Stocks to Riches Chapter 4:- Introduction to Behavioural Finance

In today’s blog, we see the introduction to behavioral finance from chapter 4 of the book stocks to riches by Parag Parikh. This is a wonderful chapter you should understand how our feeling is work in the stock market and how can we have to get precautions.

so let’s start

Previous chapter

Introduction to Behavioural Finance:-Stocks to Riches Chapter 4

Stocks to Riches Chapter 4

In this chapter 4, the author explains behavioral finance with wonderful examples

let’s start with examples of peoples behavior

  • “With such positive news from the company why is the stock going down”
  • “I am a qualified chartered accountant. I went through the finances of the company and I feel that at the current price, the stocks are too expensive. I would not buy it nor recommend the same to anybody. But I am surprised that in the last two weeks the stocks are up 15 percent.”
  • “My friend works with this company. they told me that it was doing exceedingly well and that they have an export order worth crore in hand so I bought the stock. It’s six months and I have been waiting but the stock is going down.”
  • ” the company has announced a 1:1 bonus, it’s good news so I bought the stock but the stock went down instead of going up like I thought it would.”
  • ” I read the mornings newspaper and was impressed by the finance minister’s speech and his intention to give sops to the economy. the markets greeted the news positively and went up so I bought stocks the next day the markets were down for no reason and I lost on my investment.”
  • ” I heard the expert’s comments on T.V. on the current budget presented by the finance minister. they were not very happy with it. I sold my stocks only to find that within a week the markets were up 10 percent. I don’t know why I sold my stocks which I had been holding for the last four years.”
  • ” I can not understand the markets. I would rather stay away.”

after his behavioral statement, then the author tells, how this statement happens

the author says, ” Aren’t all these statements familiar you have heard them on perhaps made then yourself. In an ever-changing and uncertain world, we are trying to find some predictions where none exists. The easiest thing to do is to avoid such irrational markets. But then you would be missing out on one of the most favorable modes of investment. (Stocks to Riches Chapter 4)

My sincere advice would be to catch the bull by the horns. confront the problem rather than run away from it. Try to understand why it is happening to you.”

then the author gives their own experience, in dot com bubble time.

the author says, ” during the IT bubble. Too found myself bewildered and confused. The valuations of the dot-com businesses and IT stocks seemed highly inflated. Pundits in the market and the media were pontificating on the new economy and giving convoluted justifications for what was approved to be sheer insanity. I wondered, was the entire world mad and I the only left the same, or was I insane and the world perfectly rational?

I had a client who had invested around 70 lakhs in different IT stocks in 1998 on his friend’s recommendations in 1999, his portfolio value was around Rs. 5 crores when he asked for my advice I told him, to sell as I thought that the PE multiples were very high and the valuations seemed for too stretched.

He did not do so and six months later when we met he informed me that the portfolio value was around Rs. 6 crores. Once again he asked me what he should do I was a bit embarrassed by the question, as I knew that he was, not asking for advice. but telling me indirectly that I was not in sync with the markets. I still insisted that he sell but he did not sometimes later the portfolio value went up to Rs. 8 crores.”

then the author explains why they 3 times give the wrong advice and his friend portfolio value is growing continuously.

the author says, ” this was the frustration I had to go through, of being in the investment business and not able to advise clients correctly. there were times I had sleepless nights fearing that the world was going too fast for me to understand. I doubted my abilities, my competencies, and my knowledge. (Stocks to Riches Chapter 4)

The inability to understand the madness added to the frustration. In fact, I lost quite a few clients as they thought that I was too conservative and not in tune with the new economy.”

then the author tries to find out the answer, for the above going wrong, why this happens

the author says, ” find an answer to this question I did some serious soul searching. my quest led to a fledging little know field called behavioral finance. ”

then the author explains, how emotions change and he is right with his decision, the only people, driven by their emotions. to understand this, the author gives good examples of true stories

the author says, ” this is a true story of a friend who ran a coaching class with one of his colleagues they started off well and within a couple of months they were full to capacity after six months, few students complained to my friend about his colleague’s rude behavior.

The allegation was that he was very short-tempered and arrogant. they wanted him removed or else they would discontinue the classes. My friend was worried. this colleague was his partner and he could not be removed. Moreover, he was a brilliant professional and an able tutor.

After a couple of weeks, the colleague fell ill and was absent for some time. the students were very happy. they thought that they had been successful in removing him.

one day my friend learned that the colleague had a brain tumor and needed an operation. this news shocked my friends, as now his partner would be out of action for quite some time. He informed the students of this calamity. the students were stunned and this shock changed their attitude. Hatred and resentment gave way to empathy and love. they visited him at the hospital and took him flowers. they repented their stand and prayed for his early recovery so that he could come back to teach.”

then the author told, what is the purpose behind this story.

the author says, ” purpose of this story is to understand that is humans we are emotional beings and our behavior and decisions are guided by our emotions. Frequently emotions prompt us to make decisions that may not be in our rational financial interest. Indeed decisions that enrich us emotionally may impoverish us financially.” (Stocks to Riches Chapter 4)

Behavioral finance is the study of how emotions and cognitive errors can cause disasters in our financial affairs.

then the author explains, Classical economic theory vs behavioral economic theory.

Classical Economic theory V/S Behavioural Economic theory:-

the author says, ” Classical theory talks about the efficiency of the markets and people making rational decisions to maximize their profits. It assumes that the markets are efficient and no one can take advantage of its movements. It also assumes that humans are rational beings and will act to maximize their goals.

However behavioral economists believe that the markets are inefficient and human beings are not rational beings.”

then the author, give the examples

the author says, ” Consider the examples if you and I were walking down a busy street in Colaba and you said you saw Rs. 5 coins on the road. I would say it is impossible. so many people walk this read and the markets being efficient someone would have definitely picked it up.

But in reality, we do come across such instances. this shows that the markets are not as efficient as they seem to be further, if we assume that people make rational decisions to maximize profits then how do we explain people giving to charities or throwing a party to celebrate a birthday or an anniversary?

Definitely, this is not about maximizing profits by rational people.

here’s another example of how irrational we can be. the acronym Tips:- stand for To Insure prompt service

If TIPS ensures good service we should be tipping before the service starts. Yet, we give tips at the end of the meal. We even give tips when the service is substandard. (Stocks to Riches Chapter 4)

Tipping is more a custom, we do it mechanically unaware that we are behaving irrationally. yet, in economic theory we are rational beings always intent on maximizing our economic status. this is a common mistake we make without realizing its pure economic implications.”

after this, the author explains behavioral finance and why we react like this.

the author says, ” Behavioural finance researchers seek to bridge the gap between classical economics and psychology to explain how and why people and markets do what they do. Behavioral finance raises a couple of important issues for investors. the first is whether or not it is possible to systematically exploit irrational market behavior when it occurs.

The second issue is how to avoid making sub-optimal decisions as an investor. the goal is to close the gap between how we actually make decisions and how we should make decisions.

  • Hold on to stocks, that is crashing
  • Sell stocks that are rising
  • Ridiculously overdue and Underdue stocks
  • jump in late and buy stocks that have peaked in a rally just before the price declines.
  • Take desperate risks and gamble wildly when our stocks fall.
  • Avoid taking the reasonable risk of buying promising stocks, unless there is an absolutely ‘ assured ‘ profit.
  • Never find the right price to buy and sell stocks.
  • Prefer fixed income overstocks.
  • Buy when we have to sell and sell because others are selling.

then the author explains, how psychology plays a wonderful role.

the author says, ” Psychology can play a strategic role in the financial markets, a fact that is being increasingly recognized.

Students and proponents of behavioral finance create investment strategies that capitalize on irrational investor behavior. They seek to identify market conditions in which investors are likely to overreact or under react to new information,

These mistakes cause underpriced or overpriced securities. The goal of behavioral finance strategies is to invest in or disinvest from these securities before most investors recognize their error, and to benefit from the subsequent jump or fall in prices once they do.”

then lastly author gives the three sources of Alpha for superior performance.

i think you should read this in the book, for buying the book, visit the following link

 

so this is all about the Introduction of behavior finance, from chapter 4 of the book Stocks to riches.

