My Amazon Review of Benjamin Graham's and Jason Zweig's (Ed) "The Intelligent Investor (Rev. Ed.)"

 Margin of Safety

 I just finished rereading “The Intelligent Investor,” a book a I read many years ago and much of its investment insights are still very valid for today. I would note that I was weaned on Benjamin Graham’s “Security Analysis, Principles and Techniques” as an undergraduate at Baruch College. I guess you can say that Graham’s ideas are in my blood. Indeed, just as Graham probed the Standard and Poor’s stock guide, so too did I for many years. Today we have computerized databases.

 The most critical ideas that are useful today include:

·       * A stock certificate is more than a piece of paper; it represents an

      ownership interest in a business.

·      *  Investments should only be undertaken with a quantifiable margin of safety.

·     *   “Mr. Market” who on occasion is manic-depressive allows you to express a view on a stock or a bond every day.

·     *   Despite all of your efforts at security analysis the stock market is loosely efficient making it very difficult to outperform a broad index. Investment success flows from a few very special situations.

·      *  Investors can be characterized as defensive or enterprising, but even for the enterprising investor Graham’s rules are designed to minimize losses through diversification and heeding to margin of safety requirements.

 

As the classic value investor, much of Graham’s work is focused on tangible book value. That metric worked well though the middle of the 20^th Century, but that kept Graham and his acolytes away from growth companies who were powered by intangible capital. Thus, it was hard for Graham to get comfortable with owning many of the growth stocks of his era, but his discipline kept him away from the craziness of the bubbles that occurred in 1961 and in the late 1960’s.  Jason Zweig, the editor of this version discusses at the length the extremes of the late 1990’s dot.com bubble.

 

Graham was fond of public utility shares in the early 1970’s because they traded a low price/earnings and price/book ratios. Unfortunately, he did not foresee the debacle that cost over-runs in nuclear power brought on to this sector. Zweig points this out. Also, Graham really didn’t associate the rise in interest rates in the late 1960’s with the rise in inflation. He characterized common stocks as inflation hedges, which in the long run they are, but that is not necessarily true in the short run as rising inflation propels interest rates higher and price/earnings ratios lower.

 

Then there is a short discussion on Graham’s investment in Government Employees Insurance Co. (GEICO). There his partnership broke his diversification rule by investing 25% of its capital in it for 50% of the company. However, its valuation in terms of earnings and tangible equity was very low. It was his best investment and Warren Buffett, his best-known student, followed him into GEICO and as a result Berkshire Hathaway now owns the entire company.

 

Although the book’s examples are dated, the investing rules outlined here are timeless.

For the full Amazon URL see: Margin of Safety (amazon.com)

The Defanging of the Stock Market

 

April has brought with it the defanging of the stock market where the hitherto invulnerable FAANG stocks crashed and burned bringing with it a full-fledged bear market in the NASDAQ Composite Index. FAANG stands for Facebook (now Meta Platforms) Apple, Amazon, Netflix, and Google (now Alphabet). From their respective 52-week highs Meta is down 48%, Apple is down 13%, Amazon is down 33%, Netflix is down an astounding 73% and Alphabet is down 23%. Taken as a whole the NASDAQ Composite is down 23%. The weakness in these five stocks which at one time accounted for nearly a quarter of the market value of the S&P 500 brought that benchmark index down 14%.

 

Market behavior of this type is reminiscent of the 1973-74 and the 2000-02 bear markets. In the 1970s the so-called Nifty-50 group of one-decision growth stocks which were trading at 50-60X earnings experienced declines in excess of 50 -80% during the course of the bear market. In the collapse of the 2000 dot.com bubble such stalwarts as Cisco, Microsoft, Intel, and Oracle (a group of stocks that I then characterized as “The Four Horseman of the NASDAQ”) which traded at multiples in the 80-100X range lost about three quarters of their market value. Indeed, just as today, the stock market was bracing for a tightening of monetary policy. Needless to say, the history is not encouraging.

 

There are, however, two distinct differences between then and now. First, from 1972-74 the 10-year Treasury traded in a 6-8% range and in 2000-02 it traded in a 5-6% range far higher than the current 2.9% yield. Second, with the exception of Netflix valuations are nowhere near as demanding with Alphabet trading less than 20X earnings, Apple at around 25X, Meta at a below market 14X earnings. As a result, even if Treasury yields rise to 4%, my sense is that the worst of the declines in FAANG and the market as whole are behind us.

 

To be sure, we could soon be looking into the teeth of a recession triggered by a very aggressive Fed and continued high inflation which would haircut earnings estimates across the entire market. We are sure to have a recession at some point, but I do not believe it is soon. Simply put the end of the pandemic is fueling a consumer boom and capex remains strong fueled technology and energy related spending of all types. Thus, it will take more than 250 basis points of tightening to break this economy. Of course, if we are in a rerun of “That 70’s Show,” all bets are off. (Shulmaven: Roaring 20's or That 70's Show)

 

As I wrote in February(https://shulmaven.blogspot.com/2022/02/the-unravelling.html), my sense is that we are in a structural bear market in bonds and in for a very volatile stock market. Whether or not the lows are in or not, I do not know, but the world will not look as bad in December as market participants feared last week. Net, net although 2022 will be a down year for stocks, the market will end the year higher than where it is now.