Hello everyone, and welcome to A Word From Devil On Techno-Fundamental Investing.
My name is Nrupen and in this video we'll take a look on investing methodology of most
influential investor of our time Sir Benjamin Graham.
He is also known as "Father Of Value Investing".
Keep in mind all of Graham's books are advanced level guides and thus are extremely difficult
to understand for average investor.
In this video I'll try my best to give you easy to understand breakdown of some of his
work but as I always say no video is good enough to justify original work of any investor.
So its better for you to take a look on his books, if you are advanced enough to understand
them.
First we'll try to understand his "Investing Ideology" then "Method Of Analysis",
third "Risk Management" and finally "Strategy".
Benjamin Graham believed market is not predictable and it doesn't matter who you are, what are
your educational qualifications and how much success rate you have, absolutely no one can
predict market direction.
So there's no point in predicting market direction.
Understanding that nothing is predictable is biggest edge any investor can ever have
while investing.
Everyone buys when times are good and everyone sells when times are bad, this is how crowd
reacts.
The crowd that reacts does not make money, so to be sure we make it we have to separate
ourselves from crowd and rather than reacting we should respond to reaction of crowd.
Basic investing Psychology is high risk yields high rewards and low risk yields low rewards.
Benjamin realized that if he invests in any stock then his maximum loss would never go
below 100%, because the minimum price a stock can ever go is zero.
On other hand if business progresses, the potential rewards can be exponential.
A business can either go out of business, or it might just keep working as it is or
it can start progressing and become very huge.
He realized if maximum loss is zero and maximum profits are exponential then loss no matter
how big it is will always remain arithmetic on other hand when profits will come they'll
be logarithmic.
From which he came to conclusion, "High Risk High Reward and Low Risk Low Reward"
mentality is wrong on all levels.
On other hand we can also reap high rewards on low risk, this idea became corner stone
for value investing.
Benjamin thought what if he can devise a method with help of which he could actually pick
only those stocks which have very high probability to not go out of business.
With this thought he introduced something to fundamental analysis that Jack Dreyfus
introduced to technical analysis and thus "Value Investing" was born.
The thing that he introduced was Risk Management.
Value Stocks are those stocks which hold very high potential of profits and very low potential
of loss.
Note that Graham gave investing method for every kind of investor but in this video we'll
strictly focus on Graham's value stock.
He also realized that, to make sure risk remains minimum he should not be investing in current
market value of stock but in future financial value of business.
And therefore concept of intrinsic value was required for his method of investing.
Now reality is, Intrinsic Value is very complex term and depending on your investing ideology
you can provide different meaning to Intrinsic Value.
Some might consider Intrinsic Value based on qualitative factors, others may consider
on quantitative factors.
New investors have heard Intrinsic Value so many times that they are kind of in dream
world where they believe that if they would be able to calculate intrinsic value of business
then they would become successful.
But they don't understand Intrinsic Value can never be a precise number but an estimate,
second it is also relative, third with respect to what you want to look at intrinsic value
its definition and method of calculation varies.
If you'll search YouTube with "How to calculate Intrinsic Value ?", you'll get possible
different methods of calculating it.
Most popular variations are based on cash flows and earnings of business.
Unless you can already understand how different businesses operate differently Intrinsic Value
is possibly the most useless number you should be worried about as an average investor.
Benjamin's Method definitely was based on his method of Intrinsic Value calculation.
Final thing that you should know is that Benjamin Graham was first to introduce idea of automating
investing process.
He introduced this idea because there are hundreds of stocks in stock market and researching
all of them will take like forever.
So we must have method to short list stocks of our interest for research rather than taking
a look on all of them.
As per his method he would prefer stocks in which Price To Book Ratio should yield result
less than 1.25, As we'll move ahead with video you'll understand why that number is important
but for now keep in mind it does not mean stocks whose PBR is less than 1 are value
stocks.
As per Graham a successful business makes a lot more than what it requires to stay in
business.
Now what it tells about that business, first since this business makes more than what it
requires, it can not have huge debt.
So the very first thing that we need to know is debt is low or not, for which we see Debt
to Equity ratio.
Formula for Total Equity is Total Assets – Total Liabilities, whereas formula for Debt to Equity
is Total Debt divided by Total Equity.