Ways of Investing

Hello, friends in today’s article we see chapter 3 from the book, Stocks to riches. In this chapter, we learn three ways of investing. let’s see them one by one.

Previous Chapter

Three Ways of Investing:-

there are three ways by which an investor can invest to achieve superior results.

1) Intellectually Difficult

2) Physically difficult

3) Emotionally difficult

let’s see first is an Intellectually difficult path

The Intellectually Difficult Path:-

the author says, “An investor like Warren Buffett, Charlie Munger, John Templeton, and a few others have taken the intellectually difficult path of beating the markets. this path is pursued by those who have a profound understanding of investing can see future trends clearly, and can comprehend business and the environment. they know that Patience is a virtue and therefore take a long-term position.

We admire them but usually in retrospect initially, we may see them as being misguided but that is only because of our inability to grasp their point of view.”

then the author explains the method that helps this big investor to become big.

this method’s name is cashflow.

Those are big investors, they see how businesses work, their economic policies and market forces that affect the business environment, and how businesses show the cash flow. So this is the most difficult path, and it required a keen mind to study the different concepts of investing.

the author says, ” A good grasp of the various fields of management is required to understand the organizations and their ability to capitalize on various business opportunities. Good knowledge of the field of liberal analysis is basic to the development of various investment concepts.” (Ways of Investing)

then the author explains the name of the game in investing to get a superior return.

the author says, ” Here the name of the game is Patience. Such investors are always on the lookout for good opportunities and bargain prices. As long-term investors, they are willing to wait for them. they are not perturbed by events news rumors and gossip that create short-term volatilities.

They have a strong belief in their abilities since their goal is investing long-term for cashflows. As against capital gains, they are in no hurry to invest. They strongly believe that opportunities are always there but that when the biggest of them come, one must have the money to invest.

They are therefore very careful about allocating resources. They never buy on impulse. They can be out of the market for months, even years. they have the patience to wait till the right moment. Brokers usually do not like such investors as they do not churn their portfolios regularly.”

Then the author explains Intellectually investor qualities.

the author says,” Intellectually investors are also emotionally strong. that is the reason they are able to exercise such restraint.

we all want to be such investors but we cannot as we believe that we are not allowed intellectually blessed as they are. This is a wrong notion. the reason they are intellectually capable is that they work hard and make effort to reach that stage.

They constantly explore opportunities by talking with management, examining different viewpoints on business, trying to understand economic policies and their effect on business environments, etc.

their intellectual capability is derived from their hard work and their strong belief in the long-term approach to investments. Moreover, they use common sense in their judgments and are not swayed by rumors.” (Ways of Investing)

so these types of intellectual qualities you should practice to get a superior return.

then author talk about the second difficult  path is The physically difficult path,

The Physically Difficult Path:-

then the author explains, how we have to do work physically to get the proper investment opportunities, for that author gives the following explanation.

the author says, ” Most people are deeply involved in the physically difficult way of beating the market. they come early to the office and stay late. they do not know what their children are doing as they don’t have time for them.”

the author explains the whole things that regularly fund manager does each and every day of life. And this type of doing is the same as the other fund manager is doing.

then the author explains, why these people do this, and also gives their own experience on the physically difficult path.

the author says, ” In my experience, in the stock market dealing with fund managers has been really amusing. they sincerely believe that keeping themselves busy this way makes them look important and increases their ability to pick up the winners. Once I was at the office of a fund manager and we were chatting informally The telephone rang but he did not answer it. after a couple of rings, the call went to the answering machine. This is how most of them behave. show the world they are busy.”

then author explains how the day trader has also a physically difficult pathway.

the author says, ” the day traders also take the physically difficult path of investing. they spend the entire day collecting information and making decisions based on that information. (Ways of Investing)

so, with all the fund managers and the day trader trading the same path, how can any one of them achieve better results.?”

then author explains how good opportunities come, and what we have to do physically difficult path.

the author says, ” Good opportunities come once in a while and you spot them only when you are cool and have the time to think. The physically difficult path is based on the assumption that there are a lot of opportunities out there and you have to keep digging hard to be successful at investing. the current volatility in the market is the result of too many people trying to invest by this method.”

Life is simple. we make it complicated.

then the author explains the third difficult path and its most important and difficult path, if you master this way of investing then you are 90 percent ready to get a superior return.

The emotionally difficult Path:-

the author says, ” Most of us may find the intellectually and the physically difficult paths too daunting. In that case, we could opt for what is called the emotionally difficult path. Actually, this path is very straightforward. Simply work out, a long-term investment policy that is right for you and be committed to it.”

then the author explains how people think and act on the television news and rumors happening in newspapers, you can read, by ordering this book, link in below image.

after this author gives one example

the author says, ” If one were to compound money at a modest rate of seven percent the money would double at the end of 10 years and it would be 16 times at the end of 40 years.

Patience also helps you to control transaction costs. the more you churn your portfolio the more you pay the broker in terms of brokerage and of course the government in terms of taxes on your capital gains.

then you also have costs like depository charges, transactions tax, and service tax. all these costs would be avoided if one has Patience.

The emotionally difficult path requires an understanding of how our emotions guide our decision making especially when we deal with money. Our emotions directly affect our decisions on investments and expenditures.

We have to learn to think with our emotions rather than have our emotions do the thinking. understanding our own anomalies as also that of others will help us become better investors.” (Ways of Investing)

In the next fourth chapter, we will learn how to use our emotions to our benefit.

lastly, the author explains why is investing so difficult.

Why is investing so difficult:-

the author says, ” the most difficult part of investing is understanding the behavior of the stock markets. Market fluctuations are based on the varied opinions expressed by its participants, which in turn are subject to change commensurate with the changing sentiments of people.

it’s the crowd behavior that dominates the decision making and it is responsible for the sudden changes in the sentiments. take for instance.

The black Monday in May 2004. the markets lost around 700 points when the elections brought Congress to power.

What precipitated this huge fall? had anything gone drastically wrong with the performance of the companies whose stock prices crashed?

Definitely not. but the sentiments changed the BJP being voted out of power was a big change and normally we do not like changes.

Hence there was gloom all around and people dumped stocks as though there was no future. The herd mentality was at work and the markets crashed as each one wanted to get out faster than his neighbor.

If you were emotionally strong and you had bought when the others were panicking, you would have ended up making a huge fortune. (Ways of Investing)

But this seems easy only in hindsight. At that point in time going against the crowd is the most difficult but the most sensible thing to do. Understanding behavioral science is the key to success in this financial market. Its application not only helps you control your emotions but also helps you to understand others’ emotions and benefits from their mistakes.”

On emotion, Warren Buffett has a quote

“ If you can’t control your emotion, then you can’t control your Money”

so emotion is the main part of investing.

so this is all about the ways of investing from the book, ” Stocks to riches ” by Parag Parikh

Investment strategy:- Stocks to Riches Chapter 2

Hello friends, in today’s blog, we see Investment strategy from the book Stocks to riches chapter 2, this book was written by value investor Parag Parikh. so in this chapter 2, we see investment strategy and the difference between investment and speculation. so let’s see one by one strategy.

Previous Chapter 1

Investment Strategy: Investment and Speculation

Investment strategy:- Stocks to Riches Chapter 2

In this chapter, the author explains investment strategy and the difference between investment and speculation.

the author says, ” Investment strategy is the first issue that investors should consider. Investing is an act of faith, a willingness to postpone present consumption to save for the future, thus investing for the long term is central to the achievement of optimum returns for the investor.

there are two sources of returns in the stock markets:-

  1. Fundamentals are represented by earnings and dividends.
  2. Speculation is represented by the market’s valuation of these fundamentals.

then the author ( Parag Parikh) explains in detail above two sources of return.

the author says,” the first is reliable and sustainable over the long run; the second is dangerous and risky. these lessons of history are central to the understanding of investing. these two sources of return could be further classified into cash flow and capital gains.”

After this, the author explains what is Cash flow and how we have to consider ourselves.

