Intelligent Investor Chapter 5 Summary: The Defensive Investor and Common Stocks


 The Defensive Investor and Common Stocks

  • Stocks mostly perform better than bonds in long term as they protect against inflation, offer higher average dividend compared to bond yield and due to increase in market value when the dividends are reinvested. But all these benefits are lost when too high price is paid while buying.
  • Public tends to buy stocks when they are rising - that's when they are actually risky. When market becomes depressed, public avoids stocks - this is when they are actually available at bargain prices and less risky.
  • Stock yield=dividend/share price.
  • Having an all bond portfolio is more riskier than owning a proportion in stocks.
  • Adequate diversification - 10 to 30 different stocks.
  • Company should be large, prominent(leading company/primary-first quarter/third in leading industry) and conservatively financed(common stock at book value is at least half of total capitalization including bank debt).
  • Long record of continuous dividend payments(10-20 years).
  • Limit on buying price in relation to earning over past 7 years - <25 times and not more than 20 times over past 12 months. This eliminates all growth stocks(per share earnings above the rate of other common stocks and expected in future too). Growth stocks tend to have a speculative element as they are already sold at high prices. This makes them risky for defensive investor. Unpopular large companies that are selling at reasonable earnings multiplier are a better option.
  • Get a periodical inspection of portfolio - at least every year.
  • Dollar cost averaging even with small monthly payments can fetch good returns.
  • Start early especially if you are aggressive investor to account for the mistakes you are bound to make. Don't try to beat the market as a beginner.
  • Safety and risk are different. Bond is unsafe when it defaults it's interest/principal, stock is unsafe when it fails to pay the promised rate of dividends. Risk is when you have to sell something at a very low cost - this shouldn't include temporary/cyclical fall in prices, unless the fall is because of a very high buying payment in relation to the actual stock value.

Commentary:


Human felicity is produced not as much by great pieces of good fortune that seldom happen as by little advantages that occur every day.

After you burn your mouth on hot milk, you blow on your yogurt.

  • "Buy what you know" gets you into trouble. Finding a promising company is just the first step, researching is the next step - from financial statements and estimating it's business value. Home bias makes people to invest more in what is familiar - local/nearby companies, company they are working for. Familiarity breeds complacency. We don't probe well known things.
  • Stocks can be bought from online brokerages with minimum fees or directly from the issuing companies. Take care of tracking every purchase for tax and diversification.
  • If you have a online autopilot portfolio, you shouldn't be trading more than twice in a year or spending more than 1-2 hours per month.
  • If you are going for an external discount broker, financial planner or full service stockbroker, investigate well if adviser is trustworthy and charges reasonable fees.
  • Mutual Funds with index portfolios gives you the ultimate freedom from bother.
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See Intelligent Investor Summary for other chapters summary.

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