The 3 Most Timeless Investment Principles

Warren Buffett is widely considered to be one of the greatest investors of all time, but if you were to ask him who he thinks is the greatest investor he would probably mention one man: his teacher, Benjamin Graham. Graham is an investor and investing mentor who is generally considered to be the father of security analysis and value investing.

Principle No.1: Always Invest with a Margin of Safety

Margin of safety is the principle of buying a security at a significant discount to its intrinsic value, which is thought to not only provide high-return opportunities, but also to minimize the downside risk of an investment. In simple terms, the main goal should be to buy assets worth Re1 for Re 0.50.

 The business assets may have been valuable because of their stable earning power or simply because of their liquid cash value. Try to invest in stocks where the liquid assets on the balance sheet (net of all debt) were worth more than the total market cap of the company (also known as "net nets"). This means that one would be effectively buying businesses for nothing. While there are a number of other strategies, this is the typical investment strategy for safe investor.

This concept is very important for investors to note, as value investing can provide substantial profits once the market inevitably re-evaluates the stock and ups its price to fair value. It also provides protection on the downside if things don't work out as planned and the business falters. The safety net of buying an underlying business for much less than it is worth is the central theme of a successful investor. When chosen carefully, it is found that a further decline in these undervalued stocks occurred lesser number of times. 


Principle No.2: Expect Volatility and Profit from It

Investing in stocks means dealing with volatility. Instead of running for the exits during times of market stress, the smart investor greets downturns as chances to find great investments. Market offers investors a daily price quote at which he would either buy an investor out or sell his share of the business. Sometimes, he will be excited about the prospects for the business and quote a high price. At other times, he is depressed about the business's prospects and will quote a low price.


Because the stock market has these same emotions, the lesson here is that you shouldn't let Market's views dictate your own emotions, or worse, lead you in your investment decisions. Instead, you should form your own estimates of the business's value based on a sound and rational examination of the facts. Furthermore, you should only buy when the price offered makes sense and sell when the price becomes too high. Put another way, the market will fluctuate - sometimes wildly - but rather than fearing volatility, use it to your advantage to get bargains in the market or to sell out when your holdings become way overvalued.


Here are two strategies that can be used to reduce the negative effects of market volatility:

Rupee-Cost Averaging

Rupee-cost averaging is achieved by buying equal Rupee amounts of investments at regular intervals. It takes advantage of dips in the price and means that an investor doesn't have to be concerned about buying his or her entire position at the top of the market. Rupee-cost averaging is ideal for passive investors and eases them of the responsibility of choosing when and at what price to buy their positions.

Investing in Stocks and Bonds 

It is recommended that distributing one's portfolio evenly between stocks and bonds as a way to preserve capital in market downturns while still achieving growth of capital through bond income. Always remember, first and foremost priority should be given to preserve capital, and then to try to make it grow. Having 25-75% of your investments in bonds and varying this based on market conditions can be very helpful in achieving optimum growth. This strategy has the added advantage of keeping investors from boredom, which leads to the temptation to participate in unprofitable trading (i.e. speculating).

Principle No.3: Know What Kind of Investor You Are 

There are different types of investors based on their risk appetite, operating in the market.

Active vs. Passive

Active and passive investors can also be referred as "enterprising investors" and "defensive investors". 
You only have two real choices: The first is to make a serious commitment in time and energy to become a good investor who equates the quality and amount of hands-on research with the expected return. If this isn't your cup of tea, then be content to get a passive, and possibly lower, return but with much less time and work. Market psychology notion is of "risk = return", in fact it should be "Work = Return". The more work you put into your investments, the higher your return should be.    


If you have neither the time nor the inclination to do quality research on your investments, then investing in an index is a good alternative. A defensive investor can get an average return by simply buying the 30 stocks of the Sensex in equal amounts. Getting even an average return - for example, equaling the return of the Sensex - is more of an accomplishment than it might seem. The fallacy that many people buy into, is that if it's so easy to get an average return with little or no work (through indexing), then just a little more work can yield a higher return. The reality is that most people who try this end up doing much worse than average. 


In modern terms, the defensive investor would be an investor in index funds of stocks. In essence, they own the entire market, benefiting from the areas that perform the best without trying to predict those areas ahead of time. In doing so, an investor is virtually guaranteed the market's return and avoids doing worse than average by just letting the stock market's overall results dictate long-term returns. Beating the market is much easier said than done, and many investors still find they don't beat the market.

Speculator vs. Investor

Not all people in the stock market are investors. It is critical for people to determine whether they are investors or speculators. The difference is simple: an investor looks at a stock as part of a business and the stockholder as the owner of the business, while the speculator views himself as playing with expensive pieces of paper, with no intrinsic value. For the speculator, value is only determined by what someone will pay for the asset at any given point of time, but a speculator is a mere guesser.

Graham's basic ideas are timeless and essential for long-term success. He bought into the notion of buying stocks based on the underlying value of a business and turned it into a science at a time when almost all investors viewed stocks as speculative. Graham served as the first great teacher of the investment discipline, as evidenced by those in his intellectual bloodline who developed their own. If you want to improve your investing skills, it doesn't hurt to learn from the best; Graham continues to prove his worth in his disciples, such as Warren Buffett, who have made a habit of beating the market.

