Lesson 14 – Is there one right way? Pragmatism vs. Dogmatism.
In the thirteen lessons prior to this, I have gone through the various aspects of stock analysis and investing. My aim has been to arm you with the tools of the trade.
This lesson talks about keeping an open mind and not being rigid.
Dogma is defined as
Something held as an established opinion; especially: a definite authoritative tenet
You will see some people talking of the virtues of value investing. Others swear by growth investing. What is one to do? Which path should you follow?
Over the next few years you will understand that there are multiple ways to grow your wealth in the stock market.
Let me give you a few examples.
Take an example of a value investing method. Benjamin Graham, widely accepted to be the father of value investing, proposed buying what were called “net-nets”. All the external liabilities of the company are to be deducted from the current assets. He would buy if the market capitalization was 2/3rd of the net current assets figure (after deducting external liabilities)
This was not the current assets that you see on the balance sheet. You reduced current assets further to come to a net current assets value.
Cash was taken at full value. Inventories were to be reduced to half their value assuming that you will not get the full amount if you liquidate them. Accounts receivable were to be reduced to 3/4th following a similar logic.
In Graham’s time, there were plenty stocks that satisfied this criteria. If you were to apply this in today’s markets it will be tough for you to find good opportunities for investing.
Similarly, growth investing styles caused many to lose badly in the dotcom boom of 1999-2000.
Growth investing vs. value investing
“Value investors” like to pick up stocks cheap. They tend to focus more on what they can see today. They will pay greater importance to past records. They will tend to give less importance to what might happen with the business in the future. They will preferably want juicy bargains.
This is not a bad thing.
You will typically try to invest with a margin of safety if you are a value investor.
Growth investors pay greater importance to, well, growth. They care about how fast the company can grow in size and profitability. They are alright if the company has weak free cash flows in the interim before they grow to a respectable size. You will remember from an earlier lesson that free cash flows are used to calculate value by DCF analysis.
Please read this article that I had posted at Capital Orbit some time back. It talks of the Keynesian Beauty Contest.
Do read it and come back.
You will accept that there are all types of investors in the market. Well, some are not even “investors” in the right sense because they don’t have a clue of anything beyond the stock price. Let us say “participants”.
If you accept that there are multiple participants with multiple views, different strategies of making money are bound to be successful. Not only one, as many would want you to believe.
Is value investing superior to growth investing?
I will be uncomfortable in saying that “value investing is the best strategy”. Or say that, “growth investing is superior”.
Each style of investing has its own time and place. Each style has made people money and can make you money if applied right.
What should you do as a beginner?
I will be sharing an action plan in the next lesson which is the final lesson in the Start Stock Investing E-Course.
But before that here is a definition of pragmatism,
A practical approach to problems and affairs.
I feel that these guiding principles will help you in your investing journey.
- It is my firm opinion that initially it is better for a beginner to invest with a margin of safety. Value investing is better for beginners.
- You might make a mistake in your study of the company or stock valuation. You might make a mistake in both these respectively. Value investing will ensure that you keep a buffer that should protect you to some extent.
- If you feel you are getting better at analyzing businesses, you can then be confident of understanding the growth potential of a sector or a company.
- Unless, you cannot do that, growth investing is not for you.
- Growth investing requires you pay for future growth today. Essentially, pay for something that no one can truly predict. Something that might not materialize.
- Growth investing has greater risk. If you want proof, read an article that I wrote about Infosys and how it left investors underwater for more than 6 years.
Keep learning. You cannot say you know it all.
As you get familiar with the stock market, it is instructive to look in the past and see which stocks have done well over time. More importantly, it helps to understand which stocks did not do well and why. This is the biggest learning.
Just because something has worked in the past, does not mean it will work again. Keep re-evaluating the market, the economy, the sector and the companies you invest in.
Be open to learn different investing styles. This is not to say that you should be a jack of all trades.
Be a specialist if you are good at it. But don’t say that your style is the best.
It might be the best for you. Everyone’s personality, capabilities, risk appetite and investing time horizons are different.
Some people become experts at analyzing companies which are in dire shape or close to bankruptcy. The possible rewards from such stocks are tremendous. Such situations are comparatively high-risk too.
Right now, this talk of different styles might be intimidating. Don’t worry. You will develop your own style in time.
Take small, safe steps initially.
Always be open to learn and tweak your investing methods to make them better at making you money.
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