Cash Flow concept:-Investment strategy:- Stocks to Riches Chapter 2

the author says, ” When one believes in the fundamentals of investing, one is looking at the dividend payout of the company. these arise from the company’s earning potential, and are possible, only when the company has a positive cash flow. this cash flow is a product of the fundamentals or inherent strength, of the company, the sustainability of the business, and the robustness of the business model.

along with that, there are other variables such as the quality of the management, competitive market position, core competencies, etc. Investing in such companies enables the investor to earn a regular income over many years.”

then, the author explains investment value.

the author says, ” the investment value of a stock is the present worth of all the dividends to be paid upon it. this is best explained by John Burr Williams, ” A stock is worth only what you get out of it. A stock derives its value from its dividends, A cow for her milk, a hen for her eggs, bees for their honey, and stocks for their dividends.”

then the author explain capital appreciation,

the author says, ” the capital appreciation that takes place is seen primarily from the angle of bonus and right shares, which in turn increase the shareholding leading to higher dividends. As a result, the shareholding cash flow is augmented.

The rise in stock price is secondary as there is no intention of selling for capital gain. It is only satisfying to know that one can cash in on such a huge appreciation in times of need.

When investors follow this cash flow model of fundamental Investing. it is always based on the premise that over a long period, the stock markets will go up irrespective of the turbulence.

For them, the bull and bear markets are part of the investment process. on the contrary, they wait for a bear market, as they are able to get bargains there is also a strong belief that equity investments are the best hedge against inflation.” (Investment strategy:- Stocks to Riches Chapter 2)

You all know, nowadays, there is huge inflation, so if you want to beat inflation, then equity investment is best.

then the author talks about the Capital Gain concepts, and what is the benefit of that, and how can we use them for our purpose or goal in life?

Capital Gains Concept:-

The author says, ” When a stock goes up in value and one sells it at a profit, that gain is known as a capital gain. When people buy stocks in the belief that the prices will go up and they will be able to make a profit, it is known as speculation.

the price of a stock listed on the stock markets reflects the value of the fundamental. Speculators bet on the market value of the fundamentals. Now there are traders and speculators who buy and sell stocks according to their perception of the correct price of the stock based on the fundamentals. Say a company like Colgate is quoted at a price of Rs. 145.

A trader may feel that according to the fundamentals of the company Rs. 145 is a low price and that the stock could go up so he would buy that stock at Rs. 145. when it goes up he makes a profit, which is his capital gain, if it goes down he makes a loss.

Stock price movements take place for a variety of reasons and the investor is vulnerable to a host of uncertainties yet he is willing to take the risk. Here people are not looking at the fundamentals of a company.

they are looking at the stock price going up because of probable factors, Such as the fortunes of the company changing, expectations of higher profits a technological breakthrough, etc. they buy and sell stocks on information or an opinion or a rumor. the idea is to benefit from a price movement.

the inherent gambling instinct in a human being is responsible for the huge turnover in this kind of speculation.

speculation perse is gambling. In the stock markets, the other name for speculation is trading. it gives some credibility to the process and also has a different tax treatment ( the basic difference between speculation and trading is that in the former no delivery of the stocks is taken and in trading, the delivery is effected.

The capital gains model is based on the premise that stock markets always witness bull and bear phases; one follows the other. For speculators and traders, the trick is to take advantage of the ups and downs of the market,

Volatile stock price movements excite them, they follow the short-term approach. They strongly believe that since markets always fluctuate, a long-term strategy is useless. In fact, during the tech boom, I interacted with some experts and fund managers who held the firm view that the old ways of investing were out as the rules of the game had changed. (Investment strategy:- Stocks to Riches Chapter 2)

To buttress their claim they cited the example of how warren Buffett missed the tech boom. today I know for sure that all of them are nursing their wounds, this is what short-term success does.”

then the author explains why warren Buffett missed the tech boom, and why they are so successful.

the author says, ” Warren Buffett’s success till date is due to the fact that he would refrain from buying business he did not understand. He would buy stocks that were quoting a discount to their intrinsic value, and he would buy businesses from which he could visualize sustainable earnings over the long term. As the tech stocks did not fit in with these conditions he stayed away from them.”

Then the author gives the case study of Infosys companies.

I think you should read this case study, by buying this book from the following link

then the author says ” let’s sum up, let’s take the example of a cattle farm and a dairy farm. In a cattle form, the asset is the cattle, cattle are bred and reared to yield good value when they are sold to the slaughterhouse. this is what is speculation and trading. You buy on the asset, wait till the price, Increase, then sell it off in the market for a profit. this is how capital gains investing works.

on the other hand in a dairy farm, the asset is also cattle, here too the cattle are bred and reared but they are not sold to the slaughterhouse. the cattle have long-term use, they are used to obtain a regular supply of milk.

In both cases, the asset is the same but it is used differently one for meat and the other for milk. similarly, in the investment world, some people used stocks for capital gains by trading while others use them. Stocks for cash flow by investing long term.”

then the author explains the law of the Farm

The Law of the Farm:-

Then the author explains how to make money in the stock market, by applying the simple law of the farm.

the author says, ” Stock market investing is all about managing the rewards associated with the risks undertaken. without risk, there is no return. Invest you must but before that, you must bear in mind the law of the farm. You reap what you sow but the crop is also subjected to the changing seasons. the seeds have to endure summer, rain, winter, and spring before it turns into full-blown tree. Stock market investments also work that way. there are no shortcuts if we invest in the right stocks with the right business model and fundamentals, over the long run we are assured of optimum returns. However, to do this requires patience and we have to go through the ups and downs but it is important to stay the course. (Investment strategy:- Stocks to Riches Chapter 2)

Getting carried away y the greed of quick returns ultimately destroys wealth as it does not conform to the law of nature. Many of us forget that nature and society are one.”

then the author gives the best strategy of investment.

The Best Investment Strategy:-

the author says, ” There is nothing wrong with speculation as such on the contrary it is beneficial in two ways, Firstly without speculation untested new companies like Infosys, Satyam, and in earlier times companies like Reliance, would never have been able to raise the necessary capital for expansion.

the tempting chance of a huge gain is the grease that lubricates the machinery of innovation.

Secondly, the risk is exchanged every time the stock is sold and bought, but it is never eliminated. when the buyer buys a stock. He takes the primary risk that the stock will go down.

However, speculating can go wrong if people.

  • Do not understand the difference between investing and speculating.
  • Speculate without the right knowledge and skill.
  • Speculate beyond their capacity to take a loss ( that is called margin trading.)
  • The Greatest problem today is that most investors are acquiring speculative habits believing that they are investing.
  • The Attraction of quick money and the advent of the futures market have lured them to margin trading. for a number of people, this has become a full-time occupation due to the advent of the internet and online trading. This could be bad news especially when they are dealing with their life savings. “

then the author explains the risk Reward ratios.

Risk-Reward Balance:-

the author says, ” the important thing to remember is that investing is all about risk and Reward and vice versa.

the investor needs, to select the right balance when choosing investment vehicles and the strategy.

During the IT sector boom, the stock prices of IT companies were going up by leaps and bounds and people were buying such stocks at any price thinking that the price would go up. There was no rationality as to the value and the price. People were thus only buying risk, there was no effort to balance the risk-reward ratio. (Investment strategy:- Stocks to Riches Chapter 2)

We all know the fate of various IT Investors when the markets crashed. In March 2003, when the Iraq war was on, the markets were vert down and some of the stocks were available at ridiculously low valuations. the dividend yield was also very high. the price to earnings (P/E) ratios was attractive. This was the time to invest in Good Stocks as one would be only buying reward and the risk would be minimal. The risk-reward ratio would be in the investors favor.”

so this is all about how much you take risks with companies fundamentals, not speculative manner, that gives the high rewards.

then the author explains long-term investment.

the author says, ” Here are certain facts which prove the point that long-term investment is very rewarding and that patience is a virtue in equity markets. Three companies ( and there are several others), that have given excellent long-term returns to investors who bought stocks over a decade ago and held on to them, are Hindustan lever, hero honda, and Infosys.

