I am an avid reader of John Mauldin (one of his 1.5 million closest friends, as he puts it).His weekly mail is a must-subscribe for any investor.
I’m a bit behind on my reading material, so just a couple of days ago I finished reading his “Out of the Box” article, which was written by James Montier (never heard of him, but I’m definitely going to add his blog to my reader and probably buy The Little Book of Behavioral Investing). The following sentence caught my eyes and I think it is so true that I must pass it on, if at least one of my readers (do I have more than one?) stops listening to economists and starts thinking by himself, I will be very happy.
“ attempting to invest on the back of economic forecasts is an exercise in extreme folly, even in normal times. Economists are probably the one group who make astrologers look like professionals when it comes to telling the future… economists are simply useless when it comes to forecasting. They have missed every recession in the last four decades! And it isn’t just growth that economists can’t forecast: it’s also inflation, bond yields, and pretty much everything else.”
Having said that, it is now time to say good night.
One of the things that I do in my spare time (competing with caring for 3 children, loving my wife, programming, reading and knitting) is stock analysis for investment purposes. With all of the other competing hobbies (specifically the kids), I don’t have much time to do this, but when I get to analyze a company it is a very fulfilling work.
So, how did I learn to do this? well, first of all I started “investing” about two years ago. I say “investing” since what I was really doing was betting on the stock exchange. And bad bets I did – I lost about 10% of my money, which is not much but as you may have read in an earlier post of mine, my reactions to losses are not pretty good. At about the same time my father-in-law started sending me the great newsletters of John Mauldin (which is free, you can subscribe to them here and here), and I began to understand that I had to learn more. And since reading is also one of my hobbies, this was a win-win situation. I read two Mauldin books (“Just One Thing” and”Bull’s Eye Investing“ which you can obviously buy at amazon), and from there continued reading “The Snowball” (A biography of Warren Buffett) which directed me to the great and basic book for all value investors, “The Intelligent Investor” by Benjamin Graham. My conversion was finished.
Since this post is getting a bit long, let’s just point out the basics filter done by Graham for a defensive investor:
- First of all learn how to invest. Start by investing most of your money on a simple investment (like an index fund which are largely available today) and leaving a small amount to stock picking. When you think that you have learned the trade, increase the amount of money you invest using stock pickings.
- Invest in enterprises that have:
- Adequate size: in the days when Graham revised his book he proposed at least $100 million annual sales, today after forty and using the inflation calculator provided by the US Department of labor, this would amount to $500 million more or less.
- Strong financial condition: the company’ current assets should be at least twice the current liabilities, and long term debt should not exceed current assets. This leaves you will enterprises that owe relatively little compared to what the own.
- Earnings stability: some earnings in the past ten years.
- Dividend record: uninterrupted dividend payments in the past 20 years.
- Earning growth: at least 33% earning growth in the last 10 years. This is pretty moderate and may be raised by a more defensive investor.
- Moderate P/E (price/earnings): a P/E of 15 should be the highest you should go (The average US equity P/E ratio between 1900 and 2005 was 14, which means that graham wants you to buy companies with below average P/E). As Mauldin says a lot, the stock market is a voting machine in the short run, but in the long run is a weighting machine, and the P/E always returns in the long run to it’s average.
- Moderate P/B (price/book): current price should not be more than 1.5 times the book value of the company. When this happens a company has real assets and it’s book don’t contain outrageous amounts of intangible assets that being intangible you can never really know their value.
- Do your homework! Learn about the company you are investing in, in what market it works, how are it’s competitors. When you buy a stock you don’t buy a piece of paper, you become part owner of the company. Behave as such.
I think this is enough for today. My next post on the subject will include the guidelines for the more enterprising investor (who has more risks but gets better rewards), and maybe other things.