GETTING STARTED IN VALUE INVESTING PDF
Library of Congress Cataloging-in-Publication Data: Mizrahi, Charles, – Getting started in value investing / Charles Mizrahi. p. cm. – (The getting started in. Editorial Reviews. From the Back Cover. "Beginning investors will find all the ABCs of success inGetting Started in Value Investing. Seasoned investors will want. An accessible introduction to the proven method of value investing An ardent follower of Warren Buffett-the most high-profile valueinvestor today-author Charles.
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The Popularisation of Value Investing. Why You Should Not Be Trying To Invest Like Warren Buffett . 6 How to get started?. investors into growth and value investors) is that anyone who invests in low .. excess returns since the screens may end up eliminating just those stocks that. Unlike some investment strategies, value investing is pretty simple. fundamental concepts you'll need to understand before getting started.
During the abuses of the s, no fewer than NYSE-listed stocks had prices fixed, and nothing seemed to effectively remedy these problems. At the turn of the twentieth century W. Gann, known to his followers as the founding father of financial astrology, believed that specific geometric patterns and angles had unique characteristics and that these could be used to predict price movements.
In the Dow Theory, which was based on trends in price for the Dow Jones Industrial and Transportation Average, was gaining a wide following. A different way of looking at the market was still some years away. Instead, Graham went to make his fortune on Wall Street starting as an analyst, and then managing an investment partnership. In , Benjamin Graham and coauthor David Dodd wrote the book Security Analysis in which they laid out the intellectual framework for what was later called value investing; this book was geared to the professional investor.
This work was like a ray of sunshine peeking through the clouds of confusion. In Graham followed up with The Intelligent Investor, a version of his earlier book but this time aimed to the individual investor. Think like a business owner. When making an investment in a stock, keep in mind you are downloading a part of a business.
The stock market is there to serve you, not instruct you. Most of the time, the stock market prices businesses correctly. However, there are times when the stock market greatly overvalues or undervalues businesses. Make a download only when there is a gap between the stock price and the underlying value of the business. Each one attributes their success to the philosophy laid out by Graham more than 70 years ago and has the track record and net worth to prove it works.
Old Habits Die Hard Many studies and papers have been written over the past several decades on how value investing works. In later chapters, I summarize a few landmark studies that make the point.
None of this, however, has stopped academics from trying to prove that the market is efficient and there is no way that an investor can beat the market. In a nutshell, EMT says that all market participants receive and act on all information as soon as it sees the light of day. Those who follow this theory believe that there is perfect information in the stock market.
As soon as information becomes available about a stock, everyone has it at the same time, and the price of the stock should reflect the knowledge and expectations of all investors. How do proponents of EMT invest their own money? The main flaw in this theory is that it neglects to take into account the number one reason the stock market becomes inefficient at valuing companies: When it comes to money, most people hate losing. Efficient markets become very inefficient when fear grips Wall Street.
Business schools continue Warren Buffett took a positive view regarding EMT and wrote: From a selfish point of view, Grahamites should probably endow chairs to ensure the perpetual teaching of EMT. Once you have finished this book, you will be among a select group of investors able to view the stock market and all the noise that surrounds it with more clarity and peace of mind. In Chapter 2, I take you through the basics and provide you with the compelling logic of value investing.
Here you will see why this is the only approach that has withstood the test of time. Following these basics, Chapter 3 gives you a framework for investing in stocks, and even shows you why putting all of your eggs in one basket simply makes sense and improves your overall return. Chapter 4 examines another important concept, which is finding businesses that truly are the champs.
In Chapter 5, I explain the importance of picking not only great businesses but great managers as well, which is another way of adding value. Chapter 6 explains the importance of competition and why certain companies invariably have a strong competitive advantage. In Chapter 9, I tie up the whole concept by explaining how price and value differ, and how to determine exactly what you should pay for a stock.
Chapter 10 is devoted to reminding you about some of the mistakes people make in the way they invest, and why, as a value investor, you actually simplify your decision-making process by sticking to a short list of tried-and-true ideas.
I provide you with some final thoughts in Chapter Words to Live By Warren Buffett has often said that intelligence is no guarantee for success when it comes to investing. He has observed that anything above a IQ is wasted. And if you were never good at math or do not have a head for numbers, so what?
You will be better able to focus on what makes your portfolio tick: Instead of spending hours looking at the cash flow statement, you will be asking yourself relevant questions like: What edge does this business have? Is management candid? In other words, the qualitative stuff that is not so readily found in the numbers. Your present occupation should not be a barrier, either. Great value investors come from all walks of life: You can do it. Even now, Charlie and I continue to believe that shortterm market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.
