Intelligent Investor Ch. 9-11 Flashcards
Dual purpose funds
Popular in the late 1980s have disappeared
Hopefully they will come back, because they put great stock
Picking on display
Closed end mutual funds
The number of shares remains relatively constant
Graham: selecting mutual fund managers
Studies indicate that an investor can seek comparative
performance over a period of years in the past, at least 5 yrs.
As long as this there was not a strong upward movement in
The stock market, as fund managers could get unconventional
profits
Large mutual fund performance
If managed soundly, you can only expect them to beat the s&p
By a small margin
When do mutual funds usually outperform the market
When they are in specialized fields and are closed to the public,
With self imposed limits
Herding
When all the mutual fund managers own the same companies
Finding the best mutual funds
1 the managers own most of the fund 2 low fees 3 different holdings than an index fund 4 they shut the door 5 they don't advertise
Best time to sell a mutual fund 4 things
1 sharp and unexpected change in strategy (value fund loads up
On tech stocks in 1999)
2 increase in expenses
3 large and frequent tax bill from excess trading
4 suddenly erratic returns (conservative fund generates large loss,
Or even huge gain)
How long should you be prepared to stick with a mutual fund through a period of lean performance?
3 years, patience is the investor’s ally
How is the investment of money in securities unique among business operations?
Almost always based on some advice received from others
Investment services that provide useful data and advice for security analysis?
Moody’s Investment Service and Standard & Poor’s
Investment services are good when they have a reputation for…
Analyzing whether a stock appears over or undervalued at its
Current price as indicated by Longterm future earning power
Most CFA’s do not analyze businesses, instead they…
Engage in guesswork on future stock prices
Where can individual investors find analyst research reports?
Zachs.com and multex.com
What is necessary when dealing with a CFA, to gain the most valuable advice?
Show the CFA that you are value oriented instead of quotation
oriented
Securities Investor Protection Corporation (SIPC)
Investors are generally assured recovering their full account values
if their brokerage firm becomes insolvent
Underwrite (in investment banking)
To guarantee to the issuing corporation, or other issuer, that the
Security will be fully sold
Recommendations from reputable investment banking houses
Recommendations should be considered by the investor
Worthwhile investment subscription for financial analysis?
Association for Investment Management and Research: Financial Analysts Journal
What time frame does the security analyst deal with for a given security issue?
Deals with the past, present and future
What does a security analyst report on? 7 things
1 describes the business (operating results + financial position)
2 sets forth strong and weak points
3 possibilities and risks
4 estimates it’s future earning power under various assumptions
5 compares company to competitors or same company at
Different times
6 expresses safety of issue if bond/preferred stock
7 describes attractiveness of purchase if common stock
Standards of safety of a bond or preferred stock are measured by? 4 things
1 primarily past average earnings
2 capital structure
3 working capital
4 asset values
The more dependent a valuation becomes on anticipations of the future and the less it is tied to the figure of demonstrated past performance…
The more vulnerable it becomes to possible miscalculation
and serious error
Growth stocks relying on high rates of future earnings growth
Are most prone to risks and error
Graham’s experience with valuations with 44 years of Wall Street Experience
He’s never seen dependable calculations made about common
stock values or related investment policies that went beyond
Simple arithmetic
Usually elementary algebra, when calculus or higher algebra
Is brought in this is speculation
The chief criterion used for safety/quality of corporate bonds
# of times total interest charges have been covered by available Earnings for years in the past
The chief criterion used for safety/quality of preferred stocks
Number of times bond interest and preferred dividends have
Been covered
What are the 2 means for measuring the minimum ratio of earnings to total interest charges?
1 Average earnings of past 7 years
2 poorest years earnings
Either test is sufficient
3 other safety tests applied to bonds
1 size of enterprise
2 stock/equity ratio
3 property value
Stock/ equity ratio
Ratio of: market price of the common stock/total face Amount of debt
Senior to common stock
Preferred stock is senior because all dividends must be paid
To preferred before they are paid to common stock
Junior stock issues
Shares of common stock
What is the stock to equity ratio a measure of
Measure of protection or cushion afforded by the presence of
Junior investment that must first bear the brunt of unfavorable
Developments
This factor includes the market’s appraisal of future prospects
Of the enterprise
In most cases what does safety of a security rely on?
Earning power
What happens to the company’s asset values if earning power is deficient?
The assets lose most of their reputed value
In what 3 groups do asset values retain importance in a separate test of ample security for bonds and preferred stocks?
1 public utilities
2 real estate concerns
3 investment companies
Investment history shows that bonds and preferred stocks that have met stringent tests of safety, based on the past have in a majority of cases…
Have been able to face the vicissitudes of the future successfully
History shows that an investor should confine purchase of industrial bonds and preferred stocks to companies that
Are of major size and have shown the ability to withstand
depressions
Valuation of common stock
Found by estimating average earnings over a period of years
In the future and then multiplying the estimate by an appropriate
Capitalization factor
A great investment service that forecasts the future of earnings and dividends?