Note that Total Equity means Net Worth of business.
In front of you is balance sheet of Uflex in which total Net Worth is 2,041.79 whereas
total debt is 1,116.36, to get Debt To Equity ratio we'll divide Uflex Total Debt with Net
Worth.
The answer is 0.55, we can verify answer by taking a look on "Key Financial Ratios"
page.
Our answer 0.55 tells us, for every 1 Rupee Uflex is under 0.55 paise in debt.
For matching Benjamin's Criteria Debt To Equity should be lot less than 0.55, 0.25 or less
is mostly likely the best choice.
Next since business is consistently making more than what it requires to stay in business,
its Net sales should be increasing every year along with positive EPS.
Note that I said increasing Net Sales with positive EPS not increasing EPS.
It is very less likely for you to find a business with increasing EPS and low Debt to Equity
ratio.
In front of you is Yearly results for Uflex in which you can see increasing Net Sales
every year, along with this we only need positive EPS not growing EPS.
Finally if a business makes more money than it requires to stay in business it will always
have a positive cash flow.
Now I have already created a video on reading cash flow statement so I wouldn't be wasting
time in this video too.
You can either take a look on one of my older videos or just search YouTube with "How
To Read Cash Flow Statement" and you'll find more than required number of videos on
it.
For now, just remember a businesses that makes more money than what it requires to stay in
business have low Debt to Equity ratio, low debt.
Total equity and net sales grows every year along with positive EPS and positive Cash
Flow.
That's general method of analysis, step 2 is risk management.
Graham believed a business have 2 types of valuations, first is business valuation and
second it market valuation.
Business valuations are those valuations which reflect actual financial worth of business.
A price for which you would be interested in buying the business of underlying stock.
Business valuation and intrinsic value of business are one and the same thing.
First you have to understand a standard formula to calculate intrinsic value of stock can
not exist looking at the fact there are lot of different things that needs to be considered
before you decide to buy business as whole.
Second thing to keep in mind is that it can never be a precise number but always an estimate.
There is so much hype about intrinsic value among average investors that they are in kind
of dream land that somehow if they could calculate intrinsic value, it would guarantee them successful
investment.
What they fail to notice is educational qualification and amount of experience required for estimating
value of business based on its current state which includes taking into note equity, leverage,
life of business and ability of business to perform for its expected life.
Calculations are not only arbitrary but also tricky in themselves.
Keep in mind there can not be a standard formula to calculate intrinsic value of business,
every formula is circumstance specific.
Market Valuation of stock is value that market assumes should be value of business.
It can be less or more than actual valuation of business.
Since market valuations stocks can be higher as well as lower as compared to actual business
valuation Graham decided to buy stock when Market Valuation of sock is equal to Business
Valuation of business.
Now to make sure he is buying stock at business valuation he needed something that can be
used as price benchmark for purchase.
This price benchmark was book value of business.
[PBR PE]
We would buy stocks if Price To Book ratio would be near one.
For example take a look on price to book ratio of Uflex.
Here you can see Price/Book ratio is 0.85 which translates to Market Valuations of Uflex
is less than its business valuations by 0.15 points.
The stock is available for 15% discount or 15% bargain price.
This discount/bargain is what can be called as margin of safety for Graham's investing
method.
The role of margin of safety is to provide protection to our investments against market
fluctuations.
Margin of safety only guarantees less risk, it doesn't guarantee any rewards.
Benjamin's personal favorite were those stocks which could be bought for PBR of 0.66, in
short we can say that Benjamin preferred 30 to 35% discount on price.
Next thing that was important to Benjamin during purchase was Price to Earning ratio.
He mostly preferred PE less than 15 and reason for that was Benjamin's point of view on PE.
Graham would consider PE as number of years in which he would be able to recover his investment
from business if business continues to earn at same rate or as number of years required
for business to grow to an extent so that its earning potential matches the price paid.
[PBR PE]
For example take a look on PE of Uflex, at present Uflex is trading at 431 with PE approximately
equal to 9, right now EPS of Uflex is 28.
The PE of 9 states if Uflex continues to grow its EPS at current rate then addition of EPS
over next 9 years will yield number greater than 431.