For example, if the media are talking about the DJIA making an all-time high or an unemployment report coming in better than expected, people who know that I manage a limited partnership and write an investment newsletter want to hear my take on current economic events. I usually respond the same way each time I am asked: It is the most widely known index and is used as a measure of the health and direction of the overall stock market.
Top-Down Approach vs. Bottom-Up Approach Because I follow a value investing philosophy, I have the advantage of taking a bottom-up approach, which means identifying investment opportunities one at a time through analysis of financial statements. In contrast, most professional investors take a top-down approach, which carries with it greater risk of being wrong.
This involves three steps: Making a prediction about the future. Discerning its effect on the investment. Making the trade. This approach is a very risky way to go because each step of the way is subject to error. Money managers who take this path are basically making a big picture or macro bet on the future. Once they pass that hurdle, they are faced with interpreting the impact of their decision on the sector, industry, and then company in order to maximize the value of their prediction.
Big-picture prediction A weak U. Conclusion drawn from Value of U. Areas of investment U. Timing Need to download ahead of crowd have to act quickly before the rest of Wall Street makes the same trade, causing prices to rise and minimizing any money profit potential they would have had. Table 1. For example, portfolio of even if the top-down investor is correct on the big-picture securities. Then they have to make the correct specific investment i.
When they are downloading the specific investment, what kind of margin of safety will they have? They are downloading based not on value but on which company, regardless of stock price, will move higher the fastest. And one last hurdle: Topdown investors have to know when the trend has run its course. How much of the recent stock move is already factored into the price? For me, the top down approach is fraught with risks each step of the game and does not offer any margin of safety that would satisfy me.
After evaluating the company and determining an appropriate price to pay which includes a margin of safety , they then check the price the stock is trading.
If the stock is currently trading below the price they used to determine the underlying worth of the business, they will download the stock and wait patiently for annual report it to rise. It could take months or even years for the stock all shareholders market to reward you for your patience. But if you on a yearly basis.
If you act as a bottom-up investor, the unknown factors are mostly within your control. You only have SEC Form K to be right regarding the valuation of the company at audited report the time you bought the stock.
Similar and reward on your investment. When you follow a bottom-up approach, the chance for errors and mistakes along the way will be much lower than the chance of trying to predict the future of the U. Legendary fund manager Peter Lynch offered very sound advice about making predictions: Nobody can predict interest rates, the future direction of the economy, or the stock market.
The biggest problem I see for top-down investors is in determining when the investment no longer makes sense or simply knowing when they are wrong. They also have to speculate on the magnitude of their prediction.
If they predict that the U. If the company undergoes new management, or a supplier or sales channel suddenly closes up, the bottom-up investor would then be able to assess and reevaluate the situation. For top-down investors, there is no clear answer; the best they can do is to make a judgment call.
Judgment calls made in the heat of the moment are usually wrong. In addition to the logic and simple steps used by a bottom-up investor, I promise you will sleep better at night.
And to me, that is worth all the tea in China. Common Misconceptions about Value Investing Before we go on, I want to take a moment and share with you five of the most common misconceptions people have about applying a value approach to stock investing. Value investors do not let others make up their mind for them; they absorb the facts and then come to a decision.
Independent thinking is a trademark of value investors. Benjamin Graham said: Buffett downloads businesses that he can understand, has competent management in place, has an enduring competitive advantage, and will download them only at an attractive price. From to Berkshire Hathaway grew at an average annual return of Securities and Exchange Commission SEC the federal agency responsible for oversight of publicly listed corporations, and for enforcing laws and regulations at the federal level.
You are right because your data and reasoning are right. Much of the information needed to research a stock is too costly, hard to get and difficult to understand. Many of the SEC statutes are designed to promote full public disclosure and protect investors from fraud.
Because of the SEC, there is an enormous amount of information that publicly traded companies need to disclose. The letter is written by the chairman of the board or CEO. Once you get past the charts, graphs, and glossy pictures of smiling employees, you find a wealth of financial information tucked away in the back of the report.
This is where you can find the real meat and potatoes of how the company is doing. You will then be able to see if they kept promises made in previous years, admit to mistakes, and have a consistent message. Most annual reports are written in a very friendly and relaxed manner and are not difficult to understand. The great part about annual reports is that they are free. All you need to do is call the company and request it or go to their web site and download or read it.
