The aggressive investor should start from the same base as the defensive investor, that is, dividing funds into high-grade bonds and high-grade ordinary shares, bought at reasonable prices. He will also want to be prepared to expand into other security commitments, but in each case he will need a logical reason for deviation. It is difficult to discuss this subject systematically, since there is no single or ideal pattern for aggressive operations. The range of options here is wide. The choice depends not only on the individual's ability and equipment, but possibly also on his tastes and preferences.The most useful simplification for the enterprising investor is of the negative kind. He should leave high-grade preferred stocks to corporate buyers. He should also avoid inferior bonds and preferred stocks until they are at bargain levels, which usually means at least 30% discount on high-coupon issues and even more on lower coupons."This is where Graham slips his tongue. In the chapter, Graham emphasizes that the definition of an entrepreneurial director is not how much risk you take. It depends on how much effort you are willing to put in. But here Graham resorts to the traditional definition that entrepreneurial investors are more aggressive. However, the rest of the chapter makes it clear that Graham supports his original definition. (It seems that the great British economist John Maynard Keynes first used the term entrepreneurial as a synonym for analytical investing.)
It should also allow foreign-government bond issues to be bought by others, no matter how attractive the yields. It should also stay away from all types of new issues, including convertible and preferred bonds, which look very tempting and be cautious of ordinary shares that have limited their earnings in the recent past.For standard bond investing, the aggressive investor should, as far as possible, follow the pattern suggested to the defensive investor, and choose between high-grade taxable issues, which can now be chosen for a yield of 7.25%, and good quality tax-exempt bonds, which have a long-term maturity yield of 5.30%.Second-Grade Bonds and Preferred Stocks Since it has been possible since late 1971 to find first rate corporate bonds yielding 7.25%, or even more, it is not wise to buy second grade issues simply because they offer a higher return. Over the past two years it has become impossible for corporations with relatively poor credit ratings to sell 'straight bonds', i.e., non-convertibles, to the public, even though their debt is financed by the sale of convertible bonds (or bonds with warrants), which place them in a separate category. This means that nearly all low rated non-convertibles represent old issues selling at a large discount. Thus, they have the potential for a substantial return on principal if favourable conditions prevail in the future-which here means an improvement in the company's credit rating and a lower ordinary interest rate.But even in terms of price discount and the consequent opportunity for return on principal, second-grade bonds compete with the best issues. Some well-secured obligations were associated with 'old-style coupon rates' (2.5% to 4%).
They sold for about 50 cents on the dollar in 1970. For example, American Telephone & Telegraph 25s, maturing in 1986, sold for 51, Atchison Topeka & Santa Fe R.R. 4s, maturing in 1995, sold for 51, McKeon Hill 3s, maturing in 1992, sold for 501/2.So in the conditions of late 1971, enterprising investors could probably find good-grade bonds selling at deep discounts, including those they wanted based on both income and growth prospects.Throughout this book we have referred to the possibility that some well-defined and long-term market condition of the past may return in the future. We must therefore consider what policy the aggressive investor in the bond sector would choose if prices and yields on high-grade issues returned to a normal point in time. For this reason we have reprinted our views here, starting with the point we presented in our 1965 edition, when high-grade bonds yielded only 4.5%.We now turn to a few points about second-grade issues, which rarely yield a typical return of 4% or more. The main difference between first and second grade bonds is often how many times the interest charge is covered by income. For example, in early 1964 the Chicago, Milwaukee, St. Paul and Pacific 5% income debenture bonds had a yield of 7.35% at 68, but the road's total interest charge before income taxes was only 1.5 times the yield in 1963, while our requirement for a well-secured railroad issue was 5 times.'Many investors buy such securities simply because they need income and so cannot afford the meager returns offered by top-grade issues. Experience clearly shows that there is no sense in buying a bond or premium without a return protection just because of its attractive yield. (Here 'only' means that the issue is not selling at a large discount and therefore does not offer any opportunity for a large return on principal. When such securities were bought at full price, they were not much below 100 points - so in the future the Barack Obama may find himself trading well below it. When business is bad, or the market is bad, such an issue is likely to sink.
