I have read Intelligent Investor by Benjamin Graham. One more thing (other than my earlier Q about selling), I am not so clear about is what kind of diversification in the equity part of your portfolio does BG recommed? I got mixed messages.in the book. At one place, I felt that he didn't recommend too much diversification - i.e hold a max of 5-6 stocks only in your portfolio. At other places he seemed to recommend 20 odd stocks. Another confusing thing is that I seem to lose track of what was BG's recommendation & what was Jason Zweig's? (the chap who wrote the notes at the end of each chapter)
Does someone have an answer?
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On Mar 1, 3:34 pm, "BGFan" wrote: ...> One more thing (other than my earlier Q about selling),
Decent question - BG's focus is on analysis of companies. I prefer the
1964 edition "Security Analysis" over the later revision "The Intelligent Investor." On page 55 of my preferred he points to the high safety of T-Bills (and consequently little need for diversification) as opposed to lower safety and thus a "prudent" requirement consistent with margin of safety. He also makes the point that highly reliable information reduces the need for diversification, and that many fortunes have been concentrated in the stock of only one company. The entire chapter 4 "Investment and Speculation" speaks to the limitations of analysis, the advisability of analysis, and the assurances of safety pursuant thereunto. :-)
Your ballpark numbers of 5 to 20 stocks sounds familiar, and generally practical, since one is subject to work limitations in trying to keep track of more than 20 or 30 companies with any degree of accuracy. I'll look through my 1973 4th revised edition of "TII" and see if I can find anything else. Btw, I didn't see any notes by Jason Zweig - I thought it was Marty Zweig who is well-known as a writer on Wall Street in any event. Which edition do you have?
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In _Security Analysis_, the textbook that Graham wrote with David Dodd, diversification is seemingly given somewhat short shrift. The book even seems to derisively imply that diversification has come to replace quality as the dominant factor in security selection.
However, Graham's popular investing book, _The Intelligent Investor_, emphasizes diversification for the individual. Graham explicitly recommends that the defensive investor hold between 10 and 30 stocks in the equity portion of the investor's portfolio. However, he later mentions that an investor should have at least 20 stocks to achieve a portfolio margin of safety.
Interestingly, Graham implies that the enterprising investor should have at least 100 stocks to be widely diversified, unless that investor is the rare bird who can dependably pick winning issues, like Warren Buffett. However, Buffett describes a 100+ stock portfolio as "diversified enormously" in his appendix to Jason Zweig's revision of the Fourth Edition of _The Intelligent Investor_, and eschews diversification in general.
-Will
william dot trice at ngc dot com
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He recommends diversifying among different business sectors.
He's not explicit on the number of equities because that entails estimating the risk for each equity. If one invests in large firms, the need for diversification is lower, but probably limiting the investment in each equity to 10% will reduce the effect of an Enron type of investment.
I have 32 different equities distributed among the tech, energy, health, industrial goods(primarily residential construction), and basic materials sectors. My largest investment in a equity is 12% of my portfolio.
-- Ron
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Graham actually does not recommend this in _The Intelligent Investor_, although Jason Zweig discusses diversification across sectors in his commentary.
I think you're conflating diversification with asset allocation. Graham does not suggest the need for estimating risk in any sort of quantitative way in either _Security Analysis_ or _The Intelligent Investor_. But he does give some explicit numbers of equities that should be held, although he does not really justify the numbers.
-Will
william dot trice at ngc dot com
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Twain apparently said, and Buffett apparently quoted him in saying it this way:
Behold the fool saith, "Put not all thine eggs in the one basket"--which is but a manner of saying, "scatter your money and your attention," but the wise man saith, "Put all your eggs in the one basket and WATCH THAT BASKET."
Buffett also said "Diversification is protection against ignorance."
I'm not sure it was meant all that derisively, though. He's also made it clear that those who don't have the time or energy or ability (and he considers his stock picking/managing ability to be a gift just like athletic ability) - he's made it clear that most folks would do a lot better just buying an index than messing around. (several of his letters to investors, as well as in a speech he gave last year at the Berky annual meeting - google for "Buffett Index Funds")
"Will Trice" wrote (Hopefully I did not snip too much.)
Not to split hairs over wording, I hope, but I would not say this. Graham gives several basic, numerical parameters that he advises an investor (defensive category) to apply to reduce his/her risk in investing. E.g.
P/E But he does give some explicit numbers of equities that
I think maybe a distinction should be made between "does not really justify" and "is circumspect due to the nature of the science of economics."
Just the usual one-and-one-half cents.
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Hi, guys. I picked some well-known names out of the brim of my hat, and checked charts back to 1982 in sequence: Becton Dickinson, ADP, McDonalds, Kimberly Clark, General Mills, Exxon, Sigma Aldrich, Emerson Electric, United Technologies, and Wells Fargo. (Symbols for BigCharts.com : BDX, ADP, MCD, KMB, GIS, SIAL, EMR, UTX, WFC .. let's add JNJ to make a round 10.) All are big companies. I did not own them. Anyone who did probably doesn't care about average annualized appreciation. "You did good," as Newt Gingrich might say. I have purchased my indiscernible stake in all but BDX over the past two years.
