Growth vs Value Investing

How to Build a Stock Portfolio that Finally Gets Results

1. There are many different ways you could approach investing. In my limited knowledge though, you simply won’t find a better investing framework than Ben Graham’s.

2. You will find Peter Lynch’s investment framework highly accessible. If you are just beginning, you could start your journey with his book One Up on Wall Street. He explains the qualitative part very well. Sadly, the quantitative part is sketchy.

3. You will be surprised to know that the Discounted Cash Flow is actually a qualitative method in Grahamian terms. Why? Because, at the heart of DCF is trend or future growth, which is essentially a qualitative factor expressed quantitatively.

4. My friend Taha Merchant is right. Buying Hero Honda at 18x to 20x earnings is speculation. Though he should call it ‘intelligent speculation’ :-).

5. You’ll have to add to the picture to get Ben Graham’s complete framework. The missing component is the analysis of ‘Margin of Safety’. That further splits into market price (its factors) and intrinsic value (its factors).

6 thoughts on “How to Build a Stock Portfolio that Finally Gets Results”

  1. Great chart you have there I must say!

    The 18x – 20x earnings that you’ve mentioned, the context of that 20x is also quite important. And when we spoke about Hero last year, I was referring to FY11 earnings as the base for that multiple, wherein it had an ROE of 60% or so in that year. That’s important because, at the same absolute price for the stock, the P/E multiple would become 34x-35x in a year when the company earns say a 35% ROE (which was also roughly the ROE earned by the company in FY08 and FY09). So that’s mighty important I think.

    In other words, Hero selling at a trailing-twelve-month multiple of 20x post FY08 (I think it was actually selling for much lower at the time) is quite different from Hero selling at a 20x multiple post FY11.

  2. Quite good. It is like peeling the banana and giving it to a kid.
    But i would like you to write sometime about how is margin of safety computed. I have almost come close to understanding it and lost the thread 😉

  3. Taha, the conceptual leap for me was this – beyond a certain valuation (measured strictly in terms of a historical trackrecord), it is speculation (intelligent or unintelligent) in the Grahamian sense.

    Growth/highly quality at a fair price would make it intelligent speculation. Growth/highly quality at an excessive price would make it unintelligent speculation. I think that’s the point you are making.

    But once we bring growth into picture – should we still obsess about historical or trailing-12-months earnings? There is room for debate here, given how growth – if it materialises – can make a mockery of historical earnings-multiples. The Dividend Discount Model makes this very clear. Also, think of how growth impacted Page Industries. So, in such cases, it’s much better to focus on how sure you are about your assessment of growth prospects. In other words, how sure you are about sustainable ROE being closer to 35% than 60%. There could be a difference in opinion here.

    Unlike earlier, however, I would admit it is “speculation” and not “analyst’s investment” in the Grahamian sense.

  4. Praveen, I didn’t quite get the reference to bananas :-). But sure thing, I’ll write on the calculation of Margin of Safety. I’m right in the middle of my revision of Ben Graham’s Security Analysis. So, hopefully that should be soon.

  5. Banana reference is a telugu saying. I tried to convert it into english ;).
    Will look forward for your entry on margin of safety.

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