Security Analysis is arguably of one the best investment books transcending generations ever since it was first published in 1935. To date, it is still widely used by aspiring investors and professionals as a guide to help them in their journey to wealth. Written by Benjamin Graham and David Dodd, two of the people instrumental to launching the highly successfully career of the Oracle of Omaha. Warren Buffett only has high praise for the book and the authors, "They laid a roadmap for investing that I have now been following for 57 years. There's been no reason to look for another."
We will break down the principles ideas, and insights shared from the book and see how it would help us make investing decisions and guide us from being part of the herd to becoming an Intelligent Investor.
Preface (as written by Seth A. Klerman)
Klerman is a very conservative investor with unconventional strategies, and often holds a significant amounts of cash in his investment portfolio
Klerman makes these important points about Investors and Investing in general:
- While some might mistakenly consider value investing a mechanical tool for identifying bargains, it is actually a comprehensive investment philosophy that emphasizes the need to perform in-depth fundamental analysis, pursue long-term investment results, limit risk, and resist crowd psychology.
- Far too many people approach the stock market with a focus on making money quickly. Such an orientation involves speculation rather than investment and is based on the hope that share prices will rise irrespective of valuation.
- Institutional investors often prefer the safe haven of assured mediocre performance that can be achieved only by closely following the herd.
- Many investors make the mistake of thinking about returns to asset classes as if they were permanent. Returns are not inherent to an asset class; they result from the fundamentals of the underlying businesses and the price paid by investors for the related securities. Capital flowing into an asset class can, reflexively, impair the ability of those investing in that asset class to continue to generate the anticipated, historically attractive returns.
On cable TV broadcasts tracking market movements on a per-minute basis:
- The daily cheerleading pundits exult at rallies and record highs and commiserate over market reversals; viewers get the impression that up is the only rational market direction and that selling or sitting on the sidelines is almost unpatriotic
Point of Emphasis
Losing money, according to Graham, can be psychologically unsettling. Anxiety from the financial damage caused by recently experienced loss or the fear of further loss can significantly impede our ability to take advantage of the next opportunity that comes along. If an undervalued stock falls by half while the fundamentals—after checking and rechecking—are confirmed to be unchanged, we should relish the opportunity to buy significantly more “on sale.” But if our net worth has tumbled along with the share price, it may be psychologically difficult to add to the position.
Applying it to the Philippine setting, take SM Investments Corporation's case. In August it was trading at P950 level after a 25% stock dividend. When news that its shares in MSCI weighting would be significantly cut, It traded for as low as 605 per share. If you invested right before the stocks dropped, it would have been very difficult to watch almost 36% of loss even if you know that there is nothing wrong with the stock fundamentally. After two months it is now trading at P840 and still shows momentum of rising.
Investing Strategies
-Graham and Dodd recommended that investors purchase stocks trading for less than two-thirds of
“net working capital,” defined as working capital less all other liabilities. Many stocks fit this criterion
during the Depression years, but far fewer today.
-Sometimes, it is a good strategy to hold enough cash, but only when you cannot find bargains should you default on doing so.
- While Graham and Dodd emphasized limiting risk on an investment-by-investment basis, they also believed that diversification and hedging could protect the downside for an entire portfolio. This is what most hedge funds attempt to do. But investors are warned of overdiversification - holding more of individual securities that, considered alone, may involve an uncomfortable degree of risk, than having less risky and highly valued securities.
- So long as value investors aren’t lured into a false sense of security, so long as they can maintain a long-term horizon and ensure their staying power, market dislocations caused by Fed action (or investor anticipation of it) may ultimately be a source of opportunity.
Klerman also discusses some of the opportunities that will help you decide to invest (with added insight):
1. An urgent need for cash. This is specially true for real estate investments. Often, sellers are compelled to sell properties at a discount out of their need to have adequate cash.
2. Inability to perform proper analysis. Investors who just follow the herd tend to get affected easily by market speculation. This could also be a good entry point if the security proves to be of good value.
3. A bearish macro view. External factors can also affect a stock, or even the overall index s a whole. When the news of Fed tapering surfaced, Most of Philippine stocks gains for the year were wiped out of fear that there will be a shift in investing appetite back to US.
4. Investor disfavor or neglect. Some stocks are just not attractive enough to gain attention, but if analysed fundamentally, can also offer satisfying gains.
Part II of our discussion and analysis of the preface will be posted next week. Happy learning!
Quote of the week:
If you can tell a good investment from a bad one, you can also distinguish a great one from a good one.
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