Category Archives: Investment criteria

What stocks to buy: 15 points to look for

“What are the matters about which the investor should learn if he is to obtain the type of investment which in a few years might show a gain of several hundred per cent, or over a longer period of time might show a correspondingly greater increase?

” In other words, what attributes should a company have to give it the greatest likelihood of attaining this kind of results for its shareholders?”

Common Sense And Uncommon Profits by Philip A. Fisher, in answering these questions, gives the fifteen points to look for in a common stock:

1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?

Companies which decade by decade have consistently shown spectacular growth might be divided into two groups:  “fortunate and able” and “fortunate because they are able”.  A high order of management ability is a must for both groups as no company grows for a long period of years just because it is lucky.

An example of the “fortunate and able” group is The Aluminium Company of America, says Philip Fisher.  The founders of this company were men with great vision. They correctly foresaw important commercial uses for their new product. However, neither they nor anyone else at that time could foresee anything like the future size of the market for aluminium products that was to develop over the next seventy years.

Du Pont is an example of the other group of growth stocks – the “fortunate because they are able” group –  says Philip Fisher.

This company was not originally in the business of making nylon,  cellophane, Lucite, neoprene, orlon, milar or any of the many other glamorous products with which it is frequently associated  in the public mind and which have proven so spectacularly profitable to the investor.

“Applying the skills and knowledge learned in its original powder business, the company has successfully launched product after product to make one of the great success stories of American stories,” says Common Stocks And Uncommon Profits.

 

2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?

The investor usually obtains the best results in companies whose engineering or research is to a considerable extent devoted to products having some business relationship to those already within the scope of company activities, says Philip Fisher. “This does not mean that a desirable company may not have a number of divisions, some of which have product lines quite different from others.”

3. How effective are the company’s research and development (R&D) efforts in relation to its size?

4. Does the company have an above-average sales organization?

5. Does the company have a worthwhile profit margin?

6. What is the company doing to maintain or improve profit margins?

7. Does the company have outstanding labor and personnel relations?

8. Does the company have outstanding executive relations?

9. Does the company have depth to its management?

10. How good are the company’s cost analysis and accounting controls? .

11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

12. Does the company have a short-range or long-range outlook in regard to profits?

13. In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this anticipated growth?

14. Does management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?

15. Does the company have a management of unquestionable integrity?

 

 

When it comes to stocks, Berkshire Hathaway looks for wonderful companies

“Woody Allen once explained that the advantage of being bi-sexual is that it doubles your chance of finding a date on Saturday night,” Warren Buffett said in his FY2015 letter to Berkshire Hathaway. Why did the Berkshire Hathaway chairman say this?

“In like manner – well, not exactly like manner – our appetite for either operating businesses or passive investments doubles our chances of finding sensible uses for Berkshire’s endless gusher of cash. Beyond that, having a huge portfolio of marketable securities gives us a stockpile of funds that can be tapped when an elephant-sized acquisition is offered to us,” Mr Buffett continued.

A stockpile of funds from marketable securities?

Yes a stockpile. “Berkshire increased its ownership interest last year in each of its “Big Four” investments – American Express, Coca-Cola, IBM and Wells Fargo. We purchased additional shares of IBM (increasing our ownership to 8.4% versus 7.8% at yearend 2014) and Wells Fargo (going to 9.8% from 9.4%). At the other two companies, Coca-Cola and American Express, stock repurchases raised our percentage ownership. Our equity in Coca-Cola grew from 9.2% to 9.3%, and our interest in American Express increased from 14.8% to 15.6%. In case you think these seemingly small changes aren’t important, consider this math: For the four companies in aggregate, each increase of one percentage point in our ownership raises Berkshire’s portion of their annual earnings by about $500 million.”

The legendary investor’s subsequent FY2016 letter to Berkshire Hathaway shows the stakes in these Big Four as at end-2016 were: American Express 16.8%, Coca-Cola 9.3%, IBM 8.5% and Wells Fargo 10%. Apple Inc stocks also came into Berkshire Hathaway’s radar screen, with the group owning a stake of 1.1%, which, according to a CNBC report on Feb 27, 2017, had grown in January 2017 to 2.5%. “At this point, Buffett owns US$17 billion worth of the tech giant’s stock,” said the report.

