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The Defensive Investor vs. The Enterprising Investor

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  Benjamin Graham’s The Intelligent Investor is a foundational text on value investing, emphasizing the importance of rational decision-making, long-term thinking, and risk management in building wealth through the stock and bond market s . Benjamin Graham’s disti nguishes between the D efensive I nvestor and the E nte rprising I nvestor . The D efensive I nvestor seeks to achieve satisfactory returns with minimal effort. Th e Defensive I nvestor is not interested in poring over balance sheets or actively managing a portfolio. For the Defensive Investor , Graham recommends a simple, disciplined approach—such as allocating funds between high-grade bonds and a diversified portfolio of reliable, established stocks. For the D efensive I nvestor , the goal is stability and protection from major losses, not out-performance. Graham advises periodic re-balancing and refraining from market timing. In contrast, the E nterprising I nvestor is willing to put in substantial time, r...
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Liquidity Ratios Explained

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  Liquidity ratios measure the ability of a company to use its short-term assets to meet its short-term liabilities (1,2). Short-term assets, also called current assets, include cash, cash equivalents, accounts receivable, and inventory. Short-term liabilities, also called current liabilities, are the payments due within the upcoming 12 months. Short-term liabilities include accounts payable to suppliers, interest on loans, and the portion of the loan balance due. For the purposes of this article, we will lump the different types of short-term liabilities together under “current liabilities”. This is done to focus on the impact of the subcategories of current assets. The most commonly used liquidity ratios are the Current Ratio , Quick Ratio , and Cash Ratio . The Current Ratio is calculated by dividing current assets by current liabilities. Current Ratio = (Cash + Cash Equivalents + Accounts Receivable + Inventory) / Current Liabilities The Current Ratio greater than 1 indic...
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Mental Accounting and Financial Decision Making

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  Mental accounting is a behavioral economics concept that people separate their money into discrete buckets based on subjective criteria. These buckets are often based on the source of the money or the intended use of the money (1). Recent work has found the effects of mental accounting are influenced by individual personality traits and cognitive factors (2), such as the perception of scarcity (3). Mental accounting provides a theory as to why people treat sources of income differently. For example, people treat tax refunds differently than their paycheck. The differential treatment occurs despite the fact that a tax refund and a paycheck are both simply sources of income (4). Through mental accounting people often place a tax refund in the “found money” bucket. They then use the tax refund for frivolous expenditures rather than saving for their future. This may occur because a tax refund is an unexpected and infrequent event (i.e. “found money”). Compare this with the e...
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Loss Aversion in the Stock Market: Watering the Weeds and Cutting the Flowers

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  Investors often hold losing stocks for extended periods of time and sell winning stocks too early (1). At best, this reduces gains. At worst, this results in large losses. Loss aversion is a psychological bias that can result in irrational behavior (2,3) . For many people , the pain of loss is much more intense than the pleasure of gains. In fact, it takes approximately twice as much of a gain to offset the pain of a loss. For example, many people would say they are indifferent between losing ten dollars and gaining twenty dollars. If people were rational, losing ten dollars would be perfectly offset by gaining ten dollars. In the stock market, people often hold declining stocks to avoid realizing loses. These people find the unrealized paper loss more palatable than a realized loss. These individuals hope the stock will rebound so they can avoid the pain of a loss. If the stock price decline is due to poor current and projected earnings, holding th e stock simply to avoid t...
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Behavioral Economics and the The Livermore Loss Table

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                                                                 Image created by ChatGPT Jesse Livermore was a stock trader who made and lost multiple fortunes. Stating his life was tumultuous is an understatement. His stock trading method was discussed in the book “How to Trade in Stocks” (1). His method appears to have primarily been price trend following. There is also a brief reference to analysis of a business’s competitive advantage. The book is an interesting read, providing a glimpse of his life and stock trading. One mathematical concept discussed in the book is the Livermore Loss Table. Livermore points out that a loss of 10% in stock price requires only slightly more than a 10% gain in order to return to break-even. However, losses greater than 10% require increasingly asymmetrically gains to return to break-e...
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Stock Market Volatility: Remember the teachings of Benjamin Graham

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                                                               Image created by ChatGPT The stock market can be intimidating. If you find it unpredictable and irrational at times, you’re right! It moves up and down based on past company performance, expectations about future company performance, buyer/seller emotions, and external pressures. Bubbles develop (stock prices reach overly high values) when investors are emotionally exuberant. Bubbles pop (stocks prices fall, sometimes to unjustifiably low values) when investors become overly pessimistic. However, over the long run, the stock market tends to price stocks fairly. The market has been volatile and pessimistic lately. Reviewing the work of Benjamin Graham, one of Warren Buffett’s mentors, may be helpful. Graham’s approach: 1. Graham emphasized understanding the financi...
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New Product Introduction and Cannibalization

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                                                                               Image created by ChatGPT In business, cannibalization occurs when a company introduces a new product or service that takes sales away from its existing offerings. Cannibalization can be positive or negative, depending on how profits are affected. Please note, in the nonprofit world, profit is called change in net assets. We use the term profit because it is more familiar to readers. Consider the following fictitious nonprofit example: Get Financial Ready! is a nonprofit that supports retirement planning from an early age. The nonprofit’s main product is providing financial education through an online newsletter. Get Financial Ready! sells 100 subscriptions to their Gold News...
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