WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
You may recall my blog, Gold Mining, Hang Gliding and Power Walking. We started exploring fundamental analysis, gold mining, in April of this year. We have looked at Philip Carrett's work, The Art of Speculation; Benjamin Graham's classic, The Intelligent Investor; Al Frank's book, Al Frank's New Prudent Speculator; Philip Fisher's Common Stocks and Uncommon Profits, among others. If you consider how many financial characteristics they all mentioned, you can probably come up with a fundamental formula for your own investment strategy. Here are some of the consensus ideas:
1. Buy companies, not stocks. They all agreed that investing should be conducted in a business like manner; based on financial facts, not emotion.
2. Diversify. Each author suggested investing in a number of companies. Al Frank recommended that no one stock should account for more than 5% of an investor's total equity portfolio. Mathematically, this means that a well rounded portfolio would hold approximately 20 stocks in different industries.
3. Earnings and dividend growth. Everyone recommended companies with histories of, at least, three and, preferably, five years of both earnings and dividend growth. Philip Fisher looked for companies with earnings which exceeded the market's overall earnings growth. When looking at dividends, the investor must also check the payout ratio, i.e., how much of each dollar of earnings is distributed to shareholders. A lower percentage indicates that the dividend is safer than the dividend of a company which distributes a large percentage of its earnings to its owners.
4. Low debt and high return on equity. When hard times hit, the company with a small percentage of debt in its capital structure has a better chance of weathering the down turn. Although they do not all agree on an acceptable amount of debt, you get the sense that a company whose capital consisted of 70% equity and 30% debt would be one that these investors would consider a solid investment opportunity. A return on equity (ROE) of 20% is considered a sign of a good company.
5. Avoid a high price/earnings (P/E) ratio. The lower the P/E, the cheaper the stock's earnings. The P/E measures how much an investor is paying for each dollar of earnings. David Dreman pointed out that a high ratio is usually an indication that the market crowd has taken over and the price is being bid up based on frenzy, not finances. Some companies might deserve a low P/E due to poor performance or business prospects; so an investor can not rely solely on this ratio.
6. Be patient and invest long term. All of the authors recommended viewing investments as long term commitments. Warren Buffett said his time line for holding a stock was "forever." Al Frank cited research that concluded that the volatility of the market is taken out of play if an investor holds his or her stocks for years, not weeks or months. He referred to this as time diversification. Each one also counseled investors to maintain patience, ignore market gyrations and stick with their investment strategy.
With this summary, we conclude our study of fundamental analysis. Reading the books written by these investment greats will provide an individual with the necessary information with which to formulate his or her personal fundamental investment strategy.
Comments are always welcome. I just published and replied to two recent comments from readers; one of which commented on Stocks and Used Cars. The other one was a comment on On-Line Brokers: Stock Screens and Stock Research.
We investigated the "Inner Investor" in earlier blogs. In the next blog, we will look at a topic related to an investor's personality.
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