower level, Johnson & Johnson might once again have become a growth stock with room to grow-making it an example of what Graham calls "the relatively unpopular large company."
This kind of temporary unpopularity can create lasting wealth by enabling you to buy a great company at a good price.
Buying bargain issues of various types
The type of bargain issue that can be most readily identified is a common stock that sells for less that the company's net working capital alone, after deducting all prior obligations.
By "net working capital," Graham means a company's current assets (such as cash, marketable securities, and inventories) minus its total liabilities (including preferred stock and long-term debt).
This would mean that the buyer would pay nothing at all for the fixed assets-buildings, machinery, etc., or any good-will items that might exist.
As of October 31, 2002, for instance, Comverse Technology had $2.4 billion in current assets and $1.0 billion in total liabilities, giving it $1.4 billion in net working capital.
With fewer than 190 million shares of stock, and a stock price under $8 per share, Comverse had a total market capitalization of just under $1.4 billion. With the stock priced at no more than the value of Converse's cash and inventories, the company's ongoing business was essentially selling for nothing.
As Graham knew, you can still lose money on a stock like Comverse-which is why you should buy them if you can find a couple dozen at a time and hold them patiently. but on the very rare occasions when Mr. Market generates that many true bargains, you're all but certain to make money.
Buying into “special situations”
The exploitation of special situations is a technical branch of investment which requires a somewhat unusual mentality and equipment. Probably only a samll percentage of our enterprising investors are likely to engage in it, and here is not the appropriate medium for expounding its complications.
- The Intelligent Investor, Benjamin Graham
