1

THE TAO OF THE DOW A Philosophy of Financial Securities Investing

By R.S. Heyer
1993

PREFACE
This little book distills the results of 35 years of investment experience, crystallized and conveniently expressed in terms of principles expressed in the Tao, but reached independently. The pun in the title is my own proclivity, but the idea of combining these two elements was inspired in part by such examples as the Tao of Physics, the Tao of Leadership, and the less serious Tao of Programming. The reader need not conscientiously peruse every line of this book to make use of it, although every author hopes that every reader will benefit from every word written. The plan of the work consists of four principal parts, each of which provides its own value and can be read separately. The first part presents the fundamental principles of the Tao, as I construe it. My approach differs from that of others, but that is not unusual or surprising. This part contains chapters I-III. Those mainly interested in the Tao, in an analytic way, but not in investment, might read only this. The second part details the application of these general principles to the particulars of investment problems. This is the longest part, containing chapter IV, parts A-D, and chapter VII. Those interested only in the investment practicalities might concentrate on this part. The third part contains a lighter, more sloganeering, less analytic approach to investment philosophy. It consists of appendices I and II. Appendix I relates to investment ideas suggested by each verse or section of the Tao, arranged in the poetic order in which the Tao itself is known rather than any analytic order. Although this is a verse-by-verse approach, it is not a translation by any means, but a sort of correlation, numbered to correspond to the verses of the Tao. Appendix II is a set of modern aphorisms (some old, some new, some revised) which are or might appropriately be applied to investment. Some readers may prefer this part to any of the others. It was the most fun to put together. The fourth part consists of the remaining appendices, which provide additional information which may be useful to the investor, especially a new one, for reference only. Appendix III contains acronyms and other odd abbreviations which help a new investor in reading or listening to the financial news media, and Appendix IV lists formulas used by fundamental analysts, as suggested by Graham and Dodd, and their successors, Cottle, Murray, and Block. It is hoped that the reader will enjoy and find useful this little book. It is of course too short to be complete in any of its aspects, certainly not in the summary of financially pertinent reality. For greater detail the reader may consult other sources, a few of which are suggested in the bibliography included after Appendix IV. Suggestions for corrections, clarifications, and additions are welcome. Taoism refers to the doctrines expressed in a concise ancient book, the name of which is usually spelled Tao Te Ching in English, following the Wade-Giles spelling system for Chinese (Dao De Jing in Pinyin). It is pronounced dow duh jing referring to the concept of the Tao (pronounced Dow), the Way of nature and of sensible human behavior. Hence The Tao of the Dow is a play on the identical sound of the two words, Tao (or Dao) and Dow. Some observers regard the Tao as emphasizing mere passivity,

3 but it was intended as advice to government in a tyrannical time; therefore, a more plausible and useful view is that the Tao is a guide to action, allowing for more patience, more forbearance, more reason and self-control, more liberalism of spirit than the actual tyrants of the time displayed.

THE TAO OF THE DOW Table of Contents

Preface Table of Contents I. II. III. IV. Introduction Harmonious Balance Cosmic Harmony in General Financial Securities Investing Defined A. Investing B. Financial Securities Harmonious Balance in Investing A. Psycho-Strategic Balance (Appropriate Goals) B. Emotional Balance (Reasoned Action) C. Market and Selection Balance (Independence, Avoidance of Extremes) D. Chronological Transactions Balance (Averaging) E. Portfolio-Holdings Balance 1. Asset Allocation 2. Diversification 3. Geographic Balance 4. Risk Balance F. Balance in Approach (Adaptability, Flexibility) Cosmic Harmony in Investing: A. Initial Comments B. Background Environment 1. Economic Environment a. Nature of Economy b. Financial Securities c. Classic Economic Laws d. Effective Demand e. Organizational Flexibility and Social Inclusivity f. Economic Cycles g. Interest Rates h. Geographical Scope of Economic Environment 2. Politics 3. Resources 4. Trading System C. Fundamental Analysis 1. Objectives and General Principles 2 4 6 9 12 14 14 14 17 17 17 18 18 19 20 20 20 20 20 22 24 24 24 25 25 29 30 32 34 36 36 37 39 40 40

V.

VI.

6 Valuing Debt Securities Valuing Stocks Compound Interest Rule of 72 Reading an Annual Report Primary Factors Accounting Concepts a. Earnings Report (profit) b. Balance Sheet (equity, book value) c. Cash Flow 9. Ratios a. Measures of Progress b. Measures of Value c. Measures of Safety d. Measures of Profitability and Stability D. Technical Analysis 1. Trends 2. Dow Theory 3. Averages and Indices 4. Patterns 5. Support and Resistance 6. Volume 7. Sentiment 8. Seasonality Conclusion 2. 3. 4. 5. 6. 7. 8. 41 41 42 43 43 44 46 46 47 47 47 47 48 49 49 50 50 51 51 52 52 53 53 54 55 56 64 67 74 81

VII.

Appendix I. Interpretation and Application of Each Verse Appendix II. Aphorisms Appendix III. Acronyms Appendix IV. Formulas Bibliography

I.

Introduction

Principles of good sense and sound behavior long endure and widely apply. A truly sound philosophy can provide valuable guidance in a surprisingly wide variety of times and circumstances. Much of life turns out to consist of finding ways in which lessons learned in one context often apply to other contexts as well. For example, 25 centuries ago in China a man known simply as the Old Master wrote a poem to guide his people and especially the rulers through troubled times. The Chinese call that poem the Tao4 Te2 Ching1 (pronounced Dow Duh Jing), which can be translated as Guidebook to the Way of Virtue (more commonly as the Classic of the Way [of both reality and wisdom] and of its Virtue [human application]). The Old Master (Lao Tzu, pronounced Loud-zz) wrote in a time and for a culture far separated from ours, but I believe his ideas fit everyday life here and now. Some people call this poem mystical, but I believe it is clear and eminently practical common sense. Lao Tzu never heard of capitalistic financial investing, much less the Dow-Jones Average of stock prices of major American industrial companies, but I have found that his principles assist in stock market investing. That application is what I call the Tao of the Dow, i.e., a Way to invest. The Tao Te Ching basically enunciates two primary principles which I will call Cosmic Harmony and Harmonious Balance. Flowing from these are the corollary principles of careful, open-minded examination of past and present, imaginative and prudent foresight, patience, self-control, economy of action, independence of analysis and decision, modesty, generosity of spirit, honesty, steadfastness in plan, and agility and adaptability in application.

A. Cosmic Harmony
By Cosmic Harmony I mean external harmony between the self and the outside world. This comes, not from mere lazy passivity or fatalism, but rather from closely observing reality and purposefully adapting ones own behavior to that reality. This examination of reality looks for truth, in the manner of a scientist, a judge, or a financial analyst. This adaptation is like that of the old-fashioned rag sailor, who depends on his sails to propel his vessel. He cannot get out and push the vessel; he has no engine on which he can turn up the power. Yet he does not passively drift wherever the wind takes him. Instead, he quietly and constantly observes the wind, the current, the waves, and the shore, and fine-tunes the position of his rudder and the trim of his sails to harmonize his vessel with the uncontrollable forces of nature to navigate his intended course. In a similar way, the prudent investor observes closely the geographical, political, economic, and psychological realities, the progress of particular products and companies, the trends of prices, interest rates, and so on, and acts accordingly.

8 Professional investors have a saying, The trend is your friend. Successful investors watch for trends and use them like a favorable wind. They dont fight the trend, even if it is only caused by a mere fad in the mass psychology of the market. Yet they keep attention on their goals and longer time periods, and remain ready to adapt to new information.

B. Harmonious Balance
The other major principle of the Tao Te Ching or Taoism is that of Harmonious Balance, or internal harmony. The ancient Greek Stoics called this same idea the golden mean, but most of us would call it the happy medium. The idea here is like the experience of Goldilocks (in the childrens story of the Three Bears), who tried food that was too hot, too cold, and then just right. The basic idea is to maintain personal balance. The most obvious investment applications flowing from this principle include: 1. First, the prudent investor tries to keep emotions in balance, because success depends on avoiding impulsive actions resulting from extremes of overconfidence when things are going well and of panic and despair on each setback. 2. Second, and related, the investor must position the individual portfolio as a balance to the market, buying what the market has neglected and selling what the market has overemphasized. This is called buying straw hats in the winter, when prices are low. 3. The portfolio itself needs to be balanced, as discussed below. Market terminology uses different terms for different aspects of this balance (asset allocation, diversification, cost averaging, etc.). At the opposite end of the civilized or developed world in the ancient classical period, the Greek Stoic philosophers also emphasized essentially the same guides to human internal and external behavior: harmonious balance and harmonization with the real world. The differences between the modes of expression of these two groups of philosophers do not represent real differences in the underlying ideas. The Stoics used the term Golden Mean, conceived as a middle ground between extremes, as the term for the goal of harmonious balance. The Taoists, by contrast, refer to the union or complementarity of opposites, but the idea is similar. Similarly, the Greeks tried to analyze and reason out the fundamental nature of the world, while the Taoists sought to be in harmony with nature, with the flow of natural events in the world. As any scientist or sailboat skipper knows, these two processes are essentially the same. One must be aware of and attentive to the principles or persistent tendencies of the real world (the scientific laws) and set ones mind and body in step in tune, in harmony with them to make effective progress. The Greek version of this principle of close attention to the real world has grown into the modern scientific method. The Taoist version has traditionally been associated only with a certain mental state sought for the sake of inner peace. Yet a few modern Taoist scientists have recognized the essential identity of the single principle underlying the two modes of expression of the importance of

9 close attention to the real world, undiverted by prejudices, preconceptions, labels, or opinions. We may briefly refer to this principle as that of cosmic harmony. These two guides to action can profitably apply to investment strategy as well as to other aspects of life, with effectiveness arising from the same qualities which make them so valuable in the phenomenological sciences and for psychological health, even though the earlier formulation of these guides did not specifically have securities investment in mind. Readers interested only in the practical application of this approach to investing in financial securities (stocks, bonds, cash equivalents, and derivatives of these) may skip chapters II and III, which refer to the general philosophy suggested here.

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II. Harmonious Balance

A. The Unity of Harmonious Balance with Cosmic Harmony
One quality of cosmic harmony is conformity to the real nature of the world, implying common sense attention and adherence to reality. That quality clearly arises from the principle of attention to the real world and the effort to conform ones own thoughts and action to the pattern of the outside world. This does not mean passively going along, like the proverbial sheep; it means trying to learn what is real and to act in recognition of that reality. One of those realities is that people, like all forms of life, function best in a certain range of conditions. Outside that range come various degrees of discomfort, reduced effectiveness, and, at extremes, disaster. The middle of that range is the Golden Mean. If we are too hot, dry, stuffed, or oxygenated, we die. If we are frozen, submerged, starved, or suffocated, we die. Near those extremes we are uncomfortable and inefficient. Near the Golden Mean we are healthy and able.

B. Harmonious Balance in General

Thus, harmonious balance itself arises from cosmic harmony. Yet harmonious balance does not mean finding some middle ground and calcifying there. Staying in one situation at all times is also a kind of extreme. We need exercise for mental and physical health, but not to the point of exhaustion. We need mental concentration to develop our minds, but not to the point of utter frustration. We need a variety of kinds of food for health, and a variety in many aspects of life to make it interesting and enjoyable, and to maintain our ability to cope with changing circumstances and make the most of opportunities. In these respects, too, a human being needs balance not necessarily perfect equality of all aspects of life, because people differ in their need for and enjoyment of various aspects but sufficient variety to maintain interest, health, effectiveness, and adaptability. A human also needs a certain amount of stability in certain aspects of life, but the search for unchanging stability often leads to unfortunate rigidity, forcing oneself or others into unreasonable, even unbearable courses of action or experience, or to inability to cope with change. What one needs is not a single, immobile, rigid, dogmatic straight line, perfectly poised between unbearable extremes, but rather a dynamic equilibrium constantly correcting tendencies to excess. The chemical processes which characterize, maintain, and perhaps constitute biological life illustrate such a dynamic equilibrium. A living body cell is not limited to being able only and always to produce various chemicals at one rate. Instead, it has a variable capacity, and in practice produces more or less of each under varying circumstances. If some chemical which it needs and produces is, for whatever reason, being used up too fast or is still in inadequate supply, the cell will increase the supply. If some chemical is in excess supply, a healthy functioning cell will reduce its production. Thus, not by a rigid inability to change, but instead by constantly adapting to the actual situation, the cell maintains its balance. The Wright brothers may illustrate the same point in a different way. In the early years of experimentation with vehicles intended for flying, the principles of lift from air flow and the

