Harimau Capital

TO Warren Buffett, the world’s most successful stock investor, investing is about foregoing consumption now in order to have the ability to consume more at a later date. So it follows that when we invest, our aim is to buy an asset whose price will grow faster than inflation over time.

What makes the price of an asset grow? Well, when you buy it cheap, and it continues to be able to generate profits over time.

The one asset class which has demonstrated its ability to do that over the long term is equities.

Here are the numbers.

It was end-March 1990. Brothers Ah Long and Ah Su had just inherited about RM175,000 each from their father. Since both brothers already owned the roofs over their heads, the father’s instruction was that the money should be invested in things other than real estate.

Chart 2: The disappearing cash


Ah Long, the elder son, understands how the economy works. He knew that he needed to grow the purchasing power of his inheritance if he were to be able to send his daughter to Harvard University 20 years later. He also understood that the best way to grow his money was to invest in businesses that can generate profits over the long term. But he had no time to do research on the stocks listed on the stock market at that time. So he decided to take a diversified approach, and spread his RM175,000 equally into 33 stocks listed on the Bursa then. The stocks in his portfolio included Malaysia Airlines, British-American Tobacco, DRB-Hicom, IJM Plantations and Public Bank.

Meanwhile, the younger son Ah Su is very “risk averse”. Rather than exposing his RM175,000 to the vagaries of the markets, he decided that he’d sleep better if he just kept the money in the bank and earned the yearly interests. And that’s what he did. He kept rolling his money in the bank in one-year fixed deposits, earning the prevailing interest rates each time.

Fast forward to today. How have Ah Long and Ah Su done since then?

For a full ten years after they received their inheritance, Ah Su who put his money in fixed deposit was getting more income in interest than Ah Long did from his dividends. Ah Su’s fixed deposit was giving him an average of 7% a year between 1990 and 1999, whereas Ah Long’s portfolio only yielded less than 4% in dividends. But over time, the companies in Ah Long’s portfolio grew and they were able to pay more dividends. By 2001, the dividends from the portfolio of stocks had exceeded the interest received from the fixed deposit. (See Chart 1)

Stock portfolio

Meanwhile, because the companies have grown in size, their market values have also risen. By 2001, Ah Long’s stock portfolio, which consisted of super performers like Dutch Lady, IOI and Public Bank and laggards like Malaysia Airlines, DRB-Hicom and IGB was worth RM267,000. The portfolio was worth RM407,000 the year before in 2000. But because of the dot.com crash, the portfolio value was reduced by about 34%. Some of the individual stocks in Ah Long’s portfolio have not performed. But since he has a fairly diversified basket of stocks, on a portfolio basis, he has done well.

As for Ah Su, the amount of cash he had in the bank remained at RM175,000.

By end-March 2014, Ah Long’s portfolio had a market value of RM1.38mil. The dividends he received for the preceding 12 months amounted to RM37,500. As for Ah Su, his RM175,000 fixed deposit is still in the bank. One year fixed deposits paid about 3.15% in interest in 2013. So he received about RM5,500 in interest from the bank.

So after 24 years, Ah Long’s portfolio is close to 8 times that of Ah Su’s cash. And Ah Long is receiving about 20% of Ah Su’s cash in dividends in a year! In the last 24 years, Ah Long has received dividends amounting to some RM388,000, while Ah Su’s bank interests totalled RM208,000.

So Ah Su had kept his money safe. But has he? The fact is, he has been losing purchasing power – to the tune of 50% in the past 24 years! (See Chart 2)

Because of inflation, which according to World Bank averaged about 2.8% a year in Malaysia in the past 24 years, his RM175,000 today has a purchasing power equivalent to only RM90,000 back in 1980. His RM5,500 interest today is equivalent to RM2,800 of the money back in 1980.

Here’s one clear example of how severe the loss of purchasing power can be. Not too long ago, you can get a three-room terrace house in Penang for slightly over RM200,000. Today, without some RM1mil, no seller would even talk to you.