What does Berkshire Hathaway look for in marketable securities?
On the Big Four in the FY2015 letter, Mr Buffett said that the four investees possess excellent businesses and are run by managers who are both talented and shareholder-oriented. “Their returns on tangible equity range from excellent to staggering. At Berkshire, we much prefer owning a non-controlling but substantial portion of a wonderful company to owning 100% of a so-so business. It’s better to have a partial interest in the Hope Diamond than to own all of a rhinestone,” said Mr Buffett.

The Berkshire Hathaway chairman said that if Berkshire’s yearend holdings were used as the marker, its portion of the “Big Four’s” 2015 earnings amounted to US$4.7 billion. “In the earnings we report to you, however, we include only the dividends they pay us – about $1.8 billion last year. But make no mistake: The nearly $3 billion of these companies’ earnings we don’t report are every bit as valuable to us as the portion Berkshire records.”

The earnings of Berkshire’s investees retain are often used for repurchases of their own stock – a move that increases Berkshire’s share of future earnings without requiring it to lay out a dime. “The retained earnings of these companies also fund business opportunities that usually turn out to be advantageous. All that leads us to expect that the per-share earnings of these four investees, in aggregate, will grow substantially over time. If gains do indeed materialize, dividends to Berkshire will increase and so, too, will our unrealized capital gains.”

This investment philosophy gives Berkshire Hathaway a significant edge, explained by Mr Buffett this way: “Our flexibility in capital allocation – our willingness to invest large sums passively in non-controlled businesses – gives us a significant edge over companies that limit themselves to acquisitions they will operate.”

Benjamin Graham on stock selection for the defensive investor

The Intelligent Investor Chapter 14 – Stock Selection for the Defensive Investor

1.  Adequate Size of the Enterprise

The idea is to exclude small companies which may be subject to more than average vicissitudes especially in the industrial field.

(I) Not less than S$100 million of annual sales for an industrial company and, not less than $50 million of total assets for a public utility.

(Note:  These figures in 2015 are approximately $600 million and $300 million respectively. Veteran investment writer Jason Zweig in his accompanying commentary for Benjamin Graham’s The Intelligent Investor, Chapter 14 said: “Nowadays, “to exclude small companies,” most defensive investors should steer clear of stocks with a total market value of less than $2 billion.” Jason Zweig  also said: “However, today’s defensive investors – unlike those in Graham’s days – can conveniently own small companies by buying a mutual fund specializing in small stocks.”).

2. A Sufficiently Strong Financial Condition
According to Benjamin Graham, for industrial companies, current assets should be at least twice current liabilities – a so-called two-to-one current ratio. Also, long-term debt should not exceed the net current assets (or working capital). For public utilities, the debt should not exceed twice the stock equity (at book value).

3. Earnings Stability
Some earnings for the common stock in each of the past ten years.

4. Dividend Record
Uninterrupted payments for at least the past 20 years.

5. Earnings Growth
A minimum increase of at least one-third in per-share earnings in the past ten years using three-year averages at the beginning and end.

6. Moderate Price/Earnings Ratio
Current price should not be more than 15 times average earnings of the past three years.

7. Moderate Ratio of Price to Assets
Benjamin Graham said that current price should not be more than 1.5 times the book value last reported. However, a multiplier of earnings below 15 could justify a correspondingly higher multiplier of assets. “As a rule of thumb,” he said, ” we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5 (this figure corresponds to 15 times earnings and 1.5  times book value. It would admit an issue selling at only 9 times earnings and 2.5 times asset value, etc.).”


Mr Market a Drunken Psycho: Warren Buffett

Legendary investor Warren Buffett,  the Sage of Omaha, recently referred to Mr Market as the “Drunken Psycho”. Aspiring value investors need to know who Mr Market is to understand why Warren Bufftett calls him a Drunken Psycho. Warren Buffett has in a letter to Berkshire Hathaway also called Mr Market the poor fellow with incurable emotional problems. The term Mr Market was coined by Benjamin Graham,  the father of value investing and the author of the famous book , The Intelligent Investor, a book widely referred to  as the bible of value investing. 

Benjamin Graham used the term to personify the behavior of the stock market. Here is how Wikipedia put it: “Benjamin Graham’s favorite allegory is that of Mr. Market, an obliging fellow who turns up every day at the shareholder’s door offering to buy or sell his shares at a different price. Often, the price quoted by Mr. Market seems plausible, but sometimes it is ridiculous. The investor is free to either agree with his quoted price and trade with him, or ignore him completely. Mr. Market doesn’t mind this, and will be back the following day to quote another price.

