Intelligent Investor Chapter 7 Summary: Portfolio Policy - Enterprising Investor : Positive Side

Portfolio Policy for the Enterprising Investor : The Positive Side

• Enterprising investor is someone who devotes his attention and efforts to obtain better than average results.
• Tax free industrial bonds issued by municipalities, but serviced by lease payments made by corporations can be tried.
• Defaulted/distressed bonds of a troubled company are as good as common stocks of a healthy company - because in case of bankruptcy, bond holders are given preference over stock holders. Bond holders often receive stock when such company is reorganized well and even the bond value improves as the company recovers to pay interest.
• Operations in common stock- buy low and sell high, growth stocks, bargain issues, special situations.
• Entering market when it's depressed and selling in the advancing stages of boom. 25-75 variation between stocks and bonds depending on the market-danger/attractive.

Growth stocks

• Catches - 1)stocks with good records and prospects already sell at high prices. 2) wrong judgement - unusually rapid growth cant keep up as company grows very large in size, highly difficult to repeat the achievements - in such cases, growth becomes stagnant and even turns downward.
• Stay away if P/E(consider multi year average) is already higher than 20.
• Speculative element is higher in growth stocks.
• Growth stock profits are generally made by the close controlling people of the company which makes them invest lot of resources in just one medium and holding on to them no matter what.

3 recommended fields:

• Policy must be sound and different from what is followed by most other investors and speculators.
• Unpopular large company:
• Just like some stocks are overvalued, some are undervalued because of temporary unsatisfactory developments. Focus only on large companies that are going through a period of unpopularity. Small companies have the risk of loss of profitability and protracted neglect despite their high earnings. Large companies will have the resources and brain power to carry through adversity and market may respond to any improvements.
• Don't simply rely on P/E multiplier. You can start with low multiplier, but add more tests to check for any speculative factors. Check if price is less than past average earnings.

• Purchase of bargain issues: 
• Common stocks that are selling under par, indicated value is at least 50% more than the price are Bargain issues. These can be detected by Value analysis - a)appraisal - estimating future earnings and multiplying it by an appropriate factor - if this is above market price and if the appraisal technique can be trusted. b) Value of business to private owner-similar to a, but more stress on realizable value of assets - net current assets/working capital.
• Lack of interest may lead to price decline. Issues can be undervalued because of current disappointing results and protracted neglect/unpopularity.
• Check for reasonable stability of earnings over past 10 years or more - no earning deficit and sufficient size and financial strength.
• So the combo is large and prominent company selling below it's past average price and it's past P/E multiplier.
• Market may fail to recognize true earnings because of peculiar accounting methods like of railroad.
• Sells less than company's net working capital alone after deduction of all obligations.
• Secondary company bargain issues: Company may be chief in an unimportant line. Medium sized companies are neglected by public in general. High dividend, reinvested earnings affect the price and advantages may be high in 5-7 years, bull market is generous to low priced issues, even normal market condition's adjust the price to normal, the factors for temporary decline may have corrected themselves by new policy/management, acquisition by large companies - bargain issue cases.

• Special situations: 
• Risky-needs unusual mentality and equipment. Acquisitions demand the share be priced above current level by shareholders of small company. Bankruptcy bonds. Breakup of public utility. Because of legal risk, public ignores these ultimately turning them into bargain issues.

Broad implications of rules:

• Foreign bonds, ordinary preferred stocks, secondary common stocks and initial offerings of stock are all off-limits to defensive investor and enterprising investor should buy these only at bargain levels(<2/3 of appraisal value).
• Difference between the worth of a single detached share and one in controlling block(private group of people close to company) is less in primary companies and very high(and controversial) in secondary companies.

Commentary:

It requires a great deal of boldness and a great deal of caution to make a great fortune, and when you have got it, it requires ten times as much wit to keep it.

• Timing is impossible, hindsight is 20/20, but foresight is blind. Experts often fail. Life can only be understood backwards; but it must be lived forwards. 
• Faster the companies grow, the more expensive the stocks become and as stocks grow faster than companies, prices collapse.
• A great company isn't a great investment if you pay too much for the stock.
• The bigger they get, the slower they grow. Growth stocks are worth buying only at reasonable prices.
• Johnson & Johnson became unpopular temporarily because of accusations of false record keeping. This helps intelligent investor.
• Putting all your eggs in one basket may have benefited some people with huge investments, but it doesn't help small fortunes and keeping up the big fortunes.
• Bargain issues can be easily found online. 
• Company current asset-liabilities(including preferred stock and long term debt)=net worth capital
• Invest at least a third of stock money in mutual funds holding foreign stocks.

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