The Hindustan lever has given a compounded annual growth rate ( CAGR) of 21 percent in returns for the last 13 years, whereas hero honda, has given 41 percent CAGR to shareholders on their investments during the same period. Infosys has delivered an astounding 79 percent annual return to shareholders since its listing 11 years ago. All these figures include dividends. as we can see this is higher than the returns available in any other investment avenue like bonds or bank deposits. (Investment strategy:- Stocks to Riches Chapter 2)

However, this does not mean that these stocks have only gone one way that is upwards.

They have had pretty serious declines at various points in time but despite that, the long-term result from owning them has been impressive.

The Hindustan lever has been falling for the last two years, Infosys had a very sharp decline after the bursting of the bubble in technology stocks and Hero honda also fell significantly in early 2003 when its quarterly sales slowed down.

Short-Term investment can also be rewarding for the speculator who is able to take risks and time the markets. Take the case of a speculator who had bought Infosys, at Rs. 2000 when the market started moving up and sold it when it went to is 13,800 within a year and a half. He made tremendous gains and he laughed at the investor who hold on to the stock since the beginning and got a return of 79 percent CAGR.

a Speculator could have short sold Hindustan lever at Rs. 210 in November 2003 and recovered it at 4,120 in august 2004 making a return that even a long-term investor in Hindustan lever would envy.

Speculators do make a killing, as some would have definitely done during the various periods of the boom and the bust cycles. the only rider is, can they do it consistently over time! A lot of speculators could have made more money than the long-term investor on the above stocks.

So it is different to say which strategy is good and which is bad. It depends upon the individual’s mental attitude, discipline, risk-taking ability, and patience.

from the above paragraph, some points conclusively prove

  1. Long-term investing can be very rewarding if you buy the right company at the right price.
  2. a stock can decline significantly in the short run and yet give a decent long-term return.
  3. Short-term investing ( speculating) can also be very rewarding if you are able to time the markets and take advantage of short-term volatility.

 

As we can be seen from the above table even though the net profit of Infosys has grown it 43 percent CAGR, 2000-2004 the market capitalization has fallen by 14 percent CAGR in the same period.

This is the impact on investors when a good business is bought at irrational prices. the P/E ratio has continuously declined. (Investment strategy:- Stocks to Riches Chapter 2)

So if one had bought the stock at a higher price in 2000 he would be losing money in spite of the company showing improved performance, this is the risk one takes when one is speculating.

Most of the IT experts and fund managers ignored Benjamin graham’s words of warning. ” Obvious prospects for physical growth in a business do not translate into obvious profits for investors.

In today’s changing times there is so much uncertainty that looking at the long-term approach seems unviable. Hence the stock markets have become the bedrock of brute speculation.

this is the reason for so much volatility. It is also turning long-term investors into short-term punters. this is how the investment world works today. If you want to be a successful investor there are three ways of investing Chapter 3 looks at the best way to invest.

so this is all about chapter 2 from the book Stocks to riches by Parag Parikh

If you want to earn a lot of money in the stock market, you must read this book. This is only of my favorite book, so when I was looking I am away from my value investing strategy, then I read this book, and again set my mindset as a value investor.

this book explains wonderful investment strategies, be read continuously.

Stocks to Riches Chapter 1 Summary

In this article, we see chapter 1 summary of the book Stocks to Riches by Parag Parikh. This is one of the books regarding the psychology of investing. Guy’s if you are haven’t read this book, then I highly recommend to you, order this book from the following link and read it. this is my all-time favorite book, and this book has only  110 pages. If you want to succeed in investing.

What is investing:-Stocks to Riches Chapter 1

Stocks to Riches Chapter 1

let’s start, chapter 1 investing, before that let’s talk about the author

Author’s profile:- Parag Parikh is the Founder Chairman of Parag Parikh Financial advisory services limited (PPFAS), Mumbai. Mr. Parikh Has over 25 years of experience in investing, broking, and advisory business. he regularly shares his insights through guest contributions in many of India’s leading financial publications such as the Economic Times, Business Standard, and DNA, through appearances on CNBC, NDTV Profit, Aaj Tak, and Star News, as well as by undertaking lectures at various investor and educational forums.

Mr. Parikh has a Masters in Commence from Mumbai University and is a Certified Financial Planner ( CFP) from the Financial Planning Standards Board Of India. He is an alumni of the Harvard Business School having successfully completed the prestigious Owner President Management Program. He has also attended the program on Investment Decisions and Behavioral Finance at the John F. Kennedy School of Government at Harvard. (Stocks to Riches Chapter 1)

A keen Believer in nurturing one’s physical, mental, emotional, and spiritual side, Mr. Parikh engages in Physical activities such as golf, reads extensively, and practices Vipassana regularly.

so this is the profile of the author

let’s start, chapter 1 investing.

The author ( Parag Parikh ) says, ” Investing is a challenging game and we were all into it at some time or the other the clearer we are about it, the more successful we will be at mastering it.”

Son:- Dad, give me some money, I want to invest in the stock market. All my college friends go to this broker who provides terminals where one can invest.

Dad:- Invest?

Son:- Yes, My friends make a lot of the money they buy stocks on the broker’s advice and when the prices rise, they sell and make a clean profit. (Stocks to Riches Chapter 1)

Dad:- Well, this is the age for you to study, get good grades so that you can get a good job that will secure your future, I don’t want you to get into speculating in stocks.

Daughter:- Dad, you have to give me some extra money this month, as I need to buy some gold jewellery. I will be getting married in a couple of years and I need to start building my jewellery collection now.

Mother:- Baby, look at yourself in the mirror. you are putting on so much weight if you want to look good wearing gold jewelry you require a good body. Why don’t you go to the gym for a regular workout instead of wasting your time watching Tv? it’s high time you start watching your figure if you want to get a good husband and settle down in life.

Daughter:- Oh mom, my boyfriend is a big investor he buys and sells commodities. he knows how to make money. We have decided to get married. you need not worry about my future.

Son:- Oh, So he is a commodity investor? Great! Dad, I talk to you it’s a great business. I want to be a stock investor. you don’t understand what a big thing investing is you can make a lot of money through it, See dad, you slag the whole day at your factor, become an investor and we will become rich.

Mother:- Children, your dad works, so hard at his factory, which is why we have a comfortable life. it’s wrong to run down your father, he choose to set up this factory, so what if he did not get into investing.

Son and Daughter:- But we can make big money through investing. Why should dad work so hard at the factory when this is a better option?

Mom:- I don’t want to get into this debate but I am happy to have inherited from my father some stocks and a real estate property. I get my regular dividends from my stocks and the rent from the property. why should I bother about investing?

Dad:- Well, I think I will go to sleep. I am really confused about this. Investing is a difficult subject good night.”

Then the author explains the above conversation. (Stocks to Riches Chapter 1)

the author says, ” In the above conversion no one understands ‘ Investing ‘. The son and the daughter talk about it but do not know what it exactly is.

Father has invested in the factory and asked his son to invest in his education, but he does not know about investing means either. the mother asks her daughter to invest in her body by exercising regularly. the daughter does not real investing Not commodity trading. the mother is a real investor in stocks and real estate. yet she does not know about it.”

After this, the author explains, what is investing?

the author says, ” Investing is a very exhaustive subject. It means different things to different people. At some point in time well all are investing in something. It may be relationships, It may be a marriage or a career.

Life is all about doing something to reap benefits in the future. so all of us are in the investment game. However, it means different things to different people.”

then the author gives examples of Investment.

People Invest in.

  • Large families so that when they grow old, their children can take care of them.
  • Land and crops, in order to fend for themselves and their families.
  • Small families, to provide a good standard of education ad living for their child.
  • their health, by exercising regularly and eating a balanced diet.
  • Charitable works, to serve the poor and the needy, and
  • An external asset like real estate, shares in listed companies, gold silver, etc, so that they can fall back upon them in tough times. (Stocks to Riches Chapter 1)

after this, the author says,” thus we have a lot of people doing different things in the name of investing. this makes the subject of investing very complex.”

then the author explains the different types of investment products.

Investment Products:-

the author says, ” these come in the form of stocks, bonds, mutual funds, real estate, precious metals, insurance, commodities, etc.”

then author explains how these products fulfill their purpose.

the author says,” the reason people choose one form or another is distinct as each is designed to satisfy a particular need.

