Friday, April 2, 2010

The Intelligent Investor (Part 4): Security Analysis

As noted in the previous post, the Intelligent Investors have these traits:

- They see stocks as businesses - when you buy a stock you become an owner of that company
- They recognize two basic patterns the market has in unsustainable optimism and unjustified pessimism - both extremes are wrong so maintain a level head during bubbles and crashes
- They understand future value is a function of present price - the higher price you pay, the lower the return you will be
- They maximize margin of safety - never overpaying for a stock and reducing risks
- They develop discipline and courage - recognizing that your biggest enemy is yourself and not to be swayed by the market or other people's moods. You decide your fate.

Page 288 outlines a valuation technique for lay investors.

The ideal form of common-stock analysis leads to a valuation of the issue which can be compared with the current price to determine whether or not the security is an attractive purchase. This valuation, in turn, would ordinarily be found by estimating the average earnings over a period of years in the future and then multiplying that estimate by an appropriate "capitalization factor".

Factors Affecting Capitalization Rate:
- Long Term Prospects - we can't predict the future, but we can have educated guesses. we can expect our population to grow, we can expect need for more resources, continued use of automobiles, gasoline, etc. we can expect a certain amount of computers being used, mp3 players, ipads, etc. Use some of these data to see how your company will grow
- Management - By looking at who is in charge allows you to see what direction a certain company is headed
- Financial Strength and Capital Structures - look at cash on hand, debt, etc. how is the company using it's resources.
- Dividend Record - whether or not company is giving a consistent dividend over time
- Current Dividend Rate - whether or not the dividend is increasing over time.

Graham uses this formula to estimate value (p.295):

Value = Current Earnings * (8.5 + 2 * expected annual growth rate)

So is your company a value compared to its current price and market cap? Buying companies at a discount means knowing you are getting a deal. By knowing it's earnings you can figure out when your company is growing as expected or out of hand.

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