Investment Principles for Conservative Investors

Key Insight

The text presents a comparative analysis of four companies, highlighting that current price/earnings (P/E) ratios vary significantly more than their underlying operating performance or financial condition. For example, two companies were modestly priced at 9.7 and 12 times average earnings, compared to 15.5 times for the DJIA, while two others showed very high multiples of 33 and 45 times. This wide disparity is often explained by superior profit growth in favored companies, such as Emery Air Freight. However, such high valuations are noted to entail high risks, and a P/E ratio exceeding 60 times recent earnings, though possibly justifiable for an investor with exceptionally firm and optimistic in-depth study conclusions, is not recommended for a careful, conservative investor due to the risk of overenthusiasm.

Conservative investment principles prioritize fundamental business value over 'market action' or perceived 'glamour.' Companies like ELTRA and Emhart, despite lacking market appeal, demonstrated strong statistical performance, including satisfactory earnings on invested capital, profit stability, and surprisingly good past growth rates. These companies offered sufficient value behind their price, allowing an investor to consider themselves a basic part-owner at a cost reflective of the balance sheet. This contrasts with firms like Emerson Electric, which, despite an enormous market value and over $1 billion valuation for intangible earning power, carries considerable risk, echoing past examples of brilliant growth followed by significant profit and price declines, such as Zenith Radio.

A diversified list of common stocks selected by a conservative investor should meet seven statistical requirements: adequate size, a strong financial condition, continuous dividends for at least 20 years, no earnings deficit in the past ten years, ten-year growth of at least one-third in per-share earnings, a stock price no more than 1.5 times net asset value, and a price no more than 15 times the average earnings of the past three years. Adhering to these principles is expected to yield good overall performance over the years, even if individual stocks disappoint. Ultimately, the decision to pursue value-type investments versus glamour-type investments depends significantly on the individual investor's attitude and philosophy.