Intelligent Investor Ch. 6-8 Flashcards
Example graham gives of second quality bonds
Railroad income bonds
Graham’s requirement for earnings before income taxes relative to total interest charges when buying second grade bonds in order to provide safety?
Pretax earnings should be 5 times that of interest charges
When seeking safety in bond purchase
2 contradictory attributes which second grade bonds and preferred stocks possess
1 nearly all suffer severe sinking spells in bad markets,
2 most Recover when favorable conditions return
When should the investor invest in second rate bonds and preferred stocks?
Bought at bargain levels at least 30% below par
for corporateBonds paying above average interest rates,
or preferred yielding 10% or more
Cumulative preferred stocks that fail to pay dividends for many
Years
Work out when business conditions improve
Graham on foreign government bonds
Stay away
New bond issues
Investors should be wary and perform careful examination before
Purchase
In 2003 how much did Wall Street make for selling IPOs
7% for IPOs compared to 4% for old securities
Wall Street makes almost twice as much on new issues
2 caveats for new issuance of securities
1 harder driving sales force behind it
2 always sold in favorable market conditions for the seller and
Consequently less favorable conditions for the buyer
Corporations choose to offer new issues of stock when…
Stock market is near a peak
Great time for buyers in the overall stock market is when there are…
Few IPOs
When there are a lot of IPOs the markets are overheated
Closed end fund financing, European financing
Investors are asked to pony up fees to own the same proportion
Of ownership interest (closed end funds are only example in US)
In Europe, this is still prevalent among common stocks
What is a dependable sign that the end of a bull market is occurring
When new common stocks of nondescript companies are offered
At prices somewhat higher than medium sized companies with
Long market history
For every dollar you make speculatively…
You will be lucky if you only lose 2
What do junk bond funds tend to do when interest rates rise?
Outperform most other bond funds
Jason zweig’s opinion on foreign bonds
Emerging market bonds could be up to 10% of your bond holdings
Because they never move with the s&p 500
Market impact
Extra price you pay for a stock while frequently trading
Ex. investors won’t sell you the shares unless you pay 10 cents more
How much do day traders underperform the market on average
6% from transaction costs, market impact
Special situation bond purchases
Bonds recover if a company is able to reorganize successfully
During bankruptcy
4 characteristic scenarios for the enterprising investor
1 buying in low markets and selling in high markets
2 buying carefully chosen growth stocks
3 buying bargain issues of various typed
4 buying into special situations
What time periods did graham use to analyze past data?
50 year periods
Graham’s PE RATIO
Use multi year average of past earnings
Investment selection: twofold merit
1 it must meet objective tests of underlying soundness
2 it must be different from policy followed by most investors
Or speculators
Relatively unpopular large company
Look for companies that are undervalued due to temporary
Setbacks
Risks of small companies facing temporary setbacks
Risk of definitive loss of profitability
Also protracted neglect from the market in spite of better earnings
Companies that are speculative because of widely varying earnings
Tend to sell at…
Relatively high price and relatively low multiplier in their good years
And low prices with high multipliers in their bad years
When is an issue considered a “true bargain” by graham
If it’s value is at least 50% more than the price
2 tests by which a bargain common stock is detected
1 the method of appraisal
2 value of a business to a private owner
Method of appraisal
Relies on estimating future earnings and multiplying these by
A factor appropriate to a particular issue
Value of business to private owner
Value determined chiefly by expected future earnings
Attention is also paid to realizable value of assets, with particular
Emphasis on net current assets or working capital
What are the 2 major sources of undervaluation for companies?
