Basics of Successful Investing II

Basics of Successful Investing II
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Stay with What You Know: Picking Stocks

Picking sound investments stocks or otherwise, may simply be a matter of keeping your eyes open. A now-famous investor went to the mall with his wife and two daughters. The girls dragged their parents to a new store that was packed with adolescent females buying sweaters, blouses, slacks, etc. The father was impressed by how much business the store was doing and investigated the stock. It was the Gap. This stock sold for nine cents a share adjusted for stock splits and now sells for $40 a share. The same investor, Michael Lynch, noted that in the late 1970s the popular investment for physicians was railroad box cars which they would then lease to railroads. This turned out to be a bad idea and many docs lost money. At the same time Smith-Kline-French marketed the first effective drug to treat heartburn and peptic ulcers, Tagamet. This drug was sold in huge quantities and SKF stock went up. This is where the basics of successful investing dictate that you invest in what you know or what you see and do research on. Dads who invested in Gap in the early days made money and so did docs who invested in SKF and ignored an investment (railroad box cars) about which they knew nothing.

Choosing to Invest or Not: Intrinsic Value

One of the basics of successful investing is intrinsic value. This concept was introduced by Benjamin Graham in the aftermath of the 1929 stock market crash as part of the concept of value investing. The idea was to develop a rational means of investing in stocks. Intrinsic stock value is its fundamental value derived from solid numbers and not the current stock price which is often driven by current market sentiment. If the intrinsic value of a stock as calculated by the Graham formula is higher that its market value the basics of successful investing dictate that you buy the stock. If the reverse is true you sell the stock if it is in your portfolio. The Graham formula considers earnings per share, a five year growth estimate and the current rate of interest on AAA corporate bonds. Here is the formula as updated by Graham in 1974.

  • V is the intrinsic value.
  • EPS is earnings per share.
  • G is the expected five year growth of the company.
  • Y is the current yield on AAA corporate bonds.
Choosing to Invest or Not: Intrinsic Value
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