11 consequences on the design of the shape of flying machines led to some fairly successful gliders. The invention of the internal combustion engine provided a light enough source of power. Yet early experimenters died in the attempt to build an aircraft stable enough to avoid tipping over and crashing. The important contribution of the Wright brothers was that they had learned from making bicycles not to think in terms of stability, such as a rail car gains by having four wheels, but in terms of continuous balancing, as a cyclist does. A bicycle is inherently unstable, but in motion is easy to keep balanced by positive balancing action. By observing birds they learned about steering a flying object, and used that learning to find ways to achieve a dynamic balance instead of static stability. From this finding they put together all these elements to make an airplane that not only flew but initiated an entire new and important aspect of human life in this world. These are illustrations of the goal of harmonious balance. In subatomic physics the nature of reality appears to consist in the interactions of discrete bits or packets of whatever composes the world and these appear to have a number of opposite characteristics. Electric bits are positively and negatively charged, different spin categories are recognized, etc. On a larger scale we are familiar with the north and south poles of magnets. These all seem to be opposite, or at least different, yet they are compatible they act together to make our world what it is. We do not need, and we would not want, to eliminate, say, all the negative charges in the world. A world of protons would not provide an adequate place to live. The harmonious balance of these opposites constitutes the core of reality and a healthy environment. A biological example was given above. Another is the presence of males and females in a wide range of species. The sex differences provide advantages to a species in adapting to changing needs. That advantage is so great that sex differences are fundamental throughout most of the more complex and even some of the simpler parts of the biological world. The mean or balance is not achieved by a single average form, but by a healthy dynamic balance between two (or sometimes more) rather different forms. The same principle applies as well at the psychological level. The stress of immediate problems may at times seem overwhelming. We may then rail against reality, but that behavior achieves nothing useful. Instead, we may retreat from reality. Yet a total and permanent rejection of reality usually also does not succeed, and often only worsens the problem. A brief retreat from reality may however be healthy if it means accepting the basic truth of reality but turning the mind briefly to other pursuits in order to regain ones mental balance and perspective, and rest it from discomfort. Hereby we can regain an internal harmonious balance. Similarly, the push of urgency or necessity or responsibility sometimes may make us push too desperately on others, passing on our tensions and emotional pain. If we can try to regain some of our own internal balance, and think about our effect on the world in which we live, we can make it better for ourselves and others. If we all or most of us do that, we shall all live in a world more like what we prefer.

12 We cannot eliminate emotion from our nature, and could not get much joy from life without it. Yet we can try to balance our emotions, so that we do not lose control and cause harm from venting an excess of anger, sinking to an excess of grief or despair, taking unreasonable risks in a fit of euphoria, losing the power to function in a paroxysm of fear or a cloud of depression, exhausting the body or psyche in some manic enthusiasm, or losing sight of crucial considerations in life through some narrow and obsessive fixation. Balancing activity and balancing thoughts can help to restore a degree of balance in emotion. The object is not a straight line of emotional death, but a damping of extremes and a balancing of the humps and swales toward a range of reasonable emotional health. At still more complex levels, the goal of harmonious balance is crucial for societies, of whatever size and complexity of organization. The modern invention of consciously written national, state, and association constitutions and charters attempts to apply some of what we have learned about this principle to social organization. (The same is true of statutes creating and constituting local and special governmental agencies, city and county charters, corporate charters and articles of incorporation and partnership agreements.) Power is centralized for certain purposes but with balance to prevent is monopolization and consequent abuse by any one element (or limited group of elements) within the society. We have not yet mastered this process fully, which should not be surprising since we have not yet fully mastered it at the simpler level of psychology of the individual human being. But we have learned much. The particular techniques of achieving the goal of harmonious balance in particular types of situation are the proper subjects of consideration by particular sciences and arts. The fundamental principle of seeking such a goal, and what we mean by such a goal, is a main constituent of the Way (i.e., the Tao). From harmonious balance flow patience, self-control, economy of action, modesty, generosity of spirit, steadfastness in plan, and agility in actions.

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III. Cosmic Harmony in General

The practice of paying close attention to reality and of acting in accordance with what one learns is practical, and is what successful, healthy, and intelligent beings do naturally, whether they are human or not. Sometimes, however, 1. Their emotions make them forget what they have learned, or 2. Their circumstances become too complex for them to fathom, or, 3. If they are human, they are taught misleading and unhelpful ideas. The Tao attempts to return to basics, restore the common sense perspective, and deal with these problems. The goal of seeking harmonious balance is the attempt to overcome the first problem. The practice of observing reality closely and directly is the attempt to overcome the last problem and to cope with the second one step by step. Observing reality attentively does not mean merely looking at sunsets and rivers and mountains and other aspects of what we sometimes narrowly call nature. Everything that really exists is part of reality. Nature includes the tendencies of physics, chemistry, biology, astronomy, and geology, but it also needs to be recognized as including human nature (psychology), the nature of group behavior and of ideas (sociology), and the nature of reasoning and philosophy itself. We learn about reality from looking at all of these things, and from thinking carefully about (not their essence, as the Greeks tried to do, but rather) what consistent tendencies appear in their behavior. We seek to know, not what they are, but what they repeatedly tend to do. Trying to act in accordance with reality does not mean passively blending in, following the next person, accepting foolishness and cruelty, insensitivity and selfishness, or any other form of meanness of spirit, as ones own method merely because many others seem to regard that course as realism. It means looking at the capacities and needs of the real world and seeking to adapt ones own course so as to utilize these toward building an ever better life for us all. Cosmic harmony means fitting ones methods to the tendencies or laws of nature, including human and societal nature, to achieve ones individual objectives. That does not mean fatalism, saying nothing can change, for history shows that the most repetitive of all human and societal tendencies is to change. It does not mean following the current fads of diet or thought, for history shows that the most repetitive of societal tendencies is for such fads to change. (Such fads sometimes go to foolish and even unconscionable extremes.) It does not mean blindly following societys current direction, even if bad, under the excuse that I cannot make a difference among so many, because society is only made of individuals, and thus every continuity or change in the behavior of a society consists in what each individual human does. The push or urgency or necessity or responsibility sometimes may make us push too desperately to achieve some short term, highly personal or narrow-group objective, struggling to overcome nature or the natural processes. Western civilization tends to describe its successes as coming from such behavior. In fact, successes more often come not from opposing but from utilizing some natural law

14 to achieve a desired objective. We cannot, without excessive effort, stop the flow of a river; we can often use and redirect that flow in a more helpful direction. We cannot overcome gravity. We can, however, use it or some other principle, such as aerodynamics or buoyancy, to make a flying vehicle. Major social projects sometimes excessively disrupt pre-existing natural environments. The authors of the projects may feel that the value of the project outweighs the damage done. Indeed, it may. But often the damage done is inadequately considered and exceeds what was needed. A more careful plan might have gained much of the benefit without much of the social cost. Failure to observe reality often blinds us to the full range of consequences of a contemplated course of action. We only look at a narrow and see little potential harm. Those who think only of the next quarters bottom line, without regard to the public weal, fall uniformly in that category. Such reckless approaches lead often to wreckage of the very enterprise which undertook the action and for which the benefit was intended. A convenient or expedient or practical but anti-social or short-range action often leads to very impractical results for the doer in addition to the misfortune to his society. After all, humans live in societies because it is generally to their advantage to work for the common good. Each gains (or loses) from the action of each. Likewise, each part of the entire ecosphere affects every other part; all of life is in some degree a common enterprise. Certain competitions are practical among its parts, but not an action which tends to harm all life. The Tao Te Ching expresses these ideas more elegantly, more succinctly, and more poetically. Details of their application could be compounded infinitely. The wisdom of humanity consists in a very few principles learned slowly over the millennia, and a continuous process of rediscovering their applications to a never-ending list of circumstances. Here the only further examples will be more specifically those related to the application to investing of the two principles of harmonious balance and cosmic harmony. From the principle of cosmic harmony or conformity to reality flow the corollaries of (1) careful (and open-minded) observation of past and present, (2) logical foresight based on trend analysis, (3) independent analysis and decision, and (4) adaptability in action.

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IV. Financial Securities Investing Defined

A. Investing
Investing here means setting aside a little of todays resources to increase tomorrows opportunities. It includes acquiring or improving some natural resource, creating or acquiring some tool, forming or obtaining an interest in some enterprise, acquiring some object or substance or right, lending something, or otherwise making some contribution to society or to the development of something which will be of value to society or some person. In current local usage it includes creating, buying, or lending some property. (The terms used here are to be considered in their broadest meaning. A tool includes anything of use to humans [buildings, clothing, roads, ideas, machinery, crockery, holding tanks, heating and communications systems, vehicles, etc.] A property includes both physical things and rights, i.e., privileges which society grants for some social purpose to its members and which they can individually buy, sell, lease, or otherwise use to increase their claim on the total benefits of society.) Some people characterize investing as gambling, but this is not an accurate perception. Investment always involves risk, as does all of life, but a sound investment is based on a careful and realistic analysis of actual information about the subject, including awareness of direction, velocity, and consistency of trends. In other words, in investing, we try to minimize the risk aspect. By contrast, the essence of gambling is maximization of risk and minimization of information on which logical judgments can be made. Indeed, possession of such information is considered cheating in a gambling situation, whereas failing to provide it is considered cheating in an investment situation. The original reason for the distinction was that all life involves risk but an effort to control it through knowledge, while gambling was specifically invented to make choices uninfluenced by knowledge, either to resolve conflicts without taking sides, or to learn the will of the gods. Only later did gambling become a conscious game. As a game it has the advantage, in theory, of making all participants equal, so that the weak or the foolish have as much chance as the strong or the wise. Now it is to a considerable extent a business enterprise by large organizations, which deliberately set the odds in their favor. In this form, what is gambling to the individual is sound business to the gambling house, the manufacturer of gaming machines, and the insurance company, because these businesses are able to play the averages and win. For them, that activity is economic. But in this sense they are not gamblers anymore they know what result to expect over time. The prudent investor takes risks but never gambles.

B. Financial Securities
By financial securities is meant interests in ownership, debt, money, their equivalents, and derivative interests. The basic securities are (1) shares of stock of business corporations and (2) tradable long-term debt of those corporations. A buyer of debt becomes a creditor of the company, and thus entitled to interest and principal payments from the company. Technically, tradable long-term debt consists of debentures, which represent unsecured debt, and mortgage bonds, which are secured by

16 the right to foreclose on certain property, such as land, buildings, machinery, aircraft, ships, railroad cars, etc., if the debt obligations are not timely paid. In looser usage, the term bonds often includes both types of debt paper. Stock includes both common stock, ownership of which may result in receipt of dividends and usually entails a right to vote for the board of directors and proposals to change drastically the nature and organization of the company, and preferred stock, which usually involves dividends of a specified amount out of profits, but no voice in most corporate decisions. Derivative securities include shares of mutual funds, which are companies, called investment companies, which invest in the shares or debt of other companies. Investment companies may be closed-end, meaning that they issue their own shares once at the establishment of the fund, and rarely after that, and trade in the market like any other stock shares (e.g., General American Investments, traded on the New York Stock Exchange under the symbol GAM). Open-end investment companies, on the other hand, continuously sell shares in themselves to the public and buy them back in (called redeeming them); owners do not sell these shares to other individuals; and the number of shares outstanding thus constantly changes. Options are also derivative securities. In this sense an option contract is effectively an enforceable promise by one person, the option writer or seller, to obey anothers (the option buyers) demand to buy or sell a certain amount of the underlying security (say, 100 shares of stock) at a specified price. The writer is willing to make such a promise in return for a payment of cash (called a premium) at the time the promise is made. This premium payment is completely separate from any payment that must be made if the underlying stock is actually bought or sold. The demand is called exercise of the option contract, and must be made, if at all, only within a time specified by the original option contract. Option sellers do so mainly for the premium, hoping that exercise will not occur. Option buyers do so either for speculation to take advantage of price movements or for insurance against adverse price movements. The level and movements of the stock (or underlying security) during the life of the contract (between its open and its close) determine whether exercise of the option makes investment sense and hence which contracting party gains and which loses. The two types of option contract are named puts (buyers right to sell and writers obligation to buy the underlying security) and calls (buyers right to buy and writers obligation to sell the stock or other underlying security). An intermediary company sets the terms of the option contracts, but supply and demand determine the premium at which each trade occurs. Other derivative securities also exist. Warrants and stock rights resemble options, usually conferring a right to buy stock at specified prices, or to buy stock below market value, but their terms are usually set by the company which issued the stock. Indices are averages of various groups of stocks, weighted in various ways. Index options are option contracts similar to those mentioned above, but ties to the level of the pertinent index rather than to prices of individual stocks. Futures and commodity options may also be considered securities, but lie outside the scope of this manual.

17 Other categories of financial securities also exist. Unit investment trusts are like mutual funds, but differ in keeping essentially the same portfolio throughout the life of the trust. Partnership shares are sometimes traded like financial securities, but for reasons too complex to discuss here, I would generally avoid them, whether limited or general. My experience with them has not proven satisfactory. Real Estate Investment Trusts (REITS), which also trade like stocks, attempt to profit from real estate ownership or lending. These instruments will not be specifically discussed further in this manual.

