Essential Takeaways From Chapter 15 of The Intelligent Investor: Stock Selection for the Enterprising Investor

In Chapter 15, he discusses stock selection for enterprising investors. An enterprising investor is someone who is willing to do their research and take calculated risks to achieve higher returns. This article will explore the key concepts in this chapter and explain how they can be applied to stock selection.

Enterprising Investor Defined:

Graham defines an enterprising investor as someone who is willing to spend the time and effort required to analyze stocks in detail. This type of investor is looking for investments that offer the potential for higher returns but also carry higher risks.

The enterprising investor is not limited to just stocks and bonds, but can also invest in other securities such as real estate, commodities, or private equity. This type of investor is more focused on maximizing returns rather than preserving capital.

The Key to Stock Selection:

Graham believes that the key to successful stock selection for the enterprising investor is to focus on the value of the company rather than its current market price. This means looking for companies that are undervalued by the market and have the potential to increase in value over time.

Graham identifies six criteria that enterprising investors should keep in mind when selecting stocks.

1. Strong Financial Condition

Regardless of the type of investor you are, it's important to assess the financial condition of the company you are considering investing in. This factor can help boost your confidence about the investment. The financial condition can be assessed by examining the company's balance sheet, cash flow statement, and income statement.

2. Earning Stability

Enterprising investors should also assess the earning stability of the company. Ideally, earnings should have increased by at least 5% in the previous year. Examining the earning stability of a company can give you insight into the company's potential for future growth.

3. Dividend Record

Renowned investor Warren Buffet once said, "Your investment principle comes from the dividend, and with this dividend, you can invest in other companies. All your investment money comes in dividend form, so check for the dividend record." A company's dividend record is a key factor to consider when evaluating its potential for investment.

4. Earnings Growth

In addition to the dividend record, enterprising investors should also consider the earnings per share (EPS) growth. The EPS should have increased by at least 4% in the previous year as compared to the previous year. Examining a company's earnings growth can give you insight into its potential for future profitability.

5. Moderate P/E Ratio

The price-earning (P/E) ratio is another key factor to consider when selecting stocks. The ratio should not be more than 15. If the P/E ratio is higher than 15, it suggests that the company may be overvalued. Such a company may take money from investors for trading events that can be changed at any time.

6. Moderate P/B Ratio

Enterprising investors should also consider the price-book (P/B) ratio, which should not be more than 1.5. Additionally, you can calculate the multiple of P/E ratio and P/B ratio, which should not be more than 22.5. The P/B ratio can give insight into a company's value compared to its assets.

Graham recommends using a combination of quantitative and qualitative analysis to identify undervalued companies.

• Quantitative analysis involves analyzing financial statements and ratios to determine the company's financial health and growth potential.

• Qualitative analysis involves looking at factors such as management, industry trends, and competitive landscape to assess the company's potential for growth.

Graham also emphasizes the importance of diversification for the enterprising investor. He recommends investing in a minimum of ten to fifteen different stocks from different industries to reduce the risk of one company or industry affecting the entire portfolio.

Value Investing:

One of the key concepts in Chapter 15 is value investing. Graham is considered to be the father of value investing, a strategy that involves looking for undervalued companies with strong fundamentals. Value investors look for stocks that are trading at a discount to their intrinsic value, which is determined by analyzing the company's financial statements and growth potential.

Graham believes that value investing is a superior strategy to growth investing, which focuses on investing in companies with high growth potential but often at a higher price. He argues that value stocks have a margin of safety built in, which reduces the risk of losses.

Contrarian Investing:

Another strategy that Graham discusses in Chapter 15 is contrarian investing. Contrarian investors look for stocks that are out of favor with the market and are trading at a discount to their intrinsic value.

These stocks may have suffered a setback due to industry trends or other factors, but they have the potential to rebound over time.

Graham recommends that the enterprising investor be a contrarian and look for opportunities where others see only risks. By taking a contrarian approach, the enterprising investor can find undervalued stocks that offer the potential for higher returns.

Conclusion:

In conclusion, Chapter 15 of "The Intelligent Investor" lays out the strategies for stock selection for enterprising investors.

These strategies involve a combination of quantitative and qualitative analysis to identify undervalued stocks with strong fundamentals. The enterprising investor should focus on value investing, the margin of safety, and contrarian investing to achieve higher returns. Diversification is also essential to reduce the risk.