Analyzing Your Stock Market Investment Performance

How did your stock market investments perform last year? Or the year before? What about over the past 5 years? Do you ever check the performance figures. If you invest directly in the stock market (by that I mean you buy stocks directly rather than using a mutual fund or some other managed investment vehicle) one of the most important things you can do is to monitor and measure your performance.

What do I mean by that? Lets say you're looking back over the performance of your share portfolio and you notice that in 2006 you earned a return of 12% including dividends. This looks like a pretty good return doesn't it? It's better than leaving your money in the bank, right? If you then noticed that the S&P 500 returned 15.8% in the same year, would that interrupt your self-congratulation? You may be asking yourself now, what is the point I'm trying to make? Well there are several actually - let's take them one at a time.

Calculating Investment Performance:

The first thing to note is that you need to calculate your performance on a regular basis. You should know (or be able to find out fairly easily) what you average annual returns have been over the medium term (say 1 to 5 years). Make sure you're honest with yourself. Include your mistakes as well as your successes - they all count. And remember to include your costs as well. This will include brokerage of course, but you may also pay for research or other investment related services. You want to know your return after all costs.

Comparing Your Performance:

Once you have your own performance figures in hand, it's time for some comparison. At minimum, you should be comparing against an unmanaged index like the Dow Jones Industrial Average (DJIA) or the S&P 500 (or the FTSE or whatever is relevant in your region). Have you done better than the stock market average? This is critical. If you're managing your own portfolio and you haven't managed to beat an unmanaged index, it might be time to seek out a professional money manager or simply invest in an index fund.

Over What Period Should Your Comparison Be Made?

Don't be too worried if you under perform over 1 or 2 years. Likewise, don't get too cocky if you've outperformed over that same period. I think 3 years should be the minimum period of comparison with 5 years being better. If you're not beating the average over 5 years, you need to address the situation. Have a look at your investment strategy and see if it needs any adjustment. Drill down and see what individual stocks have not performed. Can you learn anything from this? If despite your best efforts you're unable to address your underperformance, there's no shame in seeking professional help to manage part or all of your portfolio.

Even from his early days investing in the stock market, Warren Buffett advocated the benchmarking of his returns against that of the average. In Buffett's letter to partners at the beginning of 1961, Buffett wrote:

"My continual objective in managing partnership funds is to achieve a long-term performance record superior to that of the Industrial Average. I believe this Average, over a period of years will more or less parallel the results of leading investment companies. Unless we do achieve this superior performance there is no reason for the existence of the partnerships."

While we can't all expect to achieve the outstanding returns that Warren Buffett did, we still shouldn't accept a less than average return. Over an extended period of time, such under performance can be extremely costly. The following table shows the expected returns over 20 years for $50,000 invested at each of 8% and 10%.


As you can see, the difference by the end of 20 years is significant - over $100,000.

Choosing An Investment Benchmark:

The last thing I want to cover today is the importance of choosing an appropriate benchmark - before getting started in the stock market. If you hold a broad spread of domestic stock market investments, you could use the Dow or S&P 500 index (or whatever the equivalent is in your region). International stocks would obviously require the selection of a different index as would a concentration of stocks in a particular sector. Another benchmark to consider might be one or two mutual funds with similar investment strategies to your own and for which a reasonable performance history is available. Remember to check whether reported performance is before of after costs.

You may manage your own investments because you enjoy doing it or to save money or for some other reason. But if you're not honest with yourself about the performance you're able to achieve then it may be a costly exercise. This applies as much to the experienced investor as to the stock market beginner.

Stock Analysis - Debt To Equity Ratio

What is debt to equity and how can it help beginners when investing in the stock market?

A company's debt to equity ratio or it's gearing ratio is a measure of the level of borrowings a company has used in proportion to stockholders' equity to finance it's assets. It's often used as an indicator of the amount of risk inherent in the shares of a particular corporation.

How To Calculate Debt To Equity:

In it's simplest form, the debt to equity ratio formula is as follows:

Debt To Equity = Total Liabilities / Stockholders' Equity

While there are many variations on this basic formula, I find this one to be easy and convenient to apply. Both these figures are readily available in the Balance Sheet contained in a company's published Financial Statements. Variations are mainly around what is included in the Total Liabilities. I've seen some analysts subtract cash on hand from total liabilities or leave working capital out altogether.

The only major difference is when gearing is measured as debt to total assets (or debt / (debt + stockholders equity). Using these figures will normally give a materially different result. The reason I mention this is that gearing ratios and debt to equity ratios are sometimes used interchangeably and you need to understand whether gearing is being quoted as debt to equity or debt to total assets.