1 currently disappointing results
2 protracted neglect or unpopularity
Ideal combination for a bargain company
Large, prominent company selling both well below its past average
Price and below its past average P/E ratio
Net working capital
Current assets - total liabilities - preferred stock
Most readily identified bargain issue of common stock
Common stock sells for less than company’s net working
Capital after deducting all prior obligations
Secondary company
Company not a leader in fairly important industry
6 ways in which profits can arise from purchase of secondary issues
1 high dividend return
2 reinvested earnings in relation to price paid
3 bull markets are most generous to low priced issues
4 in sideways markets price adjustments to undervalued issues
Will cause them to rise
5 new, better management may take over
6 company is acquired by larger company at a premium
Security values and the aggressive investor
The aggressive investor must have considerable knowledge of
Security values to warrant viewing his security operations as
Equivalent to a business enterprise
Full price purchases: 3 things they should not be made for
1 foreign bonds
2 ordinary preferred stocks
3 secondary common stocks
Full price definition
Close to par for bonds or preferred stocks
Fair business value of enterprise in case of common stocks
When should the enterprising investor buy foreign bonds, preferred stock or secondary stock?
At prices no more than appraisal value of the securities
Secondary issues: value fluctuations
Tend to fluctuate at central level below fair value
However they reach and surpass at times fair value in the
Upper reaches of bull markets
Jason Zweig’s: When is it bad to buy growth stocks
When they have PE’s exceeding 25 or 30
What does Graham consider relatively short maturity for high grade bonds?
What will they not be affected by significantly?
7 years or less
Won’t be significantly affected by changed in market prices
Between 1897 and 1949 there were ten complete market cycles (bear market low to bull market high to bear market low). How long did these cycles usually take? What was the percentage of advance and declines in these cycles?
6 took no longer than 4 years, 4 ran 6-7 years,
one ran 11 years (1921-1932)
% advance was 44%-500%, most between 50%-100%
% decline was 24%-89%, most between 40%-50%
Well defined characteristics of nearly all bull markets? 5
1 historically high price level 2 high PE ratio 3 low dividend yields as against bond yields 4 much speculation on margin 5 many IPOs of poor quality
Why is it hard to buy low and sell high in the market?
When bull markets last a long time, investors jump in with both feet
Easy ways to make money in the stock market fade for 2 reasons
1 natural tendency of trends to reverse over time
2 large numbers of people who adopt stock picking scheme
And spoil all the fun
Second line companies
Companies not included in S&P
What does graham see as the typical fluctuation for most stocks in a 5 year period?
50% advance and a 33% decline
Equation book value per share
Book value per share =
(total shareholder’s equity - intangible assets)
/(fully diluted # shares outstanding)
Paradox of investing in companies with great past records and great prospects
The better the company, the more speculative the price it trades
At, as it’s high valuation is more prone to the moods of the market
The higher the premium over book value, the less certainty in
Determining its intrinsic value
Recommendation for conservative investor buying an excellent company: the recommended valuation
Buy issues approximately selling no more than one third above
Their tangible asset value
What should an investor demand from a company aside from just trading near its tangible asset value? 3 more things
1 satisfactory price to earnings ratio
2 strong financial position
3 prospect of at least maintaining its earnings over the years
Over time businesses usually change…
For the worse
Sometimes they get better
What should an investor not allow themselves to do.
Should not be worried about unjustified market declines
People who worry about market declines would be better off
If the stocks had no market quotation at all
It is far from certain that the typical investor should regularly
Hold off buying until low market levels appear, because this may…
Involve a long wait and very likely a loss of income
And possible missing of investment opportunities
Management and market prices
Good managements produce good average market price
Bad managements produce bad market prices
Predicting bond and stock prices
Virtually impossible to predict price movements of stocks
Completely impossible to predict price movements of bonds
To invest in bonds the investor must value them using…
Amortized cost
Best deals in convertible bonds
Found during bear markets and in securities with credit ratings
Below the best
The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is…
Transforming his basic advantage into a basic disadvantage
The investor has the full freedom to choose whether or not
To follow mr market, you have the luxury of being able to think
For yourself
Graham: the primary cause of the failure of investors
They pay too much attention to what the stock market is doing currently
What do investors control and what do they not control
Investors do not control short term fluctuations of the market
Investors control: brokerage costs, mutual fund fees, their expectations (using realism not fantasy), risk (rebalancing, asset
Allocation), taxes, behavior
What returns did investors who received constant news updates get compared to investors that received no news at all?
Investors that received constant news updates got half the return that investors got who received no news at all
When can selling into a bear market make sense?
When it creates a tax windfall
