A stock is not just a ticker symbol or an electronic blip, it’s an ownership interest in an actual business, with an underlying value that does not depend on its share price
The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap).
An intelligent investor is a realist, who sells to the optimist and buy from pessimist.
The future value of every investment is a function of its present price – The higher the price you pay, the lower the return will be
The margin of safety – Never overpaying, no matter how exciting an investment seems to be, can minimize your odds of error
While enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street, it almost invariably leads to disaster
Obvious prospects for physical growth in a business, do not translate into obvious prophets for investors
The silver lining – Stocks become more risky as their prices rise, and less risky as their prices fall
Speculation account –
Set aside a small portion of your capital you don’t mind losing to a speculation account, an account you invest in things you feel like they will make bug bucks for you but without doing a real research.
Never mingle your speculative and investment operation in the same account
“All of human unhappiness comes from one single thing, not knowing how to remain at rest in a room” Blaise Pascal
To make it an investment and not just a speculation there must be 3 things:
- Thoroughly analyze a company and the soundness of its underlying business before you buy it’s stock
- You must deliberately protect yourself against serious losses
- You must aspire to adequate not extraordinary performance
For the aggressive investors (those who do not treat it as passive income) there are few ways to beat the market:
Never put more than 10% in your “mad money” account (speculation account)
The money illusion
Inflation eats our wealth – Not just by how much we make, but how much we keep after inflation
To fight it, there are 2 options:
- Real Estate Investment Trusts (REIT) – Companies that own and collect rent from commercial and residential Properties. Bundle into real estate mutual funds. Best choice is Vanguard REIT index fund. Other low cost options include Cohen & Steers Realty shares, Columbia Real Estate equity fund and fidelity real estate investment fund
- Treasury inflation protection services (TIPs) – US government bonds that automatically go up in value with inflation and can’t default because it’s backed by US Treasury department. When the value of your bonds goes up as inflation rises,
NThe value of any investment is and always must be a function of price you pay for it
By the rule of opposites, the more enthusiastic investors become about the stock market on the long run, the more certain they are to be proven wrong in the short run
In the long run, stocks are average to make 6% return (or 4% after inflation)
Robert Shiller prof. Yale university valuation approach –
Compare the current price of standard impors 500 stock index against average corporate profits in the last 10 years (after inflation)
When the ratio is well above 20, the market usually delivers poor returns afterwards.
When it drops well below 10, stocks typically produce handsome gains down the road
In the financial markets, the worst the future looks, the better it usually turns out to be
Blessed he who expects nothing, for he shall enjoy everything
Preferred stock – Corporate pays income tax on only 15% of the income they receive in dividends, but on the full amount of their ordinary interest income
All investment grade preferred stocks should be bought out by corporations, such as all tax exempt bonds should be bought by investors who pay income tax
If you just starting to invest (doesn’t matter what age you are) Graham suggest that you keep a minimum of 25% of your money in bonds.
Given your salary and spending needs, how much money can you afford to lose on your investments.
If you feel like you can take the higher risks and better ownership in stocks, use the minimum 25% bonds or cash, 75% stock approach. If you don’t feel like you can take higher risks, use the 75% bonds/cash and 25% stocks approach
Rebalance your portfolio every 6 months and do it on predictable dates such as New Years and the 4th of July
Investing in bond funds (has monthly income)
Invest in companies/industries you already know and do your research of their financial statements
30% of people’s 401K is invested into the company they work for.
This is sometimes a problem, as people think they know more than what they actually know.
This is caused by the distortion of familiarity, the more you know going in, the less likely you are to prob a stock for its weaknesses
Whenever we too close to someone, something, we take our beliefs for granted, instead of questioning them as we do when we confront something more remote
The more familiar a stock is, the more chances are for a defensive investor to turn into a lazy onei
Don’t invest in only one stock, or even just a handful of different stocks. Unless you’re not willing to spread your bets, you shouldn’t bet at all!
Graham guideline – Own between 10-30 stocks
Don’t forget that no matter what, you and only you are responsible to investigate whether an advisor is trustworthy and charges reasonable fees
Farm it out –
Mutual funds are the ultimate way for the defensive investor to capture the upside of stock ownership without the downside of having to police your own portfolio
Index funds is the best way to autopilot your investment portfolio
Your very refusal to be active, your renunciation of any pretend ability to predict the future, can become your most lethal weapon
By putting investments into autopilot, you drop any self illusion that you know where stocks are headed, and you take away the market power to upset you, no matter how bizarre it bounces.
Dollar cost averaging – Allows you to put a fix amount of money into an investment at regular intervals (week/month/quarter) you buy more, regardless if the market is about to go up/down or sideways. Ideally invested into index funds
Let’s say you can spend only $500 a month,
Owning and dollar cost averaging 3 index funds:
- $300 that holds the entire US stock market
- $100 that holds foreign stocks
- $100 that holds US bonds
You ensure that you own almost any investment on the planet that’s worth owning
If you would invested $12000 in the standard impors 500 stocks in the beginning of September 1929, 10 years later, you would have only $7023 left.
But if you would started with only $100 and simply invested another $100 every single month, by August 1939 your money would have grown to $15571.
That’s the power of discipline buying, even in the face of the great depression and the worst bear market of all time
After you build an auto pilot investment portfolio, you can answer any question about the market with a simple “I don’t know, and I don’t care”
Best time to shop around is at the wreckage of a bear market –
If you build a diversified basket of stocks that their assets are at least double their current liabilities and their long term debt not exceed their working capital you should end up with a basket with enough money
Best values are in stocks that were once hot and got cold
- Earnings stability – 86% of all S&P 500 companies have had positive earnings in every year from 93-2002. Having some earnings each year as Graham suggested is still valid for the passive investor’s stock picking strategy
- Dividend record – 71% of the S&P 500 companies paid dividends.
- Earnings growth – Graham rule of thumb is that companies increase their earnings per share by at least 33% in 10 year span (seems conservative and in the S&P you can find companies increase their earnings per share by 50%-100% in a decade span.
- Moderate PE ratio – Graham recommends limiting yourself to stocks who’s current price is no more than 15X average earnings over the past 3 years. Wall Street is valuating stocks by something called Future PE and it’s based on unknown factor such as next year earnings. Research as shown that more than 59% of wall Street either overvalued or undervalued stocks using this method by at least 15%
- Moderate Price to Book ratio
- Due diligence – Do your homework! www.sec.com check companies annually and quarterly reports along with the disclosure of management compensation, ownership and potential conflict of interest (read at least 5 years worth)
- Check the neighborhood – http://quicktake.morningstar.com quicken.com can tell you what percentage of a company shares is owned by institutions (everything over 60% suggest that a stock is scarcely undiscovered and probably over owned. When big institutions sell they tend to move in large steps and this disasters results for the stock. Those website will also tell you who the largest investors in the stock are, if they are money management firm with similar style to yours, that’s a good sign
Think you can beat the market? Build a demo stock picking portfolio and run it for a year long. Got good results? Invest real money! But no more than 10% of the your entire portfolio and the rest in index funds