Sunday, January 13, 2008

Book reflections on "Everyman and His Common Stocks" - Laurence H.Sloan

Another review for another book, titled “Everyman and His Common Stocks –a study of long-term investment policy” by Laurence H.Sloan. This one is a classic 1931 edition which I’m reading. I love the classics of investment – it marvels me that the advice dispensed out 70 years ago is as applicable in the past as it is now. The typeface, the long poetic sentences and the very polite way of phrasing ideas all contributed to my pleasure of reading such classics.

Here’s what I think is important in this book:

1. The 5 most essential tools in which an investor needs is the following:

a. Accounting – this is the language of business, without which, the information that companies present to you will be lost. This is so important I think it’s like the alphabet to the English language.

b. Statistic – nicely described by the author as the chemistry of arithmetic. With statistic, we transform raw arithmetic data and change them into use forms to derive relationships and patterns, so that one can forecast within a reasonable limit.

c. Economic analysis – Basically to interpret general business facts (like interest rates change, steel oversupply, wheat crop dies…) and apply them to more specific circumstances

d. Forecast – forecast is different from prediction or prophesy. To buy a stock and hold, one must have forecasted it to appreciate in value. Forecasting, I think, might be valuation in more modern context. Forecasting draws on one’s knowledge of economic analysis and statistic.

e. Recurring sources of factual information, and esp of interim information – I think easily the most important point to neglect. Check that your forecast is right on track. There must be a constant process to revaluate your holdings so as to decide the 3 important questions – buy more, hold, sell.

2. The purpose of a long term investment plan is to take some risk so as to earn higher returns than that offered by life insurance, annuities, savings accounts and high grade bonds. It makes no sense to risk more yet earn less return than these supposedly safer instruments.

3. Credit is the blood of a bull run. Anything that diminishes credit will dampen or kill off the bull. It interests me to read that in 1930s, the FED is already using interest rate to control the widespread speculation. They said that 6% interest rate will kill ANY bull. Raising bank’s lending rate to each other, raising loan’s interest, rising bank’s reserve…I think these some of the things that can be played around. I think it’s as relevant in the past as it is now.

4. The author mentioned a combination of low PE and high yield as a sign of an attractive market to enter. The high yield will ensure that the investor will get some income while waiting for more substantial capital appreciation. I think this point had been mentioned in a lot of books that I read. Must be quite important.

5. The ideal and most valuable security is one that satisfies the following criteria:

a. It must give the investor the most income (definition of income: capital appreciation and dividend)

b. The income rises the fastest

c. The income had risen over the most substantial period of time

6. Ideal means it’s a model. Investor should always adjust their portfolio to hold stocks that closest resemble the ideal stock. If the stock do not satisfies the ideal stock, then there must be compensation for sacrificing that ideal. For example, holding a high growth stock with no dividends…the compensation is that the growth will one day translate into earnings, which will raise the intrinsic value of the stock. Price will therefore follow, allowing the investors who sacrificed the initial lack of dividend for a substantial gain in capital appreciation. If one is holding a non ideal stock with no compensation of the sacrifices made in holding it, a rational decision is to sell it. An ideal stock in the past might not be in the future too, so constant reevaluation and reforecast is necessary.

7. The author talks about a particular period where there is a bad crash. Before that, he showed the headlines of the period leading up to the crash. He’s trying to show that there is absolutely no direct signs that point that the market is crashing. However, to a thoughtful investor, the signs are there. While one cannot predict the exact peak or bottom of a market, one can definitely see a region where the market is topping or bottoming out. Here, the author mentioned about the news headlines are lagging behind the stock market by 4 months. That means that whatever good or bad news you hear in the media must be discounted to the present by 4 months, since it had already happened. E.g. GDP, employment figures…

In summary, I think this book provides a very good reading about the intricacies of the stock market. There is more inside, including a very interesting part about how the BBs in the past do bidding up, bidding down and ‘make market’ for stocks. The details are incredible, if you can look past old fashioned language.

Ok, next book: Security analysis. Concurrently reading "Investment Madness - how psychology affects your investing...and what to do about it" by John R.Nofsinger. I'm reading the latter book to understand why I did that stupid trade on Friday. Mistakes are such a valuable source of lesson to be learn from that it's such a waste not to capitalise fully on them.