Linkin Park - Points Of Authority

What is Great Management Worth?

What Is Great Management Worth?

In some respects, corporate management seems to be a bit like the weather - everybody talks about it and everybody agrees it's important, but nobody can ever seem to quite figure it all out. More to the point, only a momentum investor or chartists would likely even try to claim that management does not matter when assessing a stock merit's. Yet even value hounds have a hard time assigning value to management, or even proposing how such a thing could be measured.

Great Management Sees the Future

In 1998, Finland's Nokia was the world's largest cell phone maker and Apple was struggling to right itself just over a year into Steve Jobs' return to the company. While Apple developed breakaway winners like the iPod and the iPhone, Nokia introduced lead balloons like the N-Gage. Worse still, Nokia seemed to make the decision to play it safe and follow the market instead of looking out ahead of the curve and anticipating what customers would want. As a result, while Nokia is still the largest phone company in the world, Apple has jumped ahead both in revenue and in how much investors will pay for that revenue (Apple is over nine times larger in terms of enterprise value).

This is relatively common occurrence in business, and a major axis around which management value revolves. It is incredibly difficult to succeed by forever playing catch-up or hoping to take an already proven idea and execute it just a little bit better. The CEOs of companies like Microsoft, Intel, Wal-Mart and Nike saw a future that other CEOs could not see and they positioned their companies accordingly - building billions in shareholder value along the way.

Allocates Capital

Product development and marketing is not the only, or even the most important, job of management. Management is also preeminently responsible for allocating a company's capital. If management wisely feeds high-return projects and chokes off (or milks) low-return businesses, the business will thrive.

Supposedly Apple spent around $150 million to develop the iPhone, a product that produces billions of dollars in revenue per year now. What if Apple had allocated that to a gaming system to rival Microsoft's X box? Alternatively, what if Microsoft had allocated just some of its multi-billion dollar annual R&D budget to a smart-phone concept five years ago? Ultimately, how and where a company spends its money determines whether any particular management's view of the future has a chance of coming true.

Also consider the case of conglomerates and Berkshire Hathaway. Typically conglomerates trade at a lower valuation than the sum of the parts would imply - a so-called “conglomerate discount” that recognizes that most management teams make suboptimal decisions and misallocate capital over their unwieldy collection of businesses. Under Warren Buffet's leadership, however, Berkshire Hathaway trades at a premium to many well-run and profitable insurance businesses due in part to his reputation as a top-tier allocator of capital.

Executes the Plan

Brilliant plans are all well and good, but there is also undeniable value in management teams that are capable of executing the plans they create. Since 1995, Nucor, AK Steel and U.S. Steel have all basically been in the business of selling steel - and yet, Nucor has done substantially better for its shareholders over that time-frame. Moreover, Nucor has returned more than the S&P 500, and that is something that materials companies aren't supposed to do. A lot of this can be laid at the feet of the operational excellence of Nucor's management.

Likewise, it is difficult to say that the differences in the fortunes of Boston Scientific and St. Jude can be chalked up solely to different visions or plans. Both companies have had to navigate significant slowdowns in their core markets (pacemakers and ICDs), competition, and changes to insurance reimbursement and FDA policy. Yet, St. Jude has shown itself to be far more adroit in navigating this tricky market.

The Right People Are Worth Billions

Taking a step back, investors need only consider the fortunes of McDonald's, Burger King and YUM! Brands - or Southwest Airlines versus practically the entire airline industry - to see the ultimate value of good management. There was no obvious or inherent reason that McDonald's and YUM should have emerged as global giants in quick-service restaurants, while Burger King is little more than an afterthought. Instead, McDonald's and Yum prospered because they had management teams with clear and far-reaching visions, sound capital allocation priorities and the ability to execute on their plans.

Likewise, Southwest Airlines was regarded as a joke when it launched with its air hostesses in hot-pants and go-go boots. Now Southwest is second only to LAN in terms of market cap in the airline industry and has not gone through the serial bankruptcies of its rivals. This was not the product of chance. Southwest had a distinct vision (low-cost service to under-utilized airfields), disciplined capital strategies (using older aircraft) and solid execution (including excellent customer service metrics).

The Bottom Line

Since Apple's CEO took another medical leave of absence and Google's CEO stepped down, those two companies have lost billions in market capitalization. Even allowing for the general decline in the market during the same time, both stocks have lost more than they otherwise should; suggesting that investors realize that those prior CEOs were worth potentially billions to shareholders.

Looking around the board, that seems like a reasonable assessment. After all, top-flight management can fairly be expected to produce at least a few extra points of return on invested capital relative to industry averages. Leverage that over a few billion dollars of invested capital and a few years, and the differences in profits, free cash flow and investor value add up very quickly. 

Simply put, the question of whether your company has great management may very well be a billion-dollar question. Over time, companies whose managers excel in seeing the future of their industry, allocating capital to the right projects and prospects, and actually running the business with disciplined efficiency ultimately create valuation gaps over their rivals that can be measured in the billions of dollars. That, then, is certainly justification for investors to go the extra mile and ferret out those companies led by top-notch management teams, and particularly those that are not yet widely known and appreciated by Wall Street institutions.