Benjamin Graham has served as the inspiration and intellectual mentor for generations of value investors.
Many successful careers have been launched by a reading of the Intelligent Investor. Many others have perfected the art and science of investing by studying the classic editions of Security Analysis. Investors like Walter Schloss, Peter Cundill, Michael Price and of course Warren Buffett have found their inspiration in Graham’s work — and his theories provided the basis of much of their long term success.
In spite of all this, very few investors use the lessons provided by the father of value investing to achieve success in the stock market.
The Fallacy Chasing ‘Winning’ Stocks
Most investors appear to be content to chase the hot issues of the day, and to trade the same securities everyone else is buying. Most often they resemble swing traders more than investors, as they move from stock to stock, in search of the magic winning stock that will make the difference in their net worth and lifestyle.
History tells us this approach is doomed to fail, but it still appears to be the preferred approach used by most individual investors. Worse still, they have a tendency to take small profits, to enjoy the experience of winning, while holding losers in the hope they will come back to breakeven someday. With no idea of what the stock is actually worth as an ownership interest in an ongoing business, this is a recipe for disaster.
1. Work Towards Business-Like Investing
After a five-year market advance that has lifted stock almost three times the bottom price reached in 2009, it might be wise to consider what Graham said in his book, The Intelligent Investor. He told readers that investing worked best when it was most business-like. He elaborated on that business-like process in the chapter on market fluctuation.
“Why could the typical investor expect any better success in trying to buy at low levels and sell at high levels than in trying to forecast what the market is going to do?,” he wrote. “Because if he does the former he acts only after the market has moved down into buying levels or up into selling levels. His role is not that of a prophet but of a businessman seizing clearly evident investment opportunities.”
“He is not trying to be smarter than his fellow investors,” Graham continued, “but simply trying to be less irrational than the mass of speculators who insist on buying after the market advances and selling after it goes down. If the market persists in behaving foolishly, all he seems to need is ordinary common sense in order to exploit its foolishness.”
In other words, react to the market, and do not try to predict what it may do. This simple form of buy low, sell high advice has made fortunes for people like Andy Beal of Beal Bank, Hetty Green, the Witch of Wall street, Warren Buffet, Seth Klarman and a host of other value-oriented investors — including of course our favorite pig farmer, Mr. Womack.
2. The Market Is Not A Popularity Contest
John Templeton gave us another version of this advice when he said to buy at the point of maximum pessimism, while cautioning that this took unusual fortitude and discipline.
While evidence overwhelmingly shows the opposite approach works best at earning high rates of return, investors insist n chasing markets at new highs and extended levels. It is always going to be different this time, because of new paradigms or zero interest rate conditions — and for a time this seems to be the case.
It was Graham, once again, who pointed out that while in the short term the market may be a popularity contest, ultimately it is a weighing machine. Once the transition between the two begins, it is never differently, and chasing overextended stocks and markets always ends badly.
Making market projections is a fool’s errand, but being aware the valuation levels and risk levels are quite high is not a prediction as much as a condition. Even if surfing the highs and ignoring valuation works for a while, as Stanley Druckenmiller pointed out last week, accidently winning the lottery does not mean you made a smart bet.
A look at the markets show that,when measured by valuation such as market cap to GDP, the Value Line Median Appreciation Index and the Schiller PE ratio, the market is priced to the high side of fair.
3. nternational Events Can Change Everything
A look at the world around us shows that geopolitical problems are growing, and the regions that are flaring-up the most are important providers of energy and commodity resources. A simple count of safe and cheap stocks shows that there simply are not many bargain issues to buy at this moment in time.
Throwing caution to the wind and investing aggressively based on predictions of interest rates, earnings and market expectations is risky behavior most of the time. To do so when valuations are extended and the market has been moving higher for a long period of time is more than risky, it is foolish.
Confine your buying to the safest and cheapest of stocks and stockpile cash, in anticipation of the inevitable opportunity to react to what the market does, rather than what we hope it will do.
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