Value line
Considerations for the multiple of earnings paid for a company: general long term prospects
No one knows what will happen in the future but analysts and
Investors have strong views that are reflected in PE rations
When high PE ratios are dictated mainly by past performance
They are as likely to be wrong as right
Good management will be evident in
1 past record
2 it will show in estimates for next 5 years
3 and in long term prospects
Considerations that enter into divergent PE multiples. 5
1 general long term prospects 2 management 3 financial strength and capital structure 4 dividend record 5 current dividend rate
Financial strength and capital structure
A stock with a surplus of cash and nothing ahead of common
Is a better purchase than another stock with large bank loans
And senior securities
Leverage
Too little common stock in relation to bonds and preferred may
Under favorable conditions make a huge speculative profit in
Common
Dividend record
One of the most persuasive tests of high quality is an uninterrupted
Record of dividend payments going back over many years
Continuous dividend record over 20 years is a plus for the
Defensive investor
Dividend payout ratio of the s&p in 2000
25.3%
Any scientific or reasonably dependable stock evaluation based on anticipated future results must take what into account?
Future interest rates
Industry analysis
Security analysts devote much attention to economic position of
Industry and individual company in industry
These factors are not always fully appreciated by the market,
When this conclusion is drawn it affords sound basis for
investment
What are three things an analyst can do to research?
1 field trips
2 interviews with research men
3intensive technological investigation
Two part appraisal process
1 work out past performance value (based only on past record)
2 extent value based solely on past performance should be
Modified because new conditions expected in the future
Past performance record
Assumes that it’s relative past performance will continue
Unchanged in the future
Relative growth rate over last 7 years will continue over next 7
Years
The intelligent analyst should confine himself to groups in which the future is reasonable predictable
Industries not affected by unforeseeable changes in interest rates
Or future directions of commodity prices
Industries include gaming, cosmetics, alcoholic beverages,
Nursing homes, waste management
3 steps to procedure for 2 part appraisal process
1 set up formula to apply to all companies based on past
Performance value
2 work up factors that affect the companies
3 determine what elements of company’s performance is
Likely to differ from past record
What 2 questions do you ultimately want to answer when looking over a company’s 10-K
1 what makes this company grow?
2 where do and where will its profits come from?
Red flags to look for in the 10-K
1 company is a serial acquire, average of more than 2 major
Acquisitions per year
2 OPM activities: excess debt or issuing new stock
3 a company relies on 1 or very few customers to generate
Most of its revenues
Argument against serial acquirers
Bad if a company would rather buy stock of other businesses
Than invest in its own
What should an enterprising investor look over aside from 10-K’s
1 years worth of 10-Q’s
Where can an investor find information of acquisitions in the 10-K
Under “Management’s Discussion and Analysis”
What is bad to see in a company’s statement of cashflows? What does it signify.
Cash from operating activities is consistently negative, while
Cash from financing activities is consistently positive
2) The company craves more cash than its businesses can
Produce
Positives to look for in the 10-K
1 company has a wide moat/competitive advantage
2 the company grows earnings smoothly not erratically
3 company engages in useful R&D
How are high margins created
1 strong brand identity 2 monopoly power 3 economies of scale (ability to supply large quantities cheaply) 4 trade secrets 5 resistance to substitution
Resistance to substitution
Most businesses have no alternative to electricity so utility
Company’s are unlikely to be supplanted any time soon
Evaluating the quality of management’s conduct
Read past annual reports to see if the forecasts managers made
We’re fulfilled or fell short
Managers should admit their failures instead of blaming the “economy”, “uncertainty” or weak demand
Check whether chairman’s letter…
Stay constant or fluctuate with the latest fads of Wall Street
Management and stock options
Stay away from company’s that reprices or reissues or exchanges
It’s stock options to insiders
If option’s value are never allowed to go to 0, while their potential
Profit is always infinite, how does this encourage good stewardship
Or corporate assets?
Looking up options
Look at the mandatory footnote about stock options,
you should Factor in potential flood of new shares from options
when you estimate a company’s future value
What form on the EDGAR database at sec.gov shows whether a firm’s senior executive directors have been buying or selling shares?
Form 4
Graham on managers and stock price
Managers should keep the stock from going too low or too high
Earnings guidance
Better when company’s refuse to give earnings guidance or
Give low estimates
What form should be you view on the EDGAR database to find out if a company fairly communicates with it’s investors
8-K filings made by Expeditors International of Washington
Posts superb question and answer dialogue with investors
When are a company’s accounting practices not shareholder friendly?
1 non recurring charges keep recurring
2 extraordinary items crop up often
3 EBITDA and pro forma earnings are used to cloak actual losses
Most basic possible definition of a good business
It generates more cash than it consumes
Good managers and cash
Good managers keep finding ways of putting cash to productive
Use
Companies that generate more cash than they consume and that have managers that keep finding ways to put that cash to use. These companies are…
Are certain to grow in value over the long run, no matter what the
Stock market does
Evaluating financial strength
Start with the statement of cashflows and see whether cash
From operations has grown steadily throughout the last 10 years
Determine owner earnings
Owner earnings, equation
Owner earnings =
net income + amortization + depreciation - normal capital expenditures
- granted stock options - non recurring/extraordinary charges
- income from company’s pension fund
How does Christopher Davis of Davis Selected Advisors characterize owner earnings?
If you owned 100% of this business how much cash would you
Have in your pocket at the end of the year
What owner earnings per share growth over the past 10 years make a company a stable generator of cash with good prospects?
Growth of 6-7% per year
What should you look up about debt?
In footnotes whether the debt is fixed rate or variable (costly when
Rates rise)
What’s important to determine in a company’s capital structure on the income statement?
The ratio of the company’s earnings to its fixed charges
When can a firm justify not paying a dividend
If the firm consistently outperformed competition in good markets
And bad
When should company’s buy back their shares?
When should it not, and why is this done?
When they are cheap
A company should not buy back shares when it’s overpriced,
But this is done so managers can cash in on stock options
Destroying shareholder value