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V. Harmonious Balance in Investing

The goal of harmonious balance is crucial in investing in at least six respects: A. B. C. D. E. F. Psycho-Strategic Balance Emotional Balance Market and Selection Balance: Avoidance of Extremes Chronological Transactions Balance Portfolio-Holdings Balance Approach Balance

A. Psycho-Strategic Balance (Appropriate Goals)

The investor must adapt his/her investment philosophy, strategy, and tactics to his/her own individual objectives and personality. If the attempted approach is not in balance with the individual human outlook and nature of the investor, or is not directed specifically toward the individual investors real life goals, then the result will not be satisfactory. (1) In particular, in terms of goals, the investor needs to think about the relative value, to him/her, of: (a) Opportunity versus safety, of (b) Short term versus long term, in timing, of (c) Current income versus growth of principal, of (d) Current and likely future income, other resources, needs, and obligations, and of (e) Possible future needs arising from loss of employment or ability to work, funds needed for education, retirement, illness, and death. (2) An investor also needs to consider his/her own emotional (a) Level of patience, (b) Tolerance for volatility of price, (c) Ability to decide independently or accept advice, (d) Risk tolerance, (e) Interest and enthusiasm, (f) Diligence, and (g) Consistency.

B. Emotional Balance (Reasoned Action)

In abstract theory, investment should be approached logically, although, like much of reality, forecasts involve an element of risk (uncertainty). When a person has actually invested money, whether for oneself or for another, however, emotion tends to become deeply involved. Consequently, when prices are rising, the investor tends to become overconfident and buy eagerly, even recklessly. Because this is happening to many people at the same time, the euphoria all around tends to exaggerate the effect on the individual, and on the market in general. Similarly, when prices fall, the investor may tend to lose confidence, even to panic, and sell when prices are low. The consequence is a strong tendency

19 to buy when prices are high and sell when prices are low exactly the opposite of a successful investor who, by definition, buys low and sells high. Of course high and low are relative, and in retrospect may seem very different from how they seemed at the time. The important point, however, is that emotions tend to motivate us to do exactly the opposite of what is prudent and sensible. An important principle in investment buying and selling therefore is to keep the emotions in balance, or at least exercise self-control over actions: avoid manic (reckless) and depressive (panicky) actions. Do not become overconfident no one and nothing can climb to the sky; do not become overly discouraged the world is not yet about to end. In either case, the market will turn. There are times when a recent price rise implies a future price rise, or a fall suggests further falls, but these must be evaluated by reason and not by emotion.

C. Market and Selection Balance (Independence, Avoidance of Extremes)

For the same reason as outline in section B, the market (the general tendency of prices) tends to go to extremes. Prices will rise farther than is reasonable, then fall farther than is reasonable. This tendency creates risks sometimes prices are too high for a purchase to work out well, sometimes too low to permit a reasonable gain from a sale but it also creates opportunities (buy when prices are too low, sell when too high). Essentially, the principle of balance dictates avoidance of extremes, whether in ones own psyche or in price levels. The exception is the investor who is doing the opposite of the markets tendencies, because here another kind of balance is in play: the market will ultimately balance itself by swinging back and the individual investor can gain by balancing out the market extremes. Great caution is needed in doing this, however, for there are risks to going against a current trend. Thus it is important to recognize extremes. The reasonableness of a price depends ultimately on fundamental analysis (see below), but the technical analysis is particularly valuable for determining trends, extremes, and likely turning points. For example, when everyone seems overoptimistic and prices (or a particular price) are unreasonably high, or when prices (or a price) rise at an accelerating rate, it may be time to stand aside or even sell; and vice versa. This principle applying to the market in general, also applies to individual securities, especially stocks, mutual funds, and options.

D. Chronological Transactions Balance (Cost Averaging)

Partly to avoid the excessive effect of emotions and partly to avoid the pitfalls of unexpected or unforeseeable market-trend shifts, a wise procedure is a measured pace of gradual change of investment stance: if an investor wants to buy (expecting a sustained rise in the whole market or in a major part of the intended investment portfolio), gradually buying in over a period of time (months or years) is often prudent (called cost averaging); likewise in selling, expecting a major market decline, it is sometimes useful to sell a little at a time, gradually over time.

20 These procedures require self-control and patience, do not suit everyone, and are not always appropriate (especially where the particular item is to be only a small part of the total investment portfolio), but I believe they produce superior results when an investor is trying to time a primary (relatively long term) market change or moving into a particularly risky investment area. When buying of a single security is done at exactly equal intervals of time and in exactly equal dollar amounts, purchasing in this measured, balanced way is called dollar cost averaging, and is common in acquiring substantial holdings in mutual funds, but it is just as sensible in moving into an industry and moving between different major asset-type allocations. When it involves buying more shares when a stock falls, it is called averaging down; when it involves buying smaller amounts as a stock rises in price, it is called pyramiding. In selling, it has no name, but all of these examples are applications of the same idea, which is balance in the timing of major changes in the investment portfolio.

E. Portfolio-Holdings Balance
Because no one can forecast the future with absolute certainty, some allowance must be made for the unforeseeable. The solution is not a search for the absolutely safe investment, like the search for stability in early aeronautics; as in the case of the Wright brothers, the solution instead is a dynamic balance. Viewed another way, balance in the portfolio allows the investor to gain from one class of investment to offset potential losses in another. There is no safe investment. Stocks can grow more than most investments, but call fall rapidly, and do so at irregular intervals they tend to be volatile. Bonds vary less in dollar value, but may lose in purchasing power when inflation occurs. They also change value depending on prevailing interest rates. Money-market funds are liquid and retain dollar value essentially unchanged, but deal with inflation even less well. Several kinds of balance are needed in a sound portfolio. The appropriate proportions of each element of the balance varies according to the needs, resources, and personality of the investor. The various facets of such portfolio balance are outlined below, with their customary names as used in the market. 1. Asset allocation: shifting trends among: a. Equity (participation) in enterprise for profit (=stocks), which also come in severl classes, among which a portfolio should be properly balanced: (1) Cyclical (rise and fall with economy); (2) Growth (tend to grow at most or all times); (3) Growing income (utilities); b. Debt (=bonds) provides fixed income, sometimes capital increase; one must vary maturity dates; c. Cash equivalents (=money market funds, etc.) Provide liquidity for emergencies or opportunity or allow waiting in time of uncertainty; provide limited interest; d. Physical assets, which protect against massive inflation:

21 (1) Real estate (2) Gold, etc. 2. Diversification a. Different types within each asset allocation (growth, cyclical, emerging, yield stocks; or bonds of different degrees of credit risk, different maturities, different debtors, etc.) b. Different industries c. Different companies d. Contra-cyclicals, i.e., companies whose individual cycles tend to offset each others cycles (for example, gold mining companies versus interest-rate sensitive companies, heating supplies with warm-weather products, etc.) 3. Geographic balance a. Different localities for local public utilities and regional banks b. Different global regions for world-class stocks 4. Risk balance: foreseeing the unforeseeable (because the future is never fully foreseeable, it is prudent to balance obviously riskier investments entered for their greater potential gain with apparently less risky investments, and keep the former to a limited percentage of the latter.) It is also prudent to provide protection against each of the major risks: a. Market or volatility risk (prices rise and fall); b. Credit risk (debtor doesnt pay); c. Interest rate risk (interest rates may rise, reducing value of existing long-term bond); d. Currency rate risk (risk that currency in which the purchase is denominated [e.g., marks or pounds] will fall relative to that which the investor must use to live [e.g., dollars]); e. Inflation or purchasing-power risk (prices for particular goods and services used by the investor may rise more than the value of the security); f. Quality risk (investment may simply prove less valuable than expected because the issuing entity is not as economically sound as expected).

F. Balance in Approach (Adaptability, Flexibility)

Whatever approach the investor or trader takes in all of the above mentioned respects, occasions will still occur when a change of direction or portfolio proportions or methods will be needed. Balance in approach means avoidance of rigid attachment to a single approach. An investor needs a consistent, basic strategy, but must maintain adaptability and flexibility in details, making reapportionments from time to time (especially in different phases of the economic cycle or of company development), and dealing with new circumstances as they arise, whether in the nature of new problems or new opportunities. The Tao Te Ching and other Asian scriptures speak of avoiding attachments to things. In the mundane practice of investment, the prudent investor avoids falling in love with (becoming emotionally or habitually attached to) one stock or tactic, to the point of using it at an inappropriate time.

22 Balance in tactics implies modesty about previous positions and expectations, patience coupled with adaptability, self-control, generosity of spirit toward trading partners (the other side in the contract), economy of action, and a balanced plan steadfastly applied.

23

Diversification among Stock Types (above) and among Growth Stocks (below).

24

25

VI.

Cosmic Harmony in Investing:

A. Initial Comments
As indicated above, by cosmic harmony is here meant conforming behavior to fit reality. Aside from avoidance of wishful thinking and emotional responses, the difficult part of this process is discovering reality and its significance. The universe is whole and interacting, so everything influences everything else. Humans, however, with finite minds, cannot absorb the whole; we must settle for bits and pieces of information which we evaluate in light of each other and of past experience. We therefore never have enough information, but life requires decision on the basis of this limited information. We therefore must make judgments on how much effort to devote to gathering information, determining the relative weights to assign to various parts of it, and elucidating the relationships among the various parts of our data. A successful search for truth, for reality, requires intellectual honesty, independent analysis, and ignoring prejudices, preconceptions, labels, and opinions. We have to look beyond the words to objective reality. Discovering truth leads to the old conclusion that honesty with others, humaneness or generosity of spirit, and the golden rule, regardless of temporary temptations, really do constitute the best long-term policies, which do not permit exceptions. A reputation for honesty has great value, but a single breach will destroy it beyond repair. Factors most pertinent to financial securities investing are: 1. The background milieu, including such subjects as a. Economics (1) World (2) Regional (3) National (4) Provincial (5) Local (6) Enterprise b. Politics (1) Policies and practices of official government at all levels (2) International trends and demands c. Resources (1) Social Policy (2) Physical resources (3) Routes (Many other background factors are also relevant but not discussed in detail in this little book, such as the fundamental directions and current status of science, technology, education, demography, etc., and particularly the geographic, chemical, biological, sociological, and ecological facts which affect human life.) 2. Fundamental Analysis

26 (the attempt to discover true value of a security, relative to other investments, on the basis of actual and projected business considerations) 3. Technical Analysis (the search for patterns of mass psychology affecting prices of financial securities)

27

VI. Cosmic Harmony in Investing, Continued

B. Environment
1. Economic Environment a. Nature of Economy The nature and current status of the general economy in which investment is under consideration is obviously a crucial aspect of the investment environment. Ours is a mixed economy, in which several types of organization operate: (1) Individual autonomous subsistence activities (such as hunting, fishing, gathering berries and roots, etc.) which may involve sharing (within the family unit), but do not involve formal exchange this form of organization, unlike all the others mentioned here, is disregarded in virtually all national economic statistics and is not subject to the laws of economics taught in the schools (all others below are); (2) Individual and family enterprises, in which one person or family provides all the labor and capital, but the product or service is exchanged for money or barter; (3) Cooperatives, in which several humans participate as approximate equals, with various kinds of organizational structure; (4) Sole proprietorships, in which one person owns and manages the enterprise, though often borrowing funds for capital and hiring employees for labor; (5) Partnerships and joint ventures, in which more than one person operate the enterprise jointly, sharing profits, losses, investment, management, and liability to lenders, suppliers, employees, and customers, operating otherwise in a manner similar to a sole proprietorship; (6) Limited partnerships, in which one or more partners have management and liability, and others merely invest for a share in profits; (7) Corporations, which have the status of separate legal persons functioning like sole proprietors, but operated like a sort of subsidiary state, with a ruling group (board of directors) elected by the investors (shareholders) overseeing officers and a general manager (chief operating officer or CEO); (8) Associations (such as clubs), a form of little interest here; (9) Trusts; and (10)Public entities, such as governments of national, state, and local jurisdiction, schools, libraries, hospitals, research institutes, etc. Think tank futurists now argue that future enterprises will be characterized by more equality among the humans comprising the enterprise; more individual autonomy and initiative; flexibility; more widely distributed decision making; and perhaps a more responsible approach to the common good than has generally characterized business enterprise in the past.