Ah Long, after 24 years of being invested in equities, is in a better financial state. After adjusting for inflation, his portfolio is worth 4 times in terms of purchasing power relative to the RM175,000 he was given back in 1990. Had he reinvested all the dividends he received throughout the years back into the market, his portfolio would have been worth even more today. But of course, we all need to strike a balance between living today and in saving for the future.

So if we agree that investing is about delaying consumption today so that we can have the capacity to consume more at a later date, then the risk of investment is the probability of the loss of our purchasing power over the investment period. Given the data presented above, holding cash is indisputably more risky than holding equities!

Since we started with Buffett, let’s end with him as well. In October 2008, when the world was reeling from the global financial crisis, the Sage of Omaha told The New York Times: “Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”

Today, just five years on, the Dow is above 16,000 points. Shun equities at your own peril!

- The Star Business

Teh Hooi Ling was a multi-award winning investment columnist in Singapore who is now a partner in Aggregate Asset Management, manager of a no-management fee Asia value fund.

In this chapter we'll look at several techniques that some of today's leading money manager use for picking stocks. 

First, though, it's worth repeating that for most investor, selecting individual stocks is unnecessary-if not inadvisable. The fact that most professionals do a poor job of stock picking does not mean that most amateurs can do better. 

The vast majority of people who try to pick stocks learn that they are not as good at it as they thought; the luckiest ones discover this early on, while the less fortunate take years to learn it. A small percentage of investors can excel at picking their own stocks. Everyone else would be better off getting help, ideally through an index fund. 

Graham advised investors to practice first, just as even the greatest athletes and musicians practice and rehearse before every actual performance. 

He suggested starting off by spending a year tracking and picking stocks (but not with real money). In Graham's day, you would have practiced using a ledger of hypothetical buys and sells on a legal pad; nowadays, you can use "portfolio trackers" at website like www.morningstar.com, http://finance.yahoo.com etc.

By test-driving your techniques before trying them with real money, you can make mistakes without incurring any actual losses, develop the discipline to avoid frequent trading, compare your approach against those of leading money managers, and learn what work for you. 

Best of all, tracking the outcome of all your stock picks will prevent you from forgetting that some of your hunches turn out to be stinkers. That will force you to learn from your winners and you losers. 

After a year, measure your results against how would have done if you had put all your money in an index fund. If you didn't  enjoy the experiment or your picks were poor, no harm done-selecting individual stocks is not for you. Get yourself an index fund and stop wasting your time on stock picking. 


If you enjoyed the experiment and earned sufficiently good returns, gradually assemble a basket of stocks-but limit it to a maximum of 10% of your overall portfolio (keep the rest in an index fund). And remember, you can always stop if it no longer interests you or your returns turn bad. 





- The Intelligent Investor, Benjamin Graham

Today's defensive investor can do even better-by buying a total stock-market index fund that holds essentially every stock worth having. 

A low-cost index is the best tool ever created for low-maintenance stock investing-and any effort to improve on it takes more work (and incurs more risk and higher costs) that a truly defensive investor can justify. 

Researching and selecting your own stocks is not necessary; for most people, it is not even advisable. However, some defensive investors do enjoy the diversion and intellectual challenge of picking individual stocks-and, if you have survived a bear market and still enjoy stock picking, then nothing that Graham could say will dissuade you. 

In that case, instead of marking a total stock market index fund your complete portfolio, make it the foundation of your portfolio. Once you that foundation in place, you can experiment around the edges with your own stock choices. 

Keep 90% of your stock money in an index fund, leaving 10% with which to try picking your own stocks. Only after you build that solid core should you explore. 

Let's briefly update Graham's criteria for stock selection. 

Adequate size. 

Nowadays, "to exclude small companies," most defensive investors should steer clear of stocks with a total market value of less than $2 billion. 

However, today's defensive investors-unlike those in Graham's day can conveniently own small companies by buying a mutual fund specializing in small stocks. 

Strong financial condition.