A large percentage of your research can be found by just reading the annual reports. You will be amazed at how few investors read them. In addition to calling the company, there are many free sites on the Web that not only have financial data on a company, but with one click you can compare how a company is performing against its competitors.
Thank the SEC and the Internet for helping create a level playing field for investors allowing them to access information for no cost. Like everything else in life, this statement is both a reality and misconception for different types of investors.
After hearing some analyst from Big Brokerage, Inc. If, however, you begin to view stocks as pieces of businesses, download quality companies when they are selling for fair prices, ignore the daily gyrations of the stock market, and hold stocks for the long term, then you have a very good chance of beating the market.
Fortunes have been made by investors with modest means, who bought quality companies and held on to them for years. You picked these three companies because they have been in business for years, are market leaders, and you are very familiar with their products. Right You were amply rewarded for investing in companies that you understood and held for the long term, while ignoring the stock market. You can beat the market if you stick to a few of the principles I share with you in this book.
See Figure 1. Value investing is all about downloading stocks trading at low prices. Trying to determine if a stock is selling at a good value based on a single number is a mistake most investors and professionals have in common.
If I told you that my friend Joe weighs pounds and asked you to tell me if he is over or underweight, you would probably ask me a few questions about him. You might ask his age, height, body frame, occupation, how often he exercises, and so on. If you found out that Joe is six feet tall and plays tight end for the New York Jets, you would say he is underweight average weight for tight ends NFL draft: If you try to download a stock based on the level of the stock price, most likely you will be downloading a lot of terrible companies and you will be missing According to them, the stock price is not properly valuing the earnings of the company and the stock is trading at a discount to its underlying value.
Soft sales, terrible earnings, and immense competition might force this company to close its doors as it recently needed to borrow money to pay bills. A value investor is never concerned with the price level of a stock.
The price of the stock always has to be measured against the worth of the underlying business. That should give you some idea as to the advantage you have if you educate yourself to a few simple accounting concepts.
If you have no idea how to read a financial statement, you are not alone. By not knowing basic accounting you will have a very difficult time valuing a business. Accounting is the music of business and by learning how to hum just a few simple tunes, you will avoid overpaying for quality companies and can achieve a higher return on your investments.
Thanks once again to the SEC, there are four statements that public companies need to file each quarter: Why four and not one statement? Because four statements allow you to come to a conclusion on the health of the company from four different vantage points.
Picture going to a doctor to have your heart checked. The doctor might take your blood pressure, do an EKG. Each test provides the doctor with valuable information so he or she can make a proper diagnosis. A balance sheet shows the financial position assets, liabilities, and net worth of a company as of a specific date in time. The income statement shows how much money came in sales or revenue and how much was paid out expenses for a period of time, usually a full year or quarter.
By subtracting the money that came in from the money paid out, you arrive at the amount the company put into its pocket net profit. The cash flow statement shows where the money came from and where it was spent for that same period of time. You can make more money investing in growth stocks than value stocks.
This argument always strikes me as silly. Should we classify someone who downloads an item at a price that is greatly above its underlying value a growth investor? They take a more conservative and cautious view of the future. On the other hand, growth investors pay up for growth in anticipation that it will continue.
Charlie Munger, vice chairman of Berkshire Hathaway, had this to say about this foolish argument: But to me, all intelligent investing is value investing.
The Art of Value Investing
The goal of investing should be to download businesses that are selling below their underlying value. If there is a wide gap between your valuation of the business and the value the stock market is giving it, you should download.
Warren Buffett said: Forget about trying to predict the future growth of the economy or where interest rates are headed; no one can do that. Today he works with Buffett as vice chairman of Berkshire Hathaway.
Buffett gives him the credit for much of the enormous success of Berkshire Hathaway. Munger is a worthwhile model for how value investing can work. Munger is content to invest a lot of capital in very few holdings and hold those positions for a long time. His extreme patience combined with extreme decisiveness has paid off handsomely. By the time you finish this book, you will have all the tools you need to find them.
Key Points 1. Bottom-up investing makes more sense than top-down investing. It places unknown factors within your control. A Few Things You Must Know here are two questions that I hear every time investors pay silly prices that have no relationship to the underlying value of a company: Does value investing work and will it continue to work regardless of what you might hear in the popular media?
I would like to tell you about a conversation I overheard several years ago. During the height of the stock market bubble in , I attended an investment conference and overheard two money managers discussing how each viewed himself as an investor. How could value investing be out of style?
A research paper titled Searching for Rational Investors in a Perfect Storm by Louis Lowenstein1 should once and for all dispel the nonsense that the stock market is always efficient.
