Buying Shares---Basic Principles to Remember
Before you Start
If you do not START to do your home-work and understand what businesses you are investing in, you will Definitely lose your hard earned money. A sure way to gamble your money away is to buy shares without doing your homework.
So, before you start to invest, constantly ask and remind yourself:
Am I investing or speculating or betting or actively trading?
And, according to https://www.youtube.com/watch?v=KEhwASqbtZM
the two keys to investing are:
1. Quality of the business and
2. Valuation of the business
Anything else is speculation.
Thus, I would recommend that you study and adapt from what the two greatest investors in the world say on:
1. What to Buy ----Charlie Munger on his Investment Evaluation Process and
2. At what Price ----Buying Berkshires Shares by Warren Buffett
Warren Buffett’s Basic Rules in Investing:
"Rule No. 1: Never lose money.
Rule No. 2: Never forget Rule No. 1.”
Charlie Munger’s Rules in Investing:
Rule No. 1: Don’t make big financial mistakes.
Rule No. 2: Is the same as the first rule.
Two RISKS (Downsides) you should Avoid:
1. Shun permanent or Huge capital loss ---don’t invest in large gearing (high lleverage) and low profitability Firms
2. Firms that are heading for Suspension in the Market
Two possible ways to Make money in the Stock Market:
1. The way of Timing ---speculation with speculative outcomes
2. The way of Pricing---large discount with larger margin of safety
Two types of MISTAKES according to Charlie Munger:
1) Doing nothing; what Warren calls “sucking my thumb” and
2) Buying with an eyedropper thing we should be buying a lot of.
1. By periodically investing in an index fund that charges minimal fees, for example, the know-nothing investor can actually outperform most investment professionals.
2. But it is given to human beings who work hard at it—who look and sift the world for a mispriced bet — that they can occasionally find one. And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.
John Maynard Keynes said
“As time goes on, I get more and more convinced that the right method in investments is to put fairly large sum into enterprises which one thinks one knows something about and in management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no special reason for special confidence. One’s knowledge and experience is definitely limited and there are seldom more than 2 or 3 enterprises at any time which I personally feel myself entitled to put full confidence”.
Benjamin Graham advocated:
1. All throughout his career, he advocated Diversification but
2. Ironically enough, the aggregate of profits accruing from the SINGLE investment decision, GEICO, far exceeded the sum of ALL the others, realized through 20 years of wide-ranging operations in the partners’ specialized fields, involving much investigation, endless pondering, and countless individual decisions. [p. 533, The Intelligent Investor, Revised Edition, 2003]
Philip Fisher assigned
1. Significant weight to the quality of the underlying business.
2. Believe that an investor should focus on a relatively small number of stocks if he or she expects to outperform a market.
Warren Buffett advised in general against investing in:
• Textile manufacturers
• Producers of raw foodstuffs such as corn and rice
• Steel producers
• Gas and oil companies
• Lumber industry
• Paper manufacturers
• Internet portal companies
• Internet service providers
• Memory-chip manufacturers
• Automobile manufacturers
• Penny Stocks
• IPO (Initial Public Offering)
Buying a fraction of the Business
When you buy shares, you are buying a fractional amount of the company; never consider yourself as buying scripts or pieces of paper. Thus, you want the company to work for you and to give you a good return in 3 to 5 years’ time. You don’t work for the company by spending your money for a quick return like playing in a casino.
1. Investing is Company works for you to give a good return in 3 to 5 years’ time
2. Speculating is You work for the company for an immediate return like gambling in a casino
Mr Market----Benjamin Graham on the Investor and Market Fluctuations--Chapter 8
1. The Market is there to SERVE you, Not to Guide you.
2. Wait Patiently and Swing (buy or Sell) Only when it is to your advantage
Margin of Safety---Benjamin Graham on Margin of Safety--Chapter 20
“The idea of a margin of safety, a Graham precept, will never be obsolete. The idea of making the market your servant will never be obsolete. The idea of being objective and dispassionate will never be obsolete. So, Graham had a lot of wonderful ideas.” Charlie Munger
In the forty-seven years that Warren Buffett has run Berkshire Hathaway, the company’s stock has fallen roughly 40 percent to 50 percent at four different times. We will identify three of those episodes--- 1973–1974 [Arab oil embargo], 1987–1988 [financial crisis], and 2007–2008 [sub-prime crisis]--- and move on to the other perpetrator, the Internet bubble [2000-2001]. (p. 204, Tap Dancing to Work).
