For the Enterprising Investor
In the last article you had to choose between being a Passive investor or an Active one. If the decision was to be Active, this article is for you.
Benjamin Graham states that there are four possible strategies when talking about stock investing.
Buying in Low Markets and Selling in High Markets
Every single market, and the stock market ain’t no exception, moves around somewhat prolonged cycles, positive and negative ones. The positive are called bull markets, and the negative are called bear markets. The strategy is simple, buying in bear markets and selling into bull markets. “Buy in fear, sell in greed.”
Though if it were that simple, everyone would do it. There´s a reason why 80+% of fund managers and 90+% of retail investors can´t beat the market and it´s because investing is not easy.
Buying Carefully Chosen Growth Stocks.
A growth stock is a share in a business that’s shown above-average earnings and has the potential to grow faster than the overall economy. The reasoning on buying these types of stocks is the following:
If a business produces one dollar in earnings per share, but eventually gets to produce ten dollars per share, the price should theoretically 10x…. right?
As per usual, it´s not that simple. In this strategy you lose if you overpay, if you are wrong about a business future prospects or if you overdiversify. Besides, it´s psychologically difficult since growth stocks are characterized by their higher than average volatility.
Buying Bargain Issues
First of all, a warning should be made that rarely occurs that an issue is at an actual bargain price. Always remember that a stock is literally worth what people would pay for it, so, what is low can always go lower.
This type of strategy is usually referred to as value investing. It is said that every single company has a ‘true’ intrinsic value and, if it is selling at a lower price than it, it is ‘cheap’ and should tend towards this true value. An investor can determine this theoretical intrinsic value by ‘knowing’ what the business will earn in the future and discounting this money to the present to then add it all.
The easiest factor to go wrong with this strategy is that the model the investor uses is incorrect. This will be most of the cases since we are talking about forecasting the future.
Buying Into Special Situations
Benjamin defines a special situation as an investment situation where the ultimate payout is independent of stock market factors. A typical example of this is a risk arbitrage play, a situation where a company announces that it entered into an agreement to sell itself to a firm for slightly more than the current price of the common stock.
Conclusion
All of this strategies work, when done correctly. The difficult part is to implement them correctly, which is where 9 out of 10 investors go wrong. This is something the enterprising investor has to acknowledge.
Warren Buffet is a legendary investor and he’s actively managing Berkshire Hathaway. My next article will be about the strategy he has been utilizing for the past fifty years.