The theory is relatively simple: In order to make money in the stock market, investors have to compete with so-called smart money investors, rational investors who are constantly searching the market for opportunities.
The smart money has already erased any discrepancy between price and value. You could do just as well having monkeys throw darts at the stock tables in the newspaper.
For years the academic world has paid homage to this great theory, and I doubt you can find more than a handful of professors who will tell you otherwise. The theory is based on a belief that markets states all information about are efficient all of the time. Despite market events a company is like the October crash and dot. Luck explains why coming out with a new flavor of chewing gum, exsome investors pected to increase earnings, should you download the stock?
Sorry, pal, not a factor. The answer is easy: You will at least match the market and save the trading costs and hours spent researching. In the late s, stock prices became so detached from value that the market exceeded even the s in its wild excesses. In a very short span of time, the NASDAQ rose from 1, April to 5, March , for a gain of percent, before plummeting back down to 1, October , for a loss of 78 percent.
Where were all the smart money investors during that period? How did they allow the market to spin out of control? Did the smart money investors lose money during this period as well? The Really Smart Money Since no one can really identify the so-called smart money investors to see how they did during the selling frenzy, are there any rational investors who did not suffer the losses that so many other investors suffered? If so, what did they do right?
The answer is, yes, there is a group of investors who did very well during the deflating of the bubble. It so happens that they share a common philosophy called value investing. Their results are amazing: Value investors beat the market averages by huge amounts, hold concentrated portfolios a small number of securities , and hold stocks for years.
The funds he studied were the following: Clipper Fund. FPA Capital. First Eagle Global. Longleaf Partners. Legg Mason Value. Mutual Beacon. Oak Value. Oakmark Select. Source Capital. Tweedy Brown American Value. Did these funds follow the crowd? Did the portfolio managers stick to their principles? Did the funds avoid the meltdown? The findings should have big implications for investors, traders, and academics.
They attribute their strategy to a book published more than 70 years ago by Benjamin Graham and David Dodd called Security Analysis.
Typically, these managers search for companies that are trading at a substantial discount from the value a reasonable downloader would pay for the business as a whole. Warren Buffett explained a margin of safety by saying, If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. His basis for comparison was an article in the August issue of Fortune.
Charles Schwab. Morgan Stanley. Nortel Networks. By the end of , these 10 stocks had declined an average of 80 percent from the July prices quoted in the article. A sample of responses from the fund managers echoed consistent themes: Most of the other managers gave the traditional Graham—Dodd response: In other words, they stuck to their guns. In , with money flowing to technology, telecom, and Internet stocks that were trading at gravity-defying multiples, value managers were scooping up so-called old-economy stocks that were selling at substantial discounts to intrinsic value.
Avoiding the Meltdown The value managers knew that all they had to do was wait it out and prices would once again make sense. The return of the 10 value funds was staggering. Mathematicians call this a fivesigma event, or one that cannot be explained by pure chance. The five-year average annual return through random walk theory a theory that stock prices move randomly and unpredictably. Fundamental analysis is a waste of time since no one can forecast stock prices.
The results can be seen in Figure 2. The fact that a group of investors sharing the common philosophy of value investing avoided the flavor of the day those stocks recommended in the Fortune article and beat the market by a wide margin over a five-year period should have made headline news. Not necessarily. I believe that a knowledgeable individual investor, without all the resources of big mutual funds, can beat the market on your own, without having to give up control of how their money is managed.
How could that be possible? In the investing world, the underdog has the edge. In the Bible, Samuel I, Chapter 17, records one of the biggest upsets in military history. Today, the mere mention of the two participants, David and Goliath, evokes an image of the underdog beating the favorite. The story takes place in biblical Israel. The Israelites, led by King Saul, are fighting a battle with their Philistine oppressors when both sides face off on adjacent hills.
He taunts the Israelites to send a soldier to fight him, but no one steps forward. A Few Things You Must Know 25 David, whose older brothers are serving among the Israelite troops, is sent by his father to bring them food. Instead of wearing heavy armor, David faces Goliath with nothing more than a stick, a slingshot, and a few smooth stones.
Goliath is furious and says: In the investing world today, institutional investors are the Goliaths. They are staffed by very bright people with unlimited resources and extensive teams of assistants.
My definition of a knowledgeable investor is one who downloads shares in a business stock for less than its underlying value. This type of investor is trying to get the most value for their dollar. Evolution Institutional investing has evolved over the past 30 years in ways that have handicapped their performance. After studying this phenomenon over the past several years, I have identified three stumbling blocks that make mediocre performance the norm for institutional investors: Short-term time horizon.