Graham's criterion of financial strength still works: If you build a diversified basket of stocks whose current assets are at least double their current liabilities, and whose long-term debt does not exceed working capital, you should end up with a group of conservatively financed companies with plenty of staying power. The best values today are often found in the stocks that were once hot and have since gone cold. Throughout history, have often provided the margin of safety that a defensive investor demands. 

Earning stability.

Graham's insistence on "some earnings for the common stock in each of the past ten years" remains a valid test-tough enough to eliminate chronic losers, but not so restrictive as to limit your choices to an unrealistically small sample. 

Dividend record.

It's a comforting sign if the companies paid a dividend,  have paid a dividend for at least 20 years in a row. 

Earnings growth.

Graham set a very low hurdle; 33% cumulative growth over a decade is less than a 3% average annual increase. 

Cumulative growth in earnings per share of at least 50% or a 4% average annual rise is a bit less conservative.

Moderate P/E ratio.

Graham recommends limiting yourself to stocks whose current price is no more than 15 times average earnings over the past three years. Instead, calculate a stock's price/earnings ratio yourself, using Graham's formula of current price divided by average over the past three years. 

Moderate price-to-book ratio.

Graham recommends a "ratio of price to assets" (or price-to-book-value ratio) of no more than 1.5. 

In recent years, an increasing proportion of the value of companies has come from intangible assets like franchises, brand names, and patents and trademarks. Since these factors(along with goodwill from acquisitions) are excluded from the standard definition of book value, most companies today are priced at higher price-to-book multiples than in Graham's day. 

What about Graham's suggestion that you multiply the P/E ratio by the price-to-book ratio and see whether the resulting number is below 22.5? Graham's "blended multiplier" still works as an initial screen to identify reasonably-priced stocks.

- The Intelligent Investor, Benjamin Graham

This chapter will begin with two pieces of advice to the investor that cannot avoid being contradictory in their implications. 

The first is: Don't take a single year's earning seriously. 

The second is: If you do pay attention to short-term earnings, look out for booby traps in the per-share figures. 

If our first warning were followed strictly the second would be unnecessary. 

But it is too much to expect that most shareholders can relate all their common-stock decisions to the long-term record and the long-term prospects. 

The quarterly figures, and especially the annual figures, receive major attention in financial circles, and this emphasis can hardly fail to have its impact on the investor's thinking.  He may well need some education in this area, for it abounds in misleading possibilities. 

A few pointers will help you avoid buying a stock that turns out to be an accounting time bomb:

Read backwards. 

When you research a company's financial reports, start reading on the last page and slowly work you way toward the front. Anything that the company doesn't want you to find in buried in the back-which is precisely why you should look there first. 

Read the notes.

Never buy a stock without reading the footnotes to the financial statements in the annual report. 

Usually labeled "summary of significant accounting policies," one key note describes how the company recognizes revenue, records inventories, treats installment or contract sales, expenses its marketing costs, and accounts for the other major aspects of its business. 

In the other footnotes, watch for disclosures about debt, stock options, loans to customers, reserves against losses, and other "risk factors" that can take a big chomp out of earnings. 

Among the things that should make your antennae twitch are technical terms like "capitalized", "deferred," and "restructuring"-and plain-English words signaling that the company has altered its accounting practices, like "began", "change," and "however."

None of those words mean you should not buy the stock, but all mean that you need to investigate further. Be sure to compare the footnotes with those in the financial statements of at least one firm that a close competitor, to see how aggressive your company's accountants are. 

Read more.

If you are an enterprising investor willing to put plenty of time and energy into you portfolio, then you owe it to yourself to learn more about financial reporting. That's the only way to minimize your odds of being misled by a shifty earnings statement. 

- The Intelligent Investor, Benjamin Graham

Which factors determine how much you should be willing to pay for a stock?

What makes one company worth 10 times earnings and another worth 20 times?

How can you be reasonably sure that you are not overpaying for an apparently rosy future that turn out to be a murky nightmare?