  • Stocks offer dividends and capital appreciation.
  • Bonds are much safer than stocks and offer a safe return on the money invested.
  • Mutual funds may be seen as less risky than stocks.
  • Investment in real estate could be for capital appreciation, to earn rent, or for self-accommodation.
  • Insurance is used as security.
  • Precious metals like gold and silver appreciate over time and are therefore a good hedge against unforeseen political uncertainties.

thus, each investment product has different distinct characteristics and each is designed to satisfy a peculiar need. Each is designed to do something different. (Stocks to Riches Chapter 1)

After this long list of investment products. the author gives the investment procedure.

Investment procedure:-

the author says, ” there are three-technique methods or formulae for dealing the various investment products.

  • If one were to buy an investment product and hold it, then the procedure adopted is called going long.
  • If one were to sell an investment product and then buy it, the procedure adopted is called Going Short.
  • If one buys and then sells, the procedure adopted is called trading.

There have been various innovations in investment procedures by the introduction of the future and options market.l we have thus different procedures to speculate and hedge in the form of call options, put options, and futures. all these different types of procedures make the interactions of the financial market.”

After this procedure, the author explains Investor Classification.

Investor Classification:-

the author says, ”

  • A stock trader is one who uses the product stock and the procedure trading.
  • A long-term investor, on the other hand, used the product stock and the procedure of buying and holding long.
  • A short-sellers uses the same product stock and the procedure of selling and then buying back.
  • Similarly, a real estate speculator whose product is real estate adopts the procedure of speculation.
  • A collector of rare coins buys and holds long the product of rare coins. (Stocks to Riches Chapter 1)
  • A commodities futures trader adopts the procedure of the futures market to trade in commodities.
  • A stock options trader adopts the procedure of the futures market to trade in commodities.
  • A stock options trader adopts the procedure of hedging in the product of stocks.
  • A day trader uses the product stocks and the procedure of speculation.
  • A square is one who wants to hold over a long term by putting his money in the bank.

so thus, there are different types of people doing different things with the same investment products. Under the banner of Investing are people who are really gamblers, speculators, traders, hedgers, savers, dreamers, and losers.

after this, the author gives the wonderful investing plan and the difference between trading and investment.

If you want to read it, then buy this book from the following link.

Security Analysis: Chapter 15

Hello friends, in today’s article, we see a summary of chapter 15 of the Security Analysis book by Benjamin Graham and David Dodd. Chapter 15 is about the Technique of Selecting Preferred Stocks for Investment. so let’s see

Previous Chapter 14

The technique of Selecting Preferred Stocks for Investment:-Security Analysis: Chapter 15

In this chapter, the author explains, if we decide to buy the preferred stocks while seeing their disadvantages, so author gives some techniques to select preferred stocks.

The Author Says, ” For preferred stocks, we required to stringent the minimum requirement as compared to bond. So what is the minimum requirement for interest coverage ratio, this given in the following table (image)

Security Analysis Chapter 15

Now you can see, in three industry Segments

So for preferred stocks required more high multiple like in public utility is 1.75 of Fixed charges and for preferred stocks earning is 2 times of Fixed charges and Preferred stocks dividend.

Now Come for minimum stock Value requirement, in this also as compare bond and preferred stocks.

In this, you can see for preferred stocks required more. (Security Analysis: Chapter 15)

In public utilities, required 50% more than bond means 1/2 and for preferred stocks, 66.67% means 2/3 ( Bond + Preferred stocks equal)

So in this chapter 15, we discuss both tables and how to calculate this value.

 

How to calculate Rations?

The first thing is to use the method name is ” Total Deductions method“, for interest coverage ratio to compare with minimum coverage ratio.

So in this method, we have to divide earning by Bond interest + Preferred dividend.

In Bond, we only divide by bond interest but in this, we use both ( bond interest + Preferred dividend)

so some of you say, why not we use the prior deduction method,

Because, we know that, by using the prior deduction method

the result looks like Preferred stocks are more secure than Bond. so that’s why the author uses the total deduction method.

Let’s come in Stock Value Ratios

Security Analysis Chapter 15

For Bond, we use in the numerator, stocks equity( common stocks) and divided by funded debt( bonded debt).

For the preferred Stocks case, in the Numerator, We take only common stocks and in the denominator, we take bonded debt + Preferred stocks.

If Suppose You want the stock value ratio, for this preferred stocks are two type

1st Seniority preferred stocks

2nd Seniority preferred stocks

so for this type of preferred stock using the following method

  • If we want to calculate for 1st seniority preferred stocks Value ratio. so In 1st seniority of preferred stocks in the Nenomenator of equation presents 2nd seniority preferred stocks + common stocks and in the denominator, we can use Bonded debt + 1st preferred stocks. (Security Analysis: Chapter 15)

In Bond, we have to take face value, and 1st preferred stocks we have to take market value.

1st preferred stocks face value we can’t take, because, preferred stocks’ actual par value is different than the stated value.

for this, the author gives example to understand the above statement

e.g, The preferred stocks and this stated par value is $1 but those are preferred stocks holders, they have to get $100 for liquidating preferred stocks.

so the actual par value of that stock is $100, not $1. so for this, we have to use Market Value.

We can see tables(for referring above note page image) in that we say, for Preferred stocks the minimum requirement is more as compared to bonds.

So for seeing this formula, we know that, let’s take

The interest coverage ratio, in the numerator same ( EBIT- earning before interest tax) but in the bond case, we divided by fixed charges, and in the case of the preferred stock, we divided by fixed charges + preferred stocks dividend.

so those are preferred stock coverage is found less, because, we required maximum, as the author gives us

Let’s see in Public utility examples, for the preferred stocks the interest coverage ratio is 2 times. (as given in table by author)

Means, Interest coverage ratio = EBIT / Bond interest + preferred dividend.

            Interest Coverage ratio = 2

so, for Bond ( Interest coverage ratio = EBIT / Interest charges )

Now we surprise

so its value is more than 2 times because the denominator is small

If for preferred stocks is 2, so then bond interest coverage ratio is more than 2. obviously by math

So then the author says, ” Yes, the interest coverage ratio for the bond is more than 2, but people thinks, for preferred stocks coverage ratio is have to be lenient or less stringent, (Security Analysis: Chapter 15)

Because, preferred stocks coverage ratios denominator is more, so the value may be small,”

then Author says, This type of thinking is wrong.

Because, in any company have a bond and preferred stocks, and in this company preferred stocks is when safe, then this company bond is safer, with a good margin of safety.

If the bond is less safe then how are preferred stocks safe? ( common sense)

If the coverage ratio is minimum then this is only limited to bond coverage ratio, not for preferred stocks.

that’s why the author takes 2 times the interest coverage ratio for preferred stocks and for bonds only 1.75.

then the author talks about cumulative Issues and Non Cumulative issues

 

Non-cumulative stocks Issues/ cumulative Stock issues:-

Cumulative Stock issues:- Cumulative preferred stocks are those, in them, the dividend is suspended by the director, so this dividend is accumulated and this dividend is paid later.

But in Non-Cumulative Stock Issues:- In this, if the dividend is suspended, then they are not be recovered or accumulated. So those are new continued dividends, that are only given by the company.

That dividend is missed by the director, that dividend is gone forever.

Then the author says, ” Buying cumulative stocks is better than the Non-cumulative stocks.

Because, in non-cumulative stock problem is, those are common stockholder, they taking advantage, because, the director can suspend, your dividend. in those years also when companies earning is good, and this money is used by the director to improve the company. By this activity, the direct benefit to the common stockholder.

And Your dividend is missed by the company is not given in the next dividend time.

so there is not any benefit for non-cumulative stocks means full loss

On this Non-cumulative Preferred stocks lose, taking benefit by a company means on your expense, taking other profits. (Security Analysis: Chapter 15)

So those are company directors they play in trick, is that

Firstly they suspend your dividend and when they give a dividend to common stocks holder before some time that they give the dividend to the non-cumulative stockholder.

