Our approach is a combination of all the knowledge we’ve compounded and while no one man has provided the full picture, Benjamin Graham, Warren Buffett, and Philip Fisher remain at the core.
An investor would not normally buy a business that did not, on proper research, appear to have reasonable expectations of producing good profits over time. Share investors should take the same approach and buy, as Graham says, “not on optimism, but on arithmetic”.
In The Intelligent Investor, Benjamin Graham sums up his investment philosophy by saying that an intelligent investor must be “businesslike” in approach. Investing in shares in a company is just like owning a share in a business enterprise and the investment must be approached as if one were buying a business, or a partnership in one.
Invest for profits and in a business-like mannerism
1. The company should be soundly managed. Tests of good management include:
Know the business
The investor needs to become knowledgeable about the business or businesses carried on by the company in which they propose to invest – what it sells, how it operates, what is the competitive environment, what are the threats and opportunities, the strengths and weaknesses.
An investor who bought a fruit shop, or a shoe factory, without investigating these things, and knowing them, would be foolish. The same applies to share investment. An investor who does not understand the business should not be investing in it.
Know who runs the business
An investor who cannot operate the business for himself or herself, needs a manager. This is the position of the average share investor, who owns a share of an enterprise that is run by others.
The owner of a business in this position would want a manager who will manage the business competently, efficiently and honestly. The share investor should not be satisfied with less. Unless the investor believes, through sound research, that the company is managed efficiently, competently and honestly, in the best interests of the shareholders, the investment should not be made.
2. The company has demonstrated earning capacity with a likelihood that this will continue. Tests of earning capacity include:
- Differentiation to handle inflation
- Capital expenditure
- Brand name power
3. The company should have consistently high returns. Look at both:
- Return on Equity
- Return on Capital
5. The businesses of the company should be simple and the investor should have a strong command of it and be able to explain it to a 5th grader
6. Assuming that all these thresholds are satisfied, the investment should only be made at a reasonable price, with a margin of safety. While investment in different businesses and arenas have different important characteristics. It is always important to consider the following:
- Price / Earnings Ratio
- Earnings Yield
- Dividend Yield
- Owners’ Earnings
- Comparative rates of return – Compare the business to its competitors. How efficient is it compared to them?
7. Investors need to take a long term approach. You need to be patient and wait for the opportunity to buy at the price that you have decided gives you the appropriate margin of safety