Why Do We Care About This?

I mentioned earlier that it can be used as an indicator as to riskiness of a stock market investment. Normally a company with more borrowings is seen as being more risky than a company with less. This is because these loans, or more specifically, a company's ability to service it's theses loans, is key to it's survival. If a corporation fails to pay interest on borrowings on time or is unable to repay the principal when it falls due, it's creditors' may move in. In the worst case scenario, insolvency could result and that could lead to significant or even total loss of capital for investors.

So why do companies borrow money at all? It's not all doom and gloom. When managed correctly, gearing can be used to help grow a business, leverage shareholders' capital more efficiently and ultimately increase returns to shareholders. If a business can borrow money at 7% and generate a return of 10% on those funds, the excess earnings will accrue for the benefit of holders of the company's stock. This means higher profits and more money to invest in growing the business or to pay out as dividends. That's why the use of borrowed money is sometimes described as leverage.

But, interest rates vary over time and corporate profits fluctuate with the business cycle. What happens when interest rates rise? Can the company still meet it's interest obligations? And similarly, as the economy slows and cash flow drops, can its loans still be serviced. The recent (ongoing?) sub prime crisis also illustrates what happens when borrowings fall due and companies are unable to refinance. All of this illustrates why I prefer to invest in the stock of companies who use borrowed money conservatively.

What Is A Good Debt To Equity Ratio?

As with much of what goes with investing in the stock market, there is no hard and fast rule here. It will depend on the company and on the industry in which it operates. Capital intensive businesses will tend to have higher debt to equity ratios. Businesses that have reliable earnings (ie. earnings which don't fluctuate much through economic cycles) like utilities and consumer staples can normally sustain higher gearing ratios as well.

You could apply a rule of thumb and say you'll steer away from businesses whose debt/equity ratio is greater than 1 (ie. it's financed more through borrowings than through stockholders' equity) but you may exclude some industries altogether. However, this may not be a bad thing as some may argue that corporations which require large amounts of borrowed funds probably don't have very strong businesses - I believe Warren Buffett is said to prefer the stock of companies with low levels of borrowing. When looking for prospective investments, I look at a company's debt to equity ratio over time and also compare it against other companies in the same industry.

Another useful stock market ratio is interest coverage or times interest earned. It measures a company's ability to service it's loans. The higher the coverage the better - there's more leeway if things turn sour. I'll write more about this in an upcoming post.

Some of my biggest mistakes in my early beginner attempts at investing in the stock market were the result of high debt. That's why I always consider debt to equity as part of my stock analysis.

Update: I've since written a post on the Quick Ratio, another useful indicator of the financial health of prospective stock market investments.

Warren Buffett Video Clips On Stock Market Investing - Part 2

If you missed yesterday's Warren Buffett Stock Market Investing Video Clip post, I suggest you go back and check it out. In this post I am showing the last 5 video clips in the set of 10 that make up a talk that Warren Buffett gave to some MBA students.

As I said yesterday, if you have the time a strongly urge you to watch all of these video clips. The enormous amount of common sense the man brings to the subject of stock market investing always amazes me. It's a pity he never wrote a book on investing - I'm sure it would be a great read for those just starting out in the stock market but also to those who have been around for a while.

On that note, if you are interested in reading Buffett's writings, I suggest you head over to the Berkshire Hathaway website and read his letters to shareholders. The complete set is available for viewing or downloading. They make for a great read.

Anyway, enough from me for now - on the with the second half of the set of video clips.

Warren Buffett Video - Part 6



Warren Buffett Video - Part 7



Warren Buffett Video - Part 8



Warren Buffett Video - Part 9



Warren Buffett Video - Part 10



As I said earlier, the man makes an enormous amount of sense. I like the point he made about Coca Cola (sorry, I can't remember what number clip it is now). It might pay to keep that example in mind as you approach your next investment. Think about what the company (and therefore the stock) will be doing years from now, rather than just months. It's something not just beginners need to keep in mind. Even those who have been investing in the stock market for a while can forget to take a long term view.

Warren Buffett Video Clips On Stock Market Investing

Warren Buffett is considered to be one the most successful practitioners of stock market investing of all time - and beginners can learn a lot from him. It's hard to write a stock market investing blog without writing about him, and I've already mentioned him in passing in Great Stock Market Investing Minds - Benjamin Graham and Stock Market Investing Books For Beginners and I will write more about him in an umcoming article. But for now, I thought I would pass on some videos I found on YouTube. If you haven't discovered it already, YouTube is a great way to waste time online.

