Chapter 7: Portfolio policy for the enterprising investor: positive side

An enterprising investor has the following characteristics:

1. Buy low, sell high.
2. Buy well researched growth stocks
3. Buy bargain stocks
4. Buy “special situations"

“Buy low, sell high” idea appears simple in nature. But in order to take advantage of market fluctuations, an investor needs to have mental competence to buy stocks with depressed prices in a bear market.

A growth stock, by definition, is expected to perform better than the market average. Thus, it would seem only natural for an investor to buy only growth stocks. Unfortunately, there are two problems. The first is that growth stocks sell at high prices and it is easy for an investor to overpay. The second is that, the anticipated growth might not occur in future.

Since markets tend to overvalue growth stocks, it is logical to assume that markets tend to undervalue stocks that are out of favor. However, it is possible that stocks of small companies are undervalued for a reason and they may never regain their highest prices. Large companies with undervalued stocks, on the other hand, have financial and human capital to bring them back to a satisfactory earnings base.

Purchase of bargain stocks
A stock is considered a bargain if it sells for more than 50% discount to its value. But how is value determined? The first method to evaluate is by appraisal which relies on estimating future earnings and then multiplying these earnings by an appropriate factor. The second method to evaluate is to consider the worth of the underlying business to a private owner. This method puts emphasis on net current assets or working capital.