28 b. Financial Securities: Relationship to Organization Forms Financial securities generally arise from the activities of business corporations owned by groups of individual humans, usually in considerable numbers, and by retirement funds, trusts, and other corporations. c. Classic Economic Laws In our society, some classic economic tendencies have been noticed. These were largely described by Adam Smith or others in the period (though some of these principles were known before that) when physicists were discovering the gas laws and atomic theory, and are therefore phrased in language and concepts similar to those scientific laws, i.e., they assume a perfect system with no friction, composed of elements of infinitely small size. Just as Boyle and Charles described how the atoms in a gas act, treating the atom as having no size (a point moving in space), Adam Smith describes an economy on the assumption that no individual enterprise or source of economic activity or resources is large enough for its size to matter, with each able to move infinitely far in a trivial time. This approach sufficed for his time, because his purpose was to ameliorate the economically stultifying restrictions imposed, and the special privileges and favoritism granted, by royal governments. For our time this simplicity in theory hides some defects in the analysis, but, keeping the limitations in mind, we must remain aware of the fundamental observations of classical economic theory: Law of Supply and Demand: In a totally free, equal, and competitive economic system, the price of a commodity, service, or other economic good depends (in part) on the supply (wide, easy availability tends to reduce price) and (in part) on effective economic demand (the desire to have it, coupled in the same person with the ability and willingness to pay for it). Demand, in this instance, depends not only on human needs, perceptions, and desires, but on the presence and distribution of buying power, which in turn depends to a considerable extent on the preservation and distribution of the results of prior production. The extent of price variability differs, however, from one type of economic good to another, depending on the flexibility or elasticity of supply and of demand. For example, in a hot country salt may be a necessity; therefore demand will always be relatively high; the amounts of salt obtainable are limited to some degree by mother nature; and therefore the price is unlikely to fall too far. On the other hand, some fad item or more discretionary purchase may have a great elasticity of demand, commanding a very high price at one time and place and an extremely low one under other circumstances. Each potential buyer has a series of prices at which that person is willing to buy certain amounts of something, and each seller similarly will sell different amounts at different prices. At some prices the seller may be unwilling ever to sell any, because the cost of production to the seller is too great to allow such a sale to be worthwhile or even acceptable, and at some prices the buyer will not buy. These series can be represented graphically as a series of points (or a curve in algebraic language). Sales occur, theoretically, at prices and in quantities revealed by the intersection of these curves. These intersection price levels are called the equilibrium prices because at these levels the supply and demand are in

29 equilibrium with each other. Different prevailing price levels may cause different amounts of a good with high demand elasticity to be sold. Actually, Adam Smiths idealized, atomic economy differs from reality. To some extent, custom, regulations, subsidies, tariffs, discriminatory taxes, waste, uneven economic policy, frictions and distortions in the market, market power such as monopoly or oligopoly (limited suppliers available) or monopsony or oligopsony (limited customers, such as only a single user, e.g., a unique business or a government) will also influence prices, as will a government requirement of having that good (such as automobile public liability insurance). In fact, any actual substantial size of any market participant distorts to some extent the operation of the market, as does geographical distance, local licensing, and other factors. Allocation of Resources: The existing price levels tend to influence the use of the resources of an individual customer or worker or investor, of an enterprise, of a country, of an economy, particularly where less expensive substitutions may be made. Of course quality of a potential purchase item also plays a part. The supply and demand curves may be analyzed in terms of value from the viewpoints of buyer and seller. The buyer must consider how much he or she has available to spend, what other demands there are on those limited resources, how much is likely to come in the future and at what rate, whether prices are likely to rise or fall or stay the same, how urgent the purchase is, what benefits it will provide, what opportunities are lost by spending the money or other resources on this purchase, etc., in light of the marginal utility to the buyer of both the purchase and the wherewithal to make that purchase, The seller must consider the costs of production (or acquisition by the seller from the producer), how urgent the sale is, what is likely to happen to price in the future, the cost of carrying the item in inventory (if it is carried), etc. Each must seek to obtain the maximum utility available to that party from the transaction. The trade can be mutually beneficial, and is likely to be consistently repeatable only if it is mutually beneficial. Trade versus Subsistence or Autochthony: A system of specialization and exchange increases productivity and prosperity over a system of self-sufficiency. Hence wider free-trade areas commonly lead to higher prosperity. When internal tariffs kept China, France, and Germany backward a few centuries ago, their absence helped Britain to lead the world economically. The unification of Germany in 1870 brought it ahead of Britain, and when the U.S. grew larger, it became the leader. The European Economic Community and China today are making strides from their more recent movements toward internal economic unity. Inclusion pays. Exchange of ideas, too, leads to more efficient advancement of more useful ideas. Where ideas from different cultures cross at some country, whether because of trade, exploration, or education from other kinds of impetus, that country often becomes the dominant culture of the time. Such has happened many times in history. It also happens in business and science. Persons from different scientific disciplines or different industries often find ways to make a company or a field of research prosper from the interaction of these divergences and exchanges.

30 For this reason, attempts to monopolize or corner the market sometimes backfire. Open architecture in computers led first Commodore, Apple, IBM, and later Sun to prosper, because of the wide range of software which outsiders quickly provided to operate on machines produced by these companies. Texas Instruments attempt to corner the market in TI software effectively killed the sales of the previously popular TI home computer and drove TI from the industry. Elements of Production: Economists generally recognize that production of goods, or even of services, requires the input of human effort (labor), natural resources (land), and capital, but not all define these terms in the same way. Many say that capital is, effectively, money, because money can often be exchanged to obtain real capital. Accountants treat money as capital, so that both long-term borrowing and saved profits, as well as initial investment in a company, are lumped together as capital structure. Other economists mean by capital the means of production saved from prior production, which for most businesses means the machinery and other equipment, special rights and privileges (such as patents, franchises, buildings, roads, electronic systems, information, etc.), and similar things used to aid labor in accomplishing the goals of the enterprise. This is, economically, probably a more useful definition. A whole country can only slowly convert money into usable capital equipment, although a single company may be able to do so fairly rapidly. Some economists include natural resources as capital, because certain systems allow them to be bought, and also because prior work may alter the immediate practical availability of some natural resources, but other economists distinguish irreplaceable natural resources as a third separate element. Since the other two elements can be changed by economic activity, and natural resources, in this sense, cannot, the separate treatment of this element is probably a sounder approach. A few economists list entrepreneurship as a fourth factor of production, but this concept seems to mean merely the investment of time, effort, initiative, leadership, and control exercised in varying degrees by some business owners, which are all forms of service, i.e., labor; investment of money or land or capital, which are already included in the other factors; and assumption of risk if the enterprise does not do as well as planned. But all participants experience risk, so this is probably not really a separate factor. In economic theory, the factor payments are termed rent if for natural resources and sites (land), interest if for capital lent with a promise of return, profit if for capital contributed as part of ownership, and wages if received for any form of service. Common usage slightly alters the applications of these terms, but in economics each must be taken into account. Each of these interests, if paid for, constitutes a part of business expense, and therefore helps determine the prices at which a seller is willing to sell. Law of Diminishing Returns: Because a number of factors affect each part of the economic process, an increase in one may often result in higher production, but this effect will be strongest when the increase is in the production element which is currently the most limiting factor. When there is a surplus of one of the three elements of production, increasing that one will not increase production

31 much. Thus, if labor is in short supply, but there is plenty of equipment and natural resources are plentiful, one more worker (if healthy, intelligent, and properly educated and motivated), will increase production considerably. But if capital or resources are in short supply, one more worker will not add much production. Thus, if the one element of production is increased and the other two are held constant, there comes a time when each further addition to that one element will add less production than did the previous addition. This is the law of diminishing return. It leads to the Law of Marginal Utility or Cost, meaning that at some point a further increase in the surplus element of production will add so little production as not to be worth doing it the point of marginal utility. Some companies find a way to sell a significant part of their products at prices sufficient to cover fixed and variable costs, and in addition sell some (in a different market) at a lower prices, determined by the law of marginal utility, usually the variable cost without regard for fixed costs, which are unaffected by how many units are sold. Scarcity: Economists say there is scarcity because reality is always finite and human desires tend to be infinite, especially so in an advertising society. Hence, total wants tend to outdistance current availability of whatever people want. Bad money drives out good: If two forms of money both suffice as legal tender and one is less valuable, or holds its value less well, everyone will pay bills in the less desirable form and hoard the other, driving it out of circulation. This was more important when gold and silver, though having variable values like any commodity, served as money, at a set ratio. Now it is replaced in importance by currency-value ratios. A rising economy and higher interest rates will tend to make one currency more attractive and therefore rise in value relative to another (say, the mark versus the dollar versus the yen versus the pound, etc.). The weak currency is sold to buy strong currency to invest in the stronger economy or at the higher interest rate, further draining money from the weaker economy. The devalued currency, however, then effectively makes the prices of goods produced in the weaker economy less expensive in international trade terms, which may tend (usually only temporarily) to improve sales of such goods and thus improve the weaker economy. Inflation usually increases in the economy with the weaker currency. Economic Stages: Since humans have considerable capacity to recognize improvements in methods, a common historical sequence of development of manufacturing in a country or region is from primary industries derived from and immediately dependent on natural resources and crops (such as textiles, wood products, metallurgy, processing of food, fiber, and fossil fuels), through secondary industries (like vehicle, chemical, and other more sophisticated manufactures) to tertiary industries with most advanced technologies (currently electronics and gene-splicing, but later something now unforeseen). Commercial activity often garners better profits than manufacturing and the latter more than agriculture per person engaged in them and per acre devoted to them, but in each case only if a large enough hinterland or market area is accessible, in which the other, more basic industries still prevail.

32 International specialization: In an ideal economic world, i.e., one without wars, national subsidies, and obstacles to international trade, each nation, like each individual, would, according to economic theory, fare better trading freely with all others, producing what it produces most efficiently, and buying from others what they produce most efficiently, because that arrangement yields the highest productivity and efficiency, coupled with the lowest prices. The major obstacles to such an arrangement, however, are (1) inertia, because current change from a different arrangement creates current disturbances and dislocations during the adjustment process; (2) the perennial effort of each to gain advantage over others, urging others to open their markets while restricting or skewing its own; (3) the inability of workers to move about to get work or access to resources, as easily as money and trade move; (4) the lack of effective international monetary and regulatory standards; and (5) the threat of interruption of supply, particularly from wars. If a group of nations can agree on avoidance of war among themselves, and provide a mechanism to assure that arrangement, and to protect them all from outsiders, they could then dare to trust their economies to one shared economy. The world slowly struggles toward this goal. Private Enterprise: The value of so-called private enterprise lies primarily in allowing competition of methods and relatively objective measurement of efficiency by profit. Yet its social costs (damage to workers, neighbors, sometimes customers, environment) become excessive if government policy fails to assign those costs to those competitors who create those costs. Hence this system only produces a consistently satisfactory result if government performs that assignment adequately. Workers compensation programs, product-liability and environmental lawsuits, health and safety regulation, and similar programs constitute attempts to accomplish that assignment. Common Observations Outside Classical Economics: Honesty and fairness in administration yield higher efficiency in the economy. Where governmental or company officers abuse their position for personal gain at the cost of the society or the enterprise, the latter loses efficiency. Irrational and unjust discrimination hurts perpetrator, object (intended victim), and bystander. Those societies and companies which have not learned this are less promising places for investment than those which have learned and consistently applied these principles. This paragraph may sound idealistic, but history proves its serious practicality, and investors often rue having ignored these commonplace ideas. d. Effective Demand The environment in which a company operates obviously can affect the success of the company, and the most obvious pertinent aspect of the environment is the economic. Markets, meaning demand for products and services are particularly vulnerable to the current general health of the economy. A maker of factory machinery will sell more when other businesses expect to expand their sales and therefore need new machinery; a builder will sell more houses when people are able to buy them; a seller of clothing and entertainment will make more sales when more people are able to buy them. When times are bad, these kinds of sales will fall drastically. Ability, desire, and confidence among buyers are not precisely constant in respect to those kinds of purchases which can conveniently be delayed. The rise and fall of economic demand largely

33 determines the level of consequent economic activity aimed at satisfying that demand. Increasing efficiency of production or supply can increase the buying power of either producer or customer or both, depending on how that efficiency is used and how the proceeds of it are allocated, but the ability to buy constitutes a crucial aspect of effective economic demand. Those who do not have the means to buy cannot do so, however much they may want and need to do so. Ability to produce is therefore crucial to economic health, but so it effective economic demand. In modern industrialized countries, therefore, effective economic demand generally controls the level of economic activity. The rise and fall of effective demand produces the rise and fall of economic activity, to which we refer as booms and busts, or growth and recession, etc. This rise and fall continues in all economic activity, at varying rates of change and over varying periods of time. Some broad tendencies seem to dominate for certain periods of time, however, and the general level of the economy tends to affect individual companies and humans. Interest rates, wars, natural disasters or unusually favorable natural phenomena, new inventions, new discoveries, new methods, and other factors can affect these broad economic fluctuations. The institution of several social insurance programs during the generation after the 1930 depression in the United States, for example, has tended to balance out and soften the effect of adverse circumstances since then, keeping the economy from sinking excessively low excessively fast, so as to allow government and businesses time to survive through temporary problems and to correct more lasting ones. Still, if the respite provided by these programs is not utilized to overcome basic problems, the results may prove unfortunate. If an individual company does not adjust its methods to a changed world in which it finds itself, its decline is assured. If a nation does not correct fundamental defects during the respite, its future will be difficult. The principles of the Tao and of common experience favor allowing the people flexibility and the freedom to adapt to reality as their many eyes see it, but also requires protection to all from each, and that no minority may seize so much that the rest cannot survive or feel that they have no stake in the benefits of their society. Each should be allowed what that person earns, but not necessarily all that the person can lay hands on, and all must contribute in accordance to their ability to those common expenses which society can best provide in a common effort. Social costs incidental to business activity will only remain within reasonable bounds if those persons or organizations with power to control them have to bear them. For example, rates of worker injury are largely determined by the nature of an economic activity and by the policies of company management. If the resulting socio-economic costs are borne by the company, it will be encouraged to keep them within reasonable bounds, either by more safety-conscious policies (such as fenders or enclosures over dangerous moving parts of machinery) or by safer manufacturing techniques (such as use of robots for dangerous work, or a substitute product allowing a different process). e. Organizational Flexibility and Social Inclusivity We also need to allow a variety of approaches. The Tao opposes straining to attain some overabstracted, oversimplified, rigid system. Such systems always become tyrannous, whether they are

