Three Ways to Invest Using Gross Profits -2-

The second method is to buy stocks selling at a discount to their gross profits. That is another very difficult one to find. It does sound like the extreme cases Graham would have recommended. The one or two stocks I found that fit this method were really hated stocks.

The third method can be split into two parts, with the second being my favorite. This method focuses on Anticipated long-term gross profit. If the stock market can be valued in relation to GDP, then the stock performance can be linked to the growth in gross profits. This should intuitively mean that companies with long-term, above-average gross profit will outperform. An example of that could be Tencent in China, Yandex in Russia, or Boohoo in England. Simply, companies that have secular tailwinds that can last beyond five years.

The final methods requires its own post.


Three Ways to Invest Using Gross Profits

Picking up from the last post, I will talk about the three ways to use Gross Profit to make superior returns.

Note however, that you are looking to invest for the long-haul and must have the time period and liquidity to do so.

The sound reason for increasing the percentage in common stocks would be the appearance of ‘bargain price’ levels created in a protracted bear market. Conversely, sound procedure would call for reducing the common-stock component when in the judgment of the investor the market level has become dangerously high.” Benjamin Graham.

The way I do it is by putting 50% of my money in stocks when they are at all-time highs. The other 50% are left liquid. I’d then increase my stock holdings by 10% increments with every 10% fall in the index.

With that in mind, let’s discuss the three ways:

1) Investing in stocks who are at a low price to gross profit ratio compared to their historical average.

This is a very hard thing to find by the way in bull markets like this one. You basically get the Gross Profit of the last 10 years. After that, you get the price highs and lows for the following years. Once you have the data, you look for the lowest and highest ratio you had over that period and compare it to the current ratio. You want to invest when the ratio is at a new low or 20% above the 10-year low.

The results of this method, once you do them, are actually counter-intuitive. For example, Samsung (which has a PE less than 10 and is actually a buy if you apply the Graham number or formula) is still some way away from being a buy according to this level. If you really want to know, buying the SMSN ticker can only be triggered below $650.

Pfizer, which has a PE of 11, is more expensive than Facebook using this method (only the latter is a buy). And Netflix is cheaper than Apple (neither are a buy), even though the former’s P/E ratio is basically 7 times the latter.

We’ll continue in the next post.

The Tenants of Modern Value Investing

“The chart shows the market value of all publicly traded securities as a percentage of the country’s business–that is, as a percentage of GNP… it is probably the best single measure of where valuations stand at any given moment.” Warren Buffett.

There is an important insight in this very important article you can read here, which is that the stock market can not outpace the GDP forever.

However the point that is often overlooked, is that we look at the strength of an economy through the growth of its GDP. If valuation of a stock is linked to the country’s GDP, then the gross profit of a company and its growth is the most important measure of valuation. That is because GDP, in one of its definitions, is basically the sum of all gross profits.

The other important thing to note is that while the stock market cannot outgrow the GDP forever, individual companies (theoretically) can. That is because GDP growth is an average. A company can theoretically grow above the GDP growth average, so long as other companies are growing below that average.

There are a number of ways this finding can be interpreted when investing in the market. I’ll discuss them in the next post.

Why It’s impossible to Beat Buffett, and How to Do It.

“I don’t think you’re going to get the kind of results we got by just doing what we did,”  Charlie Munger

That is certainly true. Legendary Investors have all shared their “wisdom” in many books over the past decades, yet Munger (Warren Buffett’s sidekick) is right in saying that no one will get similar returns by doing the same thing.

The main reason is that those investors existed at a lucky time in history where interest rates went from all-time highs to all-lows, lifting stock prices and valuations along with them. The next several decades are likely to see an (at least) end to that process. This means that stock prices and valuations are not likely to increase at the same rate in the future.

However there is a way to do that, and I will share its tenets in the next post.

Note: I realize people prefer reading posts that have illustrations in them. That will happen after I get the first two posts out of the way.