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10 Rules of the Intelligent Investor Nov-05 Edition

Keep it simple.
1. Invest 6. Don't take risks in bonds, it's not worth it
2. Only do what you understand 7. Only buy good companies
3. Know yourself, your needs, and how much 8. Buy at the right price
risk you can stomach 9. Carpe diem
4. Emotions make for bad advice 10. Trust no one but your own judgment
5. Costs can turn success into failure

Study your investment choices carefully.


1. Invest buying, you are missing your chance.
Keeping your money as cash makes you poorer – to It's hard to go against the trend – besides, that alone does
compensate for inflation alone you need at least some short not guarantee success. But, it does prevent you from losing
term investment: savings account, fixed deposit, call your money in turbulent times, and it allows you to buy
money, money market funds. In the long run, bonds are stocks at the right price.
better, and stocks are best. 5. Costs can turn success into failure
The 1997 value (inflation adjusted) of one 1802 dollar if it Beware of the costs! Costs can devaluate your property and
had been invested in the U.S. in the following (ignoring you may not even notice it. It helps to plan and to calculate
taxes and all costs): The difference to see things clearly.
Cash $ 0.07 (-1.35% p.a.) between 3.5 % and 7%
may not seem so big at ”Many institutions such as banks and insurance
Gold $ 0.84 (-0.09% p.a.) first, but it makes up for
companies try their best to hide their costs: comparing
Bonds $ 803 (3.5% p.a.) a fortune in the long and bargaining will pay off here. Compare costs over
Stocks $ 558,945 (7% p.a.) ! 10 years and you'll soon see the differences (tools for
p.a. = per annum (Data:Siegel 1998) this can be found at www.sec.gov).
2. Only do what you understand ”Calculate the cost of tax and inflation on your fixed
deposit account. Higher yield investments will carry
You must know what you are doing if you want to succeed.
even higher costs for information, transactions and
To properly deal with a topic you must know something
deposit.
about it. Now, we all can't know everything – therefore we
must keep with the things we do understand. ”Lower your cost: plan your taxes, avoid high
inflation countries, lower costs of deposit, (fund)
At the least you should learn the basics or you may pay for
management and transactions.
it sooner or later. Investment then becomes a form of
gambling. You should be able to judge the risks and 6. Don't take risks in bonds, it's not worth it
rewards of an investment before you put your money in the Fixed value investments (limited return) are not worth
line. taking risks for. Your maximum profit is limited in advance.
So, set yourself some boundaries: countries, currencies, Your whole analysis should focus on security (see Graham
investment types - and study your choices well. & Dodd 1934):
3. Know yourself, your needs, and how much risk ”What counts is the ability of the creditor to pay your
you can stomach money back with interest, and not your collateral or
other rights.
There are no "good" investments – just investments that suit
your needs. Some people plan for retirement, some need to ”Consider the worst case scenario for the creditor.
make money quick – and there are trade-offs. ”High yield does not compensate for high risk
Investing is a personal affair. Ask yourself: When will I ”Criteria of exclusion and quantitative tests for fixed
need money and how much of it? Can I stomach, and can I interest investments:
afford, to ride out emotionally trying times (bear markets)? ¾ countries: market economy, rule of law.
What unforeseen events may occur? What's my "Plan B"?
¾ only large firms, sector not restructuring,
Some hints: cyclical or unpredictable
”One year time horizon: savings account, fixed ¾ profits = 3 times interest payments or more
deposit, call money, money market funds.
¾ market value of stocks > market value of bonds
”Three to ten year time horizon: bonds.
¾ sufficient cash; current assets vs. current
”Set the interest payment and redemption dates of liabilities in reasonable balance
your bonds to suit your needs (same for dividends).
¾ Owner's equity must be at least 40% of assets
”> ten year time horizon: stocks. (exception banks, insurances)
4. Emotions make for bad advice
Emotions are the enemy: you'll run with the pigs to the 7. Only buy good companies
slaughter. If you're buying when they're all buying, you'll
be buying at a premium. If you don't buy because nobody's A company is a good company if there is a high probability
