I think this is one of the most relevant and important questions in the field of investing today.
And I'm really glad someone asked this question to one of the brightest minds in investing i.e. Charlie Munger.
Yes, that's right. This question was asked by an audience member to Charlie at this year's Daily Journal Annual Meeting.
Here's what the wise nonagenarian had to say on whether Ben Graham's valuation principles are dead.
They'll never die. You can't... The idea of getting more value than you pay for, that's what investment is if you want to be successful you have to get more value than you pay for. And so it's never going to be obsolete.
Well, I can't agree more.
Let us also consider Ben Graham's definition of an investment.
'An investment operation is one which upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.'
Aren't both these legends trying to tell you the same thing? You bet they are.
If you are buying a stock at ₹60 that you think should be valued at ₹100 per share, you are certainly getting more value than you are paying for. Therefore, it constitutes an investment as per Charlie Munger's definition.
Also, at ₹60, your principal amount is quite safe as it may not fall much beyond that. Besides, you'll also earn an adequate return once it goes back to its value of ₹100. Therefore, even Ben Graham's definition of investment is satisfied.
Please note you've neither used technicals and charts nor Artificial Intelligence and momentum.
All you've used is simple arithmetic and then waited patiently for the stock to fall significantly below ₹100. Yet, this approach has a much better chance of helping you earn good returns compared to things like charts, technicals, and momentum.
In fact, let's consider a real-life example.
Gujarat Mineral Development Corporation (GMDC) is one of the stocks that we closed in our penny stock service, Exponential Profits, recently.
It's a debt free company in India, has paid out regular dividends in the past, and has been consistently profitable.
Over the last 7 years, its EPS (earnings per share) has ranged from as low as ₹5 per share to ₹15 per share, thus leading to an average earnings power of ₹10 per share.
Now, I was quite confident that its future average earnings power may not fall significantly below ₹10 per share. This is why I decided to value the company at ₹130-140 per share.
Why ₹130- ₹140 per share? Well, because at this valuation, I was earning a return of around 7%-8% on the average earnings of ₹10 per share.
This compared well with the returns I would earn if I invested in a AAA rated corporate bond or any other high quality fixed income instrument.
Now, as per both Graham's and Munger's definition, buying the stock at close to ₹100 per share would have been a good idea from the point of view of making an investment.
It did offer good safety of principal and carried with it promise of adequate returns. Just the way Graham would have liked it.
When I recommended the stock in February 2021, it was trading at a price of ₹62. This was more than 50% off its estimate of fair value, which I thought was a great bargain.
Therefore, I went ahead and recommended the stock, enabling my subscribers make an excellent return of 131% in a little over 15 months.
Mind you, this is not an isolated example. Using the same simple strategy, we've closed 30 winning recommendations in a row over the last couple of years.
So, no technicals or charts and no AI or momentum. It was good old value investing with good old patience and discipline that did the trick.
And I am confident the same formula will continue to work its magic in the share markets in India in the future as well.
All you have to do is look for stocks with stable earnings history over the last 8-10 years, a strong balance sheet and a PE ratio of not more than 10x its normalised earnings. You have the makings of a stock that can go up around 50-100% over the next 2-3 years.
If you buy a portfolio of 15-20 such stocks, at least 60% of them will end up giving good returns and your portfolio would have done reasonably well on an overall basis.
And this, dear reader, is how you find good, money-making stocks in any market and not just the current one.
The reason this strategy works well is because it avoids the two biggest mistakes investors make while investing. Mistake number one is that they pay too much for good quality stocks and mistake number two is they often end up buying bad quality stocks.
Our criteria of only investing in stocks with stable earnings profile along with strong balance sheet and not paying more than 10x-12x in terms of PE multiple helps you to sidestep both these dangers.
I know this sounds extremely simple. But this is how it ought to be. After all, investing is simple but not easy.
The framework is simple but to keep one's emotions from corroding this framework is where the biggest challenge lies. Once you overcome it, you will be unstoppable.
Happy Investing!
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.
This article is syndicated from Equitymaster.com