34 extremely chauvinistic, selfish, or socialistic. An unbalanced system, which tries to force all group projects into one kind of organization, becomes unnatural, oppressive, inefficient, and ultimately insupportable. A one-legged stool is unstable. Some needs of society are best provided, as experience has shown, by public institutions: (1) military, police, and other regulatory organizations, because those not under public control cannot be trusted with power to coerce their fellow citizens; (2) at least a certain level of education, because it is in the interest of society that all citizens reach their maximum potential, regardless of whether individually and unaided they have the means to do so; (3) public roads and other facilities, because everyone must have access to them, because establishing them involves the power to take or spoil privately owned land, and because the taking of tolls impedes the flow of traffic. Public assistance to the destitute and other unfortunates has become necessary because those most able to help them tend not to do so voluntarily on an individual basis to a sufficient degree, perhaps partly because our competitive system tends to penalize them for doing so. Still, some social needs are best provided by separate, competing enterprises. Competition, where it stays within the bounds of efficiency, quality, service, or even educating the customer to the value of a product, provides an objective measure of the success of techniques, and thereby can reduce excessive bureaucracy, correct inaccurate judgments and forecasts, reward initiative and perception, and thus improve the economy generally. The danger is from the short sighted, who seek quick profit through fraud, overreaching, shoddiness, planned obsolescence, and dangerous practices; from the narrow viewed who injured their neighbors, their environment, their employees, or their society through disregarding the interests of these; from the vicious, who abuse for other ends the power granted them to operate enterprises; the dishonest and unpatriotic who injure their society by shirking their tax, regulatory, and other social responsibilities; and the grasping who abuse their power, acquired for management purposes, to garner an excessive part of the returns from shared enterprises. Some of these separate enterprises are actually private, one-person projects, but most economic activity in industrial countries is carried on through large-group organizations such as corporations and cooperatives, often with many employees, many stock holders, many bond holders, many customers, and many suppliers: a team requiring teamwork. A society needs to protect itself, its citizens, and its valuable institutions from enemies and to provide its members a sense of self-worth, but some societies are excessively narrow and domineering, too exclusive of other societies, or even of various segments of the society itself, whether on a genetic, religious, linguistic, or other physical or cultural basis, or just on the basis of some more trivial definition of ins and outs. All of these tendencies in societies have their useful, worthwhile side, but any society which tries to press every aspect into one of the three extremes (of excessive public enterprise, excessive private enterprise, or excessive regulation) falls ultimately on hard times and creates great, needless misery in the interim. Every society needs all of these, mixed and melded in suitable proportion civic

35 organization, privately owned (but often shared) enterprise, volunteer organizations, individual activity, working in harmony, each in its proper sphere. Wholeness comes only from the union of divergence; health comes only from the balance of multiple functions. An unstable or unbalanced society will not provide a secure investment milieu. Hence, a prudent investor will tend to invest more in societies with these various favorable features and even consider them in evaluating the effectiveness of the internal organization of a business corporation. f. Economic cycles

For financial investment purposes, then, the prudent investor must examine the state of the economy at any given time, look for the direction in which it is moving, as a whole and in its principal parts, up or down, and for its health or soundness, its balance, and whether it can continue to progress as it has. If the economy is rising and sharing the rise broadly, building soundly for the future, investment in stocks for growth may be profitable. If the economy is declining, then investment debt may be sounder. If inflation has become, or is likely to become, rampant, investment in land and physical objects may be best. If the economy is superficially doing well, but its benefits are flowing into increasingly narrower channels or growth comes only by enlarging debt faster, or economic growth is exhausting a crucial resource like forests, soil, a mineral, or the good will of its own people or its neighbors, then the prudent investor knows a time of retribution and tribulation lies ahead, and plans for it. The prudent investor also looks for how to utilize the observable trends in the economy. If interest rates are about to fall, buying bonds may produce substantial and prompt returns. If productivity is rising and depressed conditions are about to improve, stocks may be better. If inflation and recession are to be combined, physical assets may be needed. If a quick and temporary drop in prices is about to occur, cash may be best. If leisure time, disposable income, number of households or children, accessibility of resources or tourist locations, or something else is increasing rapidly, an industry able to utilize that change to its advantage may offer appropriate investment opportunity. If one industry is making another, or a part of it, obsolete, prudence suggests avoiding or deleting the loser from the portfolio. Generally, at any given time, some parts of the economy will be growing while others shrink. In general, three major price cycles overlap in our current economy: those of stock prices, of bond prices, and of physical assets. When economic activity is rising, or is soon expected to rise, business enterprise profits are generally expected to rise. People therefore invest in ownership of those enterprises. For most of us, that means buying stock. This causes the prices of stocks to rise, as demand for stocks increases faster than supply. In practice, the stock price rise tends to begin an average of six months before the actual economic rise, because investors are trying to forecast the future of prices. Individually they make many mistakes, but en masse their combined transactions function together like a massively parallel computer, which forecasts reasonably (but far from perfectly) well.

36 If the economic recovery or up-swing actually materializes, stock prices usually continue to rise for some months or even a few years. The rise in activity normally results in more employment, producing more wages and hence more buying, leading to further economic improvement. If company managers expect this improvement to continue, the traditional response was the build new factories, improve technology, or otherwise make real capital investments, which often produce still more jobs, or longer hours, with further economic improvement following. If company management has not saved enough cash beforehand, or they want to preserve cash, they borrow money for this purpose. At the same time, improving economic conditions tend to induce companies and individuals to be more optimistic and therefore become willing to take on larger debt than previously. As more borrowing occurs, interest rates are pushed up, increasing costs to both corporate borrowers and individual consumers, as well as government. The rise of interest rates pushes down the value of existing bonds, so bonds fall as stocks rise. The prospect of this tendency in turn induces investors to sell bonds and buy stocks, thereby accelerating the tendency. As increasing economic activity causes the more rapid spending of money, the effect is to increase the availability of money. If this availability grows faster than the availability of goods and services, or if some companies selling goods and services are able to raise their prices in the improved economic climate (through monopoly, oligopoly, conspiracy, or other friction in the system), then these higher prices make other things cost more, and this more general inflation, plus more demand for workers, induces workers to try to raise their wages to make up for the lost ground. The prospect of rising prices encourages people to buy sooner, before the price goes up, thereby adding still further to the rise of prices. All these factors, also, tend to reinforce each other and lead to further inflation, which in turn tends to increase interest rates. Inflation increases the value of physical assets such as existing factories and machinery, gold, and land. In addition, inflation is to some extent built in by substantial control of some products by a few holders. OPEC, for example, keeps energy prices far above the actual cost of producing oil, as de Beers does of diamonds. Thus, in the later part of an economic cycle, gold has usually been rising, because people buy it to hedge against inflation. Finally, if interest rates rise too far, or debt grows too high, debt payments may choke off purchases of large items like homes, automobiles, factories, and other buildings; this is usually temporary, but produces a recession for some months, often more than a year. If the general population does not get back enough of the yield of the increased economic activity, they become unable to continue buying at the same rate; thereupon demand for goods and services declines, or fails to grow fast enough to pay the interest required for the new factories or office buildings. Declining economic activity follows, and leads to layoffs and further decline. Where this is the reason, depression follows, lasting until the situation is forcefully corrected or government primes the pump, or some external and fortuitous event temporarily solves the problem. For example, small countries are sometimes rescued by economic activity created by wars among other countries. This kind of rescue is not very effective for very large countries.

37 The economic decline is usually forecast by a stock market decline beginning an average of six months before (but it may be anywhere from two months to a year before, and sometimes the market is wrong in predicting a rise or a decline). The stock market decline is later followed by an interest rate decline, which may itself be enough to improve the economy if it is otherwise healthy (but usually with some government help in the form of contracyclical spending on capital infrastructure, such as building of roads, schools, hospitals, and other public facilities at a time when these can be built with less expense than during more prosperous times). These cycles repeat at irregular intervals. A complete cycle tends to last an average of 40.7 months, but may be more or less. This cycle is what most people mean when they refer to the economic cycle. As noted above, prices of different types of assets follow cycles of comparable length, but divergent phase. Even within one broad category, such as stocks or bonds, different parts of the market rise and fall during different parts of the economic cycle. Electric and natural gas energy distribution stocks tend to behave more like bonds, steady growth and utility companies drop less during recessions, interest rates affect utilities and banks deeply, cyclical stocks (such as producers of large capital equipment like cars, aircraft, and machinery, and of non-necessities such as metals and paper) are most affected, and small company stocks generally tend to have more volatile prices than those of larger companies. Some students have reported detecting cycles averaging 9.2, 10, 11, and 18.3 years, but after the establishment of the New Deal reforms, these cycles seem not particularly distinct or helpful in forecasting. More importantly, a larger economic cycle also seems to last 50-60 years, probably from more basic, long term public policy cycles, tied in turn to generation cycles and the limits of human memory and perception. Perhaps, each generation tends to turn against the policies of its immediate predecessor, perceiving what the later generation regards as the errors of the prior generation. The result is to some extent a repetition by each generation of the errors of its grandparents. In the nineteenth century, when generations succeeded each other more rapidly, the period tended to average a little over half a century, but the latest cycle, in our more slowly replaced generations, is 60 years from economic bottom to bottom (1930-1990). g. Interest rates The gross effects of interest rates are hinted at in the foregoing discussion of economic cycles. Incurring a large amount of debt when interest rates are in the upper part of their cycle will impose high expense on a company and reduce its competitiveness against companies which keep their debt down or do their borrowing primarily when interest rates are low. Interest rates respond to, but may also affect, borrowing for both capital investment (improved or replacement machinery, research, training, site acquisition, building construction, patent purchases, etc.) on one hand and, on the other, financing inventories and consumer purchases. The level of interest rates generally depends on the demand for and availability of loan funds. That demand in turn depends mainly on a few factors:

38 (1) Optimism about future ability to repay. Individuals use debt to buy houses, automobiles, and other expensive and lasting items if they believe they will have a sufficiently dependable income for the foreseeable future. Businesses will borrow if they believe that the purchase to be made with the borrowed money will earn for them significantly more than they would earn without it, but again only if they expect to be able to repay. The borrower may be optimistic, but the lender may decline if without equal confidence in the future. Sometimes borrowing is also done to finance current activities. For most people, this is dangerous but is common for retailers, banks, and others, to enable economies of scale not easily attained on a cash basis. (2) Tax and other public policy. These factors influence the value of borrowing versus selling shares versus waiting to save the money needed. (3) Actions of the central bank in each country, such as the United States Federal Reserve Board in expanding or shrinking the money supply, open market purchases and sales of government debt, and various regulations relating to borrowing and lending. (4) Government fiscal (spending, borrowing, and repaying) policy. The supply of funds in the economy depends on the availability of money, its rate of turnover in the economy, the relative value of competing uses for that money (stocks, bonds, physical assets), and, circularly, interest rates themselves. Money supply is often measured by the various Ms: M1 (readily spent money, such as cash and checking accounts), M2 (M1 + short term savings), and M3 (M2 + longer term savings). Besides the level of supply and demand, other factors, in the nature of risks, affect individual interest rates: (1) The expected rate of inflation or deflation, known as inflation or currency risk. Studies have tended to show that in this century and country the real base rate of interest on major debt of highly credit worthy debtors is about 2% per year. If the lender expects a 6% annual average rate of inflation over the life of the loan, the lender will tack this 6% onto the basic 2% real base rate, demanding 8% per year (the nominal interest rate), in order to secure the 2% base rate after adjusting for inflation. Even if serious deflation is expected, however, the money will not normally be lent at negative interest (although sometimes desperate sellers will allow short periods of effectively interest free time-plan purchasing). (2) Expectations about future changes in rates. Expectations of future interest rate changes will also influence the levels and relationships among interest rates of debt with varying maturities. Existing bonds will lose value if interest rates rise, enabling a buyer to get more interest from a new bond than from the old one at its original issue price. Similarly, if interest rates generally fall, an existing bond will rise in value, because it pays more than can be obtained from newly issued bonds. Expectations of future inflation may keep long term interest rates high in a period when the demand for new borrowing is low and hence short term rates are low. Possible loss from changes in interest rates is known as interest rate risk, and is present even in U.S. government bonds, the safest investment there is. This risk is less if the bond will mature soon, regardless of when it was issued.