that it needs little capital, that it generates a high amount of The ROE is the only purpose of the owner: The ROE is the
free cash and if this benefits the shareholders in some way interest yield he gets of his equity.
(Company Analysis). 8. Buy at the right price
The basics The value of your investment has to exceed its price. The
price is given by the stock market, the value has to be
”The Management must be trustworthy in allocating
determined by … you! (Stocks At The Right Price)
assets and in accounting .
Bonds give you safety and you can easily calculate your
”The area of operation, the company itself and its
return. Stocks may yield more but your expected return is
accounting must be easily understood.
harder to evaluate. Therefore, your expected return from
”The return on owner's equity (asset turn and profit stocks must exceed your return from bonds.
margin) must be sufficiently high.
Price-earnings ratio of a stock (PE = price / earnings; the
”The capital structure, especially owner's equity, inverse is the earnings yield EY) :
must be adequate.
”A PE of about 10 or lower is best, 16 is the upper
”The market position must be excellent. limit (a PE of 16 would mean an EY of 6.25 %).
”Revenues and profit must grow. ”A stock's PE should beat the PE of a first rate bond
”The track record must be consistent. by 50 % at least.
Calculate the PEs as an average over the past 5-7 years.
The analysis You may include future expectations in a meaningful way.
Get an overview: Evaluate the properties and potential of Advantages of using PE ratios: simple and easy to use,
the company, the sector, and the position of the company accessible historical data.
within it:
Drawbacks: sensitive to creative accounting (write-offs,
¾ The business environment of the company (sector): hidden stock options). If zero or negative earnings (losses)
products (commodities or franchises), margins, capital are made, the PE becomes useless.
requirements, regulatory environment, risks, expansion,
cyclidity, stability. Other, important numbers: revenues / price, EBITDA /
price, EBIT / price, various cash flows / price, tangible
¾ The company itself: Specific market position, assets / price, liquidation value / price.
business model, communication, competitive
advantages, products / services (commodities or Other methods: discounted cash flow.
franchises), development stage, risks and dependencies, 9. Carpe diem (seize your chance)
capitalization, accounting, acquisitions, dividends. In good times, prices are high. In bad times, the trust is
Next, income statement and balance sheet analysis (and gone. If you never invest because the time is not right, you
don't forget the cash flow statement either): won't get anywhere. Every situation, political, economical,
social, has its risks – and opportunities!
Revenue
EBITDA (Earnings Before Interest, Tax, Depreciation and 10. Trust no one but your own judgment
Amortization), EBITDA margin (EBITDA / revenue) Think by yourself. Otherwise you depend on other people's
EBIT, EBIT margin (EBIT / revenue) agendas. You need your own frame of reference. Don't just
Profit margin (profit / revenue) trust somebody's assessments. Take a look backstage
yourself. Believing your sources means legitimizing them.
Equity vs. liabilities (or assets)
You need to know enough to decide who is knowledgeable!
Current ratio (current assets / current liabilities)
Literature
ROTA (Return Of Total Assets):
Graham Benjamin (1973): The Intelligent Investor, Harper
Profits / assets = (revenues / assets) x (profits / revenues)
Business | Graham Benjamin & Dodd David (1934):
Asset turn (revenues / assets) Security Analysis, McGraw-Hill | Siegel Jeremy J. (1998):
ROE (Return On Equity): Stocks for the Long Run, McGraw-Hill | Vause Bob (1999):
profit / equity = (profit / assets) / (assets / equity) Guide to Analysing Companies, The Economist Books |
The Cash Flow Statement shows actual money transfers Standard & Poor’s annual guides, McGraw-Hill.
during a period of time. No capitalization, depreciation or
amortization are involved. Cash Flow is much less sensitive
to creative accounting and should be a strong factor in your
analysis.

Related Karner Consult Pte Ltd Fact Sheets Internet (external links)
Company Analysis http://www.berkshirehathaway.com/
Companies Table http://www.sec.gov/
Bonds For Investment http://www.edgar-online.com/
Stocks At The Right Price http://www.standardandpoors.com/

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