Graham feels that five elements are decisive. He summarizes them as 

Let's look at these factors in the light of today's market. 

The long-term prospects

Nowadays, the intelligent investor should begin by downloading at least five years worth of annual report from the company's website or from the relevant database. Then comb through the financial statements, gathering evidence to help you answer two overriding questions. 

• * What makes this company grow?
• * Where do (and where will) its profits come from?

• * The burden of proof is on the company to show that you are better off if it does not pay a dividend. 


• * Companies that repeatedly split their shares-and hype those splits in breathless press releases-treat their investors like dolts. 


• * Companies should buy back their shares when they are cheap-not when they are at or near record highs. Unfortunately, it recently has become all too common for companies to repurchase their stock when it is overpriced. There is no more cynical waste of a company's cash-since the real purpose of that maneuver is to enable top executives to reap multimillion-dollar paydays by selling their own stock options in the name of "enhancing shareholder value."

Finally, bear in mind that great financial advisers do not grow on trees. Often, the best already have as many clents as they can handle and may be willing to take you on only if you seem like a good match.

 

So they will ask you some tough questions as well, which might include:

 

 

An adviser who doesn't ask questions like these and who does not show enough interest in you to sense intuitively what other questions you consider to be the right ones-is not a good fit.

 

Above all else, you should trust your adviser enough to permit him or her to protect you from your worst enermy-yourself.

 

"You hire an adviser," explain commentator Nick Murray, "not to manage money but to manage you."

 

"If the adviser is a line of defense between you and your worst impulsive tendencies," says financial-planning analyst Robert Veres, "then he or she should have systems in place that will help the two of you control them."

 

Among those systems:

There are the building blocks on which good financial decisions must be founded, and they should be created mutually-by you and the adviser-rather than imposed unilaterally.

 

You should not invest a dollar or make a decision until you are satistfied that these foundations are in place and in accordance with your wishes.

 

 

- The Intelligent Investor, Benjamin Graham

 

Do you use technical analysis? Do you use market timing? (A "yes" to either of these two questions is a "no" signal to you)

 

What do you do when an investment performs poorly for an entire year? (Any adviser who answers "sell" is not worth hiring?)

 

Can I see a sample account statement? (if you can't understand it, ask the adviser to explain it. If you can't under his explanation, he's not right for you.)

 

How high an average annual return do you think is feasible on my investment? (Anything over 8% to 10% is unrealistic.)

 

Will you provide me your resume, your Form ADV, and at least three references? (if the adviser or his firm is required to file an ADV, and he will not provide you a copy, get up and leave-and keep one hand on your wallet as you go.)

Do you, when recommending investments, accept any form of compensation from any third party? Why or why not? Under which circumstances? How much, in actual dollars, do you estimate i would pay for your services the first year? what would make that number go up or down over time? (If fees will consume more that 1% of your assets annually, you should probably shop for another adviser.)



- The Intelligent Investor, Benjamin Graham

 

As Ronald Reagan used to say "Trust, then verify". Start off by thinking of the handful of people you know best and trust the most. Then ask if they can refer you to an advisor whom they trust and who, they feel, delivers good value for his fees. A vote of confidence from someone you admire a a good start.

 

 

Once you have the name of the advisor and his firm, as well as his specialty, you can begin your due diligence.

 

Is he a stockbroker? financial planner? accountant? insurance agent?

 

Enter the name of the adviser and his or her firm into an internet search engine like Google to see if anything comes up (watch for terms like "fine", "complaint", "lawsuit", "disciplinary action" or "suspension").

 

If the adviser is a stockbroker or insurance agent, contact the office of your state's securities commissioner to ask whether any disciplinary actions or customer complaint have been filed against the adviser.

 

If you're considering an accountant who also functions as financial adviser, your state's accounting regulators will tell you whether his or her record is clean.

 

Financial planners (or their firms) must register with either the U.S. Securities and Exchange Commission or securities regulators in the state where their practice is based. As part of that registration, the adviser must file a two-part document called Form ADV. You should be able to view and download it at www.advisorinfor.sec.gov, www.iard.com or the website of your state securities regulator.

