Starting Over

State of Play: Way back in August, when I wrote my last post, I was looking at Nomad Building Solution as a potential investment. Or more correctly, I was concluding that they were not a potential investment due to their lack of transparancy on an issue that was never fully explained.

My position on this might seem a bit over the top to some people, but it is based on my training as a banker. The first question a banker is supposed to ask themselves before considering anyone for a loan is "does this borrower have integrity?". Nomad's lack of info about the issue, plus their trumpeting of double-digit revenue growth and leaving the fact this was due to the aquisition of two businesses for inclusion in the fine print, leads me to question their integrity. Banks take mortgages and charges so they can force repayment of loans, share investors are at the mercy of the market when it comes to getting their money back. This is why I'm passing over Nomad.

I also said, in my last post, that I would look at their next set of results, just out of interest to see where the story went. However, my laptop has been stolen with all my blogs and workings, so I'm not going to go back and recreate excel files just for the sake of curisoity. I did take a look at how their share prices has moved over the last year however. They reached a high of $1.23 per share on 9 Sep 2009 and closed at 26c on 3 Feb 2010. My guess is they rode the market up but reality hit them in the end.

Nomad originally came to my attention as a result of judging every listed company against a set of critera. I developed the criteria after reading a couple of books on investing (see previous posts). This was done in January 2010. You will note that a year has passed since then. [You may also note that my postings in this blog can best be described as intermittant. My only defence is that I have had a baby in November and being pregnant and then looking after a new born are not condusive to blogging or investing.]

Anyway, to recap what has happened since my last post in August 2009, I re-ran the criteria on the 30 June 2009 financial statements. Only one company made it to the shortlist - ALE (they own pubs which they rent out to others to operate). Unfortunately, about that time I attended a conflicts of interest course at work and learned that I am not allowed to trade any shares in my industry sector (property) regardless of whether they are clients or not. So, ALE are disqualified.

At that point I decided its was time for a new approach, which means a new book. The Snowball, the biography of Warren Buffet, details how he read Graham & Dodd's book Security Ananlysis, then went to Columbia University to study with them and later joined Graham's investment firm. Has ever a book come so highly recommended on any topic?

So I headed to Readers Feast in Melbourne, which always has a good selection of books on finance and investment and indeed found a copy of Security Analysis (6th edition). My first impression is that it is a very big book at 2.5 inches thick with an accompanying CD containing additional chapters and appendices. It covers both bonds and shares, so fortunately I don't have to read the whole thing (but being a Virgo I probably will).

Anyway, back to the content. The issue I am currently grappling with (which I admit might not appear entirely obvious) is how do I select companies to invest in? The short answer to this is provided in Chapter 28 - Newer Cannons of Common Stock Investment.

I have to admit, that I did not find this chapter an entirely easy read, but this is what I believe it is saying:

• there are four approaches to share investing
• first approach - create a portfolio of "carefully selected, diversified group of common stock purchased at reasonable prices". This approach is discounted on the basis that investors cannot count on a general market wide increase in earnings or profit. I would have thought this would be taken care of by the careful selection, but maybe they are just saying there's no guarantee the market will go up.
• second approach - select growth stocks. This approach is discounted on the basis that by the time you can be certain a stock is a growth stock it may have matured and will not grow further or, even if it is a growth stock the price will contain a premium taking this into account.
• third approach - exploit market swings through buying when the market is low and selling whent he market is high. This approach is discounted on the basis that it is too difficult to pick the market turning points.
• fourth approach - buy undervalued shares. Graham and Dodd contend that although it is rare for a good stock to sell at a low price, it is common to find stock that have average prospects for the future and appear cheap on quantitative measures. This is because most investors focus on companies with unusually good prospects. "Because of this emphasis on the growth factor, quite a number of enterprises that are long established, well financed, important in their industries and presumable destined to stay in business make profits indefinitely in the future, but have no speculative or growth appeal, tend to be discriminated against by the stock market - especially in years of subnormal profits - and to sell for considerably less than the business would be worth to a private owner."

This fourth approach is the margin of safety principal and is considered the best by Graham and Dodd. Unfortunately, it appears I cannot just set a few criteria and bingo - there's a portfolio. It appears I must do a fair bit of analysis to form a view on the value and discover whether a certain share is trading at a discount to value. So from this point I think all I can do is plow on with the book and see where it takes me.