We all like common stocks but in this part of the economic cycle we should also be defensive and therefore it is a perfect time to discuss Chapter 5 of Benjamin Graham’s book The Intelligent Investor – The defensive investor and common stocks.
Q1 hedge fund letters, conference, scoops etc, Also read Lear Capital: Financial Products You Should Avoid?
The topics discussed are:
- Four rules to follow when buying stocks
- Growth stocks
- Dollar cost averaging
- Investor’s personal situation
The Intelligent Investor Book Summary - Chapter 5 - Common Stocks
Transcript
Good day for investors. Welcome to the summary of the whole book The Intelligent Investor today we discussed Chapter 5 common stocks for the defensive investor. So if you are if you've had enough of the risks if you want to be defensive if you want to protect what you have and have a nice healthy return over the long term then this video is for you. The topics we are going to discuss today are four rules to follow when buying stocks. What about growth stocks and the defensive investor. Dollar cost averaging and the investor personal situation when it comes to investing. So Graham starts the chapter by discussing how in 1949 nobody wanted to look at stocks because they were considered highly speculative and the return over the last 20 years from 1929 was still very very negative. That was a great time to buy stocks. Then he discusses 1969. Everybody was very very excited about stocks looking to get into the stock market. Everybody was trading and it was a bad time to enter into stocks because then it took again. I think what 30 years for positive real returns some are in 1990 something so 23 years. So it's again the case of when you invest what is everybody else doing. And if you look it over the long term investment cycle how that feels risky when you are doing what everybody else is doing. So therefore he was not so enthusiastic about stocks in 1971 because of the high valuation.
Nevertheless he says that at each point in time we have to always be exposed to common stocks because you never know you never can really time DeMott market what you can do is allocate more to bonds or cash and less to stocks. Depends on the stock market risk in order to be more defensive. However on stocks he says that stocks have protected people from inflation over the long term that they have delivered positive returns. But those benefits from the stock market get erased. If you pay too much for stocks. That's what I said from 1929 it took 25 40 years for stocks to regain that momentum and that was the case from 1969. Now what was the case in 1971 the price to earnings ratio was eighteen point twelve and Grant didn't like stocks and you can see that it took a long time again for variations to come to those levels. Now the price earnings ratio is much higher so we could say that Graham wouldn't be enthusiastic about stocks now. However it's important to note that in 1971 the yield on the 10 year Treasury was above 6 percent which made stocks even more expensive. Now the yield is two point eighty seven percent which makes stocks look a bit better but still definitely not cheap especially if yields continue to grow go up. And it is now flirting with 3 percent as I am feeling this inflation was already 5 percent. So the situation for Bonds was similar to the current situation where yields are close to the inflation yield. Let's go to the four rules that Graham says if we follow we should have no fear when investing in stocks even in the long term but always with the proper portfolio allocation first adequate but not excessive diversification.
So he says minium often stocks and the maximum of 40 stocks and use of them by only large prominent companies with low that risk not more than 50 percent of that leading industry position. So a real leader in the position. Big mouth and have a large and in this case when I reassess it for the current market valuation larger than 20 billion market cap each company should have a long record of continuous dividend payments at least 20 years and you should put a limit to the price you're willing to pay in relation to the earnings average over the past seven years where the limit is 25 for the average earnings and 20 for the current earnings. I think in this market we could find such great companies with great dividends with great earnings with great brands leader in companies and the ones that perhaps might fit that description is Kraft Heinz which we are going to discuss in the Sanday stock analysis now on growth stocks. Graham doesn't like growth stocks for the defensive investor because the defensive investor doesn't have time to check the market every day doesn't know when to sell a growth stock when to buy. So it's more like a defensive investor will find the money growing on trees then making money over the long term on growth stocks. If which check to the Amazon chart it's up almost 500 percent over the last five years. And now you never know whether this will continue or not.
If earnings contract the growth rate which is expected to be around 25 percent contracts to 20 and then earnings also contract then Amazon is a very very risky stock and Grant compares this to IBM that lost 50 percent twice in the 1960s.