“The point of this anecdote is that the investor should not regard the whims of Mr. Market as a determining factor in the value of the shares the investor owns. He should profit from market folly rather than participate in it. The investor is advised to concentrate on the real life performance of his companies and receiving dividends, rather than be too concerned with Mr. Market’s often irrational behavior.”

Benjamin Graham, in his  parable about Mr Market, said: “Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Everyday he tells you what your interest is worth and further offers to buy you out or sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes to you seems to you a little short of silly.

“If you are a prudent investor or a sensible businessman will you let Mr. Market’s daily communications determine your view of the value of $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out  to him when he quotes you a ridiculously high price, and equally happy to sell to him when his price is low. But the rest of the time you will be wiser to form your own idea of the value of your holdings, based on full reports from the company about its operations and financial position.”

Benjamin Graham’s bottom line on Mr Market:  “Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he would be better off if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”

In his letter (dated February 29, 1988 for FY1987) to Berkshire Hathaway shareholders, Warren Buffett, the most famous disciple of Benjamin Graham,  called Mr Market “the poor fellow with incurable emotional problems”.

Warren Buffet went on to say: “Ben’s Mr. Market allegory may seem out-of-date in today’s investment world, in which most professionals and academicians talk of efficient markets, dynamic hedging and betas. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising “Take two aspirins”?

“…In my opinion, investment success will not be produced by arcane formulae, computer programs or signals flashed by the price behavior of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace. In my own efforts to stay insulated, I have found it highly useful to keep Ben’s Mr. Market concept firmly in mind.”

Recommended reading:

(1) The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition) (Collins Business Essentials)

(2) Berkshire Hathaway Letters to Shareholders, 1965-2013

Walter Schloss stock market secrets

walterschloss
“Factors to make money in the stock market”

In a note dated March 10, 1994, Walter Schloss, a famous value investor named by Warren Buffett in 1984 as one of the superinvestors, listed 16 “Factors Needed To Make Money In The Stock Market”.

Walter Schloss (August 28, 1916 – February 19, 2012)  was a notable American value investor who was one of the famous disciples of Benjamin Graham. Benjamin Graham was of course  the founding father of value investor and the author of two famous books, The Intelligent Investor and Security Analysis.   Warren Buffett, the legendary investor known as the Sage of Omaha and the Oracle of Omaha,  is of course also a disciple of Benjamin Graham.

The following are the stock market secrets of Walter Schloss as listed in his note dated March 10, 1994.

“Factors needed to make money in the stock market”

1. Price is the most important factor to use in relation to value.

2. Try to establish the value of the company. Remember that a share of stock represents a part of a business and is not just a piece of paper.

3. Use book value as a starting point to try and establish the value of the enterprise. Be sure that debt does not equal 100% of the equity. (Capital and surplus for the common stock).

4. Have patience. Stocks don’t go up immediately.

5. Don’t buy on tips or for a quick move. Let the professionals do that, if they can. Don’t sell on bad news.

6. Don’t be afraid to be a loner but be sure that you are correct in your judgment. You can’t be 100% certain but try to look for the weaknesses in your thinking. Buy on a scale down and sell on a scale up.

7. Have the courage of your convictions once you have made a decision.

8. Have a philosophy of investment and try to follow it. The above is a way that I’ve found successful.

9. Don’t be in too much of a hurry to see. If the stock reaches a price that you think is a fair one, then you can sell but often because a stock goes up say 50%, people say sell it and button up your profit. Before selling try to reevaluate the company again and see where the stock sells in relation to its book value. Be aware of the level of the stock market. Are yields low and P-E rations high. If the stock market historically high. Are people very optimistic etc?

10. When buying a stock, I find it helpful to buy near the low of the past few years. A stock may go as (h)igh as 125 and then decline to 60 and you think it attractive. 3 years before the stock sold at 20 which shows that there is some vulnerability in it.

11. Try to buy assets at a discount than to buy earnings. Earning can change dramatically in a short time. Usually assets change slowly. One has to know much more about a company if one buys earnings.

12. Listen to suggestions from people you respect. This doesn’t mean you have to accept them. Remember it’s your money and generally it is harder to keep money than to make it. Once you lose a lot of money, it is hard to make it back.

13. Try not to let your emotions affect your judgment. Fear and greed are probably the worst emotions to have in connection with purchase and sale of stocks.

