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Chapter 23 STRATEGIES OF THE GREAT MASTERS The Timeless Wisdom

Chapter 23 STRATEGIES OF THE GREAT MASTERS The Timeless Wisdom. OUTLINE Benjamin Graham : The Quantitative Navigator Philip Fisher : The Growth Stock Investor Warren Buffett : The Ultimate Businessman

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Chapter 23 STRATEGIES OF THE GREAT MASTERS The Timeless Wisdom

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  1. Chapter 23 STRATEGIES OF THE GREAT MASTERS The Timeless Wisdom

  2. OUTLINE • Benjamin Graham : The Quantitative Navigator • Philip Fisher : The Growth Stock Investor • Warren Buffett : The Ultimate Businessman • John Templeton : The Bargain Hunter • Peter Lynch : The Relentless Chaser • George Soros : The Global Speculator • David Dreman : The Contrarian Investor • Charles Ellis : Playing the Loser’s Game • John Bogle : Twelve Pillars of Investment Wisdom • Zurich Axioms : The Swiss Wisdom • India’s Money Monarchs

  3. Benjamin Graham: The Quantitative Navigator • Benjamin Graham, the father of security analysis, advocated a quantitative approach to investment. Throughout his professional career, Graham tried to develop specific, quantitative techniques that he could teach others to enable them to manage their investments profitably. • In 1934, along with David Godd, Graham published Security Analysis, a monumental work, which is regarded as basic text for serious students of investing. • In 1949, Benjamin Graham published The Intelligent Investor which appeals to almost all readers and which according to Warren Buffett is: “By far the best book on investing ever written.”

  4. Illustration of Graham’s Methods • To illustrate Graham’s methods, let us look at the following set of • Standards developed by him for stock selection by the defensive investor • in his book The Intelligent Investor. • Adequate Size of the Enterprise A company should not have less than $100 million of annual sales if it is an industrial company or less than $50 million total assets if it is a public utility. • A Sufficiently Strong Financial Condition For an industrial company, the current ratio should be at least two and the long term debt should not be greater than the net current assets. For a public utility, the debt-equity ratio (at book value) should not exceed 2. • Earnings Stability Equity earnings must be positive in each of the past ten years. • Dividend Record The company must have a record of paying uninterrupted dividends for atleast the past twenty years.

  5. Earnings Growth Earnings per share must have increased by at least one-third in the past ten years, using three-year averages at the beginning and end. • Moderate Price/Earnings Ratio The current price should not exceed 15 times average earnings for the past three years. • Moderate Ratio of Price to Assets The current price should not exceed 1 ½ times the last reported book value. However, a price-earnings multiplier of less than 15 may justify a higher price-to-book value approach. As a rule thumb, the product of the price-earnings multiplier and the price-to-book value ratio should not be more than 22.5.

  6. Philip Fisher: The Investigative Growth Stock Investor A pioneer in growth stock investing, Philip Fisher concentrated on outstanding companies. As he said: “I don’t want a lot of good investments; I want a few outstanding ones.” To evaluate whether a company is outstanding, Fisher employed several criteria, which can be grouped under two main categories: characteristics of the business and qualities of management. Characteristics of the Business An attractive business has the following characteristics; (a) growth from existing products and new products, (b) high profit margin and return on capital along with favourable trends in them, (c) effective research, (d) an excellent sales organisation, (e) a leading industry position, and (f) a durable “franchise.”

  7. Qualities of Management The desirable qualities of management include the following: (a) integrity, (b) accessibility, (c) long-term orientation, (d) appreciation that change is pervasive, (e) strong financial controls, (f) sound personnel policies, (g) special skills required for particular industries, and (h) multidisciplinary skills where relevant.

  8. WARREN BUFFETT : THE ULTIMATE BUSINESSMAN JOHN TRAIN THE MIDAS TOUCH ROBERT G. HAEGSTORM, Jr THE WARREN BUFFETT WAY : INVESTMENT STRATEGIES OF THE WORLD’S GREATEST INVESTOR 1. TURN OFF THE STOCK MARKET MANIC DEPRESSIVE . . NO DIRECT’N 2. DON’T WORRY ABOUT THE ECONOMY COMMON . . WHY NO ? • DIFFICULTY PREDICT’N • SPECUL’N & TURNOVER 3. BUY A BUSINESS, NOT A STOCK WHEN ONE INVESTS, ONE MUST BUY A BUSINESS NOT A STOCK … LONG-TERM PERSPECTIVE 4. MANAGE A PORTFOLIO OF BUSINESSES MODEST DIVERSIFOC’N . . ‘KNOW-SOMETHING’ 5-10 BUSINESSES WIDE DIVERSIFIC’N . . ‘KNOW-NOTHING’