Market cap limitations. Short-Term Time Horizon The money management business is a great business. If you gather assets and have adequate performance, investors will stay with you for a long time. Money managers usually charge a management fee of one percent of the total assets under management. The goal for many If a firm slips up and has negative performance, there is a real fear of losing assets to another firm that is performing better. The nature of the business has created an environment where institutional investors have to focus on short-term relative performance.
The penalty for short-term underperformance would be an exodus of assets, resulting in lower management fees and early retirement for the portfolio manager. The distraction of how they have been performing over the past week, month, and quarter in relation to their peers causes money managers to go into self-preservation mode.
In other words, they start thinking: Instead of investing in what looks attractive on a valuation basis and holding for the long term, they begin downloading what other managers are downloading so as not to fall behind their peers in performance. A long-term view would prove disastrous to the financial health of the firm and their own job security.
The measuring stick is not an absolute return but a relative return. For example, if fund A is down 20 percent and fund B is down 18 percent, the manager of fund B is having a happy day. It reminds me of the old joke of two hikers who see an angry bear approaching, so one of the hikers starts putting on a pair of running shoes. The goal now is to outperform the other funds in their category and a herd mentality sets in.
Due to their size, institutional investors are in a catch situation.
The more money under management, the more fees they will generate. However, the size of their assets limits their selection of stocks That holding, no matter how well it did, would not be enough to move the performance needle. There are close to 8, stocks traded on all the U. If the fund happens to be a bank sector fund, the manager cannot invest in a retail company.
If a great company, Mr. Based on Mr. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice.
That was one of the reasons that technology funds back in continued to download shares of technology companies at nosebleed valuations. In this world, cash is a dirty four-letter word. Your Edge Knowing what you are up against, do you now see how you, David, has a big advantage? As a knowledgeable individual investor, you have none of these restrictions imposed on your selection of stocks. You know that over the short term, stock prices move based on fads and popularity, but over the long term five years—10 years , stock prices move based on the earnings of the company.
How could one not take the long-term view? To you, it should really make no difference if the latest government report came in a tenth of a percent higher or lower than expected, causing the stock market to take a dive. You use those opportunities to scoop up shares of great companies selling at fire-sale prices. The United States had just suffered the worst terrorist attack in history and investors panicked by selling.
Multibillion dollar companies lost a big chunk of their market cap in one day. There will always be some type of crisis that causes people, especially Goliaths to react in irrational ways. It is during those times that you need to act and be ready to download companies on your target list. See Table 2. Investment managers frantically trade long-term securities on a very short-term basis.
The real success comes from investing in great companies that are selling at attractive prices and holding them for the long term. The knowledgeable investor is not saddled with a small universe of stocks. Thousands of companies that offer great value in excellent industries but have small market caps are available to you as well. In addition to no limitations on market caps, there are also no restrictions to any particular sector or geographic location.
Being an institutional investor is like being in that same buffet line but having high blood pressure, heart disease, and diabetes—their choices are severely limited and bland. Cash is also not a bad thing to have in your portfolio.
When the stock market bids up stock prices that are so disconnected from the underlying value of the company, cash is the place you want to be. It is better to earn whatever percent a money market is paying than to lose money.
As long as you think of yourself as a knowledgeable investor and stay the course, you most definitely have the edge.
Our investment philosophy is bimodal; either we invest in high returning opportunities or have the money in the bank or under our mattresses. I suggest that most value investors view markets as efficient about 85 percent to 90 percent of the time. It is the periods of time when irrational behavior takes over when markets become very inefficient and large profits can be made. You do not have to focus on the short term, but can choose from companies regardless of market cap.
In fact, you have an enormous edge over institutional money. In the next chapter I share three lessons that when followed will allow you to take advantage of irrational behavior and profit from it rather than being part of it.
The smart money does not follow the crowd, but instead seeks out exceptional stocks selling at bargain prices. But most underperform the market. This single fact shows how individuals using the principles of value investing can, indeed, beat the big mutual funds. Lessons from the Past A pril 14, was an important milestone in the stock market as far as I am concerned. I can still remember the scent of spring as I made my way to the office that morning.
An economic report was released before the market opened, and it caused Mr. Market to go into shock. Stock index futures immediately went limit down, which is the maximum price movement the stock index futures could fall in a given time span.
The day went from terrible to downright ugly. In a very short timespan investors went from falling in love with Internet companies at extreme valuations to dumping them at any price. On March 27, site, Yahoo, and site made all-time highs as investors bid up prices.
