This is part 2 of the book summary. Part I can be foundhere.
Chapter 4: Buy earnings on Cheap.(The lower the price, the higher the return) - Buying Low P/E has worked over the years in all countries all industries. - Earnings yield = inverse of P/E - Use it to compare to other investments. - Consider inflation effects on purchasing power - Trailing P/E (rear view mirror) v/s Forward P/E (often optimistic projections) - Graham looked for cos with stable record of earnings, predictable. - Buying cheap on past earnings for such stable cos is good. - Discussion on Cash flow and FCF and its merits. - Chris also looks at low P/E in terms of their worth to a potential acquirer. - EBITDA and how LBOs use EBITDA. Measure of debt serviceability. - Low P/E works in good and bad markets - Wait longer in bear markets to see returns. Best part of Low P/E approach is that it forces you to buy stocks when cheap and while fear is high. - Best opportunities are preceded by much pain and not great times. - Low P/E stock are low expectation companies (as opposed to high p/e stocks). - When low p/e company reports bad news, effect is minimal as its priced in. Good news results in a pop. (opposite in high p/e)
When: Poor earnings, Poor Industry conditions. Buy below book value (BV) per share. Examples: insurance, banks. Use global search approach to uncover stocks below BV. Sometimes stocks sell below cash balances. Buying stocks that sell cheaply when compared to asset values works.
Global economy; high correlation in world markets; global diversification is tough. Real reason is to increase the number of potential value ideas. At times of Regional economic problems, values can be found. Examples: Asian collapse in 98, Germany reunion in 80s. (My inference: Looks like crisis in Europe would present good buying in companies that are strong, profitable, stable earnings and good balance sheet.) Rising interest rates are enemy of the markets. Sell offs happen. Value deals can be found. (This would happen sometime in the future when rates go up).
- International investing is easier with standardized international accounting (IFRS) Example of Roche which setup Contingent liabilities reserves in profitable years. Then, after reserve was reversed, they would add it directly to book value and not have to report as income. (Swiss laws allowed this). Example of Lindt and Sprungli. 10x p/e. Swiss market down due to higher inflation, CEO had divorced. Traded at 3.5x EBITDA. Similar companies bought for 20x earnings. Countries author avoids such as Argentina, Venezuela, Russian crisis example, Mexico, Bolivia, Asian financial crisis. Now, China. Government control and policies, appropriation means that margin of safety is lacking. Author prefers looking at developed economies.
- Insider buying can help find companies whose fortunes could turn for the better. - Insiders could sell for various reasons and is not as useful. - there is only one logical reason to buy - they think stock price is going up. - Insider buying of stocks selling at low P/E or below asset value is even better. - Corp buybacks are another good sign. - Look for presence of Activist investors. - Insider buying and activist investors can act as catalyst for stock appreciation.
Markets fall time and again because of political or economic announcements. Similarly, individual stocks and sectors often fall on weaker than expected earnings or unforeseen events. This is the time to be buying, but investors panic and go to cash.Risk is more often in the price you pay than the stock itself Prices of solid companies with strong balance sheets and earnings usually recover. If the fundamentals are found, prices always have and will always recover. Today’s worst stocks become tomorrow’s best stocks and the darlings of the day turn into tomorrow's spinsters. Don’t try to catch an overpriced, cheaply made falling knife. Example of S&L crisis (very similar to current financial crisis), Big banks such as Bank of America and Chase Manhattan Bank fell to prices at or below their book value and had P/E ratios in single digits. Wells Fargo was hit hard due to high exposure to California real estate market (sound familiar ??). Investors who did their homework and investing in banks during this time earned enormous returns over the decade that followed as the industry went through a merger boom. In 1992, health care reform proposal caused stocks of leading drug companies such as Johnson and Johnson to decline sharply. JNJ traded at 12x P/E. Amex after 9/11 sold at 12x P/E Bargains are found in new low lists.
Describes Grahams Net-nets method. Net Current Assets = Current Assets (cash + inventory + receivables) - Total Liabilities NCAV = Net current assets / Shares outstanding If stock is trading at 2/3rd of NCAV or less, Graham bought it. Talks about how modern day screeners make finding value easy. Lists of new lows WSJ, Barron’s, IBD are good starting points in search for value. He cautions that such lists or screened results are just a starting point and not the destination. He expects the investor to examine the firms to make sure they are good and cheap. Another approach is to look at what other value investors have in their portfolios via their quarterly letters and from Morningstar. Look at what who else owns a particular stock. Look at prices paid in mergers and acquisitions to find stocks that are selling at a significant discount to what they are worth to a knowledgeable buyer. Look at other companies in the same industry and compare P/E, P/S and P/B. When an acquisition happens, you can take the purchase price to calculate the P/S, P/E, P/EBIT/, EV / EBITDA etc and keep them for future reference.