When a company wants to suspend its dividend, so for this they stop the first dividend of the common stockholder and some time after they stop the dividend of preferred stockholders also.

after this difference, the author talks about, ” those 21 preferred stocks, that do good in depression also.

Out of 440 listed stocks on NYSE in 1932, that on 21 stocks is doing good and perform well in depression with any loss.

So those are 440 listed stocks on NYSE in them only 40 (9%) are Non-cumulative preferred stocks.

By knowing this, you may be surprised, those are 21 stocks, that do good in depression, so in them,

the author gives 3 observations, they are as follows.

  1. The number of Non-cumulative issues was higher than cumulative issues, in those 21.
  2. No. of preferred stocks proceeded by bonds were higher than without bonds in those 21. ( as we discussed, in those company, that have only preferred stocks, that’s is good for the preferred stockholder.)
  3. The industry best represented is the snuff business, with three companies.”

(snuff business is a type of business of Tobacco)

So, the author says, ” Buy seeing the only result, we can’t say, non-cumulative stocks is superior.

or we can’t have to say, preferred stocks with the bond is better than, only preferred stocks companies.

or we can’t say, Snuff business is the safe business”

Logically the author says, ” This reverse is best means, the cumulative issue is better and preferred stocks without bond is better. (Security Analysis: Chapter 15)

But this result occurs, it only proves that if this thing does not matter most and maybe desirable but you become successful or not on this things, this observation not affect.

Then the author says, In conclusion

What matters most to success.

  1. Outstanding record of the company for a long period in past
  2. The strong inherent stability of the company
  3. Absence of concrete reason to expect substantial change for worse in the future.

so this is all about chapter 15 of the security Analysis book by Benjamin Graham and David Dodd.

Security Analysis:- Chapter 14

Hello friends, in this article, we see the chapter 14 summary of the book Security Analysis. Chapter 14 is all about the What is Preferred stocks, and their origin story, and also their advantage and disadvantage.

Previous Chapter 13

Preferred Stocks Analysis:-Security Analysis:- Chapter 14

Security Analysis Chapter 14

So, from this chapter, we discuss the only preferred stocks, and their Analysis based on the Advantages and Disadvantages of the Investor to buy that preferred stocks. let’s start

The author told, In The Intelligent Book also is that Preferred stocks are not Attractive Investment, it is Unattractive Investment.

The author says, ” Preferred stocks represent an Unattractive form of investment.”

so let’s find out why

Because 1st reason is that the Preferred stocks Principle and their income return is limited. whatever they told first is that amount only paid by the company.

and Second Reason the author told, is that Those are Preferred stocks holder, they don’t have any Claim on company. or in the author’s words is that ” Interest payment gets at any cost.”

and also Author says, ” Preferred stocks are the Limitations of Bond and Stocks Mixers, and Preferred stocks are more vulnerable than bond at the worst Condition of company.” (Security Analysis Chapter 14)

Because preferred stocks have a claim after Bond Holder.

 

What is the difference Between Bond and Preferred Stocks? (Security Analysis Chapter 14)

Ans:

The difference is that those are bond interest is compulsory to pay by the company, if the company is not paying, this type of company called a Defaulter.

Those are preferred stocks Dividend payment depends on the Board of directors of the Company, they pay or not pay.

If a company’s earnings are good and also make more than the preferred stock’s dividend, so usually preferred stock payment is done, but in this claiming point of preferred stocks looks unusefulness ( no benefited ).

If Companies Perform Bad and they generate very low earning, so bondholders have a claim on the Asset of the company, but they don’t have Practical value of that asset just like, we discussed in the bond Analysis series in all previous chapters. (Security Analysis Chapter 14)

Because, If the business fails, then properties value also fail, means decreases

so Investor think and they make the general rule, ” Bond instruments form is not have the special advantage as compare to preferred stocks. If the company is good then preferred stocks and bonds are also good. If the company is bad, then the bond is also bad.”

Read this again and think above two lines.

But the author says, ” this type of investor thinking is not good. Preferred stocks are weaker than Bonds.”

Because, bondholders get the money but those are directors of the company, they stop preferred stocks dividends.

why this happen

Because, if the company is capable, but they don’t pay preferred stocks dividend, and they give a reason like, that the Company has the good time in future, for that purpose they suspend the dividends of the preferred stocks. and say if the company grows, then you get the benefit also. for example, like, the company wants to expand.

that’s why they try to collect cash and save cash or in future any emergencies come, for that emergencies, they save the cash to deal with that problem. (Security Analysis Chapter 14)

so this happens with preferred stocks dividends.

so those are preferred stocks holder have the following types of conflict problem

Conflict of Interest come to Preferred stocks Holder:- Security Analysis Chapter 14

1 ) first is that what happens in the company I don’t care, I just want the continuous income.

2) Second is, If Company suspends the dividend, in the future, the company will perform well and become a great company.

and If the company uses the proper money of the holder of the preferred stock, then they get a good return on that money in the future.

so these two types of conflict of interest come to preferred stocks holder, and also a conflict of interest come between preferred stocks holder and commons stocks holder

Because, if companies director stops payment of preferred stocks dividend, then this money helps to build a company or grow the company.

so Because of this activity, common stocks holder get more benefits than the holder of the preferred stock

how this when, let’s see

When a company grows, then earing grows and share price is also growing so that’s benefit goes to the Common Stocks holder.

Preferred Stocks holders, not get the benefit of the company growth, because they get regular, whatever the dividend payment. This payment depends on what decides when we buy that preferred stocks.

So being great company, they don’t get benefit or advantage of that great company, as much as we see one side.

On the Other Side, The common Stocks Holder gets a benefit on earning and the preferred stockholder gets a benefit on companies expenses.

And also Board of Director of companies have also the conflict of Interest

Many times, they favor Common stocks holder, more than preferred stockholders, because they give the vote for the selection of companies’ board of directors. (Security Analysis Chapter 14)

Or In many times, the board of directors is not favored for common stocks holders, instead of that, they favor Management people.

Because, they get the salary, from the management. so many times, they don’t see the best interest of the common stockholder or preferred stocks holder, instead of that, they only see their own best interest.

Then the author says, ” this is the weakness of preferred stocks holder as compared to the bondholder.”

there is only one solution is that Preferred stocks holder has to be voting rights on the enterprise when the dividend is suspended by the director, then preferred stocks holder have to be immediately voting control to put money in the right place.

But practically is not happening. If in any company happen like this then preferred stockholder not take good advantage of that voting right.

So this thing of control also becomes useless.

Then after this author says, ” Yield or risk is not Commensurable.”

High Yield is not offset High risk

If you buy preferred stocks, and you have fear is that you will lose your principal amount and for this offer company give you a high dividend yield. so for this, they don’t offset.

What thing is offset is the thing is you have to get a good chance of principle profits, without losing it.

let’s see some qualifications of preferred stocks

Qualification of Preferred Stocks:

Here is one question come is that what criteria to buy preferred stocks

The author says, ” there are Three criteria for buying preferred stocks.”

1) Preferred stocks, have to fulfill the Minimum requirement of bonds

2) Exceed these minimum requirements by a margin to offset discretionary Feature of Dividend payment ( means those bonds minimum requirements, they have to exceed well with good margin)

Because we have those risks ( which risk) is the board of directors of the company can suspend our dividend payment, because, they have the power for this.

then author show, the 21 companies list, in those company have preferred stocks that were listed on New York Stock Exchange in 1932.

Between 21 companies only 5 companies perform well in depression also.

then, the author says, ” Sound Preferred stocks are not impossible things, but it is exceptional phenomena.”

exceptional because sound preferred stocks are the mistakes of the company. (Security Analysis Chapter 14)

Why mistake,

The mistake is, because, the company can issue bonds but they issue preferred stocks.

If they issued the bond, they get the Tax benefit, but on preferred stocks, they don’t get that benefit.

If preferred stocks perform well, then the company don’t get benefit from them, because the preferred stockholder is only benefited.

and on dividend company have to pay tax.

The author says, ” Issuing preferred stocks only benefits the company, because, they can stop any time dividend of preferred stocks.”