 

Pay special attention to the Disclosure Reporting Pages, where the adviser must disclose any disciplinary action by regulators.

 

It's a good idea to cross-check a financial planner's record at ww.cfp-board.org, since some planner who have been disciplined outside their home state can fall through the regulatory cracks.

 

 

 

 

- The Intelligent Investor, Benjamin Graham



Just as there's no reason you can't manage your own portfolio, so there's no shame in seeking professional help in managing it.

How can you tell if you need a hand? Here are some signals:

Once you own a fund, how can you tell when it's time to sell? The standard advice is to ditch a fund if it underperforms the market (or similar portfolios) for one-or is it two?-or is it three?-years in a row.

 

But this advice makes no sense. From its birth in 1970 through 1999, the Sequoia Fund underperformed the S & P 500 index in 12 out of its 29 years-or more than 41% of the time. Yet Sequoia gained more than 12,500% over that period, versus 4,900 % for the index.

 

The performance of most funds falters simply because the type of stocks they prefer temporarily goes out of favor. If you hired a manager to invest in a particular way, why fire him for doing what he promised?

 

By selling when a style of investing is out of fashion, you not only lock in loss but lock yourself out of the all-but-inevitable recovery.

 

One study showed that mutual-fund investors underperformed their own funds by 4.7 percentage points annually from 1998 through 2001 - simply by buying high and selling low.

 

So when should you sell? Here a few definite red flags:

 

 

As the investment consultant Charles Ellis puts it, "if you're not prepared to stay married, you shouldn't get married." Fund investing is no different. If you're not prepared to stick with a fund through at least three lean years, you shouldn't buy it in the first place. Patience is the fund investor's single most powerful ally.



- The Intelligent Investor, Benjamin Graham

Closed-end stock funds, although popular during the 1980s, have slowly atrophied. Today, there are only 30 diversified domestic equity funds, many of them tiny, trading only a few hundred shares a day, with high expenses and weird strategies.

 

Research by closed-end fund expert Donald Cassidy of Lipper Inc. reinforces Graham's earlier observations: Diversified closed-end stock funds trading at a discount not only tend to outperform those trading at a premium but are likely to have a better return than average open-end mutual fund.

 

Sadly, however, diversified closed-end stock funds are not always available at a discount in what has become a dusty, dwindling market.

 

However, they are generally not suitable for investors who wish to add money regulary, since most brokers will charge a separate commission on every new investment you make.


- The Intelligent Investor, Benjamin Graham
 

Most fund buyer look at past performance first, then at the manager's reputation, then at the riskness of the fund, and finally (if ever) at the fund's expenses.

 

The intelligent investor looks at those same things-but in the opposite order.

 

Since a fund's expenses are far more predictable than its future risk or return, you should make them your first filter. There's no good reason over to pay more than these levels of annual operating expenses, by fund category:

Next, evaluate risk. In its prospectus (or buyer's guide), every fund must show a bar graph displaying its worst loss over a calendar quarter. If you can't stand losing at least that much money in three months, go elsewhere.

 

It's also worth checking a fund's Morningstar rating. A leading investment research firm, Morningstar awards "star ratings" to funds, based on how much risk they took to earn their returns (one star is the worst, five is the best). But, just like past performance itself, these ratings look back in time; they tell you which funds were the best, not which are going to be.

 

Five-star funds, in fact, have a disconcerting habit of going on to underperform one-star funds. So first find a low-cost fund whose managers are major shareholders, dare to be different, don't hype their returns, and have shown a willingness to shut down before they get too big for their britches. Then, and only then, consult their Morningstar rating.

 

Finally, look at past performance, remembering that it is only a pale predictor of future returns. As we've already seen, yesterday's winners often become tomorrow's losers.

 

But researchers have shown that one thing is almost certain: Yesterday's losers almost never become tomorrow's winners. So avoid funds with consistently poor past returns-especially if they have above-average annual expenses.

