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The Intelligent Investor Chapter 3

The Intelligent Investor Chapter 3

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Published by Michael Pullman

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Published by: Michael Pullman on Jan 27, 2011
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TheIntelligentInvestorChapter3:ACenturyofStock-MarketHistory:TheLevelofStockPricesinEarly1972
 
Theintelligentinvestorshouldhaveasolidunderstandingofstock-markethistory
 
Pricelevelsandtheirrelationshiptoearningsanddividendspaidareofparamountimportance
 
Thisbackgroundinformationgivestheinvestortheabilitytogaugetheattractivenessofthecurrentmarketlevel
 
AchartisdisplayedoftheDowJonesIndustrialAverageandtheS&P500from1871through1972
 
Inonlytwooftheninedecadesshowndidcorporateearningsdecrease
 
Therewerenodecadeswhereaveragedividendyieldsdecreased
 
Growthratesvariedsignificantlyinmanyofthedecadesstudied
 
Valuationlevelsanddividendyieldalsofluctuatedwildly
 
TheS&Ptradedat6.3timesearningsin1949androseto22.9timesearningsin1961
 
Dividendyieldwas7%in1949and3%in1961
 
Grahamultimatelyconcludedthatthemarketwasexpensivein1972fortworeasons
 
Thepricetoearningsratioof18.0washighbyhistoricalstandards
 
Theyieldavailableoncommonstockswaslessthanhalfoftheavailableyieldonhighqualitybonds
 
Basedonhisconclusionthatthemarketwasovervaluedherecommendedthefollowingcourseofaction
 
Noborrowingtobuyorholdsecurities
 
Noincreaseintheproportionoffundsheldincommonstocks
 
Areductionincommonstockholdingswhereneededtobringitdowntoamaximumof50%ofthetotalportfolio
 
CommentaryonChapter3
 
“You’vegottobecarefulifyoudon’tknowwhereyourgoing,‘causeyoumightnotgetthere.”–YogiBerra
 
Graham’swarningsofdangerousvaluationlevelsin1972provedtopropheticasthemarketdeclined37%duringthebearmarketof1973-1974
 
Hebelievedthattheintelligentinvestormustneverforecastthefuturebyextrapolatingthepast 
 
Duringthebullmarketofthe1990’smanyoftheselessonswerecompletelyforgotten
§
 
Forecastersarguedthatbecausestockshadreturned7%onaveragesince1802thatinvestorsshouldexpectthatreturnregardlessofwhatleveltheypurchasedcommonstocks
§
 
Someclaimedthatstocks“always”beatbondsovera30yearperiodandasaresultcouldbeboughtwithoutpayingattentiontovaluationsaslongastheinvestorplannedtoholdforever
 
Themarketcrashintheearly2000’sprovedthatvaluationlevelsalwaysmatterandshouldnotbeignored
 
Theproblemwithextrapolatingpastmarketreturnsisthatitincludesaninherent“survivorshipbias”
§
 
Thismeansthatmanypastcompanieswentbustandarenotaccountedforwhenanalyzinghistoricalmarketreturns
§
 
Thisleavesanalystswithahandfullofexceptionalcompaniesthathavesurvivedtouseasdatapoints
§
 
ForeveryCocaColatherearetwentycompaniesfrompreviouserasthatarenolongerinexistence

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