Intelligent Investor Chapter 6 Summary: Portfolio Policy - Enterprising Investor : Negative approach

Portfolio Policy  for the Enterprising Investor : Negative approach

• Aggressive investor starts off on same base as defensive investor 50-50 in stocks and bonds. A well-reasoned justification is needed for every departure from the base.
• Depends not just on competence and equipment, but also on his interests and preferences.
• Negative: High grade preferred stocks are for corporations, inferior types of bonds and preferred stocks should only be bought at bargain levels - 30% below par for high coupon issues and even less for lower coupons, no foreign Govt bond issues even with high yield, careful with new issues including convertible bonds and preferred stocks, common stocks with high earnings in the recent past.
• Standard bonds - same as defensive.

Second grade bonds and preferred stocks:

• As first grade bonds offer good yields, second grade straight/non-convertible issues are not easily sold. Debt financing is achieved through convertible bonds. This makes the non convertible bonds of inferior rating, which are old issues, available at large discounts. So they offer possibility of substantial gain in case of favorable conditions(improved credit ranking for company and lower interest rates).
• Good grade bonds(old style company coupons) selling at discounts provide good income and chance of appreciation.
• The difference between first and second grade bonds is the number of times the interest charges have been covered by the earnings. Don't lose principal just for yield/annual income.
• May be in the long run, after such issues fall badly, they may recover under favorable conditions. Cumulative preferred stocks that didn't pay dividends for many years, may pay large accumulated profits in boom. Still, the investor will be left to worry over this long period. As these are limited, they don't provide enough diversification. Better to wait for below par prices in a weak market.

Foreign Govt bonds:

-World wars, world depression and country's conditions may all influence foreign share prices on which you have no legal claim. Advised to abstain for your own sake and for your country's sake.

New Issues:

• Thorough examination and unusually severe tests.
• New issues get sales pushed and are generally issued under favorable market conditions to seller.
• First quality issues sold to corporations only get unpleasant ill effects compared to Lower grade issues sold hard by sales to individuals.
• Bull market is characterized by transformation of private companies to companies with quoted shares.
• Already listed shares are sold at pro rata to existing shareholders with subscription fee.
• In the middle of bull market, first common stock flotations happen at good enough prices and early buyers make some profits resulting in brand financing. At the end of bull swing, new stocks of small companies are offered at prices higher than that of medium companies. More speculation and ultimately, price collapses.Such issues can be later bought after few years when no one wants them.

Commentary:

• What you don't do is as important as What you do.
• A way to invest in high yield/second grade/low grade/junk bonds is through mutual funds that provide diversification. But for high yield preferred stocks, there's no alternative.
• Junk bonds come with high fee and no protection of principal. But they outperform other bonds when interest rates rise. Good for retirement monthly income if you don't mind periodical lows. Only minor portion.
• Mutual funds for emerging markets are also an option  - but less than 10% of portfolio.
• Day trading is considered as financial suicide. Trading costs, high tax on short term capital gains and market impacts - higher buying bids and selling below recent prices all make it worthless.
• Exclusive private group of investors who participate in underwriting benefit from IPOs. Highly difficult to identify the next Microsoft. For every Microsoft, there are thousands of losers.

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