There is a lot of possibility. In this either the interest or dividends get distributed or they come at a lower price than yesterday, and the prices keep getting weaker. Operating results may not be that bad.To illustrate the behavior of the McKendrit Quality Senior Issue, let us now plot the price behavior of this group of railroad income bonds in 1946-47. These include all those that were quoted at 96 or higher in 1946, with a price average of 10212. The following year the group had a minimum average of 74, a loss of one-third in market value in a very short time. Interestingly, the income of the nation's railroads was much better in 1947 than in 1946. So the large price decline represented a sell-off in the green and green market, contrary to the trend of the business cycle, but it must also be noted that the shrinkage of these income bonds was comparatively less (by about 23%) than that of ordinary shares listed on the Dow Jones Industrial Average. Obviously, buyers of these bonds worth more than $100 would not have expected to participate in any further growth in the securities market. The only attractive feature was the income yield, which averaged about 4.25% (1.75% gain in annual income, compared to 2.50% for the third-grade bonds). Yet these results show quickly and quite simply that for a modest gain in annual income, buyers of second-grade bonds were risking a substantial loss in their principal.The above example allows us to appreciate the popular belief that comes under the moniker of 'businessman's investment'. It involves buying a yield that may be higher than a high-grade issue and that carries a correspondingly higher risk. It is bad business practice to accept the possibility of losing principal in exchange for an additional annual return of 0.5% or 20%. Even if you are willing to take a little risk, you must ensure that if all goes well, your principal will actually increase in value. A second-grade 5.5% or 634 bond selling at par will almost always be a bad buy. The same issue may be fine at 20%, and if you are careful, you will probably buy it at that level.Second grade bonds and preferred stocks have two opposing characteristics which an intelligent investor must clearly understand. When the market is bad, they almost all take a deep dive. On the other hand, most of them bounce back to their previous positions when favorable conditions prevail, and are 'vindicated'. This is also true in the case of preferred stocks (cumulative) which have failed to pay dividends for years. Such issues were abundant in the early 1940s after the deep recession of the 1930s. In 1945-47, the issue rate was 100%.
In the post-Budh boom period many such large deposits were either paid out in cash or in new securities, and the original capital was often in full. As a result, large profits were made by those who had bought these issues a few years earlier when they were unwanted and selling at low prices.It may be true, in gross accounting, that the high-yielding second-grade senior issues make up for this significant loss of principal that cannot be recovered. In other words, an investor who buys such issues at their offering price is likely to make good money, over the long term, just like those who limit themselves to prime-quality securities or better.But for practical purposes this question is largely irrelevant. Whatever the results, the buyer of second grade issues who buys at full price is bound to be worried and uneasy when the prices fall. Moreover, he cannot buy enough issues to ensure an average result, nor is he in a position to set aside some of his large proceeds to make good on these large losses that may prove permanent, or to 'pay off' the debt. Finally, it is a matter of general expediency to avoid buying securities at nearly 100, even when long experience shows that in the next weak market they may be bought at 70 or even lower.
foreign government bonds
Any investor with even a modicum of experience knows that the investment history of all foreign bonds has been poor since 1914. This was inevitable in light of two world wars and the unprecedentedly deep global recession in between, yet every few years conditions on the stock exchange have been favorable enough to allow some new foreign issues to sell at par. This phenomenon is indicative of the average investor's thinking - and not just in the realm of bonds.We have no good reason to worry about the future history of well-known foreign bonds, such as Australia or Norway, but we do know that if and when trouble comes, the owners of foreign obligations will have no legal or other means of making a claim. People who bought Republic of Cuba 41/2s at a high price like 117 in 1953 got no interest and had to sell for 20 cents a dollar less in 1963. The New York Stock Exchange bond list that year included Belgian Congee 51/4s at 36, Greek 7s at 30, various Polish issues at as low as 7s. How many readers are aware of the constant fluctuations in the 86 bond of Czechoslovakia, first issued in this country in 1922?
9603? In 1920, it rose to 112 and fell by 0.74% in 1932, rose again to 106 in 1936 and again fell to 6 in 1939, then recovered (incredibly) to 106 in 1946 and fell again to 15 in 1948 and again to 1970.Years ago, the purchase of foreign currency by countries like ours was also cited as a moral pressure by foreign investors. Over time, many enemy countries were grappling with their own balance of payments problems, part of which was due to large-scale foreign currency purchases by American investors. This was discussed. After many years, we questioned the nature of such investments. Perhaps now we can say that if Canada refuses this oiler, it will be beneficial for both it and its country.
about the new issue
It seems ill-advised to attempt to make any blanket statements about the quality of new issues, as they vary widely in quality and appeal. There are always exceptions to the rule. Our advice is that all investors should approach new issues with caution, which means that they should be carefully examined and exceptionally rigorously tested before buying.There are two reasons for this double warning. First, there is a lot of sell-side pressure behind new sell-side pressures that are required. Second, most new sell-side pressures are used, which means the result of a winner is less favorable to the buyer. Sell-side resistance
The implications of this idea become progressively more significant as we move down from the highest-quality bonds through second-grade senior issues to ordinary share issuances at the bottom. There have been many instances of large-scale financings in the past, including the calling back of existing bonds at a call price and the offering of new issues at lower coupons. Most of these were in the category of high-grade bonds and preferred stocks. The buyers were large financial institutions with considerable leverage to protect their interests. Hence, the prices of these offerings were carefully fixed in line with the issue prices of comparable issues, and high-powered salesmanship was the result. With interest rates as low as possible, the buyer would eventually have to pay high prices for these issues, and many of them would subsequently decline in value in the market. This is one aspect of the general mindset of selling new securities of all kinds when the odds were in the issuer's favour; While in the first quality issue, the impact on the banana may not be serious but may be unpleasant.The situation looks different when we study the Veche lower-grade bonds and preferred stocks during the periods 1945-46 and 1960-61. Here the effects of the selling effort are quite clear, since most of these issues were probably offered to individuals or inexperienced investors. The character of these offerings was such that they did not perform well over the years, even when judged in terms of the performance of the companies. Most of them looked safe, as if to assume that current earnings would continue without serious losses. The investment bankers who bought these issues probably accepted this assumption, and it was not difficult for their sales officers to convince themselves and their clients that this would be the case. All in all, Pa: is not a very good deal for investment, and may eventually prove costly.The bull market is usually characterised as a period of conversion of large numbers of privately owned businesses into issuer companies. This happened in 1945-16 and again in the early 1960s. This phenomenon reached enormous proportions when it led to the disastrous shutdown of May 1962. Then after a few years of general 'abandonment', the whole farce was repeated again step by step in 1967-69.