If the company is not suspending the dividend of preferred stocks, then the benefit is going to the holder of the preferred stock, because, company issues bonds but they issue preferred stocks and they don’t get tax benefits also.

Now some Investor says, Like that, We don’t agree with this, because the company is giving limited income to the preferred stocks and the company can invest properly money, that comes from by issuing preferred stocks and can get the better return on their investment ( that money come from by issuing preferred stocks). Whatever company pay to preferred stockholder on that basis company earn double profit. so this benefit gets the company.

But, the author tries to say is that ” the main purpose of preferred stocks is that company can suspend dividend at any time.”

So in this case, then the author is right.

Because in this case the only company is benefited

If the dividend suspends the loss goes to the preferred stockholder and if the dividend payments, then the company gets lost. (Security Analysis Chapter 14)

So if this type of Problem happen in preferred stocks, then why this is very much popular ( in 1940 before)

then the author says, ” just before the first world war, the majority preferred stocks is the industrial issues and they have speculative natures.”

Because they get discounted price than the par value. so profit possibility is moe and after that continue for 15 years got prosperity in the USA in 1920 on this basis preferred stocks give the awesome return.

On this basis, preferred stocks perform better than bonds, but actually, that is not.

Then the author talks about the study of the University of Michigan.

The University recently study ( 1940) and then, the author observes and prove that

Preferred stocks are without bond is better than preferred stocks with bond.

This means, If a company issue bond and preferred stocks and you buy preferred stocks of this company so this is not a wonderful idea, instead of that you can buy the preferred stocks of those company that don’t issue bonds.

When adverse development happens means depression/ recession comes, then company earnings decrease, so in that, if the company has issued the bond, then this bond gets benefited, than preferred stocks. so buy only those companies’ preferred stocks, they are not issued the bonds.

The other thing, the author observe from the Michigan university’s study is that preferred stocks stability depends on common stocks stability.

If common stocks decline then preferred stocks also decline.

then Author says,” is like, if Head’s come win common stocks, and if tail comes, preferred stocks lose.”

Why do common stocks holder win?

Because Heads means the good performance of the company and common stocks holder get unlimited capital gain.

And tail means, Company perform badly then preferred stocks also decline in values, as same as common stocks holder.

If Investor Analysis is good and they think in the future company give a multi-bagger return, then why do you buy preferred stocks instead that buying common stocks and participating in profit.

If the Investor is doubtful then buy the preferred stocks, why this doing is good

because they have to take risk of principle by buying Common stocks.

so they get lost, so they don’t have to do, at that point they get the good opportunity to principle profit.

so this is all about Chapter 14 of the Security Analysis book by Benjamin Graham and David Dodd.

Security Analysis: Chapter 12

Hello friends in today’s article, we see chapter 12 of the Security analysis book. In this chapter, we see a special factor in the Analysis of Railroad and Public-Utility companies. so let’s start with Railroad Bond analysis.

Previous Chapter

Railroad Bond Analysis:-Security Analysis: Chapter 12

Security Analysis: Chapter 12

so let’s, in this

The authors said, ” those are railroad companies they have maximum data. so those are individuals who have the competency to analyze data correctly.

The author also, says, ” if we have to do high-grade bond analysis, then why we invest in this bond, instead of a bond.

we can invest in stocks, with that much analysis, which means, there are no more benefits of analysis when we invest in the high-grade bond.

Just we have to keep remember is that those are income generating, they are more above the interest charges means good interest coverage ratios. (Security Analysis: Chapter 12)

so another thing, is that those are stock value ratio is also high.

Then the author talks about the railroad industry general things like

those are light traffic, they go in the truck, and those are passenger traffic they go in their own car.

so only heavy traffic remains for Railroad, traffic like, Coal, iron steal, mineral transport.

so railroad success, depends on this thing also, that much increases then profit increases.

and another also quantitative part is an available book,  if you want to learn, more about the railroad, then buy the book from the following link

so let’s start with Public Utility company bond analysis

Public Utility Bond Analysis:-Security Analysis: Chapter 12

In public utility bond analysis have three problems, they are as follows

1 ) People think, the application of the term of the public utility to on industrial operations.

so this is not the right thing, for the right things, we have to define and understand the public utility definition.

Public utilities are those types of companies that are providing essential services under government regulation and the most important thing is on public utility is ‘ they are stable and have legal right to charge that much to be a profitable and good return on capital investment.

stability means,

They are relatively stable with other companies in the same industry.

then the author says,” Nowadays, pseudo Utility comes more like, selling ice, operating taxi cabs, owning cold storage plant. so people also called, then also public utility.

So this is the first problem,

so these are actually industrial operations but they mean people called them a public utility.

Nowadays their combination come( 1933)(author talk in 1933, don’t forget that)

like, Natural gas is combined with Ice Plant. (Security Analysis: Chapter 12)

2) the second problem is that this one bond issue whatever their prospective they use the prior-deductions method to calculate interest coverage ratio.

we lastly talk about this method, is they are a useless method, we have to use total method.

This problem is that those are junior bond issues, they are more covered properly as compare to senior bond issues.

If you apply common sense, you see these are nonsense things.

3) the third problem is that companies do not include the depression charges, while considered or finding interest coverage ratio. if they may be understated depression or not include then.

If someone says, your depreciation is the only bookkeeping thing concept, then your money is not spent properly.

then it means, that if you listen then or agree with them, that means they make you fools or you become a fool by them.

Depression is important and you have to subtract them, because, your instruments use daily, and their value becomes less sometimes later they become obsolete.

So that instruments losing their power by using daily, for that we have to subtract depreciation and other problem is unstable in this problem, the author says,

minimum 10% of gross revenue and 4% of total profit value, that much have to subtract.

If you want to be more conservative, then you can take 12% of gross revenue as a minimum.

4) there is the fourth problem is that

those are Federal taxes are imposed after deduction interest.

How you can find, = EBIT/interest expenses

But most of the time, those are corporate people, in their reports, they deduct the tax first, and then show the earning, and then coverage ratio is found. (Security Analysis: Chapter 12)

So you don’t give the tax paid first, so in this, you don’t worry about from where I am and add tax and earning the become minimum.

So this is a good thing, you have become more conservative and you take past then actual earning, so this is no problem.

because they don’t give any big difference by adding tax.

But if you analysis of a Holding company bond, then, you have to worry about some

So those are holding company they have to pay subsidiaries and their subsidiaries bond issues and preferred stocks payments.

So holding company, first have to pay their subsidiaries preferred stocks or bond issues, and after that holding companies bond issues charges.

so in this, we have to consider the tax.

Those are preferred dividends, you have to pay to subsidiaries and tax on them and after whatever earnings come, you can use it. (Security Analysis: Chapter 12)

Then the author gives the Example, How a company fools the Investor.

How a company Fools the Investor:

The companies debenture Issues, they have price is about $3,000,000

and companies business is, this company operate 20 telephone companies and 4 ice companies.

Value of property = $12,500,000

After depreciation, this value is equal to $1650 per $1000 bond issues after deduction of prior obligations.

so following are the income account.

Gross earnings – $3,361,000

Net Before Depreciation – $969,000

Prior Deductions – $441,000

Balance for Debentures – $528,000

interest on Debentures – $195,000

Balance for Stocks – $ 333,000

the Balace is above 2.71 X(times)  interest on this issues.

so how they found this,

so Coverage ratio= Debentures balance / Interest of debentures

coverage ratio = $528,000 / $195,000

coverage ratio = 2.71X

the question arises

What is the problem with these ratios

so the first problem in this is as follows

1) Business combined means, the actual utility is mixed with industrial operations but they are ice plants. (Security Analysis: Chapter 12)

and they don’t give the gross and net income of ice plants

we don’t know how much percentage from the ice plant and how much percent from the telephone company.

so they don’t give us

if we assume ice business give maximum percentage income, that’s why they try to hide this.

second problem

2) the second problem is Depreciation is not subtracted.