 

 

 

- The Intelligent Investor, Benjamin Graham 

Why don't more winning funds stay winners?

 

The better a fund performs, the more obstacles its investors face:

 

 

What, then, should the intelligent investor do?

 

First of all, recognize that an index fund-which owns all the stocks in the market, all the time, without any pretense of being able to select the "best" and avoid the "worst"-will beat most funds over the long run.

 

Index funds have only one significant flaw: They are boring. But, as the years pass, the cost advantage of indexing will accruing relentlessly. Hold an index fund for 20 years or more, adding new money every month, and you are all but certain to outperform the vast majority of professional and individual alike.

 

Late in his life, Graham praised index funds as the best choice for individual investor, as does Warren Buffett.

 

 

- The Intelligent Investor, Benjamin Graham 

Mutual funds aren't perfect; they are almost perfect, and that word makes all difference. Because of their imperfections, most funds underperform the market, overcharge their investors, create tax headaches, and suffer erratic swings in performance. The intelligent investor must choose funds with great care in order to avoid ending up owning a big fat mess.

 

Financial scholars have been studying mutual-fund performance for at least a half century, and they are virtually unanimous on several points as below

 

 

Your chances of selecting the top-peforming funds of the future on the basis of thier returns in the past are about as high as the odds that Bigfoot and the Abominable Snowman will both show up in pink ballet slippers at your next cocktail party. In other words, your chances are not zero-but they're pretty close.

 

But there's good news, too. First of all, understanding why it's so hard to find a good fund will help you become a more intelligent investor.

 

Second, while past performance is a poor predictor of future returns, there are other factors that you can use to increase you odds of finding a good fund.

 

Finally, a fund can offer excellent value even if it doesn't beat the market-by providing an economical way to diversify your holdings and by freeing up your time for all the other things you would rather be doing than picking your own stocks.


- The Intelligent Investor, Benjamin Graham

Investing intelligently is about controlling the controllable. You can't control whether the stocks or funds you buy will outperform the market today, next week, this month or this year; in the short run, your returns will always be hostage to Mr. Market and his whims.

 

But you can control:

 

 

The Challenge for the intelligent investor is not to find the stocks that will go up the most and down the least, but rather to prevent yourself from being your own worst enemy-from buying high just because Mr. Market says "Buy!" and from selling low just because Mr. Market says "Sell!"

 

if you investment horizon is long-at least 25 or 30 years-there is only one sensible approach: Buy every month, automatically, and whenever else you can spare some money. The single best choice for the lifelong holding is a total stock-market index fund. Sell only when you need the cash.

 

To be an intelligent investor, you must also refuse to judge your financial success by how a bunch of total stranger are doing.

 

The best way to measure your investing success is not by whether you're beating the market but by whether you've put in place a financial plan and a behavioral discipline that are likely to get you where you want to go. In the end, what matters isn't crossing the finish line before anybody else but just making sure that you do cross it.

 

 

 

- The Intelligent Investor, Benjamin Graham

One of Graham's most powerful insights is this :

 

The typical money manager, however, has no choice but to mimic Mr. Market's every move-buying hight, selling low, marching almost mindlessly in his erratic footsteps. Here are some of the handicaps mutual-fund managers and other professional investors are saddled with:

 

So there's no reason you can't do as well as the pros. What you cannot do (despite all the pundits who say you can) is to "beat the pros at their own game." The pros can't even win their own game!

 

Why should you want to play it at all? If you follow their rules, you will lose-since you will end up as much a slave to Mr. Market as the professionals are.



- The Intelligent Investor, Benjamin Graham

The investor should be aware that even though safety of its principal and interest may be unquestioned, a long-term bond could vary widely in market price in response to changes in interest rates.

 

If it is virtually impossible to make worthwhile predictions about the price movement of stocks, it is completely impossible to do so for bonds.

