In this book, the author wants to teach us how to pick our assets or securities for investment in the long term. This book mainly described Magic formula which gives Benjamin Graham’s idea of picking stocks at cheap rate with a margin of safety. It also explains a concept that when we are buying the stock we should consider it as we are buying a business and we should be aware of their financial and operational stability. In the end, this book summarizes us that exactly how we can apply the magic formula.
Briefing of All Chapters:
The author has tried to take the path of Lehman’s technique and approached to deep technical methods for buying the stocks and understanding the business of any industry or country.
In the 1st and 2nd chapter, the author wants us to know how to analyze different types of risk taken to generate return. Some avenues to be mentioned are G-secs, corporate bonds and other different businesses to generate returns by investing in them rather than keeping the money in piggybank.
In the 3rd, 4th & 5th chapter, author explains us that buying a stock means we are buying a portion of business and we should first be aware of its worthiness and future earnings so that we can generate return on our investment as per the risk. Then he talks about wide price movement due to crazy guy called Mr. Market. He tells us that we should buy the business on discount with margin of safety which can lead us to safe and profitable investments and that we should buy good business at bargained prices with high return on capital. Then in further chapters author has explained the MAGIC FORMULA by BEN GRAHAM with an example which shows that the return from 1988 to 2004 was 30.8% annually whereas of S&P 500 was 12.4%. This formula has worked for both large and small companies and has been incredibly accurate of how a group of stocks will perform in the future. But, we should know that according to the formula we should pick the stocks with higher return on capital and has the ability to earn above average profits. In simple terms Mr. Market may price stocks based on emotions in short term but in long term, it’s all based on value.
It ranks the companies based on two factors, return on capital which is given by EBIT/(Net working capital + Net fixed assets) and earnings yield which is given by EBIT/(market value of equity + net interest bearing debt). We then rank all the stocks according to their highest to lowest return on capital and then with highest to lowest earnings yield, then we have to choose our group of stocks according to their rank and group them but we should also consider its future earnings sustainability.
By choosing any asset or securities for investment, we should understand the business and then apply the magic formula but we should also consider its earnings sustainability. We should trust the magic formula for long term and be sure with our decisions on buying a good business.