It should be noted that Warren Buffett has stated the following in regards to the repurchasing of Berkshire Shares:
a) In September 2011, Buffett announced that Berkshire would repurchase its shares at a price of up to 110% of Book Value. [p 185, The essays of Warren Buffett, 3rd edition]
b) Purchases of Berkshire that investors make at a price modestly above the level at which the company would repurchase its shares, however, should produce gains within a reasonable period of time. Berkshire’s directors will only authorize repurchases at a price they believe to be well below intrinsic value. [2014 annual report http://www.berkshirehathaway.com/letters/2014ltr.pdf]
c) In May 1 2016 2:25 AM
Berkshire, says Buffett, would likely buy a lot of stock if the price falls below 1.2 times book value, but it won't "prop up" the price.
Buffett: Anytime you can buy stock for less than its worth it benefits the shareholders, but it has to be by a large margin.. [http://www.cnbc.com/2016/04/30/warren-buffett-in-omaha-for-berkshires-annual-meeting.html ]
It should also be noted that in the purchases of other company shares, sometimes Warren and Charlie pay 2 to 3 times Book Value:
As, Warren Buffett stated, “It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” and Charlie Munger stated, “A great business at a fair price is superior to a fair business at a great price”
Charlie Munger explains “We realized that some company that was selling at two or three times book value could still be a hell of a bargain because of momentums implicit in its position, sometimes combined with an unusual managerial skill plainly present in some individual or others some system or other.”
Some of their purchases that fit this pattern are: See’s Candies, Coca-Cola, The Washington Post Co, Wells Fargo Bank, Geico, American Express, Capital Cities/ABC Inc and Disneyland.
Many things can go wrong in buying shares. So it vitally important to ask oneself before any purchase, “Is there sufficient Margin of Safety in this buy?”
1. Wait Patiently for the Market to fall drastically to invest in high quality businesses
2. Buy great firms with large Margin of Safety---like 10 to 30% below Book Value (Net Asset Value) or 40 to 50 % below Intrinsic Value [https://www.youtube.com/watch?v=2-nf0_voeQ4 ]
When to Buy
The standard advice is Buy low and Sell high to make a profit. What this means is that you Buy when others are Fearful and Sell when others are Greedy. Times when you can Buy Low are when the Headlines News are really bad and the economic situations are turbulent and uncertain. People are scared. They panic and they just want to get out of the stock market to go for other types of investments. At such times, you must already have made your decisions and calculations before hand so as to know What to buy and at What price.
Buy the shares that you have decided on and ONLY when ALL the conditions below are satisfied:
1. Buy at Bargain price or Discount --- Why? So as to have some Margin of Saafety.
2. Buy Big amount --- Why? It is difficult to find a bargain
3. Buy Long-term for 5 to 10 Years --- Why? To allow for market fluctuationns
4. Buy More when market goes down further --- Why? You are Investing, not Speculating
5. Don’t borrow to buy --- Why? To avoid being forced to sell
When all the above conditions are met, allocate (bet) heavily one’s hard earned money in Shares rather than in Fixed Bank Deposit or CD. It is a Mistake if one doesn’t load quickly and big. Why? Such conditions do not come often and wouldn’t last long. Shares snap back quickly and when one isn’t prepared and ready to buy at such times, one misses the opportunity.
When to Sell
1. SELL when market prices are significantly overvalued and/or irrationally over-Exuberant.
2. Sell when the P/E ratio is ridiculously high