Investing for Beginners

Hey Guys,

Ever wanted to invest? I got you. Over the past 4 days I’ve been reading the book “the intelligent investor” by Benjamin Graham. This book is all about investment wisdom and strategies that have stood the test of time.

Disclaimer: this is no investment advice from my side. I only summarize what the book “the intelligent investor” by Benjamin Graham is telling us to do.

Before we dive into the details, let's first understand some key terms that are central to Graham's philosophy.

Key Terms *

1. Security Analysis: This is the process of examining and evaluating the various factors affecting the value of a security, such as a stock or bond. It involves studying the company's financial statements, industry position, and market conditions.

2. Margin of Safety: This is a principle that involves buying securities at prices significantly below their intrinsic value, which provides a safety net for the investor against errors in judgment or unforeseen market downturns.

3. Mr. Market: A metaphorical character created by Graham, Mr. Market is an erratic, emotional investor who offers to buy or sell shares at different prices each day, illustrating the irrational behavior of the market.

4. Intrinsic Value: This is the actual value of a company or a stock, determined through fundamental analysis without reference to its market price.

5. Bond: A bond is a fixed income instrument that represents a loan made by an investor to a borrower, typically corporate or governmental.

*you can find more key terms at the end of this post

Defensive Investor vs. Enterprising Investor 💼

Graham categorizes investors into two types: defensive and enterprising.

A defensive investor is one who wants to avoid serious errors and secure a reasonable return on their investments. They are not interested in spending a significant amount of time researching and managing their portfolio.

On the other hand, an enterprising investor is willing to devote time and effort to select securities that are sound but less popular. They are more involved in the process and are willing to take more risks for higher returns.

Stock Picking Strategy for the Defensive Investor 🔎

For the defensive investor, Graham suggests a diversified approach to investing. He recommends a portfolio split between high-grade bonds and leading common stocks for the longterm. Here are some criteria he suggests for picking stocks:

1. Adequate Size of the Enterprise: The company should be large and prominent, as these companies have more resources to weather economic downturns.

   1. Not less than 2 billion of annual sales for an industrial company

   2. Not less than 1 billion of total assets for a public utility

2. Sufficiently Strong Financial Condition: The company should have a healthy financial status, with more assets than liabilities.

   1. For industrial companies: Assets should be at least twice current liabilities

   2. For industrial companies: Longterm debt should not exceed the net current assets

   3. For public utilities: Debt should not exceed twice the stock equity

3. Earnings Stability: The company should have some level of earnings stability, having posted profits for at least the past five years.

   1. Some earnings for the common stock in each of the past 10 years

4. Dividend Record: The company should have a consistent record of paying dividends.

   1. Uninterrupted payments for at least the past 20 years

5. Earnings growth: A minimum increase of at least one third in per-share earnings in the past 10 years using thee year averages at the beginning and end.

6. Moderate Price-to-Earnings (P/E) Ratio: The price of the stock should not be too high when compared to its earnings.

   1. Current price should not be more than 15x average earnings of the past three years

7. Moderate Ratio of Price to Assets: The price of the stock should not be too high when compared to the company's net assets.

   1. Current price should not be more than 1.5 times the book value last reported

   2. The product of the multiplier times the ratio of price to book value should not exceed 22.5

Brookfield Corporation Example

Let's consider an example of a defensive investor's stock picking strategy using the principles outlined by Graham. We'll use Brookfield Corporation (BN) as a real-world example.

1. Adequate Size of the Enterprise: Brookfield Corporation is a large, multinational company with over US$725 billion of assets under management in 2022. This indicates that it has the resources to weather economic downturns.

2. Sufficiently Strong Financial Condition: Brookfield has a total shareholder equity of $163.3B and total debt of $226.6B, which brings its debt-to-equity ratio to 138.8%. While this ratio is considered high, Fitch Ratings has affirmed Brookfield's rating at 'A-' with a stable outlook, indicating a solid liquidity profile.

3. Earnings Stability: Brookfield has shown strong earnings, with distributable earnings of $5.0 billion for the last twelve months. This indicates a level of stability in its earnings.

4. Dividend Record: Brookfield has an annual dividend of $0.28 per share, with a forward yield of 0.73%. The dividend is paid every three months, indicating a consistent dividend record for the last 20 years.

5. Earnings and Growth: Brookfield share did increase more than one third per share. In 2014 standing at 16.86$ and today at 38.52$ per share.

6. Moderate Price-to-Earnings (P/E) Ratio: The P/E ratio for Brookfield is not readily available. However, the company has been rated as a 'Moderate Buy' by Wall Street analysts, suggesting that the stock may be reasonably priced.

7. Moderate Ratio of Price to Assets: Brookfield's total assets are valued at $463.1B. Given the company's market capitalization of $81.66B, this suggests a moderate price-to-assets ratio.

It's important to note that investing always involves risks, and it's crucial to do thorough research and consider seeking advice from financial professionals before making investment decisions.

Important Takeaways

"The Intelligent Investor" emphasizes that investing is not about beating others at their game. It's about controlling yourself at your own game. This means focusing on what you can control – your own behavior, your own research, and your own decisions.