39 (3) Because of the latter consideration, the interest rates often differ between short term debt and longer term debt, and this relationship may result in either being higher, with the difference being greater or less at different times (=yield curve risk). (4) Nevertheless, longer term lending gives up more control and subjects the lender to more risk, and is therefore usually at higher rates (say, for a 20-year bond versus a five-year bond). A premium may sometimes be charged, however, for extremely short term borrowing (days or weeks), because the lender is put to more transaction expense in proportion to the total amount of interest to be earned. (5) Credit worthiness of the borrower involves credit risk, which depends on both the honor and the ability of the borrower. Some borrowers are willing to default on payments of their debts, or to take risks which impair the public confidence in their ability to repay, thus driving down the price of their bonds, like the corporate takeover predators of the 1980s, who often converted the highly rated and safe bonds of soundly run corporations into junk bonds by financing a buyout of the companys stock with a new bond issue mortgaging the companys entire resources, or by exhausting its cash reserves, or both. More often, the management intends to keep its commitments and tries to do so, but the enterprise may nevertheless fall into misfortune and be unable to do so. h. Geographic and Subject Matter Scope of Economic Environment These various economic characteristics must be evaluated on a world-wide basis, both for their effect in ones own country, and for their effects on possible foreign investment. Similar considerations apply to the economies of a single major region of the world (say, Europe, Latin America, South Asia, the Near East [i.e., West Asia and North Africa], the Far East, etc., or even to a single nation, province or state, or local community [the health of a public utility company, such as a supplier of electricity, gas, or other energy, often depends heavily on the local economic health]). Likewise, the state of a particular industry and the economic circumstances of an individual enterprise can vitally affect the company. This local geographic effect includes the effective demand for the companys products or services; the availability, attitude, and quality of workers; transportation and communication facilities; access to natural resources; protective laws and their enforcement: the safety of the geographic area and the public laws and insurances pertinent to that company; the nature of competition; and many such factors. Many economic enterprises have driven themselves out of business, for example, by destroying a natural resource on which they depended (many fisheries and forestry enterprises have managed this form of suicide, as have some agricultural communities, and of course mining tends that way). Also, the economic size of the area within which the product may be produced or sold, or the workers recruited, can also bear significantly on the success of an economic enterprise. 2. Politics Actions of governments obviously do affect economic conditions generally, and the fortunes of particular companies specifically. Policies relating to currencies, interest rates, taxation, regulation,

40 subsidization, transportation, education, income distribution, resource access, care of the needy, collection and provision of information, fostering of order and harmony, freedom to think, learn, comment, and create, relations among humans, communities, states and provinces, nations, and global regions, as well as other such matters can seriously affect the economy and other critical aspects of life. Wars and revolutions can destroy property or business or whole economies, in addition to individual humans, and national policies may affect the probability of such events. Governments may foster citizen participation and equality of opportunity, or stifle opportunity and suppress certain classes or castes of people. Governments may engage in wars or international economic disputes, or foster peace and cooperation with other countries. Governments may try counter-cyclical spending, or ignore economic cycles, over-borrow or over-inflate the currency, or their opposite, and may engage in huge projects, such as military expansion or special perquisites for those in power, so extensive in proportion to a national economy as to crowd out more productive activity, either by devoting too much money to these projects, or by diverting too much of the nations talent to them. The prudent investor considers these possibilities, not only in deciding in which countries to invest or disinvest, but also in deciding when to do so. It is probably also useful to consider the political organization of the individual enterprise in which one considers investing or to which one considers lending. While the activities of partnerships and corporations are supposed to further economic goals, the structure of the organization which does this is more a matter of politics than economics. That structure effectively constitutes a form of government, often more intrusive into and significant in the lives of individual employees, investors, customers, and suppliers than elected government. A prudent investor will not invest too heavily in a single enterprise over whose governing, directing, and acting that investor can exercise no effective control. Limited partnerships, therefore, often prove to be disappointing investments, and many corporate rulers grossly abuse their powers in ways deleterious to their stockholders as well as to their employees, neighbors, etc. Such conduct can ultimately damage the value of an investment, so a prudent investor learns the terms of his or her own authority in the company and the attitudes and past conduct of those who will lead it. The law which created the form of the enterprise is important to this structure, as is the responsibility to which the members of its board of directors are held. 3. Resources Resources available to a company, industry, country, or species also influence its success and prospects. A shortage of water seriously limits the agricultural productivity and the population of a region, as do certain climate and weather extremes. Mineral resources most importantly, soil are valuable to the economies of some countries, and to the species as a whole, but can be exhausted. Petroleum in the U.S. now has been so seriously depleted that this country cannot long operate in an economically competitive way on the basis of its own deposits alone. Hence it continues to drill and pump oil, but imports oil heavily from other countries. Increasing internal production can only be done by degrading other aspects of the nations

41 life, substantially increasing the cost of oil production to obtain less accessible reserves, and reducing the remaining actual reserve supply. No company can sell to more people than the world contains, or use more of some resource than is available. Some physical resources are simply disappearing, and will be unavailable in economically usable amounts or quality after a time if not reclaimed in some way. There are also renewable resources, like forests. Those who simply destroy them will exhaust their (and maybe everyones) resource base, while those who replace in some rational way will have this resource to use again indefinitely. Government policy may encourage destruction or maintenance, either by regulation or, probably more effectively, by taxation practices. If the cost of maintenance exceeds the cost of destruction to the company, destruction will occur, but the company and its entire industry may then have a limited future. Exhausted soils, fisheries, mines, and former forests litter the world, and grow more extensive and more numerous through lack of foresight. Ultimately the destroyer destroys itself. Besides (1) physical resources, which can be effectively increased only by either finding new ways to utilize existing resources more efficiently or by discovering a way to use different resources for new purposes, there are (2) financial resources; (3) physical and economic access; (4) suitable sites for various purposes (harbors, crossroads, damable river sites, suitable places for roads, factories, etc.); (5) natural routes for travel, trade, and communication, often with critical strategic bottleneck points like mountain passes, harbors, river mouths, and natural crossroads; and (6) human skills and (7) good will. More than one company and nation have fallen on hard times because of poor treatment of citizens, employees, customers, or neighbors, and others have prospered from more considerate and humane behaviors. These need to be considered, not only for sound ethical reasons, but for sound practical ones as well. Information, understanding, and methodology knowledge, science, and technology are also crucial to the success or failure of business enterprises. The enterprise using the best techniques, whether of production, personnel management, coordination, or whatever, will have advantages over its competitors. To achieve the best methods requires scientific research, perceptive conceptualization, data collection, and communication. Either the enterprise must develop these itself, or must be able to buy, rent, hire, or otherwise obtain these from others, and will normally not be long able to do so unless the firm allocates enough of its resources to promoting them. Some companies may conduct their basic, scientific research, but even so the scientists must normally be recruited from somewhere, which means that, one way or another, directly or indirectly, the firm will have to pay for the costs of educating these people and of collecting the data (often by government). If insufficient allowance is made for this, a company may get by through effective subsidy (having someone else bear the burden) for a while, but its continuance of free-loading is unlikely to be allowed to persist.

42 The quality of the science, of the public information sources, of the communication and transportation system, of the technicians, managers, and other employees, subcontractors, suppliers, and services all are crucial resources. 4. Trading System Both common experience and academic simulation experiments show that the trading system itself affects the behavior or markets. Such a system is really a part of the economic system, which in turn is part of the social system. Even so, it deserves special note here. Experiments show that posted offer pricing (retailer sets prices and potential customers decide whether and how much to buy) is less efficient than other methods in setting prices and facilitating sales volume, though it reduces direct negotiating costs. By contrast, the continuous double auction, assisted by a computerized and centralized intermediate service communicating all bids and offers to all participants, as in the stock and commodities exchanges, is far more efficient in time and in arriving at prices most conducive to high trading volume. A third and less familiar system, periodic, sealed bids and offers, as used on the new Arizona Stock Exchange, is the most efficient. Academic experiments also show unreasonable, speculative price movements in the first two types of market, even when all participants have the same data, but that the valuations tend to become more realistic near market closing times (Experimental Market Economics, December 1992, Scientific American, p. 116 ff.). These studies tend to refute the efficient market hypothesis or theory of rational expectations, according to which the market price at any one time tends to discount (=allow for) all pertinent information on the value of a stock. The evidence of experience confirms these experimental studies.

43

VII.

Cosmic Harmony in Investing, Continued.

C. Fundamental Analysis
1. Objectives and General Principles The object of fundamental analysis is to discover the basic, long term relative value of a financial security in some objective manner. Because actual prices fluctuate daily in a manner which may reflect mass psychology and even less predictable factors, more frequently than events that imply any real changes in underlying value, it is inferred that todays price is not necessarily the best measure of real, underlying value, and that future prices eventually will approximate (or at least oscillate around) that underlying value. Experience and academic experiments agree in indicating that prices do tend to move toward theoretical value over time, although often surprisingly slowly. Because investors buy (and sell) stocks primarily on the basis of their expectations of future profits in most cases, and future dividends in a smaller number of cases, these are what fundamental analysis primarily attempts to forecast for stocks. With respect to future profits, important considerations are levels (especially per share), direction, and velocity of change; riskiness or confidence of projections; and timing of various parts of the income stream. The primary factors affecting future dividends are individual company dividend policy and profits. For example, a growing company may pay out only a few percent of its profits, as dividends to its stockholders, or none at all, to enable the company to reinvest profits for future growth. A more mature company may pay out 30-60% of profits to its stockholders in the form of dividends. A company might even pay dividends exceeding profits for a year or two (usually in order to maintain a dividend level previously established, or to sustain the value of the shares), but obviously cannot long continue such a practice. From these factors the investor can estimate at least a real value relative to competing investments, and some also attempt to calculate a precise value, on the basis of certain assumptions about interest-rate levels and trends. These real or fundamental values are then compared with actual prices to discover the best buys and the most urgent sales. (More precisely, an analyst may compute current value on the basis of the expected future stream of profits or dividends by adding the annual expectations for a few years, offset by the current prevailing interest rate: V= _E_ (1+k) + _E_ + 2 (1+k) _E_ + 3 (1+k) etc.

Where V = initial value, E = expected earnings or dividends, and k = current interest rate. After a few years the terms become too small to affect the result very much, and in any case forecasts for more than a few years away are of limited value.)

44 2. Valuing Debt Securities In estimating the value of debt instruments (bonds, notes, and bills), the investor compares the rate of interest payable on the debt, and the particular interest rate risks present, as outlined under individual interest rates in section 1.g. of the previous chapter, the interest rates generally prevailing in the market for comparable risks, and any current difference between the going market price and the stated amount payable at maturity. The prudent investor also takes into account likely future interestrate trends and alternative investment classes, as well as the possibility of a bond being called. A borrowing company which sets the terms of its own bonds (and preferred stocks) often inserts a provision that the company can call the security, i.e., pay it off early. Sometimes that provision will require a little extra bonus, such as redemption at 102% of face (maturity) value, in case of a call, or will not allow the call until after some specified date. The lender (buyer of the bond, note, etc.) needs to be aware of such provisions and take them into account. If the bond pays high interest, its value is reduced by a call provision which would enable the company to pay it off early in the event of falling interest rates, because the exercise of a call will both prevent the investor from continuing to receive the promised interest rate and also take away the chance to profit from a rise in the value of the bond which otherwise would follow a fall in general market rates. A formula for approximate interest yield to maturity or to call involves two main steps: (1) Adjusting the promised interest income for any difference between the ultimate payoff and the current bond price [I + (M-V)/n] where I=yearly stated interest payment in dollars, M=maturity value of bond, V=current market value of the bond, and n=number of years until maturity; (2) Dividing by the average of the bonds varying values over the life of the bond [(M+V)/2]. The whole formula is as follows: YTM = I + (M-V)/n (M+V)/2 3. Valuing Stocks If dividends are not significant (say, 2% or less), the value of a stock will mainly depend on future earning flow, as stated above. In forecasting future earnings, a prudent and realistic investor will take into account both those factors which tend to affect earnings, as outlined in section 3 below, and the pattern of actual past earnings. That pattern may show consistency or cyclicity or simply erratic volatility. In the last case, a reasonably confident forecast may be impossible. In the second case, such a forecast will be risky, but may be possible if the cycle is either regular or closely correlated with some other circumstance which can be more accurately discovered or forecast. In the case of long, steady growth, a trend can be measured and projected for some significant fraction of its past length into the future.

