Monday, May 2, 2011

Benjamin Graham (1)

WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK.  FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON

Like Philip Carret, Ben Graham believed that the best approach for an investor was to view his or her stock portfolio as a business and to purchase stocks in a businesslike manner.  He advised the individual investor to ignore the fluctuations of the market and to value a stock strictly on the financial condition of the company.

Mr. Graham likened the market to a voting machine in which investors cast their cash ballots for the most popular investment candidates.  He felt that ultimately the market becomes a weighing machine, i.e. a scale, measuring the economic "weight" or value of stocks and setting prices accordingly.  He advised investors to find the stocks with market prices below the financial worth of the companies they represent.  He wanted individual investors to buy those stocks and wait for the market to accurately "measure" the company's value.  At that point the market would bid the company's stock price up to or beyond the company's value calculated by the investor, resulting in a profitable sale.

By finding companies worth more than their market price by a significant amount, the investor could enjoy Graham's "margin of safety", thereby avoiding substantial losses.  Ben Graham recommended viewing a stock not as a market bet, but rather, as a minority ownership in a business.  The price paid for that ownership, if too high, would never lead to a profit because the business could not ultimately justify the amount paid.  The true investment value of the stock is based on "how much" the investor pays for it at the time of purchase.

An excellent example of this was the price commanded by Cisco Systems, Inc. in the late 1990's.  Cisco is the world's largest manufacturer of computer networking routers and switches.  Cisco's stock price was over $50 per share at the peak of its popularity during the Internet bubble.  When the bubble burst, Cisco's market price plummeted with its popularity to as low as $18 per share.  The financial condition of the company did not actually deteriorate as much as its stock price.  Cisco's business continues to grow with the Internet, but it has not been quoted at a price much higher than the low to mid 20's since it touched $18 per share.  I doubt any investors who bought Cisco during the bubble (assuming they still own it) will live long enough to see Cisco once again priced at $50 per share.  The price paid today does, indeed, determine the profit to be made tomorrow.

In the next blog, we will learn some of the financial characteristics Mr. Graham looked for in companies in order to maintain his recommended "margin of safety."

Your comments are always welcome.

No comments:

Post a Comment