Secret recipe
What to buy and at what price
INVESTMENT is most intelligent when it is most businesslike, wrote Benjamin Graham, the author of the 1949 classic The Intelligent Investor and teacher to the richest stock owner in the world, Warren Buffett. Buffettology is in some ways borrowed Grahamology. To Graham, Buffett’s professor at Columbia University, successful investment needs two ingredients. One, sound intellectual framework for making decisions. Two, the ability to keep emotions from corroding the framework. Sound advice from an old master investor.
Forbes magazine columnist John P. Reese gives Graham a thumbs up thus: Graham’s investment firm posted annualised returns of about 20 per cent from 1936 to 1956, far outpacing the 12.2 per cent average return for the broader market over that time. Reese should know because he has been tracking a portfolio of stocks picked for decades using the Graham method. Since its inception, he writes in his column titled “Ben Graham’s 60-Year-Old Strategy Still Winning Big”, “the portfolio has returned 224.3 per cent (13.3 per cent annualised) vs. 43.0 per cent (3.9 per cent annualised) for the S&P 500.”
So what is the magic formula? Simply put, the investor needs to do two things: pick the right business and the right price. Investors must know what businesses bring in a high rate of return on investment. They must also know the right price to pay for them. There are two ideas behind this thought process. One, the investor must be in for the long haul. After all, buying shares is purchasing ownership of the powers of production of the enterprise, as Mary Buffett and David Clark write in Buffettology. This is why stock investors like Graham and Buffett place a high premium on the quality of the management team. Indicators are not hard to find. Does the team employ earnings profitably? Or does it throw good money after bad? Or does it just pay them out as dividends, leaving little capital for future growth of the business?
Settling on the price to pay for the shares is equally important. Because, it has an impact on the rate of return on your investment. A good place to start is the price/earnings (P/E) ratio, says Associate Professor Dr Aimi Zulhazmi Abdul Rashid, director Strategic Project, Universiti Kuala Lumpur. P/E ratios vary from industry to industry, but they are a very good comparison tool. An intelligent investor will look for a P/E ratio that is lower than the industry average. A lower P/E ratio is a sign that the shares are undervalued.
Putting your money to work in Bursa is a smart thing to do for two reasons. One, it drives the economy. Two, it is good for the investors’ pocket. Share investment isn’t without risks, but it can be managed. Aimi says a safe portfolio is 50 per cent blue chips, 30 per cent financial, energy or telcos, and 20 per cent in start-ups. The novice retail investor may, however, give the blue chips a miss for a while and concentrate on a 80-20 ratio. With more money in the kitty, blue chips would be worth a long play later. No matter what, go Graham-Buffet in approach. Intelligent investors, Malaysia needs you.
So what is the magic formula? Simply put, the investor needs to do two things: pick the right business and the right price.