The Intelligent Investor

Presented By:
Nikit Shah
Viraj Visaria
 Agenda
Benjamin Graham “The Grandfather of Value Investing”

What is Value Investing?

Investment versus Speculation

Defensive and Active Investing

Risk

Mr. Market

Margin of Safety

Stock Selection for the Defensive Investor

Graham-Newman methods

Benjamin Graham’s Investment Principles

Conclusion
Ben Graham “The Grandfather of
Value Investing”
 Benjamin Graham (1894-1976)
 Graduated from Columbia
University in 1914
 Went to work for a firm named
Newburger, Henderson & Loeb, as
a messenger.
 By 1920, he was the partner in the
firm.
 Graham – Newman Corporation
formed in 1926
 17% annualized return until it’s
termination in 1956
 What is value investing?
In the words of Mr. Graham:

“ The most realistic distinction between the investor and the

speculator is found in their attitude toward stock-market
movements. The speculator’s primary interest lies in anticipating
and profiting from the market fluctuations. The investor’s primary
interest lies in acquiring and holding suitable securities at suitable
prices. Market movements are important to him in a practical
sense, because they alternately create low price low levels at which
he would be wise to buy and high price levels at which he certainly
should refrain from buying and probably would be wise to sell”
 Investment versus Speculation

What is an Investment?
“An investment operation is one which, upon thorough
analysis promises safety of principal and an adequate return.
Operations not meeting these requirements are speculative.”

Common Misconceptions
1. Anybody and everybody who has placed money in the stock
market is an “investor”
2. During severe market declines (as we have recently
experienced), all investments are considered to be speculative
in nature due to the extra-ordinary market conditions.
Key Takeaway
1. Irrespective of the market condition, the players involved, political conditions,
etc. as long as an operation fulfils the criteria described in the definition viz.
“Safety of Principal” and an “Adequate return”, the operation is considered to be
an Investment.
2. On the other hand, all operations that do NOT promise “safety of Principal”
are considered speculative in nature irrespective of the “expected future return”.
The definition becomes a guiding factor in distinguishing between and
investment and a speculation.

Which of these Fixed Deposits is an investment?

Period Inflation Rate of Safety of Principal Adequacy
Return of return
1 1 Year 5% 8% Depends on bank Yes
solvency
2 1 Year 8% 8% Depends on bank May be
solvency
3 1 Year 12% 25% Depends on bank Yes
solvency

Need to investigate first if the principal is safe

 Defensive and Active Investing
Characteristics of Defensive Investing
Defensive or passive investors are those that invest mechanically based on
predefined limits. The advantage is that they do not react to market sentiment
but rather use it to their advantage. Typically has more than 25% and less than
75% of investable funds in common stocks at all times. They are also called
passive investors.

Methods to execute – cost averaging

1. Have a 50% bond: 50% stock portfolio, rebalancing when the proportion has
changed by over 5%.
2. Have a maximum of 75% and minimum of 25% in bond and the rest in stock.
Bring up the bond percentage when stocks are "expensive", bring up the
stock percentage when stocks are "cheap“

The defensive portfolio is essentially on auto-pilot and takes little time or effort
but requires discipline and a detachment from the swings of the market.
The Active or Enterprising Investor
These investors continually research, select and monitor a dynamic mix of
stocks, bonds, mutual funds and other investment avenues.

Key Takeaway
1. Most individuals want to be active investors without investing the time and
effort needed to be one.
2. Active investors are NOT necessarily those who trade multiple times in
a day but rather those who are thoroughly prepared to trade when the
opportunity arises.
3. The number of times you trade in a given year does not determine whether
you are an active or passive investor.
 Risk
Risk from a Value Investing Perspective
1. Risk usually arises from NOT being confident in the reasons for
investing in a security.
2. Usually risk and return are considered to go hand-in-hand.
However, many a times there are investments with low risk that
offer high returns and vice-versa. These are the opportunities that
value investors look for.
3. Measuring relative price movement versus the general stock market
may not be a way to measure risk.
4. “…. investing isn’t about beating others at their game. It’s about
controlling yourself at your own game”
Date ~Sensex ~Earnings Trailin Market Risk from Value
as on Date g PE Perception investing
perspective
Dec-2007 20,000 650 30 Confidence Risky
Mar-2008 16,500 750 23 Confidence Risky
Oct-2008 8,000 750 11 Scared Attractive
Dec-2008 10,000 750 13 Scared Attractive
Mar-2009 9,000 850 11 Scared Attractive
June-2009 14,5000 850 17 Recovering Fairly priced

