• AUGUST 27, 2010

Money burns a hole in investors' pockets

Benjamin Graham was the founding father of the securities analysis (now commonly called equity research) profession. A remarkable thinker, author and teacher; his school of thought has survived for over 75 years. As time went along, the mainstream investment profession added more bells and whistles to its craft, but abandoned his approach, commonly called value investing. But there are those who continued to follow his wise ways. The most prominent among his followers being the legendary Warren Buffett. To this day, Buffett never fails to mention where he learnt his most important investment lessons from.

In this series of articles, we will put together some of Ben Graham's sparkling observations and how they apply to the investors here in India.

The biggest stumbling block is impatience

"We already see resurgent the age-old frailty of the investor-that his money burns a hole in his pocket."

Does this sound like an observation about Indian investors today? The stock markets have well and truly made a come back from their jaw-dropping crash in 2008. It now seems like a crime to wait for the right valuations for the stocks one likes. Who knows when the valuations will be attractive next, right? Who has the patience? This quote is actually from 1934. Just as the US markets were beginning to show signs of life, after the crash during the great depression.

Apparently, investors have difficulty in exercising patience no matter which year and which country. Yes, they need a certain degree of knowledge and technique. But it is patience that truly distinguishes the successful investor from the rest. And patience is such an uncommon trait.

It is amazing is how Ben Graham's observations often take into account the behavioral aspects of the investor. Mind you, this was long before the advent of behavioral finance, which has produced several Nobel laureates. Graham's behavioral insights are important since the investor is a human being, after all. There is no escaping the human factor. Especially when things involve money and the high drama of stock market gyrations.

Think long term, look at the essence

"We have striven throughout to guard the student against overemphasis upon the superficial and the temporary. Twenty years of varied experience in Wall Street have taught ... that this overemphasis is at once the delusion and the nemesis of the world of finance."

For example, suppose a company consistently posts a return on equity of 35% over the last 15 years. A qualitative study of the company also reveals that these returns are not artificial. They have a strong foundation in the competitive advantages it enjoys. Now imagine a barrage of bad macro economic news hits the company. Or it has a few bad quarterly results on the trot. What is relatively more important - the long term trend or the recent events? What if stock price falls to the point where it trades at single digit price-to-earnings on a trailing 12 months basis? We have seen investors shunning such stocks. Just when they should be actually betting on the long term trend to come through. The opposite is also true. Investors as a class tend to get excited about any positive indication in quarterly earnings.

What Ben Graham had learnt in twenty years, continues to be relevant today. An insight that is valid more for than 95 years! Investors as a whole tend to overreact to recent events much more than they should. Long term facts get buried in the overreaction.

We shall bring more insights from Ben Graham in subsequent articles. Till then, happy investing!

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