Those are other telephone companies whose 15% of gross revenue is the depreciation.

so,

If we take 15% of depreciation = 15% of $3,361,000  

depreciation = $ 500,000

If we take Net income after depreciation = $969,000 – $500,000

Net Income = $ 469,000

and then we take calculations as follows, we get the result

Balance for debentures = $ 469,000 – $441,000

Balnce for debentures = $ 28,000

and Interest on debentures = $ 195,000

so they are not equal to the debentures

this is the trick

so if we can not assume $500,000 depreciation, Because, those are ICE plants, their depreciation is very less.

so we can assume depreciation as $300,000 ( i.e. 9th 1/2 % of Gross revenue.)

third problem

3) Third Problem is that they used the prior- Deductions method.

In this we get the debentures safety

Debentures safety = $ 528,000 / $195,000 

Debenture safety= 2.71X

and If we see for the senior bond issue, we get as follows

Senior bond safety= $969,000 / $441,000

Means Senior Issue is less secured and Debenture issues is more secure(junior bond issues)

So this is not a logical thing, as compared to the seniority (Security Analysis: Chapter 12)

If we make the right income account is as follows

Restating property:

Gross Earnings – $3,361,000

Net before Depreciation – $969,000

Depreciation – $ 300,000

Balance for Interest – $669,000

Total Interest Charges – $441,000 + $195,000

Total Interest charges – $636,000

Coverage Ratio – $669,000 / $636,000  

Coverage Ratio – 1.05X

 

so forth problem

4) So fourth problem is that,

they say, $1650 of property value behind each $1000 debentures

so given,

Property Value – $12.5 million

Total Debt – $ 10.5 Million

Senior debt – $7.5 Million

Debentures – $ 3 million

so how much actual coverage ratio, we get

let’s find it out

for that,

Calculations:

property Value / Total Debt = $ 12.5 M / $10.5 M = 1.19

( M denote here – Millions)

It means only, i.e. $1190 of property value behind $1000 of total Debt.

so what companies say, How they get see following calculations

where they misguided ( mistake) (Security Analysis: Chapter 12)

Property Value for Debentures = $ 12.5 M – $ 7.5 M

Property Value for debentures:- $ 5 M

Debentures = $ 3 M

Property / total Debt = $ 5 M / $ 3 M

so that why come $ 1650

so in this time, they used the prior deductions method ( that method secure junior) to fool investor

if we apply for senior, then they are $ 1400 of property value behind each $1000 of senior debt.

Means Senior is less safe if we see the only a number

so this type, Companies make fool to investor

Security Analysis chapter 11

In this article we see the Security Analysis chapter 11 summary, In this summary, the author explains Criteria 7 of the Specific standard for bond investment, ( continued) so let's…

Warren Buffett Books Recommandations

Hello friends, in today’s article we see Warren Buffett Favorite books on investing, and they recommend to everyone who wants to build a fortune in common stocks. This book is recommended by Warren Buffett in public speech and at the Annual Meeting of Berkshire Hathaway. If you really want to learn about investing and want to get rich like Warren Buffett, then you should mus read this warren Buffett’s best books on Investing.

Warren Buffett’s best books on investing:-

let’s start one by one

1) The Intelligent Investor by Benjamin Graham:-Warren Buffett Books

Warren Buffett Books Recommandations

In many interviews so many times asked Warren Buffett about his favorite book, and that book is The Intelligent Investor book. This book he gets in the Omaha Public library, and then they started to read this book, then he realizes that buying stocks and selling stocks have to be reasonable. (Warren Buffett Books)

When he read this book, then forgot about the time and read very clearly and then he understands the Benjamin Graham quote on investment “ The best investment is done when they have done like a business.”

This means if you invest in any stocks, consider investing in the piece of Business. Warren Buffett also says about this books is that this book is all about the mindset of investing, and you required three things

  1. Patience
  2. Self-discipline
  3. Eager to learn attitude

From this book, warren Buffett learn the two basic principles is that 1) Mr. Market and 2) Margin of safety principle

Chapter 8 is about the Mr. market and chapter 20 is about the Margin of safety principle. These two chapters are most favorite subjects of Warren Buffett.

This book also explains the Defensive investor and Enterprising investor.

If you have time to do an analysis of stocks then you should have to become an Enterprising investor, and you don’t have so much time, then you should become a defensive investor by investing in Index funds.

For me, this book is the best best best of all-time Value Investing books. if this book is not written by benjamin graham, then there is no one like Warren Buffett and another value investor that doing badass in now market. they all are scattered with stocks and no one makes the fortune in the stock market. (Warren Buffett Books)

This is the best book on investing and those are beginners, that don’t understand the quantitative part, but they understand the Investment philosophy by benjamin graham.

Everyone should buy this book: click on the book image

Let’s talk about the second book of Warren Buffett’s best books on investing.

2) Common Stocks and Uncommon Profits by Philip A. Fisher:-Warren Buffett Books

Warren Buffett Books Recommandations

Warren Buffett another favorite book from the other authors is Philip A. fisher.

One is meeting Warren Buffett says about his book is, ” I am the 85% of Benjamin Graham and 15% of Philip A. Fisher.”

Do some people say why warren Buffett only says about the 15% percent? the answer is in this book

This book is about growth investing and how to find growth stocks.

In this book, Philip A. Fisher explains the Scuttlebutt method. this method helps you to find a great company and develop the 15 points of an outstanding company that help you find a great company. (Warren Buffett Books)

 

3) Business Adventure by John Brooks:- Warren Buffett’s books

Warren Buffett Books Recommandations

I don’t read this book, but this book, warren Buffett recommends in many speeches, this book warren Buffett recommend to Bill Gates.

4) Where are the Customers Yachts by Fred Schwed’s:-Warren Buffett books

Warren Buffett Books Recommandations

5) The Little books of common sense investing by John C. Bogle:

Warren Buffett Books Recommandations

This is one of my favorite books, this book is on the Index investing strategy, this strategy beat the top 10 fund managers.

On Index, warren Buffett owns the Million dollar bet, click here to see that bet.

so this strategy works well.

learn this strategy, and this strategy for those people who don’t know much about investing, this strategy makes them very wealthy.

6) Poor charlie Almanack: Charles T. Munger biography book

Warren Buffett Books Recommandations

this book, definitely changes your life, This biography of Charlie Munger, ( vice-chairman of Berkshire Hathaway company). In one interview, Vishal Khandelwal ( value Investing teacher) asks Mohnish Pabrai ( Pabrai fund Manager, founder of Dhakshana foundation) , if you have the choice to keep one book, which book you keep for your lifetime, then he says, poor charlie’s Almanack.

7) the Most Important Thing by Howard Marks:

Warren Buffett Books Recommandations

8) The Clash of the Culture (Investment vs. Speculation) by JOHN C. BOGLE:

Warren Buffett Books Recommandations

9) Security Analysis by Benjamin Graham and David Dodd:

Warren Buffett Books Recommandations

Security Analysis is the book on Value Investing, in this book, you learn how businessmen buy bonds, stocks, or any other instruments, with the help of the real meaning of investing. (Warren Buffett Books)

So This is not for the beginner. this book is only for those people, who are very serious about investing and Value Investing.

So I am very serious about Value investing for this reason I write each and

every chapter books summary you can read by the following click

  1. Security Analysis book Introduction
  2. Security Analysis Chapter 1
  3. Security Analysis Chapter 2
  4. Security Analysis Chapter 3
  5. Security Analysis Chapter 4
  6. Security Analysis Chapter 5
  7. Security Analysis Chapter 6
  8. Security Analysis Chapter 7
  9. Security Analysis Chapter 8
  10. Security Analysis Chapter 9
  11. Security Analysis Chapter 10

10) The Conservative Investor Sleep well by Philip A. fisher:

Warren Buffett Books Recommandations

this is all about the warren buffet favorites books, that help them to become 100 billion dollar man. Warren Buffett always, says, ” I love reading whatever Philip A. fisher wrote.” (Warren Buffett Books)

this type of sentence you also say, while reading their books, because, they are not magical books, they are Logical books.

If you want to read this book, you can buy this book by clicking this book image from the world-famous site Amazon.com

Some of the books show a cheap price, and those are real hard copies, that book is on this link, I hope you should buy this book only.

So this is all about the Warren Buffett books.