  9. Tenets Applied By Buffett • BUSINESS TENETS • SIMPLICITY AND UNDERSTANDABILITY • CONSISTENT HISTORY • FRANCHISE • MANAGEMENT TENETS • RATIONALITY • CANDOUR • FINANCIAL TENETS • ROE • PROFIT MARGIN • MARKET TENETS • VALUE OF THE BUSINESS • PURCHASE AT A SIGNIFICANT DISCOUNT

  10. John Templeton: The Bargain Hunter • 16 RULES OF INVESTMENT SUCCESS • IF YOU BEGIN WITH A PRAYER, YOU CAN THINK CLEARLY AND MAKE FEWER MISTAKES. • OUTPERFORMING THE MARKET IS A DIFFICULT TASK. • INVEST-DON’T TRADE OR SPECULATE. • BUY VALUE, NOT MARKET TRENDS OR THE ECONOMIC OUTLOOK. • WHEN BUYING STOCKS, SEARCH FOR BARGAIN AMONG QUALITY STOCKS. • BUY LOW SO SIMPLE IN CONCEPT SO DIFFICULT IN EXECUTION • THER’S NO FREE LUNCH. NEVER INVEST ON SENTIMENT • DO YOUR HOMWORK OR HIRE WISE EXPERTS TO HELP YOU.

  11. John Templeton: The Bargain Hunter • DIVERSIFY – BY COMPANY, BY INDUSTRY • INVEST FOR MAXIMUM TOTAL RETURN • LEARN FROM MISTAKES • AGGRESSIVELY MONITOR YOUR INVESTMENTS • AN INVESTOR WHO HAS ALL THE ANSWERS DOESN’T EVEN UNDERSTAND ALL THE QUESTIONS • REMAIN FLEXIBLE AND OPEN – MINDED ABOUT TYPES OF INVESTMENT • DON’T PANIC • DO NOT BE FEARFUL OR NEGATIVE TOO OF TEN

  12. Peter Lynch: The Relentless Chaser $1000 (77) $28000(90) AUG 87 . . $12 BL TIME “#1 MONEY MANAGER” ONE UP ON WALL STREET 1. ADDRESS BASIC PERSONAL ISSUES BEFORE BUYING SHARES • HOUSE • NEED • PERSONAL QUALITIES 2. DEVOTE TIME & EFFORT • 1-HR • REFRIGERATOR • MUTUAL FUND 3. TRY GOING IT ALONE • TIPS • LYNCH DOES 4. INVEST IN SOMETHING YOU KNOW OR UNDERSTAND • EXOTICA 5. LOOK FOR COMPANIES THAT ARE “OFF THE RADAR SCOPE OF THE MARKET” 6. APPLY SIMPLE FUNDAMENTAL CRITERIA • P/E … CASH, DEBT, DIV, BOOK VALUE, PAT 7. DON’T TRY TO PREDICT THE MARKET • STAND BY … FUNDAMENTAL STORY UNCHANGED 8. AVOID MARKET TIMING 9. ESCHEW GENERIC FORMULAE • SELL … DOUBLE … 10% CUT OFF 10. DIVERSIFY FLEXIBLY 11. BE PATIENT 12. CAREFULLY PRUNE & ROTATE BASED ON FUNDAMENTALS 13. AVOID FINANCIAL DERIVATIVES

  13. George Soros: The Global Speculator $ 100000 . . 1969 SOROS . . QUANTUN FUND $ 130 ML 1994 35% COMPOUNDING 25 YEARS ROBERT SLATER “QUITE SIMPLY, NO ONE HAS DONE AS WELL FOR SO LONG IN FINANCIAL MARKETS AS GEORGE SOROS. NOT BUFFETT, NOT LYNCH. NOT ANYONE. HIS RECORD WAS THE BEST INSTITUTIONAL INVESTOR “THE WORLD’S GREATEST MONEY MANAGER” GEORGE SOROS, THE ALCHEMY OF FINANCE SIMON & SCHUSTER, 1987 ROBERT SLATER, THE LIFE, TIMES, TRADING SECRETS OF THE WORLD’S GREATEST INVESTOR, IRWIN (IBD . . INDIA) SOROS ON SOROS

  14. Complex Maneuvers “IF I START WITH A FULLY INVESTED POSITION & THEN SELL SHORT AN EQUAL AMOUNT, A 20 PERCENT DECLINE, EVEN IF IT AFFECTS THE LONGS AND THE SHORTS EQUALLY, LEAVES ME ONLY 80 PERCENT INVESTED ON THE LONG SIDE. IF I COVER MY SHORTS WITH A LOSS I AM BETTER OFF THAN I HAD SOLD MY LONGS AT THE WRONG TIME.”

