These notes are from a wonderful book called Benjamin Graham and the power of growth stocks.
Trading versus sitting on it
The advantage of investing in growth stocks is that if you invest at a fair price you can just sit on it and not do anything at all and see your money grow. On the other hand investing in value stocks means you have to sell them once they reach fair value and search for another. You need to keep trading. Both are good methods of investing. Value is cigar butt investing as Warren Buffet calls it- you get a puff free but only a puff. On the other hand, when you invest in growth stocks, you get at least a cigarette, and sometimes unlimited cigarettes.
The Graham formula
Intrinsic value= (8.5 + 2 x growth) x earnings per share x 4.4/y
where y= long term yield on corporate bonds
Do not downgrade P/E ratio by multiplying by 4.4/y unless long term interest rates are going to rise
- Current intrinsic value=(8.5 + 2 x growth) x earnings per share
- Long term growth rate capped at 20%
- Intrinsic value in 7 years time= Use growth rate of 7%= P/E of 22.5
Hurdle rate-12%. Minimum CAGR that you want to earn on your investment.
- Be mindful of the power of compound interest
- Identify companies with a sustainable competitive advantage
- Graham formula to set a value for the company
- Set a hurdle rate
- Build a margin of safety-know what you own, develop reasonable forecasts, set a reasonable hurdle rate
- Take advantage of Mr. market and don’t sell soon
- Follow the strategy to build a position in a company over time
- Invest for the long term
- Overcome outside influences