WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
The collective careers of Phillip Carret, Benjamin Graham, Al Frank and Warren Buffet span almost 100 years in the stock market. The similarities among their respective investment strategies are striking. In this and the next blog, I will try to list some of those areas of consensus. A list of those financial attributes on which all four men agreed could be used by an individual investor as a basis for selecting stocks for his or her portfolio based on fundamental value principles.
All four of them invested in companies, not stocks. The first rule was that any investment analysis be conducted in a business like manner. They each ignored what the market crowd said about a stock. They wanted to understand a company's business; the product or service the company provided to its customers and its financial condition. As Warren Buffett told his shareholders, he approached an investment in a publicly traded stock as if he were going to buy the entire company. Carret, Graham and Frank each started their individual stock analyses in much the same way.
Carret, Graham and Frank discussed asset allocation, i.e., the division of an investment portfolio between equities and bonds. In general, they all recommended approximately a 50/50 split between stocks and bonds. You may remember that I mentioned an allocation based on an investor's age in an earlier blog, with the investor's age representing the amount of the portfolio being invested in income producing securities, bonds, and the balance, after subtracting his or her age from 100, in stocks.
Diversification was also recommended by them. Buffett took the counter position, suggesting that an investor concentrate his or her purchases in a small number of stocks. Carret, Graham and Frank recommended diversification with ownership in 10 to 30 different stocks, in a wide range of industries. In my earlier blog on Al Frank's New Prudent Speculator, I mentioned Mr. Frank's rule that no company should represent more than 5% of the total value of an individual's holdings. Following this rule would result in an investor holding at least 20 different stocks, which should be in as many different industries. Buffett agreed with Al Frank on time diversification, i.e., longer holding periods reduce overall market risk. Warren Buffett told his Berkshire Hathaway shareholders that his preferred holding time for an investment was somewhere close to "forever."
Another metric they all mentioned is a stock's price/earnings ratio ("P/E"). A company's P/E is very much like the price per pound for food. The lower the P/E, the cheaper the purchase, regardless of the actual dollar price of the stock. A stock selling for $80 per share with a P/E of 10 is cheaper than a stock selling for $40 per share with a P/E of 15. The actual price for a dollar of earnings is one of the easiest ways to measure what an investor is actually paying for shares. Warren Buffett looks at a company's P/E to see if the company has an "attractive price." Just like the price per pound for hamburger, a P/E reflects how expensive the stock is. The lower the better. However, an individual investor can not just pick stocks with low P/Es, since in some instances the market may have correctly evaluated the company as a bad investment and given it a low P/E ratio. The P/E ratio is only one of several metrics that must be used to find a promising investment.
We will continue with this list of their recommended attributes for an investment in the next blog.
I welcome your comments.
No comments:
Post a Comment