Graham focuses on Value Investing. According to Warren Buffet it’s “the best book ever written about investing”.
Book review (by Swedish Investor): https://www.youtube.com/watch?v=npoyc_X5zO8
Book Review (by Financial Freedom): https://www.youtube.com/watch?v=18r2RCVtqTg
Speculation vs. Investment
- Thorough fundamental analysis in the companies in which you are investing in to promise safety of the principle and adequate return.
- Protect your assets via diversification
- Seek stable companies with steady returns
- Always seek a margin of safety
Develop an understanding of inflation and its impact on your wealth. If inflation is 2.5%, and your bonds / investments are returning 2%, inflation is causing you to lose money each year (0.5%).
Meet Mr. Market. Mr Market is not always rational (often either too optimistic or too pessimistic – bipolar in nature)
- Be happy to sell when prices are ridiculously high
- Be happy to buy when Mr Market offers you a bargain
A stock is an ownership interest in a business.
The underlying value of a company does not often equal the price (someone is willing to pay for it).
- A great company isn’t a great investment if you pay too much for the stock
- The bigger the firm gets, the slower its growth rate becomes
- Always be on the lookout for temporary unpopularity; allowing you to buy a great company at a great price
Two types of investors
1. Defensive (passive investor)
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Portfolio of:
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50% stocks (max 75%) & 50% bonds (min 25%)
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Rebalance yearly
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Invest regularly via Dollar cost averaging method
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Diversify (10 to 30 companies, don’t over expose to certain industries)
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Invest in only:
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Large companies > $700m
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Companies which are conservatively financed (assets are 200% its liabilities – 2 times)
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Have paid dividends over the last 20 years
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Have shown profit over the last 10 years (no earnings deficit)
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At least 33% earnings growth over the last 10 years (equates roughly 2.9% growth annually)
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Buy company cheap – Market cap less than 1.5 times its net asset value ( i.e.: market cap < (asset – liabilities) x 1.5
- By cheap earnings – Price to earning ratio (P/E) of less than 15 (i.e P/E < 15)
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2. Enterprising (active investor)
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Need to invest a lot of time, be eager to learn, have patience and discipline
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In general, avoid growth stocks as the value is based on ‘future earnings’ (may not materialise), rather than looking at a company’s current valuation.
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If you can find a company where its price is less than its net working capital – you essentially purchase all its fixed assets for nothing
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Net working capital = current assets – liabilities
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Portfolio of:
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Higher returning / higher risk assets
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Some diversification
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Invest in any size companies
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Companies which are less conservatively financed (assets are 150% its liabilities – 1.5 times)
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Paid a dividend in the last year
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Growth > 0% (don’t worry about deficits as much)
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Buy company cheap with tangible assets – Market cap less than 1.2 times its net asset value ( i.e.: market cap < (asset – liabilities) x 1.2
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Key Concepts
Stock Valuation Concepts
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Stock valuation is an art
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Stock Valuation = Past and Current Numbers + Future Narrative
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Stock valuation is a range, not an absolute (as its based on assumptions)
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Plan different scenarios (ie head winds, tail winds etc) and come up with different scenarios and value forecasts (ie ranges)
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How to determine Value
Value can be determined by:
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(Original) Value = earnings per share x (8.5 + 2 x expected annual growth rate)
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(Updated) Value = ( earnings per share x (8.5 + 2 x expected annual growth rate) x 4.4 ) / current yield on AAA rated corporate bond
- https://en.wikipedia.org/wiki/Benjamin_Graham_formula
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Online Graham value calculators:
Insist on a Margin of Safety (including how to determine value)
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Mitigates the risk of being wrong (downside protection)
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Don’t ever lose money
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When the price is less than two thirds the value, you have a safety margin
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Price < 2/3 of value (33% safety margin)
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- Graham looks for a 33% safety margin
Insist on Moats
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Competitive advantage, upside earnings engine:
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Cost advantage
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Size Advantage
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High switching cost advantage
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Intangibles (ie patents, brand, government licenses)
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Risk & Reward are not always correlated
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You don’t have to take a higher risk to achieve a higher reward
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By committing to deep and time consuming analysis, by exercising maximum intelligence and skill you can find valuable companies to invest in (with low risk)