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Value Investor's "Words of Wisdom"
10/28/2014 9:00 am EST
Writing in the 1930s, Benjamin Graham and David Dodd explained that successful investing is based not on guesswork but on analysis of a company's past record, notes Charles Mizrahi, editor of Hidden Values Alert.
Over the past 80 years, Graham's principles have continued to endure (Graham was Warren Buffett's mentor) and they are ever sounder and better understood with each passing year.
Graham's approach toward stock investing comprises three principles:
- View stocks for what they really are—pieces of a business—and not wiggles on a chart.
- View the stock market as your partner, which he called Mr. Market, that each trading day offers to buy or sell your shares. Keep in mind that he is there to serve you, not to guide you.
- And buy only when there is a gap between the price of the stock and the underlying worth of the business or, as Graham called it, "a margin of safety."
It never ceases to amaze me how successful business people apply one approach to investing in a private business and another when it comes to stocks. Imagine the owner of a private business making decisions based on the following:
- Deciding to open a new division only when the 50-day moving average of his company's daily sales crosses above the 200-day moving average of its daily bank deposits.
- Upon hearing of the nationalization of a bank in England, he calls a business broker and offers his 100-year-old very profitable family business for sale at 30% below its intrinsic value.
- After a government report is released that shows unemployment rose to 7%, he then calls a competitor and offers to buy that business for 25% above the company's asking price. The reason for his exuberance is that unemployment was 0.20% lower than his forecast.
- While charting his company's bank deposits, he notices that the chart pattern is tracing out an "inverse head and shoulders" pattern and he makes a decision to lay off 20 employees.
If these decisions were actually made by a private businessperson, I question how long the person would stay in business.
It would be hard to find a businessperson drawing conclusions on such disconnected data and actually implementing them. Yet most investors would not give it a second thought if I told you I was talking about stocks instead of a private business.
Stock price fluctuations caused by this type of approach offer the value investor an enormous opportunity. When a stock or industry becomes unloved and unwanted, the stock price drops to levels that have no relationship to the underlying worth of the business.
The recent drop in energy prices might turn out to be another good example of traders throwing the baby out with the bathwater. After hitting $115 per barrel in June 2014, crude oil prices have hit the skids.
Any company that was related to the energy industry was sold regardless of how strong its balance sheet was or the intrinsic value of the business.
This type of environment provides value investors who can analyze a business a great advantage. We currently have several companies in the energy sector in both our portfolios...and continue to hold them:
Warren Buffett said it best: "Be fearful when others are greedy and greedy when others are fearful." Viewing stocks as pieces of businesses instead of as symbols that are traded thousands of times during the day gives a value investor a big advantage.
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