Note: 1.Average PE for the Sensex over past 18 years (since 1991) is
about 13.5
2.Approximations provided based on BSE site, CNBC coverage

Takeaway
By their very nature Value Investors tend to be selective Contrarians – they
selectively pick securities to invest at a time when valuations are low and
pessimism is highest in the market.
 Mr. Market
The market fluctuates but an “investors” resolve must hold
1. As we have seen recently, even investment grade securities are
subject to recurrent and wide fluctuations in price.
2. Rather than time the market based on the attitudes and perceptions
of market participants, the intelligent investor invests in a security
based on its valuation attractiveness.
3. Mr. Market will sometimes be in a great mood bidding up the
prices of securities far higher than their fundamental worth. At
other times Mr. Market will be in a bad mood, depressing the
prices of securities far below their fundamental worth.
4. The intelligent investor must be well prepared to profit from
these fluctuations in the moods of Mr. Market
5. The intelligent investor clearly distinguishes between Business
Valuation and Stock-Market Valuation. The difference between
the two is the opportunity to profit.
In the words of Mr. Graham:
“You can’t control whether the stocks or funds you buy will
outperform the market today, next week, this month, or this year; in
the short run, your returns will always be hostage to Mr. Market and
his whims. But you can control:
• your brokerage costs, by trading rarely, patiently, and cheaply
• your ownership costs, by refusing to buy mutual funds with
excessive annual expenses
• your expectations, by using realism, not fantasy, to forecast your
returns
• your risk, by deciding how much of your total assets to put at
hazard in the stock market, by diversifying, and by rebalancing
• your tax bills, by holding stocks for at least one year
• and, most of all, your own behavior.”
 Margin of Safety
Examples of the margin of safety
1. A civil engineer when asked to build a bridge that can carry 100
tonnes of vehicles, will typically build one that can carry 125 tonnes
of vehicles just in case. This is the engineers margin of safety.
2. Similarly, a supply chain manager in a warehouse will keep some
additional safety stock on hand to prevent stock-out of goods being
supplied to his customers.

If other professionals have built in the concept of “margin of safety” into

their operations, then why not INVESTMENT professionals.

In the words of Mr. Graham:

“ [To] have a true investment, there must be a true margin of safety. And a
true margin of safety is one that can be demonstrated by figures, by
persuasive reasoning, and by reference to a body of actual experience”
 Analysts Market Variance from Margin of
Fundamental Price per Fundamental safety
Valuation per share of Valuation
share of stock stock
100 130 +30% No
100 100 0% No
100 50 -50% Yes
200 180 -10% Inadequate

Benjamin Graham typically recommended a 35% margin of safety

before investing in a stock to cover for lapses in research and
analysis
 Stock Selection for the
Defensive Investor
Parameter Description Criteria
Size of Established organizations with a history of Large
Enterprise providing shareholder returns
Financial Low debt, High interest coverage, Adequate Strong
Condition cash on hand, No major liabilities upcoming
Earnings Moat-like characteristic where competitors Relatively Stable in
Stability or technology have little influence on the good and bad
companies future earnings economic conditions
Dividend Outstanding management record of Strong
Record distributing earnings to shareholders
Earnings Strong earnings power through well branded Good outlook
Growth products or services
P/E Ratio Attractively priced as compared to its Low
earnings power
P/Assets Ratio Assets may be tangible or intangible (strong Low
brand)
Comments and Observations
Stock selection for the Defensive investors is easy but the discipline to
invest only when the price is favorable is the key
Usually “blue chip” stocks are fairly priced or over priced in the market
since most investors have high expectations from these
companies as reflected in their valuation
 Graham Newman Method
The Enterprising Investor (who is well researched and connected) can adopt the
Graham Newman method for stock selection.
Examples Description
Arbitrages 1. Simultaneous purchase and sale of the same stock across exchanges when the
prices diverge
2. Simultaneous purchase and sale of stock of 2 companies that are about to
merge
Liquidation Purchase of shares in a company whose assets are about to be liquidated. Cash
s raised is to be distributed to shareholders.
Pair-trading Identifying multiple securities in the same industry with similar characteristics
but divergent prices. Go long on the undervalued stock and short on the
overpriced stock
Net Current Acquire shares in a company whose total market cap is lower than the Net
Asset current assets on its books. If the investor could acquire all the shares in this
Bargain company, he could close down the company and walk away with the excess
cash.
Special One companies in a race to acquire controlling stakes in another company.
Situations Declared price of acquisition is higher than current market price and there is a
high possibility of the deal going through. Contemporary example of ABG
Shipyard and Bharti Shipyard wanting to acquire larger stake in Great Offshore.
 Benjamin Graham’s Investment
Principles