Yet by April 14, site, Yahoo! See Table 3.
After running in place over the next several weeks, the stock market continued to fall into the worst bear market since the Great Depression. Many market pundits over the coming weeks threw in their two cents as to what 31 What caused such a quick shift in investor sentiment in such a short span of time?
What lessons can we learn from successful value investors and how could one have avoided this meltdown? Three Things to Keep in Mind Looking back with the clarity of time, I see three lessons that investors should have learned about the stock market beginning with the events of April These lessons are not new; Ben Graham wrote about them in in his book coauthored with David Dodd, Security Analysis.
Value Investors Must Read List
Lesson 1: I asked him what business the company was in. How long have they been in business? Who is the CEO?
Many downloaders of stocks forget that what they are downloading is an ownership interest in an actual Lessons from the Past 33 business, which has an underlying value. That underlying value of the business does not depend on the share price of the stock. Investors forget that stocks are not blips on a screen or numbers on a ticker. It is all too easy to make this mistake, instead assigning a dollar value to the business based on the price the stock is trading for.
Investors confuse a rising stock price with a healthy and vibrant business.
They judge the financial strength of a company on whether the stock price is rising or falling. Many investors concluded that since the stock price was falling, so were the fortunes of the company.
Hardly what one would call a struggling business! Investors forget that the real driver of stock prices over time is the earnings of the company. Yet back in the mania, the thought of earnings was so—oldfashioned. In , Juno Online Services announced an amazing business plan: They would offer free e-mail and Internet access, and they would spend a fortune on advertising over the next several years.
How they would turn a profit was not disclosed. Over the next several years the stock sank down into single digits. There was a time when investors bought stocks, took pride in their ownership, and passed them on to their heirs. In the typical shareholder held a stock for five years. The average shareholder holds a stock today for less than 11 months. By forgetting that stocks are actually pieces of a real business, intelligent people turned the stock market into a casino by downloading what was rising and selling what was falling, instead of downloading undervalued assets.
Lesson 2: Market is Mental! Ben Graham said that Mr. Market is bipolar and is not a very good appraiser of businesses. When stocks rise, Mr. Market gladly pays more than their value, and when stocks fall, he will unload stocks for much less than their worth. During the stock market mania of , Mr.
Market was as bipolar as could be. For example, on March 17, , Mr. By September , Mr. What was the real value of Inktomi? By the end of the year, Yahoo!
I want you to keep this thought at the forefront of your mind: The stock market is there to serve you when you want it to serve you. Market influence your download and sell decisions. You should be a downloader when, after careful evaluation, you can download something for less than its intrinsic value. This simple logic could have saved investors billions of dollars. Lesson 3: Stock prices became disconnected from the actual value of the company.
Investors bid up Yahoo! Neither valuation was in sync with reality. A great company can be a lousy investment if you pay too much for its stock. downloading a great company is no guarantee of high returns; you need to pay the right price, too. Whenever I research a company, I try to figure out what the company does, how it makes money, and why I like it. I realize that a stock represents plants, employees, products or services, production, competition, and management.
Some look at the stock price only a few times a year. The stock price will bounce around over the short term, but it will be the earnings of the company that propels the stock higher over time. Imagine if you owned a retail store and the weather forecast called for rain for the next few days. Since you would have fewer people in your store, sales would be down. Now imagine someone coming to you and valuing your business at 10 percent to 20 percent lower based on a few days of rain.
Market does most of the time. I do my best to avoid the daily distractions of the stock market. The download decisions I make are not based on what the stock price will do tomorrow or next week, but on how the company will continue to grow earnings over the next five years.
Since I do not focus on the gyrations of Mr. Market, I can focus on what really counts: A great company at a lousy price will not increase the size of your portfolio. They had won back-to-back NBA championships, and it looked like they would win three championships in a row.
That would be the best record since the Boston Celtics won an astonishing eight in a row from to The amazing part is that Riley trademarked the word. I wish I could have trademarked another quote heard by investors and their advisors almost daily. To many it seems sacrilegious to violate its holy message.
I would like to share with you how great investors diversify and manage their portfolios. At the beginning of the twentieth century, Andrew Carnegie was the richest man in the world.
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His life was literally a rags-to-riches story. Carnegie had come to the United States at the age of thirteen and worked as a bobbin boy in a cotton mill. After a series of jobs with railroad companies, he started his own business in , which eventually grew into the Carnegie Steel Company, which, in turn, launched the steel industry in Pittsburgh. At age sixty-five, he sold the company to J. In fact, he said the exact opposite: Morgan at the formation of U.
