My strategy is inspired by the ideas of Benjamin Graham. I purchase common stocks that I believe are trading at a discount to their intrinsic value. I sell when I believe they are at or above their intrinsic value. I do not utilize leverage of any kind. I don’t sell short. As John Maynard Keynes put it, “Markets can stay irrational longer than you can remain solvent”. With a long position that isn’t leveraged, I can wait out irrationality. That isn’t an option when you are short or using borrowed money to buy stocks. The issues I purchase generally fit into the below overlapping categories.
- Statistically cheap stocks on the basis of sales and income. I prefer companies and industries that make people either yawn or recoil. My preferred measure of value is simple: the inverse of the P/E ratio, or “earnings yield”. As Ben Graham recommended, I buy companies when their yield doubles that of a AAA corporate bond. In addition to low P/E’s and high earnings yields, I also prefer stocks with low valuation metrics such as price/sales and enterprise value/operating income. I want a stock to be considered a bargain by multiple metrics.
- Companies that are conservatively financed. I tend to prefer firms that have a debt to equity ratio that is below 50%. For larger capitalization stocks, I will tolerate a bit more leverage (around 100%). If a company is utilizing significant leverage, they may be able to produce great results in the short run, but one mistake will kill the firm. I believe that the best way to minimize the risk of the portfolio is to focus on the balance sheets of the companies in the portfolio. Debt is danger.
- Spin-offs. I will sometimes pursue spin-off special situations if the idea hits me over the head and the investment has an acceptable margin of safety.
- Companies that trade below their liquidation value. Sometimes companies will trade at a significant discount to their liquidation value. They are typically only available in large numbers during recessions.
- Companies that are based in the United States. I shy away from international investments. I understand GAAP accounting principles. I trust the SEC will limit most but not all accounting shenanigans. I generally have an optimistic view on the long-term economic prospects of the United States economy. We have our problems, but who doesn’t? I am sure that there are amazing value opportunities in other markets, but I stick to what I know and what I have the time to research.
PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings. Read the full disclaimer.