New ordinary-share offers
The following paragraph is reproduced unchanged from the 1959 edition, with the note added:Ordinary shares are financed by two separate tranches. In the case of already listed companies, existing shareholders are offered additional shares in proportion to their shares. The subscription price is set below the current market, with the 'right' to subscribe having some initial currency value. The issue of new shares is almost always signed off by one or more investment banking houses, but this is usually expected.
The practice is that all new shares are subscribed through the subscription rights process. Hence, the sale of additional common shares of listed companies at premium does not call for an active selling effort on the part of the distribution firm.The second type involves the offering to the public of ordinary shares previously held by privately owned enterprises. Most such shares are sold to raise funds from a favourable market and to diversify one's own finances. (As mentioned earlier, when new funds are raised for the business, it is through the sale of preferred shares.) This process follows a set pattern, which may expose the public to a variety of losses and disappointments, typical of securities markets. The risk lies both in the nature of the business which is thus financed and in the market conditions which make the financing possible.In the early part of the century a large number of our major companies began public trading. As time went on, the number of enterprises that remained in the first rank declined rapidly. Hence the floatation of the original common-shares came to be more and more concentrated in comparatively small enterprises, but unfortunately, in the same period the share-buying public began to develop a preference for major companies and a similar bias against small companies. The large and quick gains shown by common shares are sufficient to dull the critical ability of the public to judge merits, such that they intensify their acquisitive instincts. This period also saw the emergence of some privately owned companies which were achieving spectacular results, although the record of many of them was not so impressive if their figures were compared back over, say, ten years or more.When we put all of these factors together, the following pattern emerges: the first ordinary share issuances tend to occur in the midst of a bull market. The prices are not unattractive and buyers make large profits in some of the first issues. As the market continues to rise, the number of such financings increases steadily. The quality of companies deteriorates rapidly. The asking and receiving prices are excessive. A clear signal of the end of a bull market is the fact that new ordinary shares of small and obscure companies begin to fetch prices higher than those offered by medium-sized companies that have been in the market for a long time. (This is in contrast to the fact that new ordinary shares of small and obscure companies are fetching higher prices at current levels.)
(It must also be added that banks of large size and reputation usually do simple shaver financing of this kind very rarely.)"The carelessness of the public and the eagerness of institutions to sell at a profit can only lead to one result: a crash. In many cases new issues fall by 75% or more from their offer price. The situation is made worse by the fact mentioned above that the public actually turns away from the smaller types of issues that they had casually bought. Many of these issues fall comparatively low, so low that they were actually sold at a higher price than they were originally sold at.The most important thing for the intelligent investor is to avoid the temptations offered by sellers of newly issued ordinary share issues during a bull market.One or two of these may pass serious tests of quality and value, but it is probably not a wise policy to engage in such a trade. Of course, the salesman will point out several stocks that have made a good progress in the market. There may be some that rise spectacularly on the day they are sold, but this is all part of the atmosphere of speculation. This is the easy cube. If you are lucky, you will lose only two dollars for every dollar you make this way.Some of these issues may be good to buy, but only after a few years, when no one will want them and they can be purchased for much less than their actual value.In the 1965 edition we took our discussion on this subject forward as follows:
Since the broad aspects of the behaviour of the stock market have not been analysed on the basis of long experience since 1949, the issuance of new ordinary shares has been fairly consistent with the old recipe. It is doubtful that ever before have so many new issues been offered, and of such poor quality, and with such a great fall in prices as we experienced during 1960-62.' The ability of the stock market to quickly recover from disaster is certainly an extraordinary event, reviving long-lost memories of similar vulnerability displayed during the great Florida real estate crash of 1925.Will the new-share offering frenzy return before the current bull market reaches its decisive end? Who knows? But we do know that the intelligent investor will not forget what happened in 1962 and leave the next group to enter the sector seeking quick profits and experiencing catastrophic losses.In the 1965 edition we followed this paragraph with an illustration entitled "A Horrible Example," which prominently featured the stock of Aetna Maintans Co., which sold for $9 in November, 1961. The shares soon rose to $15, conventionally. They fell to $200 the following year and to 7/8 in 1964. The subsequent history of this company was extraordinary. It was illustrative of the strange transformations which have taken place in American business, large and small, in recent years. The curious reader can see
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