Understanding Stocks

FUNDAMENTAL ANALYSIS: TOOLS AND TACTICS 105
Benjamin Graham, the author of two value investment classics,
Security Analysis, first published in 1934, and Intelligent
Investor, influenced Buffett early in his life. Buffett later worked
for Graham at Graham’s brokerage firm, learning from the master
how to manage investment portfolios and pick value stocks.
Buffett made a number of successful modifications to Graham’s
original strategies. He uses a stock’s book value, P/E, and
dividend yield, among other objective measurements, to calculate
the company’s fair value. He believes in buying a company
for less than it’s worth and patiently holding its stock for a lifetime.
One of the reasons Buffett avoided investing in Internet
stocks was that he couldn’t determine their true value. Buffett
strongly believes in buying stocks in companies that are simple
and understandable (so that he can calculate their future earnings
growth). Most Internet companies had little or no earnings and
sky-high P/E ratios. At the time, several pros derided Buffett for
avoiding investments in technology companies. In hindsight,
Buffett was right.
Buffett has earned a reputation for honesty and a sense of
humor. He was one of the first to point out that you should be
cautious about investing in companies that play accounting
games when they use stock options to compensate employees.
Many people have tried to emulate Buffett’s successful buyand-hold
strategies. A number of excellent books have been written
about his strategies, most of which are based on common
sense. The difficult part for most investors is learning how to
value a business—something that Buffett has learned how to do
after a lifetime of investment success.
In the next chapter, you will learn how traders use technical analysis
to buy and sell stocks.