British economist John Maynard Keynes wrote: As time goes on, I become more convinced that the right method of investing is to put fairly large sums into enterprises which one thinks one knows something about and in management of which one thoroughly believes. Life should comprise two parts. First is the accumulation of wealth and second is distribution of wealth to worthy causes.
The Carnegie Steel Company is his best-known corporation, which with merged assets controlled by another industrialist, J. Morgan, formed U. Steel in From until his death in , Carnegie followed his own philosophy and gave most of his wealth to charity. He funded libraries in most U. His philosophy on distributing wealth was later embraced by Warren Buffett who is giving most of his assets back to society.
This is a type of investor who emphasizes the importance of understanding a business before making a download, and then invests a substantial portion of their capital in it. Most people today diversify their investments among a broad range of investments and market sectors, without taking the time to research and understand what they are investing in. It seems so logical as an alternative to study the business model before putting money into a stock, but few practice this level of attention and research.
Unfortunately, investors are likely to put more research into downloading a car than they do in investing in a company. The problem of inadequate research is not limited to individual investors but professionals, too. Professionals who manage stock mutual funds usually have upwards of different companies in their portfolios. How good can their seventy-eighth idea be? How well can they know all the companies in their portfolios?
Warren Buffett once said: I often wonder what type of return the bottom 10 percent of stocks in a portfolio with more than stocks achieve. I would venture to guess they hardly add any value and probably take some away. In Phil Fisher put out a shingle, began his investment counseling business, and soon after became a legend. He, too, invested in only a few companies that he knew very well.
It never seems to occur to [investors], much less their advisors, that downloading a company without having sufficient knowledge of it may be even more dangerous than having inadequate diversification.
Diversification is only a surrogate, and usually a damn poor surrogate for knowledge, control and price consciousness. Lessons from the Past 39 ends up happening is that as soon as the stock price starts to fall, most investors panic and sell at a loss. The more they try to diversify, the worse the performance becomes; they never get to know much about any one company.
Investing in only quality companies after understanding their businesses, gives you the highest probability for success. The Dynamic Duo Great investors like Warren Buffett and Charlie Munger continue to follow the ways of Keynes and Fisher by concentrating their portfolios with only their best ideas.
After extensive research, Buffett would not hesitate to invest a large portion of his net worth in one stock. Buffett wrote: If you are a know-something investor, able to understand business economics and to find five to ten sensibly priced companies that possess important long-term competitive advantages, conventional diversification makes no sense for you. Know what you are investing in and focus your investments among your best ideas.
Diversification works against you when it is excessive. The game would be a lot easier if there were always 30 to 40 great companies selling at fair prices. But the reality is, at any given time there are only a handful of great companies selling at fair or bargain prices. What is the magic number of stocks that a value investor should download?
Each master has his or her own idea of what is optimal, but it is fair to say it is certainly fewer than Very few people have gotten rich on their seventh best idea. But a lot of people have gotten rich with their best idea. Great investors like Keynes, Buffett, and Munger have achieved outstanding performance over the long term by looking at the same stocks that the best and brightest of Wall Street have to offer. They achieved outstanding returns simply because they focused on their best ideas and invested accordingly.
I want to give you a hypothetical situation and it will become obvious to you why you should concentrate your portfolio in quality businesses. However, there was only one caveat: You have to stick with your decision for the next five years. What would you do? I highly doubt you would open up the Yellow Pages and invest equally in every company that is within 20 miles of your home.
By just using a little bit of brain power, you most likely would avoid the poor companies and invest only in the great ones. If you are a rational person, you would approach this challenge in a logical manner.
How did Warren Buffett get started in business?
You would first come up with the components of what makes a great business. Trying to select a company for your investment by only looking at the numbers would not give you a good understanding of the business. If looking just at the financials would make someone a successful investor, then accountants would be the richest people on earth.
Average stock investors download stock in the same manner they download lottery tickets. The greater the payoff and the sexier the story, the more they salivate. How else can you make sense of intelligent people downloading stocks of companies that have very little chance of ever making money in rapidly changing industries? One reason investors do such silly things when it comes to downloading stocks, which they would never do when investing in a private business, has to do with the way they think.
