Portfolio policy for the Enterprising investor : Negative Approach


What does day trading mean? It refers to the tendency to hold stocks for a very short time. Many people are into it but day trading is actually the quickest way to financial suicide. When you day trade, you may win some but definitely lose most of your money. The one who will benefit the most is your broker. Day traders are always excited to buy or sell their stocks. The result is that they tend to buy on a higher price and sell on a lower price. Remember that each time you trade your stocks; you need to pay your broker. The more you day trade, the lower your returns are. The extra cost you pay is called market impact. It doesn't show up on your broker's statement but it's there. For example, you want to buy 1,000 shares at the soonest time. Because of your eagerness, you pay the stocks 5 cents higher than the normal price. That will already cost you $50.


The same thing goes when you want to sell. Because you are desperate, you agree to part with your shares at a lower price. Imagine that your stock is a chunk of wood. Every time you buy or sell, you swipe sandpaper on it. You become eager to buy and you pay 4% more. You want to sell fast and you pay another 4%. That's already 8% “sandpapered" away on your chunk of wood. There's a popular saying that 'goes, “Don't just stand there, do something." but that doesn't apply on investing. An intelligent investor will do the exact opposite. "Don't do something, just stand there." you will get more returns if you keep your stocks for the long-term. 


Portfolio Policy for the Enterprising Investor: The Positive Side

How exactly do you follow Graham's golden rule of buying low and selling high? Everybody wants to invest in top companies. These corporate giants are less likely to go bankrupt and more likely to give desirable returns. But the problem is that the bigger they grow, the faster their stock prices shoot up. From 1995 to 1999, the companies Home Depot, General Electric and Sun Microsystems grew bigger every year. The revenues of Sun and Home Depot doubled. Both companies tripled its earnings per share. GE's revenue went up by 29%. Its earnings per share rose to 65%. And so because these are the hottest stocks at the time, they became very expensive to acquire. The problem is that the growth of stocks eventually exceeds that of the growth of the company. The investors who paid for high priced stocks often don't get the returns they expected.


Here are a couple more lessons. A top company is not such a good investment anymore if you pay an extremely high price for it. There is such a thing called financial physics. The bigger a company becomes, the slower it grows. For example, there is a hot new company which is worth $1 billion. It can easily double its sales in the following year. But if the company's stock grows up to $50 billion, where is it going to get $50 billion more in sales? Now, how can you buy shares of a top company for a quality price? Here is the trick that every intelligent investor should know. Every once in a while big company gets into problems and controversies. They become unpopular and their prices get lower.


In 2002, Johnson & Johnson was investigated for false record keeping at one of its factories. J&J stocks decreased 16% in just one day. The price of each share decreased significantly. This is a great opportunity for the intelligent investor. While most of the people doubt J&J, you can seize this big company's stocks for a lower price. When the “unpopular large company" resolves the issue, you will find yourself on the upper hand.



The Investor and Market Fluctuations


What does market fluctuation, mean? It 

refers to the increase and decrease of stock prices. It's the day to day blipping on the stock exchange screen. Graham advises that it is best to ignore these reports on fluctuation. By doing so, you will not be influenced by the moods of other investors and by the market as a whole. Inktomi Corp was a top software, company. After hitting the market in June 1998, its shares increased to 1,900%. In December 1999, the share price even tripled and in March 2000, it set a high peak of $231.62.


What caused Inktomi to increase in share value so fast? The reason is that the company is growing rapidly. Towards December 1999, Inktomi has $36 million in sales. If this rate of growth continues for the next five years, its revenues would increase from $36 million per quarter to $5 billion per month. But the truth is Inktomi was actually losing lots of money. Yes, the company made $36 million in sales but it also lost $6 million in that quarter. It lost $24 million 2 months before and another $24 million in the past year. Ever since Inktomi started, it has never made any profit. Yet investors put in a total of $25 billion in this new company.


Two years after setting the high, of $231.62, Inktomi's share price dropped to a mere 25 cents. Its market value dived from $25 billion to just $40 million. That is amidst the fact that Inktomi made $113 million in revenue. What happened? What caused this extreme change? It's just another of the stock market's mood swings. In early 2000, investors were raving about tech companies. Two years after, they became doubtful of the industry. This is when Yahoo! stepped in. Yahoo was able to acquire Inktomi for $1.65 per share. Yahoo acted as an intelligent investor in this situation. The bigger company took advantage of Inktomi' sun popularity. This is what Graham means by buying from pessimists and selling to optimists.


Now that you know how bipolar the market is, will you let it affect your decisions? The job of the stock, market is to set the prices, your job as an intelligent investor is to decide for your own In 1999, the stock prices of tech companies were skyrocketing. Most investors want to get their hands on them. Because people want what everybody wants, they came to ignore that the share of “Old, Economy" companies are getting cheaper. Examples of which are Gillette, Coca Cola and Washington Post. Their prices have dropped to 24.9%


'If you are an intelligent investor, you would not buy tech companies stocks on a high price like everybody else. You would take advantage of the situation and buy stocks of the unpopular large companies. Why invest highly on tech start-ups when you can have Coca Cola shares on a bargain price? The lesson is do not let the stock, market control you. Instead, take control of your own decisions. You cannot control the stock prices but you can control 5 practical things.


First, you can control your expectations. Be realistic about estimating your returns. Second, your risk.You can control where, when and how much you will invest. Third, your brokerage costs. You can control this, cost by trading cheaply, patiently and rarely. Fourth, your tax bills. If you keep your stocks for one year to five years, it will lessen your tax liability. The most important thing that you have control over is your behavior. Do not buy when everyone else buys and do not sell when everyone else sells. An intelligent investor buys periodically when he can from his permanent portfolio or list of companies. An intelligent investor sells only when he really needs cash like for serious illnesses, house down payment or college tuition.


An intelligent investor can live without checking the stock market fluctuations. He can rely on his own judgments. An intelligent investor can hold his stocks for a minimum of 10 years. 


Conclusion 

You learned how to be an Intelligent Investor. You learned about speculations and failed forecasts. You learned how to build a permanent autopilot portfolio. You learned about day trading, unpopular large companies and market fluctuations. Your financial outcome is in your hands. Do not let any outside factors affect you. The power to be rich and successful is within you. Choose to stand out from the crowd and, become an intelligent investor now.