Essential Takeaways From Chapter 7 of The Intelligent Investor: Portfolio Policy for the Enterprising Investor: The Positive Side

 

Chapter 7 of the book is dedicated to the portfolio policy for the Enterprising Investor, with a focus on the positive side. Graham begins by highlighting the importance of committing fully to the analysis and exercise of investment plans, especially for aggressive investors. A half-hearted approach may lead to half the return.

The Risks of Growth Stocks

The main focus of the chapter is on growth stocks and how they can be attractive but come with certain risks. Graham defines growth stocks as those that have done better than the average over a period of years and are expected to continue doing so in the future. However, he also shares his concerns about investing in growth stocks. Common stocks with good records and expectations sell at correspondingly high prices, and the judgment of the future may prove incorrect. The growth curve can flatten and sometimes even turn downwards.

Allocation of Funds

The Intelligent Investor recognizes that allocating a massive amount of funds to one company should be reserved for those closely tied to the company's management. Defensive investors should limit their purchase price to 25x average earnings over the past seven years. Additionally, the faster the advance of a high-growth stock's price compared to the actual growth of earnings, the riskier the proposition it becomes.

Three Distinct Policy Approaches

For the Enterprising Investor, Graham offers three distinct policy approaches. Firstly, the Enterprising Investor can focus on relatively large and unpopular companies. The key here is to focus on larger companies going through a period of unpopularity. Smaller companies may become undervalued as well but present more risk since they do not have access to large amounts of capital and brainpower to carry them through adversity, and the market may not respond with reasonable speed to any improvement.

Secondly, the Enterprising Investor can purchase bargain issues, which emphasize issues that appear to be worth considerably more than their current selling price on the basis of analysis. An issue is not considered a bargain unless the indicated value is at least 50% more than the price. Graham suggests two bargain tests: estimating future earnings and then multiplying by an appropriate factor and paying more attention to the value of assets, emphasizing net current assets or working capital.

Lastly, the Enterprising Investor can focus on special situations or workouts. Graham regards these tactics as reserved for a specific subset of investors and mentions that it is not intended for everyone.

Conclusion

In conclusion, Graham advises investors to commit fully to their investment plans and exercise sound judgment when selecting investments. It is essential to recognize the risks associated with growth stocks and focus on relatively large and unpopular companies, purchase bargain issues, and focus on special situations or workouts.

An investment strategy that aligns with these recommendations and focuses on sound fundamentals will lead to positive investment outcomes in the long run. The Intelligent Investor is a valuable resource for any investor looking to make sound investment decisions.