Everything after 9 years is pure profit on investment, as we know Graham was long term
investor and his minimum holding time was 15 years due to which he recommended to buy
stock when PE is below 15, unless this condition is matched low PBR is useless.
Things to learn from his risk management is, PBR and PE contribute to margin of safety
if stock matches investing ideology.
You can scan for value stocks by looking for low PBR and PE but for being called a true
value stock it should also match his investing ideology else you would be just picking junk
on name of low PBR and PE.
Low PBR means margin of safety in quality stock and low PE means earnings are extremely
high but price is less.
Which concludes to extremely low risk potential but extremely high profit potential, a condition
required for being a value stock.
Now most investors who try to invest on Graham's model though are able to find ideological
match but couldn't find a mathematical match of PBR equal to or less than one.
For which he gave strategy, buy a business when it is getting unappreciated by market.
The time when business delivers less quarterly earnings or time when blood is running high
in market.
Which means if Uflex would have matched every required criteria of Graham then January and
February would have been the best time to buy Uflex because Quarterly results of December
2016 were lower than December 2015.
You have understand that one bad quarterly result does not equate to over all bad performance.
This is the time when crowd is acting irrationally and this is the time when you should be acting
rationally by starting to buy because this is the only day you might be able to pick
mathematical match to Graham's Value stock.
The final thing that you should know is that Graham recommend to invest in multiple stocks
not just in one stock.
In fact Graham recommended over diversified portfolio of value stocks and as per him if
all other factors of value remain unchanged then you should scale up your positions with
each new fall.
He also recommend not to depend on investing once or twice a year, on other hand one should
invest a small amount every month in stocks you trust because it'll help you average the
best bargain price.
Finally we'll take a look on why Graham's method works, its advantages, limitations
and how it contributed to overall investing community.
But before that I would like to share just few lines from original work of Graham for
those investors who are mislead by idea of value stock may be because of marketing or
because they intentionally mistook it.
Here's the first one from "The Intelligent Investor" Indian Subcontinent Edition Chapter
20 Margin of Safety page number 518.
Here in his own words Graham said, Unless stock matches very low risk vs very high reward
criteria it ain't a philosophical match to his investing method.
On very next page he also mentions a growth stock though are little riskier if manage
to have low risk with respect to high rewards it qualifies to be a value pick.
The reason I am mentioning it so that you can understand Benjamin never said only my
stock picking method is value investing.
He stated if your invests hold low risk against huge rewards then it definitely means its
a value pick.
Either you pick stocks fundamentally or technically, either you pick high PE or low PE, it doesn't
matter if you pick micro cap, small cap, blue chip or industry leader.
The only criteria a stock has to match for being value pick is low risk vs high reward,
everything else is just BS you believe in.
And here's definition of "Margin of Safety" on same page.
"We have here, by definition, a favorable difference in price on the one hand and indicated
or appraised value on other.
That difference is margin of safety".
He also mentions the role of Margin of Safety is only protecting your investments from market
fluctuations.
Absolutely anything that can serve this purpose can be called as margin of safety, for Graham's
investing method it was low PBR and low PE.
If your method of investing differs, you can have different margin of safety.
Here is next thing that you should take a note of.
"There is a close logical connection between the concept of safety margin and the principle
of diversification.
One is correlated with the other.
Even with margin in the investor's favor, an individual security may work out badly.
The margin guarantees only that he has a better chance for profit than for loss, not that
loss is impossible.
But as the number of such commitments is increased the more certain does it becomes that the
aggregate of the profits will exceed aggregate of the losses.".
"Diversification, by accepting it so universally, investors are really demonstrating their acceptance
of the margin of safety principle, to which diversification is the companion".
"The more numbers he wagers on, the better his chance of gain".
Finally, "To have true investment there must be present true margin of safety.
And true margin of safety is one that can be demonstrated by figures, by persuasive
reasoning, and by reference to a body of actual experience.".
The reason why I showed you this is because there is lot of bullshit I hear about value
investing and people who spread this bullshit tell they read it in the Intelligent Investor.
First thing to keep in mind is that even the most experienced investors will agree that
Benjamin's work is probably the most advanced work on investing.
It is advanced even for advanced investors, anyone who claims he understood it in single
read is most likely a moron and you shouldn't believe anything he says.
