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Three principles to beat the market, even in the worst economic conditions

by , 06 May 2016

From 1929 to 1939, the deepest and longest-lasting economic downturn in the history demolished the Western world. This was a period of rampant speculation which led to a market crash of epic proportions - known as The Great Depression.

In just three days, the Dow Jones sank from 400 to 145 wiping over $5 billion worth of market cap.

During this volatile period, one of the greatest investment legends, Benjamin Graham saw his company's holdings lose 70% of its value.
But from this experience, Benjamin Graham developed a new investment strategy to find undervalued investments.

He changed 3 key things in his investment strategy. And by applying these three basic investment guidelines, he guided his firm to a 20% return, every year for the next 20 years.
Today, I’m going to explain what these three principles are and how you can use them below…

The answer lies in these three principles

Value Investor Principle #1: Volatility always shaking the markets, but you can profit from it

Volatility is a no-brainer when it comes to investing in stocks. Share prices react vigorously to any significant changes in current earnings, short-term earnings prospects and economic conditions.

Volatile markets never worried Benjamin Graham. In fact, it actually presented him with great buying opportunities. This is best explained with the General Motors volatile share price movements.

·         From 1925 to 1929, GMs shares rose from $13 to $92 (a 607% increase).

·         In 1932, GMs shares crashed to $7.50, bounced back to $77 two years later, and then relapsed to $25.50 in 1938 (over 700% increase).

·         By 1946, GM was trading at around $80, but in the same year fell to $48 (a loss of 40%).

Each drop of GM’s share price presented an opportunity to buy the group below what it’s really worth.

Key takeaway: Benjamin Graham encourages you to view downturns as great buying opportunities and not let the market’s views dictate buy and sell decisions.

Value Investor Principle #2: The greater the margin of safety, the less risky the investment

Probably the most important principle of Benjamin Graham’s market-beating investment strategy is, investing with a margin of safety.
Simply, a margin of safety is the difference between the real value of the stock and the price at which the stock is trading at. By investing with a margin of safety, the aim is to pay less than the real value - that simple. 

That’s why, Benjamin Graham applied a ratio to determine a company’s real value. He called this calculation the Net Asset Value (NAV) or book value and it’s what he believed was the secret to picking good value stocks.

In fact in January, I applied Benjamin Graham’s famous NAV indicator to unearth a stock that’s trading at a massive discount for my Unconventional Millionaire Stock of the Month members.

I looked at the company’s share price of R22 compared to its NAV of R40.29. This meant, the stock was trading at a 67% discount. I analysed the company and made sure that it also was a great long-term share. So I couldn’t resist not tipping such a solid company that’s trading at a massive discount to my Stock of the Month members.

Key Takeaway: The greater the margin, the more freedom you have for any negative impacts or unforeseen events before you start losing money.

Value Investor Principle #3: Never forget you’re an owner of the business

According to Benjamin Graham, stocks aren’t just quotations on a computer screen. Rather, they represent ownership in the businesses. That’s why before Benjamin Graham buys a company, he makes sure he thoroughly analyses the underlying business and its prospects. And he encourages investors to do the same.

Graham also urges investors to never forget that they’re owners of a business and not owners of a quotation on the stock market.  So it’s crucial that you understand, when investing in a company, you’re trusting your hard-earned cash with its management.

The problem with this, management can easily fail to act in the best interest of its shareholders.  To find this out, you can look at these two red flags:

·         Management fails to pay dividends both with earnings and with the value of the shareholder’s equity

·         Management fails to use shareholders money in a profitable manner

As a last key takeaway, Benjamin Graham urges you to know what kind of investor you are. Being able to understand yourself will go a long way in making the right investment decisions.

Three principles to beat the market, even in the worst economic conditions
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