45 In recent centuries, interest rates for the most credit-worthy borrowers have usually tended to oscillate around an annual average rate of 2% + the expected inflation rate. Short-term debt (less than two years) usually tends to be slightly lower, while long-term debt (10 years or more) tends to be modestly higher. Benjamin Franklin mentioned a rate of 6%, most of which he attributed to credit risk. The best time to buy bonds is when rates are above these levels and likely to move downward, or when inflation is above average and likely to decrease. For example, steady profit growth at 15% annually for, say, 12 years might reasonably be expected to continue another two years into the future. This will not always be accurate most growing companies eventually reach a level of maturity which ends that growth but it happens often enough to provide a useful forecasting tool, when considered together with the factor analysis mentioned in later parts of this chapter. If a company shows long, steady growth, the investor needs to analyze the reasons for that growth and consider whether it is likely to continue (its reason still applies) or is likely to end (the market for the product is approaching saturation, the need for the product is likely to end, the quality of the product has declined, the effectiveness of competitors is increasing, profit growth in recent quarters is losing momentum, etc.). A stock which pays high dividends (say, more than 3%) usually does not show high growth. Such a stock needs to be considered from both the income perspective, as though it were a bond, and the profit viewpoint, as a stock. In all such cases, the current price and likely future price movements must also be considered. Of course the important question here is that of total return, i.e., how the investment fares counting both dividends and changes in price.

4. Compound interest Because of the effect of compound interest, a good investment held for a considerable time proves highly valuable often better than attempts to time the market, especially when the cost of multiple transactions is considered. Someone has calculated that, if the native sellers of Manhattan Island had been able to invest their $24 price at current interest rates from then to now, and reinvest all the interest similarly, the investment would not exceed the actual current price of all the realty now located at that great island commercial center. (This observation, if true, does not make the original deal any more equitable, since the owners have had all the use of that land for 3.5 centuries, in addition to its present value, but does illustrate the power of compounding interest or profit growth.) The converse of this principle is that future money is worth less than present money. In addition, future receipts are less certain than present cost. Hence it is possible to calculate a theoretical present value on the basis of a forecast of future interest or profits for a limited number of years. For example, the future value (F) after a certain number of years (n) of an investment (V) earning a known rate (k) of a particular investment = original investment times nth power of 1 + the rate of growth, or

46 F = V (1 + k)n Conversely, the present value of money to be received in the future can be calculated by solving this equation for V, which gives V = F [1/(1 + k)n] Because the question to decide is normally which is the best place to invest, relative value is normally more important than absolute value. It is also easier to calculate. Although not precisely accurate, a convenient and practical method is the rule of 72. It is only approximately true, and only for a limited range of rates, but it is more accurate than we can normally forecast anyway, so it is more used than the foregoing more precise formulae. 5. Rule of 72 In comparing investments, analysts often use the rule of 72, dividing 72 by the rate of return on an investment to get the number of years for an investment to double (or by the number of years to find the required rate). Thus, an investment (say, a bond) paying 8% annual interest on the original investment will double the investors money in nine years, before taxes and assuming reinvestment of proceeds at an equal rate of return. Another investment (say, a stock) dependably producing 12% annual profit growth will double its profit in six years. A stock in a company which produces 18% annual profit growth will double its earnings rate in four years. To double in three years requires 24% annual growth. Of course the investor must also consider price level, prospects for future interest and profitgrowth rates, markets, debt, social and economic factors, quality of management and product, competition, risk, and other pertinent factors. In investigating a company, the annual report may provide important information. 6. Reading an Annual Report Fundamental analysis of securities refers to determining the expected future earnings progress of a company by analysis of its financial documents; the information on which financial documents are based (to the extent determinable); evaluation of the industry, the company methods, resources, markets, competitors, problems, etc.; management; and such other considerations as would be used in buying a private business. Especially important considerations are the nature of the business (does it provide something widely and consistently needed); whether its field is growing, stagnating, or shrinking; the skill and wisdom of management; and particularly the actual existence, consistency, and growth of earnings. If the product sells well only in certain periods, when is the next such period, and how long will it last? Annual reports sometimes provide (they are always supposed to provide) such information and should be examined carefully with particular attention to

47 (1) earnings per share compared to past years; (2) whether total sales (gross revenues) are growing, flat, or shrinking (a company can increase profit for a year or two by dismissing employees or out of weak parts of its business, but it cannot make profits for long without increasing sales); (3) whether debt is growing faster than profits or revenues, or is already too big, so that debt service (paying interest on debt) will absorb a dangerously large part (more than 20%) of operating income (financial institutions like banks, insurance companies, and savings and loans, plus public utilities, can afford to have higher ratios of debt); (4) whether cash flow provides enough actual cash on a current basis to meet current demands safely at all times, and likewise (5) whether cash and equivalents grow each year; (6) the auditors footnotes, where problems or defects are usually revealed, if at all; and (7) managements letter or address to stockholders, which normally is near the beginning of the report and explains management goals, achievements, forecasts, and (if they are honest and perceptive) problems. The reader must remember that this letter is essentially political campaign literature for reelection of the same board of directors (and therefore the same management) and is therefore quite self-serving in most cases. Consequently, it is important in reading this part of the report to look for (a) management attitudes toward their own responsibilities, employees, customers, society, etc.; (b) willingness of management to admit problems and deal with them in an honest and effective way; (c) certain code words. Among these code words or (often misleading) expressions are: (i)profitable which often means we just eked out a slight profit; (ii) record earnings which sounds good, but often conceals the fact that earnings growth rate has slowed; (iii) we have [re]positioned ourselves for future growth which really means they lost their shirt this year; (iv) bad economic climate which means they are relying on hope of some external event to rescue them. It is also important to notice whether so-called incentive payment plans extend widely in the company or are limited in application to the CEO, and whether he gets large bonuses under this plan in or for years when the company does not in fact do well. The annual and quarterly statements usually also contain a brief description of the nature of the companys main businesses, which may be useful as a first step toward learning about the company. Often this will show that the name is a little misleading. 7. Primary Factors Factors which affect future earnings (profits) include:

48 (1) Nature of products (including service) (a) Quality (b) Price (c) Recognition (2) The manner of financing the firm (a) Amount and proportion of debt versus stock, (b) Interest rates, (c) Maturities, (d) Provision for repayment (3) Economy and industry prospects (a) Need and demand, both long term and cyclical (b) Place in and effect of cycle (c) Technological, political, economic status and changes (d) Position of company in its industry (e) Quality, quantity, and dependability of supplies (4) Management (a) Ability to plan ahead (b) Ability to execute plans (c) Ability to deal with change (d) Motivation (e) Trustworthiness (5) Market (customers) (a) Nature of market (b) Extent of market (c) Competitors (d) Possible substitutes (e) Consistency of purchase (f) Trustworthiness (6) Accounting concepts and approaches (a) Reasonableness (b) Book value an accounting measure of value of a firm, a poor measure of real value, but a useful check on real value (c) Profit and loss, depreciation it is important to understand what constitutes profit and loss and to see whether the reports forthrightly reflect the reality (d) Cash flow the actual flow of money through the firm, important in determining the ability of the enterprise to pay its obligations when due and a check on reported profits (7) Debt and equity (a) Concepts and (b) Accounting (8) Ratios The proportions between various measures of company activity and status, which tend to reveal significance of the raw financial numbers

49 A few of these deserve more detailed consideration. 8. Accounting concepts Section 4 in this chapter gives some suggestions about reading an annual report. Corporations selling stock publicly in the United States on stock exchanges and through the various systems of the National Association of Securities Dealers normally issue statements each calendar quarter-year, and also annually, providing the types of information described in section 4 above. Acquaintance with certain accounting concepts helps in understanding these reports. The reports usually contain three major parts: A statement of profit and loss (= earnings report); A balance sheet; and A document known by various names, reconciling the other two, which we may call the statement of cash flows.

a. Earnings Report The statement of profit and loss covers a period of time, usually either a year or a quarter year. It shows gross income or revenue, gross costs, and the difference between these two, which is profit or loss. Profit is also called (net) earnings. The earnings report usually separates revenue into operating revenue (or it may take a shortcut and just show operating profit) and other revenue. The former means revenue from its actual regular business operations, while the latter includes yields on temporary investments, proceeds of lawsuits or other unusual events, as well as other extraordinary gains or losses, usually on sale of portions of the business. Costs are usually separated into operating costs, interest, and taxes. It is important to realize that revenue is commonly counted when accrued (or earned, even if not actually received). Something treated as earned in this way may never actually be received, especially if a dispute arises about the transaction, and such factors can alter the picture shown by the report. It is also important to remember that investment by the company in capital items (purchase of equipment, buildings, land, other companies, securities) is not reported as cost. Instead, the useful life of the item bought is estimated in years. The number of years is then divided into the total cost of the purchase, to arrive at a theoretical average annual cost of owning that item. This average is then shown as depreciation among the costs each year. (Other methods of calculating depreciation are also used.) Net profit or earnings are crucial and that item is the bottom line to which investors refer. This must then be divided by the number of shares outstanding in the class in which the investor is interested, with allowance for income which must be paid out to holders of securities with preference rights over those in which the investor is interested. We now have earnings per share, the number that really matters to us. The report will normally also show the comparable number for one year earlier, and sometimes for more. I like to see the comparison for 10-12 years back (at least two full economic cycles), to see whether any real trend exists. The best way to see this is in a semi-logarithmic chart,

50 which treats all percentage changes alike, and thus reveals the actual steadiness of the growth rate, if any. b. Balance Sheet The balance sheet gives a snapshot of one instant in time, the last moment of the corporations fiscal year or quarter it is a kind of super inventory. It shows assets, liabilities, and the difference between them. Assets include whatever the company owns of value. Liabilities include whatever it owes someone else. The difference is called equity or book value, which may not be very meaningful if values are shown at purchase price and actual values have markedly changed, but investors tend to value some businesses at least partly in terms of a multiple of book value. Again, book value per share is calculated by dividing company total book value by the number of shares outstanding. Certainly a price many times book value probably suggests danger of poor value. Book value per share is the bottom line for this kind of report. c. Cash Flow The statement of cash flow shows what money actually came in and went out, revealing how likely the company will be able to pay its bills on time, and provides a check on unrealistic inflating of profit figures. This report is also intended to reconcile the data in the other two types of report, identifying the sources and uses of funds. (It is sometimes called a report of sources and applications of funds.) In practice it is computed by adding depreciation to profit, subtracting capital investments, and making some other adjustments. In some industries, where reported profits are regarded as misleading for some purposes, as during temporary aberrations, analysts look at multiple of cash flow as more meaningful than profit multiple. Cash flow does give a better picture of the actual size of an enterprise than does profit, and size is a significant consideration. Adding depreciation back in, however, seems to me a dangerous approach for this purpose, since a company needs eventually to replace the capital investment which is being depreciated. 9. Ratios Analysts make value judgments about companies to a considerable extent on the basis of the relationships among various numbers revealed in annual and quarterly statements, adjusted according to the analysts preliminary judgments. These comparisons are called ratios or multiples. There are many of them and they fall into various categories. Here we shall list only a few of the best known. Others appear in Appendix IV. a. Measures of Progress To measure progress, one compares the results of each year with that of the prior year, usually in a ratio which reveals growth rate, if any. For example, to determine this years profit growth rate, divide this years profit per share by last years. The result, multiplied by 100, gives this years percentage of last years profit. If last year the company earned $1.20 per share, and this $1.50, we see

51 a 150/120=1.25 ratio, which is a 25% growth rate. One year, however, is not very meaningful. If we see eight successive years, each with growth of 23 to 28% in earnings per share, then we have a meaningful trend implying impressive growth, if no other reason exists to doubt that picture. This would be one of the best stocks available in most years. Similarly, we could compare growth of sales, cash flow, equity (book value), gross operating revenues, and other favorable items, or unfavorable items such as debt, tax rates, injury rates, losses in lawsuits, etc. For recent periods we may also want to compare quarterly reports with the previous quarter, to see whether a turn-around, favorable or unfavorable, is occurring to change the previous multi-year trend. (News media seldom mention this; when they say, This quarter earnings were up 15%, they mean from the quarter ended a year ago.) b. Measures of Value A common measure published in many news sources is the ratio between the current price of a stock and the earnings per share of the same company. This is called the price to earnings or P/E ratio. If the price is $80 per share and earnings (profits) per share for a particular year are $2, the P/E ratio is 80/2=(80 divided by 2)=40. If there is a loss instead of a profit, this ratio often is not calculated. It is also important to remember that different analysts use different earnings figures to compute P/E. Some use the last four reported quarters; some use future estimates. Some use raw net profit; others adjust this figure to omit one-time events (extraordinary gains or losses). P/E ratios for slow-moving stocks are often below 10; for steady-growth companies they are often in the teens. A P/E of 40 would normally be dangerously high, but it only occurs if many investors expect spectacular profit growth. They may be right, but extreme caution is appropriate toward stocks with high P/E ratios. The high-growth companies often have them, but so do those for which the optimism proves unjustified or premature. When is a high P/E justified or timely? This depends on many things, including prevailing interest rates (low rates allow higher P/Es, typical now), expected rate of profit growth, economic and financial trends, etc. A common way to correct for expected rate of profit is to divide the expected, reasonably steady rate of profit growth (if such exists) by the P/E. If the result exceeds 1, the price may well be reasonable, even if the P/E is high. I call this the HIR ratio. One must watch such cases, however, to be sure the ratio has not been improved by the realization of some investors that past growth is unlikely to continue at a comparable pace. With this caution, the HIR ratio has proven quite helpful to me. The better the ratio, the better the bargain. But the ratios cannot be compared reasonably unless they are based on comparable numbers. I believe in looking primarily at actual reported past earnings, long-term (12 years), medium term (five years), and short-term (last two quarters), together with my future estimate. I average these considerations and use that average figure of earnings progress (also called earnings momentum) with the current P/E. (One probably could also discuss inflation, but, except where this would differ for different investments, that step has little comparative advantage.)