14. Remember the work (of) compounding.  For example,  if you can make 12% a year and reinvest the money back, you will double your money in 6 yrs, taxes excluded. Remember the rule of 72. Your rate of return into 72 will tell you the number of years to double your money.

15. Prefer stock over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.

16. Be careful of leverage. It can go against you.

Recommended reading:

(1) The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition) (Collins Business Essentials)

(2) Security Analysis: Sixth Edition, Foreword by Warren Buffett (Security Analysis Prior Editions)

Philip Fisher’s “Fifteen Points to Look for in a Common Stock”

American stock investor Philip Arthur Fisher (September 8, 1907 – March 11, 2004) was best known as the author of the investment guide book  Common Stocks and Uncommon Profits. The book has the reputation of staying in print since it was first published in 1958.

Among his best-known followers is Warren Buffett who on some occasions was reported to have said that “he is 85% (Benjamin) Graham and 15% (Philip) Fisher”.

Warren Buffett called Phillip Fisher “a respected investor and author” in a letter to Berkshire Hathaway shareholders.

Fisher’s famous “Fifteen Points to Look for in a Common Stock” from “Common Stocks and Uncommon Profits” are seen as a qualitative guide to finding well-managed companies with growth prospects.  According to Philip Fisher, a company must qualify on most of the 15 points to be considered a worthwhile investment.

1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years? A company aiming for a sustained period of spectacular growth needs to have products catering to large and expanding markets.

2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited? A company needs to  continually develop new products to  expand existing markets or to enter new ones. This is to help it maintain above-average growth over a period of decades, the reason being that all markets eventually mature.

3. How effective are the company’s research and development (R&D) efforts in relation to its size? R&D activity needs to be efficient and effective for a company to develop new products.

4. Does the company have an above-average sales organization? According to Philip Fisher,  expert merchandising  is essential  in a competitive environment, the reason being that few products or services are so compelling that they will sell to their maximum potential.

5. Does the company have a worthwhile profit margin? Tremendous growth alone won’t do. The growth must also bring worthwhile profits to reward investors.

6. What is the company doing to maintain or improve profit margins? Philip Fisher put it this way:  “It is not the profit margin of the past but those of the future that are basically important to the investor.” Higher inflation raises a company’s expenses and, coupled with competition,  will compress profit margins. Eyes have to be on how a company’s strategy will  reduce costs and improve profit margins over the long term.

7. Does the company have outstanding labor and personnel relations? According to Philip Fisher, happy employees are likely to be more productive. Hence a company with good labor relations tends to be more profitable than one with mediocre relations.  There is no single way  to measure the state of a company’s labor relations. Indications of  good labor relations in a company: making efforst to settle employee grievances quickly; a company making above-average profits  paying above-average wages to its employees; and  attitude of top management toward employees.

8. Does the company have outstanding executive relations? A company must  cultivate the right atmosphere.  In companies where the founding family retains control, promotion of family members should not be at the expense of  more able executives.  Executive salaries should also be at least in line with industry norms. There needs to be a regular review of salaries and merited pay increases are given without the executives having to make the demand.

9. Does the company have depth to its management? Proper development of a deep pool of management talent is vital. Avoid companies where top management is unwilling to delegate crucial authority to lower-level managers.

10. How good are the company’s cost analysis and accounting controls? A company must closely track operational costs for it to be able to achieve outstanding results over the long term. Knowing precisely the cost analysis of a company is not easy but those that are exceptionally lacking are discernible and investors should steer clear of them.

11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition? The important clues  vary widely among industries.  Investor need to understand the  success industry factors  of a company and where it stands against its competitors.

12. Does the company have a short-range or long-range outlook in regard to profits? Investors need to adopt a long-range view and correspondingly should seek companies that take a long-range view on profits. A company with its eyes glued on meeting Wall Street’s quarterly earnings estimates may not go for beneficial long-term actions that dampen its  short-term earnings. Management may even resort to  making aggressive accounting assumptions so as to  report acceptable quarterly profit figures.

13. In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this anticipated growth? Seek companies with sufficient cash or borrowing capacity to fund growth. Equity offerings dilute the interests of owners.

14. Does management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur? Management must be one that reports candidly  all aspects of its business, whether good or bad.

15. Does the company have a management of unquestionable integrity? Avoid a company “if there is a serious question of the lack of a strong management sense of trusteeship for shareholders.”

Recommended reading:

Common Stocks And Uncommon Profits