  15. Reflexivity Theory “THE GENERALLY ACCEPTED VIEW IS THAT THE MARKETS ARE ALWAYS RIGHT - THAT IS MARKET PRICES TEND TO DISCOUNT FUTURE DEVELOPMENTS ACCURATELY EVEN WHEN IT IS UNCLEAR WHAT THOSE DEVELOPMENTS ARE. I START WITH THE OPPOSITE POINT OF VIEW. I BELIEVE THAT MARKET PRICES ARE ALWAYS WRONG IN THE SENSE THAT THEY PRESENT A BIASED VIEW OF THE FUTURE. BUT DISTORTION WORKS IN BOTH DIRECTIONS : NOT ONLY DO MARKET PARTICIPANTS OPERATE WITH A BIAS, BUT THEIR BIAS CAN INFLUENCE THE COURSE OF EVENTS”

  16. HE REFERS TO THE TWO-WAY CONNECT’N BETWEEN FLAWED PERCEPTIONS & THE ACTUAL COURSE OF EVENTS AS ‘REFLEXIVITY’. HE BREAKS THIS CONNECTION INTO TWO FUNCTIONAL RELATIONSHIPS COGNITIVE : THE PERCEPTION OF THE PARTICIPANTS FUNCTION DEPENDS ON THE SITUATION PARTICIPATING : THE SITUATION IS INFLUENCED BY THE FUNCTION PERCEPTION OF THE PARTICIPANTS COGNITIVE FUNCTION : Y = f (X) PARTICIPATING FUNCTION : X = f (Y) HENCE Y = f (X) X = f (Y) SOROS ARGUES THAT THE TWO RECURSIVE FUNCTIONS DO NOT LEAD TO AN EQUILIBRIUM BUT AN ENDLESS PROCESS OF CHANGE

  17. Dreaman’s Rules For Contrarian Investing 1. IGNORE TECHNICAL ANALYSIS 2. DON’T RELY ON EXPERTS AND THE FORECASTS OF ANALYSTS 3. INVEST IN OUT=OF FAVOUR STOCKS TO TAKE ADVANTAGE OF ANALYST FORECAST ERROR 4. SUPPLEMENT YOUR ANALYSIS WITH ANCILLARY FINANCIAL POSITIONS 5. DIVERSIFY BROADLY 6. WITHIN AN INDUSTRY BUY THE CHEAPEST STOCKS AS DETERMINED BY THE CONTRARIAN STRATEGIES 7. DON’T BE CARRIED AWAY BY THE SHORT TERM RECORD OF AND ANALYST OR A MONEY MANAGER 8. RELY MORE ON THE BASE RATE AND LESS ON THE CASE RATE 9. GIVE YOUR STRATEGY A REASONABLE TIME TO WORK OUT 10. AVOID INVESTMENT ADVICE BASED ON VOLATILITY

  18. Charles Ellis: Playing The Loser’s Game • IN A WINNER’S GAME THE OUTCOME IS • DETERMINED BY THE ACTIONS OF THE WINNER. • THE VICTOR GETS A HIGHER SCORE BY • WINNING MORE POINTS. • IN A LOSER’S GAME, THE VICTOR IS THE • PLAYER WHO GETS A HIGHER SCORE, NOT • BECAUSE HE WINS MORE POINTS BUT BECAUSE • HIS OPPONENT LOSES EVEN MORE.

  19. Charles Ellis: Playing The Loser’s Game • THANKS TO THE INTENSE COMPETITION AMONG • NUMEROUS INSTITUTIONAL PLAYERS, THE MONEY • GAME HAS NOW BECOME A LOSER’S GAME. • IF YOU WANT TO WIN THE LOSER’S GAME, YOU • SHOULD ADHERE TO THE FOLLOWING GUIDELINES • 1. PLAY YOUR GAME • 2. KEEP IT SIMPLE • 3. CONCENTRATE ON YOUR DEFENCE

