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The 'Father of Value Investing' has a Warning for You. It is More Important Now Than Ever

Nov 6, 2017

Rahul Shah, Editor, Smart Contrarian

Benjamin Graham once said buy stocks as if you are buying groceries and not perfume.

If the father of value investing scoured the Indian stock markets, he would see that its shelves are lined with perfumes these days. There's barely a grocery item in sight that's cheap and value for money.

Last week The Economic Times also noted that...

  • India has now become the world's most expensive market based on price-to-earnings ratio. The Sensex's P/E ratio on a trailing basis is 24.53 times compared with 19.67 for the Dow Jones, 23.32 for the UK and 17.04 times for the Shanghai composite.

The market is even overvalued compared to its own valuation history. Every time the Sensex crossed the 22x PE mark, the returns over the subsequent one to two years have been dull, even downright disastrous at times.

An expensive market, like the current one, is a value investor's worst nightmare.

The rational, value conscious part of you wants to stay away from stocks while the greedy, impulsive self is furiously pulling you towards them.

Managing this conflict might have been easy for someone like Warren Buffett. He doesn't mind sitting on billions of dollars of cash in the absence of good buying opportunities.

But it can be extremely hard for the average investor.

We often struggle against our base emotions, end up giving in to greed and come to rue it later.

Benjamin Graham puts it best.

  • Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.

So, how do you, the average, only-human, investor, overcome this seemingly insurmountable challenge?

The way I see it, you can protect yourself by doing the same thing holiday resorts do with their swimming pools.

Most pools today keep their maximum depth less than the height of the average Indian. This way, even if someone tries something adventurous, the possibility of drowning is low. They offer the fun of a pool, while also protecting their swimmers.

Don't Slip Through the Market's Cracks - You Could Break Your Bank

My strategy in the Microcap Millionaires service follows a similar plan. Instead of leaving you vulnerable to drowning in your emotional, impulsive decisions, we plan ahead for markets that turn too expensive.

If this happens, and value opportunities become rare, the strategy requires you to move as much as 70%-75% into bonds, leaving only 25% into equities.

It's a simple, completely effective tool.

When markets are cheap, you put as much as 75% in stocks. 25% in bonds.

When they turn expensive, only 25% in stocks and the rest in bonds.

No matter the markets, and even if you end up with a few loser stocks, the damage to the overall portfolio is minimal. The other 75% is safe and actually earning a small return - no matter what.

The strategy works like magic. It is beating the Sensex by two and a half times since inception, having returned 169% point to point vs 64% returns earned by the Sensex.

Stick to this simple effective strategy with a little bit of discipline and you can eliminate the chief source of losses, while unlocking the door to market beating returns.

Good investing,


Rahul Shah (Research Analyst)
Editor, Smart Contrarian

Editor's Note: If you thought mixing value investing and trading would be like mixing oil and water, this system will show you how it is, in fact, simply like stirring sugar into your tea. Find out how by clicking here.

Brain Food for the Day

Where Does Warren Buffett Get All His Cash

Warren Buffett's genius, of course, lies in his efficient use of capital. There aren't many with the same eye as Buffett for picking wonderful businesses.

But the Oracle of Omaha has another ace up his sleeve that not many people know about. Usually, when you borrow capital from someone, you need to pay an interest on it. The cost of borrowing capital, if you will.

What Buffett does, though, is something extremely smart. He has an insurance operation which gets billions of dollars' worth of premium every year.

So, that's money he can use, free of cost until the time it is paid out as claims. And these are revolving funds mind you. As claims are paid out, new premiums come in.

As a result, Buffett always has a good amount of capital at his disposal that costs virtually nothing. Which is why a crashing market is a boon for people like Buffett as they can then put the huge cash pile to work.

This is not a luxury usually available to fund managers who actually face large scale redemptions, thus forcing them to sell stocks at a time when they should be buying.

Editor's Note: How about a little soul food today as well. You read our newsletters to learn, to grow, to live better lives. But how about, you do your bit to make the world a better place. If you have 30 seconds to spare today, you can make our country a better place. A place where all people are treated equally. Where money doesn't flow from the corrupt to the corrupt. All you have to do is sign on the dotted line.

PS: This petition is only open until the 8th. So if you support it, this is your chance to show it. Click here now.

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1 Responses to "The 'Father of Value Investing' has a Warning for You. It is More Important Now Than Ever"

Anil Desai

Nov 15, 2017

Very good research work.

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Equitymaster requests your view! Post a comment on "The 'Father of Value Investing' has a Warning for You. It is More Important Now Than Ever". Click here!