One of the underpinnings of Benjamin Graham’s financial advice to investors is that, at a certain price, ninety-nine out of one hundred companies in existence become attractive at a certain price. This is true even for the companies that you identify as mediocre, simply because they could theoretically reach a price so low that you can’t help but do all right.
Take a company I would never want to own over the long-term: Best Buy. Under a Graham analysis, there is a point where the company gets so cheap that it would necessarily become a successful investment over the intervening years. Let’s stipulate that the investors in the marketplace somehow decide to value the shares at $10 each. That would knock the valuation down from the current $14 billion down to $3.5 billion. Meanwhile, the company is still pumping out $850 million in annual profits. It’s hard not to get rich when you buy a stock with a 24% earnings yield. Best Buy could simply pay out all of its profits as dividends, you’d have your investment returned to you within four years simply due to the cash extracted from the enterprise.
That’s an extreme example, but it’s how Graham’s analysis works: you size up every company, and calculate at what prices things would get so cheap that you could not help but make money. Very few stocks will be trading at those “gimme prices”, but when they are, you should seize the opportunity and buy.
Instead, though, I want to talk about the 1 in 100 (or whatever the rare odds may actually be) cases in which Benjamin Graham actually advocated that investors should refuse to even consider investing in the stock.
The first situation is when the company does not have accurate accounting. When Joseph Silveira killed himself after analyst Mark Roberts called the popcorn and kettle chip maker’s accounting policies into question, you’re not supposed to react: “Oh, shares are down 20%, therefore it’s a bargain and I should buy.” The logic is that if you can’t trust the numbers, then you can’t perform real analysis. The determination that a stock is cheap is based on understanding the relationship between a company’s profitability and the stock price you can acquire your ownership stake, and if you can’t trust the numbers on the profitability, then you can’t make an informed decision without that proper foundation.
Lawsuits, product recalls, shrouds of reputational risk, and so on, are reasons why investors should flock to a company in search of a “value” investment. But, according to Graham, you shouldn’t go run to a company that has accounting issues. That’s an opportunity best left unpursued.
The other issue, and the one that I think is most discarded right now because of the relative peace in the world, is that you should not invest in a country whose economic infrastructure and legal protections that you do not trust. For the most part, all of my investments are domiciled in the United States or Great Britain, and I’m open to going to Switzerland for Nestle at some point in time.
But I would have no desire to own stock in a company in which it is even a low likelihood possibility that we could go to war. During the Second World War, it was typical for certain communist/socialist countries to cancel the stock certificates of American investors and reissue the ownership at discounted rates to political patrons. Heck, China even called the stock certificates of some Chinese investors during the war, nationalizing the ownership stakes so that the government could run them.
During prolonged peace times, it is easy to get lulled into complacency against thinking that the world can change in an instant. The best protection, I believe, is to keep most of your wealth in American stocks, British stocks, and potentially, Swiss stocks. You don’t want to really on a potentially hostile government to enforce your legal ownership interests.
When Graham was giving speeches in New York after the World War, he cautioned against pursuing seemingly lucrative investments in war-torn Europe because he did not have faith that his ownership stake would be fully enforced.
The point isn’t to be paranoid, but rather, to recognize that peace-time can encourage investors into taking risks that they may not normally consider. Personally, I’m content to get exposure to China through blue-chip operations. Buy some Pepsi stock, and know that 10-15% of their profits come from Asian operations. That strikes me as the most sensible way to “globally invest.” That way, I’m participating in their growth, but if something adverse happens, I don’t get wiped out. If China shut its borders to Pepsi, I’d only take a 15% earnings hit and I’d still benefit from soda sales in the United States, Canada, Mexico, and so on. I’d rather calculate my risks into other countries through large multinational enterprises rather than invest abroad in Chinese domiciled corporations outright, but that’s just me.