Chapter 4: Buy earnings on Cheap.(The lower the price, the higher the return) - Buying Low P/E has worked over the years in all countries all industries. - Earnings yield = inverse of P/E - Use it to compare to other investments. - Consider inflation effects on purchasing power - Trailing P/E (rear view mirror) v/s Forward P/E (often optimistic projections) - Graham looked for cos with stable record of earnings, predictable. - Buying cheap on past earnings for such stable cos is good. - Discussion on Cash flow and FCF and its merits. - Chris also looks at low P/E in terms of their worth to a potential acquirer. - EBITDA and how LBOs use EBITDA. Measure of debt serviceability. - Low P/E works in good and bad markets - Wait longer in bear markets to see returns. Best part of Low P/E approach is that it forces you to buy stocks when cheap and while fear is high. - Best opportunities are preceded by much pain and not great times. - Low P/E stock are low expectation companies (as opposed to high p/e stocks). - When low p/e company reports bad news, effect is minimal as its priced in. Good news results in a pop. (opposite in high p/e)
When: Poor earnings, Poor Industry conditions. Buy below book value (BV) per share. Examples: insurance, banks. Use global search approach to uncover stocks below BV. Sometimes stocks sell below cash balances. Buying stocks that sell cheaply when compared to asset values works.
Global economy; high correlation in world markets; global diversification is tough. Real reason is to increase the number of potential value ideas. At times of Regional economic problems, values can be found. Examples: Asian collapse in 98, Germany reunion in 80s. (My inference: Looks like crisis in Europe would present good buying in companies that are strong, profitable, stable earnings and good balance sheet.) Rising interest rates are enemy of the markets. Sell offs happen. Value deals can be found. (This would happen sometime in the future when rates go up).
- International investing is easier with standardized international accounting (IFRS) Example of Roche which setup Contingent liabilities reserves in profitable years. Then, after reserve was reversed, they would add it directly to book value and not have to report as income. (Swiss laws allowed this). Example of Lindt and Sprungli. 10x p/e. Swiss market down due to higher inflation, CEO had divorced. Traded at 3.5x EBITDA. Similar companies bought for 20x earnings. Countries author avoids such as Argentina, Venezuela, Russian crisis example, Mexico, Bolivia, Asian financial crisis. Now, China. Government control and policies, appropriation means that margin of safety is lacking. Author prefers looking at developed economies.
- Insider buying can help find companies whose fortunes could turn for the better. - Insiders could sell for various reasons and is not as useful. - there is only one logical reason to buy - they think stock price is going up. - Insider buying of stocks selling at low P/E or below asset value is even better. - Corp buybacks are another good sign. - Look for presence of Activist investors. - Insider buying and activist investors can act as catalyst for stock appreciation.
Markets fall time and again because of political or economic announcements. Similarly, individual stocks and sectors often fall on weaker than expected earnings or unforeseen events. This is the time to be buying, but investors panic and go to cash.Risk is more often in the price you pay than the stock itself Prices of solid companies with strong balance sheets and earnings usually recover. If the fundamentals are found, prices always have and will always recover. Today’s worst stocks become tomorrow’s best stocks and the darlings of the day turn into tomorrow's spinsters. Don’t try to catch an overpriced, cheaply made falling knife. Example of S&L crisis (very similar to current financial crisis), Big banks such as Bank of America and Chase Manhattan Bank fell to prices at or below their book value and had P/E ratios in single digits. Wells Fargo was hit hard due to high exposure to California real estate market (sound familiar ??). Investors who did their homework and investing in banks during this time earned enormous returns over the decade that followed as the industry went through a merger boom. In 1992, health care reform proposal caused stocks of leading drug companies such as Johnson and Johnson to decline sharply. JNJ traded at 12x P/E. Amex after 9/11 sold at 12x P/E Bargains are found in new low lists.
Describes Grahams Net-nets method. Net Current Assets = Current Assets (cash + inventory + receivables) - Total Liabilities NCAV = Net current assets / Shares outstanding If stock is trading at 2/3rd of NCAV or less, Graham bought it. Talks about how modern day screeners make finding value easy. Lists of new lows WSJ, Barron’s, IBD are good starting points in search for value. He cautions that such lists or screened results are just a starting point and not the destination. He expects the investor to examine the firms to make sure they are good and cheap. Another approach is to look at what other value investors have in their portfolios via their quarterly letters and from Morningstar. Look at what who else owns a particular stock. Look at prices paid in mergers and acquisitions to find stocks that are selling at a significant discount to what they are worth to a knowledgeable buyer. Look at other companies in the same industry and compare P/E, P/S and P/B. When an acquisition happens, you can take the purchase price to calculate the P/S, P/E, P/EBIT/, EV / EBITDA etc and keep them for future reference.
