Chapter 7 Portfolio policy for the enterprising Investor: Positive side

Operations in common stocks:

1)
2)
3)
4)

Buying
Buying
Buying
Buying

in low markets and selling in high markets

carefully chosen Growth stocks
bargain issues of various types
into special situation

General Market timings:

50-50 plan for a defensive investor
25-75 plan for an enterprising investor
Growth Stock Approach:
Common stocks with good records and apparently good prospects sell at
correspondingly high prices. The investor may be right in his judgement of their
prospects and still not fare particularly well, merely because he has paid in full for
the expected prosperity.
Judgement about the future may prove wrong. Rapid growth cannot be kept forever.
At some point the growth cruve flattens out and in many cases it turns downwards.
CALCULATE PRICE EARNING RATIO BASED ON A MULTIYEAR AVERAGE OF
PAST EARNING. (CALCULATE AVERAGE PE FOR PAST 7 YEARS, AND THE
MAX UPPER LIMIT FOR THE PURCAHSE OF EQUITY SHOULD BE 25. However,
PE of 20 is one in which excellent prospects are fully recognized)
The striking thing about growth stocks as a class is in their tendency for a wild
swings in market price. This is true of the largest and longest established companies
and even more so for a smaller and newer successful companies.
Three recommended fields for ENTERPRISING INVESTOR
1) The relatively unpopular large Company:
If we assume that its a habit of the market to overvalue common
stocks which have been showing excellent growth or are glamorous for
some other reasons, it is logical to expect that it will undervaluerelatively, at least-companies that are out of favor because of
unsatisfactory developments of a temporary nature. (this may be
setdown as a fundamental law of the stock market)
Key requirement: To find out companies those are going through a
period of unpopularity. (Large companies are better off than small

companies as they have a double advantage over others. First, they

have resources and capital and second market is likely to respond with
reasonable speed to any improvement shown.)
Caution note: Companies that are inherently speculative because of
widely varying earning tend to sell both at relatively high prices and at
a relatively low multipliers in their good years and conversely at a
relatively low prices and at a relatively low multiples in bad years.
Purchase of Bargain Issues:
The two major soucres of undervaluation: 1 Currently disappointing
results and (2) Protracted neglect or unpopularity.
However, neither of the causes alone can be relied upon. Its only after
through analysis one must take positions in stocks
The type of bargain issue that can be most readily identified is a
common stock that sells for less than the companys net working
capital alone, after deducting all prior obligations (ITS MEANS A
COMAPANYS CURRENT ASSESTS (Such as cash, marketable securities
and inventories) minus total liabilities (including preferred stock and
long term debt)
If Secondary issues are undervalued, what reasons an investor has to
believe he can profit from it.
1) The dividend return is relatively high.
2) The reinvested earning are substantial in relation to the price
paid and will ultimately reflect in the price.
3) A Bull market is ordinarily most generous to low priced
issues; thus it tends to raise a typical bargain issue to atleast
a reasonable level.
4) Even during the relatively featureless market periods a
continuous process of price adjustments goes on, under
which secondary issues that were undervalued may rise to at
least to normal level for their type of security.
5) The specific factors that in many cases made for a
disappointing record of earning may be corrected by advent
of new conditions, or the adaptation of new policies, or by a
change in management.
NEVER BUY INTO LAWSUITS