Thinking about stocks as pieces of businesses makes all the difference in the world. Benjamin Graham wrote: The important things to understand about the business are the factors that will affect sales, earnings, and cash flow; all of which are very knowable. Great companies like Harley-Davidson, Wells Fargo, and Costco can all be summed up in just a few words. Warren Buffett had this to say when encountering a business that is too difficult to understand: Investors should remember that their scorecard is not computed using Olympic-diving methods: If you are right about a business whose value is largely dependent on a single key factor that is both easy to understand and enduring, the payoff is the same as if you had correctly analyzed an investment alternative characterized by many constantly shifting and complex variables.
Certain industries have very consistent and predictable operating histories. One example of an industry to avoid is the airline industry, which has proven to be very inconsistent and unpredictable. The price of fuel and the threat of terrorism can put a big damper on earnings and sales for long periods of time.
A consistent operating history If the past operating history is erratic, how can you project the future? Finding those companies that have a consistent long-term operating history is not such a daunting task. Out of a universe of all stocks traded on the U. Sticking with companies that consistently increase sales and earnings greatly minimizes your risk of permanent capital loss on your investment. Predictability is a key part of valuing a company, with value determined by the amount of cash an enterprise can generate over time.
By sticking with companies that have understandable businesses, a consistent operating history, and an enduring competitive advantage, you put the laws of probability in your favor. The lessons written down by Benjamin Graham and David Dodd more than 70 years ago still apply today.
Keep in mind that when you are downloading a stock, you are downloading a piece of a company. Once you download the stock, let the fundamentals of the business tell you how well they are doing, not the daily change in the stock market. Lastly, the price you pay for the stock will make the biggest difference on the return you get.
Once you find a handful of great businesses selling at attractive prices, download them so they make up a large percentage of your portfolio. Now that you are looking at stocks pieces of a company a lot differently from when you first picked up this book, the next chapter tells you how to make sure the companies you look at seriously are great companies.
Lessons from the Past 43 Key Points 1. Do you understand the business? Who are its managers? The market is completely irrational and overreacts to just about everything. Were the market a person, it would be diagnosed as bipolar. Stick with the Champs hen you view stocks as what they really are, pieces of businesses, you open your mind up to a whole new way of looking at the stock market.
When you take this minority view, the stock tables in your local newspaper are not just a jumble of numbers and symbols that change on a daily basis. Instead consider them a business listing given to you by a business broker.
You can have your choice of being partners with any company of your liking. However the selection is overwhelming. With such a vast amount of stocks traded on U. S exchanges, where would you begin to narrow down your selection?
Most investors would start with finding companies offering huge growth in new and exciting industries. They would go about trying to find the next Google, Microsoft or site. Very few would start their search by looking at companies that are household names, have been in business for decades, and have consistently produced excellent growth in both earnings and revenues.
However that is not how it works. In fact, many W 45 There are several reasons why but the three that I have heard the most are: Great companies are too efficiently priced. Looking for the 10 bagger. The financials get no respect. Since they are so widely followed by institutional investors, everything known about them is already factored into the stock price.
Since Dell is so widely followed while Daktronics is not, one would think that there is a high probability that Dell will be efficiently priced while Daktronics might not be. Looking for the 10 Bagger Many investors do not view stocks as pieces of businesses but instead look at them as lottery tickets. They want to download a young company in an exciting industry and hope to make 10 or more times their investment. The author tracks the major account frauds of the last century in a humors way to give the reader examples.
Accounting, which is often difficult to understand, is presented in an easy to read format without losing the core teachings. Fisher uses the same principles of Graham when assessing the fundamentals of a stock but moves from pure value to growth. This is the present thinking of a value investor like Warren Buffet. The idea is that an investor should be willing to pay up for growth, not just looking at discounts.
If they did their research correctly, they would be paying a discounted price for what will turn out to be a home run value stock. Dodd We keep saying that fundamental analysis is the foundation of value investing. This is the bible of value investing. At more than pages, Security Analysis is absolute guide on how to asses a security and make an informed and logical position on it.
The massive text has 10 chapters deleted since the original publication 57 years but contains all of the original chapters in PDF format in a CD at the back of the book.
Some of the information in this book is outdated and cannot be taken at face value but should make for great food for thought.Thorndike profiles eight CEO s and their blueprints for success. The Enduring Competitive Advantage vii 73 9: He funded libraries in most U. We have done well with a couple of princes—but they were princes when downloadd.
Jason Zweig, offers a nice analysis and commentary following each chapter explaining how to put in practice what Graham says as well as its relevance today. Concentrating your attention and research in these companies, downloading them at an attractive price and holding for the long term, will eventually increase your net worth.
Warren Buffett took a positive view regarding EMT and wrote: The five-year average annual return through random walk theory a theory that stock prices move randomly and unpredictably.
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