Even I have read "The Intelligent Investor" multiple times and so have the investors I
know so far.
Celebrity investors that we see on television even they would agree Graham's work is also
tough for them.
The person who tells you about low PBR and PE is condition required for value investing
is the person you should be running away from.
Graham's work tells us about all kinds of investments either you want invest for growth,
security, dividends or turnaround.
The investing model that we saw in this video is most popular investing model of Graham
but not the only model he discussed in his work.
Few things that you can take from this is that, Graham never said my method is only
method of value investing, he stated for time your investment satisfies low risk high reward
criteria it is value pick.
Next margin of safety does not mean low PE and low PBR stock, it can be anything that
can offer your stock protection against market fluctuations.
Finally bargain price doesn't mean buy below book value, it only means that price is available
at discount with respect to future price.
Value pick, margin of safety and bargain can differ based on your investing model and no
investing model is strong without proper diversification.
Now let's try to understand why Graham's investing model works.
To understand that let's take a look on economic cycle of business.
When a stock actually starts trending upwards it means business has entered its growth economic
cycle.
An economic condition developed in market which can help a business increase its earning
potential is known as Economic Trigger.
Economic Trigger is required for any business to enter its growth stage.
Graham's method focuses on finding stocks that are earning consistently every year without
fail, a business that performs consistently against all odds usually have extremely high
chance to enter into growth stage because of Economic Trigger.
As per my personal experience as investor, majority of stocks that I have seen so far
start running as soon as economic trigger makes stock enter growth stage.
Usually most of the Graham's value stocks starts exhibiting upside with break of long
term resistance.
For example, I'll show you few stocks from my portfolio.
First is Agarwal Industrial Corporation.
Here we can see that stock broke a multi year long term resistance to start its upside journey.
Next is JBMA also broke multi year resistance to start its upside journey.
Explosive results resulted in break of multi year resistance as an economic trigger.
Also keep in mind a stock can also break up with explosive upside when its book value
increases with huge margin against market value.
And it is also considered as economic trigger.
Here's Uflex which also broke multi year resistance.
Note that these are not stock recommendations these are just examples provided as Techno-fundamental
case study.
Do not buy these stocks just because I showed them to you as example.
Buy stocks based on your own research with good risk management and strategy.
I personally never look for mathematical match to buy any business, I always look for ideological
match and buy it on economic trigger.
That's my personal method and that's the only method about which I would not post any videos
because I teach it to my paid students.
Advantages of Graham's Method is that the stocks that would start generating profits
will not only generate huge gains but will also become high dividend paying monsters.
Disadvantages includes very long waiting time.
Graham knew predicting is futile, on other hand the best thing he could do is wait for
stock to unlock value.
Another disadvantage is that unless economic trigger arrives stock will not exhibit upside
and in case stock starts under-performing before economic trigger your waiting time
may go in drain.
Finally Graham's method is designed in era when concept of intellectual assets were not
as developed as today.
Therefore his method of analysis is more of focused on physical assets of business along
with its earning power.
So if a business posses more intellectual assets than physical assets Graham's model
will most likely fail to detect value in such businesses.
Businesses like Microsoft would by Graham's investing model were expensive since day one.
The magnificent gains that Microsoft delivered its investors is evidence of that fact, no
matter how expensive Microsoft appeared with Graham's model, reality is that it delivered
exponential gains to its investors for years.
It can not happen unless stock is already undervalued to begin with.
To end this video lets take a look on Graham's contribution to investing industry.
First he taught investors to not see investing as method but as process.
He introduced idea of seeing it as 3 step process of Analysis, Risk Management and Strategy.
He helped investors understand process of investing can be semi-automated with help
of ratios and numbers.
He introduced why a theoretical model of successful business as investing philosophy can help
you make better investment decisions.
He was first to introduce idea of Systematic Investing Plans, Investing Ideology/Philosophy,
Risk Management, Margin Of Safety, Systematic and Over-diversified investing.
There is no doubt Graham was one of most intelligent investor of our time if not the most intelligent
one.
His investing methodology and research inspired many and also became reason why we today can
do low risk high profit investments.
By all means he deserves the title of "Father Of Value Investing" and there shouldn't
be any doubt about it.
With that said thanks for watching this video and have a nice day.
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