What follows is a series of videos which record a talk Warren Buffett gave to a group of MBA students about stock market investing, life and everything else. There are 10 video clips in the series. I'll include the first 5 in today's post and the last 5 in tomorrow's post. So sit back and enjoy. You may want to grab a pen and paper - as usual he imparts some true pearls of wisdom.

Warren Buffet Video - Part 1



Warren Buffet Video - Part 2



Warren Buffet Video - Part 3



Warren Buffet Video - Part 4



Warren Buffet Video - Part 5


Come back tomorrow to see the rest of his talk. I'm sure you'll agree watching these video clips is worthwhile. Whether you're a beginner at stock market investing, or a seasoned professional, you're sure to learn something.

Great Stock Market Investing Minds - Benjamin Graham

A beginner's guide to 'The Father Of Value Investing', one of the great stock market investing minds.

I thought I would write a series of articles about some of history's greatest stock market investing minds starting today with Benjamin Graham. Benjamin Graham was a professional investor, a successful author and is widely considered to be the father of value investing. And in a stint teaching at Columbia University 'The Dean Of Wall Street' taught some of great minds of the following generation of investors.

Graham first went to work on Wall Street for Newburger, Henderson & Loeb after graduating from Columbia at the age of 20. Then in 1926 he formed the Graham-Newman partnership with Jerome Newman. Graham is believed to have been personally ruined by the great stock market crash of 1929 and the Great Depression which followed. His partnership survived the crash and recovered to produce outstanding investment returns over an extended period. From what I recall, his average annual return was in the vicinity of 17%.

In 1934, along with co-author and fellow Columbia professor David Dodd, Benjamin Graham published Security Analysis. Security Analysis was an attempt by the authors to bring some structure and rigor to the field of stock market investing. After the carnage of the 1929 crash this was greatly needed.

Security Analysis is a hefty volume and I wouldn't recommend it to beginner investors, however it's well worth a read if you can set aside the time. Don't make it the first stock market investing book you read, but once you have the investing basics under control then you should definitely tackle Security Analysis.

The other perhaps better know volume to be penned by Graham was The Intelligent investor. I have already mentioned this book in Stock Market Investing Books For Beginners. The Intelligent Investor is one of the best stock market books I've ever read. As a beginner, the simple yet powerful concepts introduced in the book were both enlightening and inspiring. First published in 1949 and regularly updated until his death in 1976, this book has stood the test of time. Value investors the world over frequently quote Graham's text.

Benjamin Graham is responsible for the Mr Market metaphor. Mr Market wasn't a superhero, but rather a way for investors to think about the stock market. Graham said to consider your participation in the stock market to be like co-owning a profitable, stable business with a partner called Mr Market. Each day he will approach you with a price at which he would be willing to either buy out your share of the business, or sell you his. However, Mr Market is manic-depressive and the prices he offers fluctuate wildly as his mood changes. But the good news is he cames back day after day with a new offer and you are under no obligation to either buy from or sell to Mr Market on any given day. Your challenge is to not be distracted by Mr Market's erratic behavior and to take advantage of outstanding opportunities presented by Mr Market as they arise.

(Please note: My copy of The Intelligent Investor is out on loan, so the above description may not be true to Graham's original writing. However you should get the general idea.)

Another theme central to Benjamin Graham's teachings is the concept of a Margin Of Safety. What this means is that when you approach a particular investment opportunity, you should ensure you buy at a price sufficiently below what you think the value is that, should anything unforeseen happen you should still end up with a satisfactory result. In addition, he advocated diversification as a way of reducing the risk associated with any given investment.

Measures used by Graham to determine value include Price To Earnings Ratios, Dividend Yields and Net Tangible Assets. In addition Debt Levels and management attitude to shareholders should also be considered.

I'm running out of time and space in this post. There is much more the Benjamin Graham's teachings to what can be condensed into a single blog post. I suspect I will write another one at some point to fill in all of the gaps I have left in this post. I just wanted to finish up here by giving some indication of the caliber of students he taught while at Columbia.

Warren Buffett is possibly the most famous and arguably most outstanding of these. Buffett actually spent some time working with his teacher in the Graham-Newman partnership. He then went on to form his own investment partnership before eventually leading Berkshire Hathaway to almost unparalleled success.

Other student's of Graham's include Walter Schloss and William Ruane. Both very successful professional investors in their own right, William J. Ruane went on to manage the very successful Sequoia fund while Walter J. Schloss recorded a return of 16% over a half century of stock market investing.

I highly recommend Benjamin Graham's writings and teachings. Both beginners and the more experienced will learn a great deal about stock market investing from Benjamin Graham.