When Enron was "hot" I took a look at their 10k to see what all the surge upwards was about. It took me five minutes to conclude it was not suitable for Granny's portfolio, but the real kicker was the phrase "non-cash earnings." All I looked at was in management's discussion of the business, and I didn't even glance at the numbers. After the debacle, two separate CPA's were squeezed into two thirty second spots on CNBC, and both said what I just said (one guy took 15 minutes on Enron's 10k).
One simply must look at the 10k's (press releases often spin things very badly). What characterized the market from 1982 to 2000 is still puzzling me. I'm close to settling on "productivity increases" as the key to the economic expansion. I wonder if the next couple of decades will not require a bit more selectivity, and perhaps a lowering of expectations. But if one should stumble upon a first-class company with beautiful earnings and bright business prospects (a growing market for its products and services) what is to prevent one from pulling some cash out of an index fund, and holding one company's stock? Or two, or three?
My thought is still that Graham emphasized selectivity - even in diversification.
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says: MR. GRAHAM: Yes, the approach is not based on the character of the operation, but only on the mathematical odds which you have been able to determine to your own satisfaction. It doesn't make any difference what you are buying, whether a bond or a stock or in what field, if you are reasonably well satisfied that the odds are in your favor. They are all of equal attractiveness, and they all belong equally in your diversification. You make a further sound point, and that is that you are not really diversifying if you went into ten Electric Bond and Share situations -- all substantially the same. You would not really be diversifying, because that is practically the same thing as buying ten shares of Electric Bond and Share instead of buying one share of each; since the same factors would apply to all of them. That point is well taken. For real diversification; you must be sure that the factors that make for success or failure differ in one case from another.
-- Ron
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Sorry, I didn't mean to imply that Buffett was derisive about diversification, I was referring to _Security Analysis_. In fact, in his appendix to _The Intelligent Investor_, Buffett lauds the investment records of some of those he describes as "diversified enormously."
-Will
william dot trice at ngc dot com
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I can see your point at least in the sense that Graham might have considered a high P/E stock to be more risky that a low P/E stock (although I would not call P/E a risk measure, I would call it a valuation measure - related, but not the same). But in my reading of his two most popular books, I have not seen any mention of using P/E (or some combination of quantitative values) to determine the relative risk of each holding and thus determine if you need to diversify further as Ron suggested.
-Will
william dot trice at ngc dot com
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"Will Trice" wrote snip as usual for conciseness and hopefully not losing meaning
I believe I can appreciate how you do not call P/E a risk measure. But it seems to me Graham most assuredly does consider it so. That is, roughly, I think Graham is saying High P/E = poor bargain = poor chance for increasing further, relative to lower P/E stocks. Apply a number of crude gages together (like low P/E; dividends for the last
20 years; current ratio over 2; etc.), and one can lower the risk further. Or at least backtesting indicates thusly.
Perhaps it is a mere semantical difference between us.
that one might surmise Graham is acutely aware of how imprecise estimating risk is, at least in the context you suggest here with individual stocks. Graham is circumspect. He does not speak as though it's all black and white. That's TV loudmouth stock "analyst" Jim Cramer's job, anyway.
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In simplest terms, Graham is predicated on financial analysis. Portfolio management theory is predicated on the failure of financial analysis.
The latter's quantitative explorations can be applied to determine the probability of the presence of a spaceship in your soup, but are not applied to the financial analysis of a company. The former's quantitative explorations can be applied to the financial analysis of a company, and recommend you use a spoon to look for the spaceship.
Graham acknowledges that it is virtually impossible to consider all factors affecting a company, down to the finger that may make its way into a bowl of chili, thus the prudence of diversification in the face of unknowns. That could be viewed as Graham's concession to the concept of "risk" that cannot be analyzed out of the picture. He makes it clear that some situations are more certain than others.
So, I think there may be some mixing of definitions of one word. It is also important to keep in mind the first edition of "Security Analysis" - 1934. As far as I know, that was decades ahead of any portfolio management theory - Markowitz hit the scene in the early
1950's..
Financial analysis and portfolio management theory are two fields with only the thinnest of intersections. Entire portfolio management theory textbooks have but one purpose - to "define" "risk." As one text put it, financial analysis is in another building, we don't talk to each other, don't have lunch together, and though we are required to accept their universe of admissible companies, we're completely unbiased towards it. And that's all that text had to say about financial analysis!
Texts about "Wealth Management" (Evensky, H.R., ISBN 0-7863-0478-2.) discuss "risk-related" issues very differently. This isn't the place to write one-paragraph book reviews, but I noticed a quote (op. cit.):
"Security is mostly a superstition, it doesn't exist in nature." (Hellen Keller.)
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