 

In the old days, at least, one could often find a useful clue to the coming end of a bull or bear market by studying the prior actions of bonds, but no similar clues were given to a coming change in interest rates and bond prices.

 

Hence the investor must choose between long-term and short-term bond investments on the basic chiefly of his personal preferences. If the investor wants the 7.5% now available on good long-term corporate bonds, or the 5.3% on tax-free municipals, he must be prepared to see them fluctuate in price.

 

Banks and insurance companies have the privilege of valuing high-rated bonds of this type on the mathematical basis of "amortized cost", which disregards market prices; it would not be a bad idea for the individual investor to do something similar.

 

A good many of the convertible issues have been sold by companies that have credit ratings well below the best. Some of these were badly affected by the financial squeeze in 1970.

 

As a result, convertible issues as a whole have been subjected to triply unsettling influences in recent years, and price variations have been unusually wide.

 

In the typical case, therefore, the investor would delude himself if he expected to find in convertible issues that ideal combination of the safety of a high-grade bond and price protection plus a chance to benefit from an advance in the price of the common.

 

Over the past decade the bond investor has been confronted by an increasingly serious dilemma: Shall he choose complete stability of principal value, but varying and usually low (short-term) interest rate? Or shall he choose a fixed-interest income, with considerable variations (usually downward, it seems) in his principal value?

 

It would be good for most investors if they could compromise between these extremes, and be assured that neither their interest return nor their principal value will fall below a stated minimum over, say, a 20-year period. This could be arranged, without great difficulty, in an appropriate bond contract of a new form.

 

Important note: In effect the U.S. government has done a similar thing in its combination of the original savings-bonds contracts with their extensions at higher interest rates.

 

It is hardly worthwhile to talk about nonconvertible preferred stocks, since their special tax status makes the safe ones much more desirable holdings by corporations-e.g., insurance companies than by individuals. The poorer-quality ones almost always fluctuate over a wide range, percentagewise, not too differently from common stock. We can offer no other useful remark about them.

 

 

- The Intelligent Investor, Benjamin Graham

 

 

 

 

 

 

 

The investor's longer-term bonds may relatively wide price swings during their lifetimes, and his common-stock portfolio is almost certain to fluctuate in value over any period of several years.

The investor should know about these possibilities and should be prepared for them both financially and psychologically. He will want to benefit from changes in market levels-certainly through an advance in the value of his stock holdings as time goes on, and perhaps also by making purchases and sales at advantageous price.

  

This interest on his part is inevitable, and legitimate enough. But it involves the very real danger that it will lead him into speculative attitudes and activities. It is easy for us to tell you not to speculate; the hard thing will be for you to follow this advice.

 

Let us repeat what we said at the outset: If you want to speculate do so with eyes open, knowing that you will propably lose money in the end; be sure to limit the amount at risk and to separate it completely from you investment program.

 

We shall deal first with the more important subject of price changes in common stocks, and pass later to the area of bonds.

 

There are two possible ways by which you may try to do this:

 

 The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator's primary interest lies in anticipating and profiting from market fluctuations.

The investor's primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell.

 



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.

 

 

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.

For the aggressive as well as the defensive investor, what you don't do is as important to your success as what you do. Here is Graham's "don'ts" list for aggressive investors.

• Buying IPOs. It's a bad idea because it flagrantly violates of of Graham's most fundamental rules: No matter how many other people want to buy a stock, you should buy only if the stock is a cheap way to own a desirable business.
  
  
  The Legend of VA Linux show why it matters. After going up like a bottle rocket on that first day of trading, was at $239.50, VA Linux came down like a buttered brick. By Decemble 9, 2002, three years to the day after the stock was at $239.50, VA Linux closed at $1.19 per share.
  
  Weighing the evidence objectively, the intelligent investor should conclude that IPO does not stand only for "initial public offering." More accurately, it is also shorthand for:
  
  It's Probably Overpriced, Imaginary Profit Only, Insiders' Private Opportunity, or Idioctic, Preposterous and Outrageous.