 Know the business

 Know who runs the business

 Invest for profits

 Have confidence
 Conclusion
Fundamental tenets of Benjamin Grahams Investment Style

 A stock is not just a ticker symbol or an electronic blip; it is an ownership

interest in an actual business, with an underlying value that does not depend on
its share price.

 The market is a pendulum that forever swings between unsustainable

optimism (which makes stocks too expensive) and unjustified pessimism
(which makes them too cheap). The intelligent investor is a realist who sells to
optimists and buys from pessimists.
 The future value of every investment is a function of its present price. The
higher the price you pay, the lower your return will be.

 No matter how careful you are, the one risk no investor can ever eliminate
is the risk of being wrong. Only by insisting on what Graham called the
“margin of safety”—never overpaying, no matter how exciting an investment
seems to be—can you minimize your odds of error.
 The secret to your financial success is inside yourself. If you become a
critical thinker who takes no Wall Street “fact” on faith, and you invest
with patient confidence, you can take steady advantage of even the worst
bear markets. By developing your discipline and courage, you can refuse
to let other people’s mood swings govern your financial destiny. In the
end, how your investments behave is much less important than how you
behave.
 The true investor scarcely ever is forced to sell his shares, and at all other
times he is free to disregard the current price quotation. He needs to pay
attention to it and act upon it only to the extent that the price is favourable
enough to justify selling his stock. Thus the investor who permits him self
to be stampeded or unduly worried by unjustified market declines in his
holdings is perversely transforming his basic advantage into a basic
disadvantage. That man would be better off if his stocks had no market
quotation at all, for he would then be spared the mental anguish caused
him by other personal mistakes of judgment.
 Example: Ben Graham’s
Value Investing Model:
A. Decision to purchase
Step1: Establish market capitalization:
No. Shares in Issue :5000
Current Share Price : Rs.125
Current Market Cap : Rs.625,000
Step2: Establish net Current Assets :Rs.1,000,000
Step3: Calculate ratio of market cap. to net current assets
Market Cap: Rs.625,000
Net Current Assets: Rs.1,000,000
Ratio: 62.5%
Step4: Make Buying decision

Market cap. represents less than two-thirds of current assets, so shares are a ‘BUY’
B. Event – share price to Rs.200

C. Decision to sell
Step1: Establish market capitalization:
No. Shares in Issue :5000
Current Share Price : Rs.200
Current Market Cap : Rs.,1,000,000
Step2: Establish net Current Assets :Rs.1,000,000
Step3: Calculate ratio of market cap. to net current assets
Market Cap: Rs.1,000,000
Net Current Assets: Rs.1,000,000
Ratio: 100%
Step4: Make Selling decision

Market cap. now represents 100% of net current assets, so shares are a ‘SELL’
 Key Takeaways
 Don’t under invest in equities. Bonds can only do so much for you, and it
is good to deploy capital into equities when they are out of favor.

 Stocks provide modest compensation against inflation risks.

 Be conservative in bond investing. Read the prospectus carefully. Often a

bond is less safe than one would expect, and occasionally, it offers more
value than one would expect.

 Purchase bargain issues on a net asset value basis when you can find
them, but be careful of quality issues.

 Volatility of stock prices can be your friend if you understand the

underlying value of a well-financed corporation.
 Having a longer-term investment horizon is valuable, because one can take
advantage of short-term fluctuations in price.

 Growth is worth paying up for, but be disciplined. Don’t overpay.

 Be wary of experts.

 Pay attention to the balance sheet; don’t invest in companies that are
inadequately financed.

 Buy them safe and cheap. Don’t overpay for growth and trendiness.

 Be careful with unseasoned (new) companies.

 Strong dividend policies, in companies that can support the dividends, are an
indicator of value.

 Aim for a margin of safety in all investing.

 Don’t over invest in equities. Markets wash out occasionally, and it’s good
to have some bonds around.
THANK YOU