Intelligent Investor Part 4
👉 Every Sunday I publish excerpts from Benjamin Graham’s book “The Wise Investor.”
After reading the first edition of The Intelligent Investor in 1950, young American entrepreneur Warren Buffett considered this work by Benjamin Graham to be the best that has ever been written about investment. Years later, having become one of the largest investors in the world with a fortune of $ 66 billion, Buffett has not changed his mind.
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What problems do active investors face?
Active investors differ from passive investors in that they want higher returns. However, it happens very often that promising, naturally gifted and educated investors come to Wall Street and lose money because they misuse their merits.
An active investor should make sure that his actions will not lead to results that are opposite to those expected. And therefore, it is important that an aggressive investor understands which actions can lead to success, and which – the other way around. To do this, it is worth considering several strategies, adhering to which active investors and speculators, in most cases, try to surpass the average market profit.
- 👉 Follow the market.
This method consists of buying stocks when the market rises and selling when it falls. As an investment, it is advisable to choose stocks that “behave” better than the stock market. However, this method raises a number of doubts from both theoretical and practical points of view.
- 👉 Selection of stocks based on current performance.
By adhering to this method, investors buy stocks of companies that show positive results in their reports, for example, growth in profits. The companies ‘indicators are available to all market participants and the expected indicators of the next year are taken into account by all investors who also predicted the growth of the companies’ shares. That is, an investor who chooses stocks based primarily on strong financial performance is likely to find that many other investors do the same. When choosing the most attractive stocks, an investor faces two problems: firstly, it is human to make mistakes, and secondly, the market behaves unpredictably. People often make mistakes in their predictions, but even if they come true, the current stock price already reflects the investor’s expectations.
- 👉 Selection of stocks with an eye to the future.
According to this method, investors choose stocks of companies that have shown high profit indicators in the past, while they expect the same positive indicators in the future, that is, they shift the positive dynamics in the past to the future. In some cases, investors choose stocks of promising companies, but unremarkable ones, mainly companies in high-tech industries. However, a problem arises that the probability of a gross forecast error in this method is higher than in the method of stock selection based on current indicators. In view of the fact that financial analysts often make mistakes in their forecasts, theoretically an investor can win by making, in contrast to them, a correct forecast, but how many investors can beat professional market participants in predicting stock returns?
In theory, there is such a strategy for an active investor, in which he will make a profit higher than the market average. Practical arguments can also be made in favor of confirming this hypothesis: the stock market as a whole and the price of individual stocks can be subject to strong fluctuations, and at any given time there are stocks on the market whose value rises or falls, individual stocks can be underestimated due to the lack of interest or prejudice towards them, that is, there are discrepancies between the current price and the fundamental value of the stock. However, buying undervalued stocks in the hope of making a profit from their growth requires patience and experience on the part of the investor.
Ⓜ️ To be continued…