Graham also stresses the importance of the margin of safety. By always purchasing with a margin of safety, the investor can safeguard themselves against significant losses.

Graham's Mr. Market metaphor serves as a reminder that the market can be irrational. Investors should not be swayed by market fluctuations, but instead focus on the intrinsic value of their investments.

Lastly,

1. Invest in Companies, Not Stock Tickers: A stock represents an ownership interest in a real business. Therefore, it's crucial to understand the business you're investing in, its financial health, and its prospects for the future.

2. Make Investments Objectively: Intelligent investors make decisions based on thorough analysis and facts, not on market hype or fear.

3. Diversification: Spreading investments across a variety of securities can help mitigate risk. Graham advises not to put all your eggs in one basket.

4. Patience and Discipline: Successful investing requires patience and discipline. Avoid making impulsive investment decisions based on hype or fear. Trust in your research and stay focused on your long-term goals.

I hope you learned more about investing and maybe pick few stocks based of this technique. And remember,

Today’s defensive investor can do even better—by buying a total stock-market index fund that hold essentially every stock worth having. A low-cost index fund is the best tool ever created for low-maintenance stock investing—and any effort to improve on it takes more work than a truly defensive investor can justify.

Cheers

Jonas

More Key Terms

1. Liquidity: The ease of buying or selling an asset without causing a significant change in its price. High liquidity means an asset can be easily traded, while low liquidity implies challenges in selling without affecting its value.

2. Volatility: The degree of variation or fluctuation in the price of an asset over time. Higher volatility indicates greater potential for rapid and unpredictable price changes, while lower volatility suggests more stable price movements.

3. Capital Gains: Profits generated from the sale of an investment or asset that has appreciated in value since its purchase. Capital gains can be realized when the selling price is higher than the purchase price.

4. Yield: The income earned from an investment over a specific period, often represented as a percentage of the investment’s cost or current value. It can refer to dividends from stocks or interest payments from bonds.

5. Expense Ratio: The percentage of a fund’s assets used to cover its operating expenses. It reflects the annual fees investors pay to the fund manager and impacts overall returns.

6. Bull Market: A financial market characterized by rising asset prices, investor optimism, and economic growth. It signifies a sustained increase in asset values over an extended period.

7. Bear Market: Opposite of a bull market, a bear market refers to a period of declining asset prices, widespread pessimism among investors, and economic slowdown. It typically involves a sustained decrease in asset values.

8. Portfolio: A collection of investments held by an individual or entity, comprising various asset classes (stocks, bonds, real estate, etc.) aimed at achieving specific financial goals.

9. Derivatives: Financial instruments whose value is derived from an underlying asset, index, or reference rate. Examples include options, futures, and swaps, often used for hedging or speculation.

10. Earnings Per Share (EPS): A company’s net profit divided by its total outstanding shares. EPS reflects a company’s profitability and is a crucial metric for investors assessing a company’s performance.

11. Asset Class: A group of securities or investments that exhibit similar characteristics and behave similarly in the financial markets. Common asset classes include stocks, bonds, cash, and real estate.

12. Market Capitalization: The total value of a company’s outstanding shares in the market, calculated by multiplying the current share price by the total number of outstanding shares. It determines a company’s size in the market.

13. ROE (Return on Equity): A financial ratio indicating a company’s profitability by measuring how effectively it generates profits from shareholders’ equity. It’s calculated as net income divided by shareholders’ equity.

14. PE Ratio (Price-Earnings Ratio): A valuation metric used to assess a company’s stock price compared to its earnings per share. It’s calculated by dividing the current stock price by EPS.

15. Bond Yield: The return on a bond investment, expressed as a percentage of its current market price. It includes both interest payments and any potential capital gains or losses if the bond is held until maturity.

16. Inflation: The rate at which the general level of prices for goods and services rises, eroding purchasing power over time. Inflation impacts the value of money and investment returns.

17. 401(k): A retirement savings plan offered by employers in the U.S. that allows employees to save and invest a portion of their salary before taxes are deducted.

18. Annuity: A financial product provided by insurance companies that guarantees regular payments to an individual over a specified period, often used as a retirement income source.

19. Hedge Fund: An investment fund managed by professionals that use various strategies, including leveraging, short-selling, and derivatives, aiming for higher returns (often for high net-worth individuals or institutions).

20. Index Fund: A type of mutual fund or ETF designed to track the performance of a specific market index (like the S&P 500) by holding the same securities in the same proportion as the index it mirrors.

21. Funds: Pools of money from multiple investors managed by professionals who invest in stocks, bonds, or other assets.

22. Bonds: Loans made by investors to entities (like governments or corporations) for a fixed period, with periodic interest payments and repayment of the principal at maturity.

23. Stocks: Represent ownership in a company, bought and sold on stock exchanges. Stock prices fluctuate based on company performance and market conditions.

24. Mutual Funds: Professionally managed investment pools that offer diversification by investing in a variety of securities like stocks, bonds, or a mix of assets.

25. Exchange-Traded Funds (ETFs): Similar to mutual funds but traded on stock exchanges. ETFs track specific indexes or assets and can be bought or sold throughout the trading day at market prices.