  20. John Bogle: Twelve Pillars Of investment Wisdom • INVESTING IS NOT NEARLY AS DIFFICULT AS IT LOOKS. • WHEN ALL ELSE FAILS, FALL BACK ON SIMPLICITY. • TIME MARCHES ON. • NOTHING VENTURED, NOTHING GAINED. • DIVERSIFY, DIVERSIFY, DIVERSIFY. • THE ETERNAL TRIANGLE (RISK, RETURN, AND COST) • THE POWERFUL MAGNETISM OF THE MEAN. • DO NOT OVERESTIMATE YOUR ABILITY TO PICK SUPERIOR EQUITY MUTUAL FUNDS, NOR UNDERESTIMATE YOUR ABILITY TO PICK SUPERIOR BOND AND MONEY MARKET FUNDS. • YOU MAY HAVE A STABLE PRINCIPAL VALUE OR A STABLE INCOME STREAM, BUT YOU MAY NOT HAVE BOTH • BEWARE OF FIGHTING THE LAST WAR • YOU RARELY, IF EVER, KNOW SOMETHING THAT THE MARKET DOES NOT • THINK LONG TERM

  21. Zurich Axioms MAX GUNTHER ON RISK : WORRY IS NOT A SICKNESS BUT A SIGN OF HEALTH ON GREED : ALWAYS TAKE YOUR PROFIT ON HOPE : WHEN THE SHIP STARTS TO SINK, DON’T PRAY. JUMP. ON FORECAST : HUMAN BEHAVIOUR CANNOT BE PREDICTED ON PATTERNS : CHAOS IS NOT DANGEROUS UNTIL IT BEGINS OT LOOK ORDERLY ON MOBILITY : AVOID PUTTING DOWN ROOTS. THEY IMPEDE MOTION. ON INTUITION : A HUNCH CAN BE TRUSTED IF IT CAN BE EXPLAINED ON RELIGION : IT IS UNLIKELY THAT GOD’S PLAN FOR THE UNIVERSE AND OCCULT INCLUDES MAKING YOU RICH ON OPTIMISM : NEVER MAKE A MOVE JUST BECAUSE YOU’RE OPTIMISTIC /PESSIMISM ON CONSENSUS : DISREGARD THE MAJORITY VIEW ON STUBBORNNESS : IF IT DOES’NT PAY OFF THE FIRST TIME, FORGET IT ON PLANNING : LONG RANGE PLANS ENGENDER THE DANGEROUS BELIEF THAT THE FUTURE IS UNDER CONTROL

  22. India’s Money Monarchs In an interesting book titled ‘Inida’s Money Monarchs,’ Chetan Paribh, Navin Agarwal, and Utpal Seth reported their interviews with leading investors and money managers in India. Here are some glimpses: • Raamdeo Agarwar: “I believe that if you identify about ten fast growing large companies…you…get the desirable result.” • Sameer Arora: “We really aim to anticipate and recognise change early.” • Sanjoy Bhattacharya: “Common sense and discipline are key to investing success.” • Manish Chokhani: “So when everyone thinks that the trend is down…we get excited. Or when the trend is up…we are fearful.” • Kisan Choksey: “One must ensure margin of safety in investment decisions.”

  23. Arjun Divecha: “We have two very simple ideas. We buy cheap and we buy momentum.” • Sanjiv Duggal: “ We are basically business cycle investors, wherein we decide which sectors to buy or sell depending upon the business or economic cycle we are.” • Prashant Jain: “I think it (i.e., portfolio management) is an art to the extent that you are dealing with something that is not definite. It is a science to the extent that you have benchmarks available.” • Rakesh Jhunjhunwala: “ I look at an investment opportunity where I feel that my capital is safe and the possible upside is large.” • Parag Parikh: “I believe in diversification, but diversification in another way – investing in different vehicles like stocks, debt, bonds, mutual funds, real estate etc.”

  24. Sukumar Rajah: “My objective is to invest in businesses that can generate superior return on capital over a period of time.” • Chandrakant Sampat: “I think there are 5 attributes that an investor should be looking at: 1. Management quality. 2. Is there any anallocable capital in the balance sheet? 3. The competitive advantage period. 4. The RONW (return on net worth). 5. The understanding of risk and what we pay for it” • Bharat Shah: “The most important thing is to read the annual report carefully.” • Nilesh Shah: “We don’t use the DCF valuation model because our forecasts are fairly hazy beyond one or two years… So, we try to arrive at valuations based on multiples (P/E, P/B).” • Ruchir Sharma: “There are three cornerstones to our investment philosophy-valuations, dynamics, and sentiments – that we pay a lot of attention to when it comes to analysing any asset class (or stock or market or currency.”

  25. SUMMING UP • Warren Buffett invests like a businessman • John Templeton excelled in bargain hunting. • Peter Lynch succeeded as a relentless chaser. • George Soros’ gains came from global speculation. • David Dreman is the ‘dean’ of contrarians. • Charles Ellis argues that the investment game has become a • Loser’s game. To win this game one must avoid making • mistakes. • John Bogle has spelt out the “twelve pillars of wisdom” to • guide investors. • The Swiss wisdom is captured in the Zurich axioms

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