“Investment is most intelligent when it is most business like.” These words have guided the greatest stock-market investors throughout the ages. Every time I give a stock-market investing seminar, I jokingly tell people to recite this mantra before they open their online brokerage account and make a decision to buy a certain stock. And while telling them to recite the mantra may be a joke, learning to invest intelligently definitely isn’t.
It was the great Benjamin Graham who said these words. Considered as “Dean of Wall Street”, mentor of the world-famous investor, Warren Buffett, Graham is considered by most as the father of “value investing”, an investment strategy where the stocks selected are those that trade for less than what they are really worth based on their fundamentals. In Chapter 20 of his book, The Intelligent Investor, he wrote:
“Investment is most intelligent when it is most businesslike. It is amazing to see how many capable businessmen try to operate in Wall Street with complete disregard of all the sound principles through which they have gained success in their own undertakings. Yet every corporate security may best be viewed, in the first instance, as an ownership interest in, or a claim against, a specific business enterprise. And if a person sets out to make profits from security purchases and sales, he is embarking on a business venture of his own, which must be run in accordance with accepted business principles if it is to have a chance of success.”
To put it simply, Graham is saying you have to buy stocks as a good businessman would buy a business. After all, buying a stock is buying a portion of a business. Hence, it makes logical sense to approach buying stocks or, in other cases, entering into any form of business investment from this perspective. This is nothing but common sense, pure and simple.
Unfortunately, common sense is not so common when it comes to investing in the stock market. A lot of people buy stocks that have been hyped by so-called gurus whose interest is only their own profit. If you examine these stocks, they have little or no fundamentals at all, and their prices have been so hyperinflated.
Most people disregard digging into the fundamentals of a company because they think it is too complicated to analyze. In some cases this is true, as there are lots of accounting/finance technical jargon to learn in order do a proper fundamental analysis.
However, there is a simple and quick way to determine whether a stock is worth buying or not. Here’s how it’s done:
Step 1: Assume that the market is offering you to buy the entire company. As mentioned, buying a stock is buying into a business, so ask yourself: Is it worth buying the entire company? This can simply be done by looking at its market capitalization, which is readily available at the Philippine Stock Exchange web site. The market cap, as the term is often called, is simply the stock price multiplied by the shares outstanding. It is how much the market thinks the company is worth at a given time.
Step 2: Look for income stability and growth. This is readily available in all online brokerage accounts. In the reports section, you can find key fundamentals of a certain company for the past five years, like gross income, net income, earnings per share, etc. Make sure the company you are investing has stable earnings and is growing.
Step 3: Ask yourself if the money you invest to buy the whole company is worth what it will earn compared to buying the safest investment that would give you a reasonable return. The safest investment that would give you a reasonable return are government bonds. At today’s rate, somewhere between 4 percent to 5 percent would be a reasonable assumption. If a company’s average net income for the past five years is below that, it is but common sense to conclude that the stock is not worth buying and makes no business sense.
If you approach stock-market investing or any kind of business investment using the above-mentioned steps, it is guaranteed you will not get burned or “hyped”. Determining the price you should pay a certain stock is another story, and may take learning some kind of fundamental analysis. But the above mentioned steps are certainly a start for you to become a much more intelligent stock-market investor.
Lawyer Zigfred Diaz is an entrepreneur and a Cebu-based registered financial planner of RFP Philippines. He is director for training and research for Certa Inc., a personal finance and investment advisory firm. To learn more about personal finance, attend the 63rd RFP program this July. To inquire, e-mail email@example.com or text <name><e-mail> <RFP> at 0917-9689774.