52 c. Measures of Safety Many measures of safety have been devised by analysts. The best known probably include the ratio of long-term debt to equity (except for public utility companies, governments, and financial institutions, more than 30% is probably risky, and the less the better); annual interest cost to net profit before interest and taxes (more than 20% is getting too high, with the exceptions mentioned before); current assets to all liabilities or to expenses (prefer more than 1; the higher the better); cash and equivalents to current liabilities (same); cash flow to liabilities or expenses (same).

(See Graham and Dodds Security Analysis by Cottle, Murray, and Block.) d. Measures of Profitability and Stability Many analysts emphasize measures of profitability, such as the relationships between profit and gross business done or between profit and investment. One advantage of this approach is that small percentage changes in gross revenues or costs can wipe out a narrow profit margin. Grocery stores, for example, usually make only a small profit on each item, but count on a large sales volume. A little shift in cost or sales can wipe out their profit, while a large profit margin is expected to produce larger and safer profits. Yet people buy groceries every week, so the major grocery chains have generally done quite well. The comparison is thus useful primarily only among companies in similar businesses. A large profit margin may also invite competition, also a factor to consider. Because book value is often misleading, return on (corporate) capital is a more questionable measure of profitability. More important is the expected return on the investors investment, i.e., expected profit divided by the cost of buying the stock now (present price per share, plus transaction cost). Inventory turnover is probably more meaningful than corporate return on capital. It is computed by dividing gross sales or gross revenues by inventory (sometimes with an adjustment for). The resulting quotient is the number of times the inventory is turned over (replaced) within the period being reported. In other words, if at the end of the year the amount of inventory is one third of the gross annual sales, the inventory is turned over three times during the year. The larger this turnover multiple is, the better. Because this number will vary among industries, its value is best obtained by comparison with comparable multiple for other companies in the same business, to see whether the company of interest is leading, following, or in the middle of the pack. Measures of stability look at maximum quarterly or annual declines in profits, profit margins, revenues, and debt coverage within the survey period, preferably eight or more years.

53

VI. Cosmic Harmony in Investing: Part D. Technical Analysis

In addition to the background or environment in which a business finds itself, discussed in chapter VI, part B, and the analysis of the actual relative value of a business in some general sense, touched on in chapter VI, part C, the vagaries of mass psychology also influence prices and therefore the relative produce of specific investment decisions, especially with respect to their timing. While fundamental analysis and the general environment may make a company more or less valuable or its price above or below its actual value, there nevertheless may well be better and worse times to buy or sell its shares or its bonds. The actual behavior of market prices themselves, together with some related matters, reveals information about where prices are likely to be next. Conformance to reality includes utilizing these factors, especially for short-term decisions. Ultimately, the better company will produce the better results. But in the meantime, the timing of the selection can also add or detract a measure of success. Technical analysis is observation of price, volume, sentiment, and other trends revealing masspsychological factors in price movements, while fundamental analysis seeks the real earning power of a company. Technical analysis can be applied to the price of anything a stock, bond, commodity, etc. if enough data is available. One important technical factor is the recent trend of a stocks price, and the period of time over which that trend has lasted. While different analysts perceive trends of differing lengths, the use of this technique in a reasonable and disciplined way can add significant value to a portfolio of investments. 1. Trends The first of these behaviors is the actual past movement of prices themselves. Events in the real world are human concepts, snippets of essentially continuous interaction of phenomena in a continuous flow of time. Each purchase or sale of a financial security by anyone anywhere may be considered the atom or quantum of a market, most such transactions are influence by (and usually not far from the prices of) recent prior transactions. Hence prices of an actively traded security usually do not bounce around erratically, but move in trends. These trends constitute a kind of partially discernible order in a process which is not totally predictable. Analysis of them is called technical analysis, but it has nothing to do with the physical, chemical, or biological processes involved in the business only with mass investor psychology. In the longer term, economic conditions and actual company success or failure dominate the price of a company, but individual and mass psychology of investors also play their parts, and provide some of the irregularity of prices. The trend of prices over years therefore corresponds closely to the economic cycle and the real progress of the company, but market movements over a number of months can best be sensibly predicted by also considering technical analysis. One could say it is a study of fads. At any rate, this study takes into account the three major factors: trends, support-resistance, and sentiment.

54 Trends may last any period of time and be analyzed for any period of time containing a meaningful number of transactions. The basic method is to look for a trend, to measure it in various ways, and to look for signs that it is about to end. If no such signs appear, then the probability is that the trend will continue for some additional significant fraction of the existing length of the trend perhaps 10-20% of that period. If then a price trend has persisted for say 15 years, it is likely to persist for another two years; if it has continued for 15 months, usually it will last another two months; if 15 days, then another two days; or if 15 minutes, another two minutes. As prices rise and fall, drawing a straight line through the two highest peaks and a line through the two lowest bottoms (within the time period being examined) produces trend lines. If these lines are parallel, a price trend is revealed, within which prices are likely to continue to move for at least some fraction of the existing length of the trend. 2. Dow Theory Dow theory, developed a century ago, compares the movement of averages of (energy) utility, transportation, and industrial stocks over months and years, and distinguishes between primary bull and bear markets, usually lasting a few years over one full cycle, intermediate trends lasting a few months, and short-term movements measured in days or weeks. According to the theory, which has proven fairly realistic, the utility average is a leading indicator, influenced mainly by interest rates, followed after some months by the transportation and industrial averages in a primary market. Once a primary uptrend is established, it can be expected to continue until all three averages have broken below the bottom trend line. A primary downtrend then continues until the opposite occurs. 3. Averages and Indices To measure general trends, Dow Jones Averages are best known, including Utilities (15 companies, such as Pacific Gas and Electric), Transports (20 companies, such as Burlington Northern Railroad), and especially the Industrial Average (30 big producers, such as Exxon, General Motors, and General Electric). Slightly more representative indices are Standard and Poors 100 and 500, also well known because of the efforts of the companies which originated them. The best market index, however, is the Wilshire 5000, because it includes all the exchange-listed and all the important over-the-counter stocks publicly traded in the nation. It is also the most accurate and easiest to interpret because it represents simply the total value of all the shares of all the companies in the nation that matter to the market and the economy, expressed in billions of dollars. Hence, when this index recently passed 4000, that meant simply that the total value of substantially all publicly traded stocks in the United States had surpassed $4 trillion. Other averages, such as the Nikkei and other national indices, averages of various specialized industry groups, and averages of particular portfolios or collections of stocks, all have their place as comparisons with individual prices to reveal broader trends. Most important in foretelling the action of a stock, however, is the action of that stock.

55 4. Patterns Patterns are merely additional forms of trend. A rising trend of intermediate bottoms is usually a good current sign, but price rises which are faster than profit growth, especially a pattern that bows upward in a matter of weeks or months, often means the price is dangerously high at the moment. A downward trend of intermediate tops is a bad sign for a further period of, say, 15-20% of the duration of the trend in other words, one can project an existing trend that much farther if no signs suggesting a turn have appeared. Buying during a downward trend, on the theory that the stock is now low, usually leads to misfortune, and is called catching daggers. A trend of either price or profit growth may show slowing (which may imply an end of a rise, or just a pause). A turn-around from a downward trend usually looks like a profile of a saucer; the turnaround is only demonstrated when the rounded bottom is clear, has lasted a significant part of the duration of the prior downward drift, and actually acts as if it is beginning to turn upward. A divergence (highs and lows getting further apart) is a sign of a possible reversal (or at least change) of direction. A triangle (converging highs and lows) implies the approaching beginning of a new trend, usually of unforeseeable direction a time to refrain from purchasing. Rising and falling triangles (with one horizontal leg) imply coming break-outs in the direction of the horizontal leg level tops and rising bottoms suggest an upward breakout. Other patterns are also recognizable and usable. (See, e.g., Pring, Technical Analysis Explained.)

Trend Lines, Channel, and Break Out (Down), above; Price Movement Patterns, below.

56 5. Support and Resistance If a considerable number of shares are held by people who want to sell them whenever they reach some pre-determined price, this overhead supply of shares provides resistance to rise of share price beyond that resistance price, until all of the potential sellers have sold. That is why the rising triangle has that shape and predictive value. In the meantime, a retreat in price whenever the price approaches a particular level is called a resistance level. It may occur at round numbers (multiples of 10, etc.), but especially occurs when many persons bought the stock at that price in the past, when it was very popular, and it then dropped in price, leaving them feeling that they had made a great mistake. They sometimes wait years to get out, keeping the price from exceeding that level in the meantime. When they have all sold out, the price then usually has an extended rise from the old resistance area. In fact, many people sometimes the same ones will feel left behind at that price level after resistance is overcome, when many have sold out there only to see a following rise. These people will then often buy when the stock drops back to this price, thus preventing it from falling lower. If these wanted shares are numerous enough, the old resistance level will then become a support level. Support and resistance levels look like horizontal lines on a chart and may persist for long periods. They do not necessarily prevent the long-term movement of the price of stock, but may delay it for considerable periods. At other times, though expected, apparent support and resistance levels seem to have little effect at all. These are something like trend lines, and may cause the formation of flat trends.

Reaching for falling daggers.

6. Volume Volume also provides useful information. As an adjunct to price movement, greater volume of trading tends to accompany more meaningful price moves and help identify support and resistance levels. Greater volume also implies greater interest, and is therefore often a sign of a pending rise in price, both for individual stocks and for the market as a whole. Conversely, volume shrinkage may imply lack of interest in the market, and hence a shrinking array of possible buyers. Personal reasons always occur to induce individuals to sell stock in order to raise money: a family illness or other crisis, loss of income,

57 need to purchase a home or desire for some other purchase, etc. Hence selling will always occur at a certain level. Buying, however, only occurs when interest and optimism are present. Hence consistently low volume implies that future prices may trend lower. 7. Sentiment Sentiment is optimism or pessimism about the market or a stock or segment. This data can be measured in various ways, such as by comparing recent up and down price moves with their respective volumes or their usual volatility range, or by comparing the proportion of short sales or certain types of option transactions to the volume of trade or number of outstanding shares of the underlying stock, or by the recommendations of investment advisory letters. At turning points and at extremes, market sentiment (i.e., the majority) is usually wrong. Indeed, sentiment is usually considered a contrary indicator. If everyone seems worried, the market may continue to rise (if it was already rising), since those expressing worry have probably already sold everything. This is called rising on a wall of worry, and occurs for the reason states, and also because a loss of worry would have brought everyone into the market sooner, and most of those available to buy would already have bought. 8. Moving Averages In addition to observing horizontal support and resistance lines and usually diagonal trend lines, some analysts compare the current movements of stock price or index level with its own average for some past period. If, say, the Standard and Poors 100, though moving apparently at random on any one day, shows an upward trend, an analyst might average together the closing level of the index on each of the last 10, 15, 50, or 200 trading days. If todays level of the index closes the day above this average, the analyst will conclude that the upward trend is still intact; if below the average, then a downward trend may be in store. The number of days averaged depends on how far ahead the analyst wants to forecast. This may depend on a preference for shorter or longer term action, or on the analysts expectation of (or concern about) the nearness of a significant trend change. Analysts call this average a moving average if it is regularly recomputed, by substituting a new days level number for the oldest previously averaged. This tool gives earlier warning of a trend change than does looking for a crossing of old trend lines (an advantage for the moving average), but gives more frequent erroneous trend-change signals (a disadvantage). A computer can easily recomputed the moving average as new data is electronically fed in, and the result is almost totally objective (except for the selection of the appropriate period to average), thus protecting the analyst somewhat from being misled by his emotion (advantages), but the eye can instantly grasp not only a trend breach but some subtler accompanying features missed by a computer program. Thus, each technical tool mentioned, and others outside the scope of this little statement of principle, can contribute something to the creation of an overall, reasonably realistic picture of the likely behavior of a price, at least for a limited time, even though no single indicator is extremely accurate.

58 The prudent investor will consider both fundamental and technical factors, as well as background considerations, in forming a sound and reasoned judgment of a prudent investment course. 9. Seasonality The probable level of future earnings of a company usually do not change in one day. Sometimes new information may issue, but not on most days. Yet on most days prices change. Therefore, many of these changes are irrelevant to real or future value. Some of the technical changes reflect unpredictable personal circumstances of those who bought or sold on particular days. Some depend on speculative binges and market sentiment, or emotion; some on trend; some on news or recommendations or actions of prominent people. Some price changes, also, result from periodic or seasonal patterns. Toys R Us, for example, does most of its business around Christmas time, so its price usually peaks when many investors think they can foresee a good Christmas selling season for this company often between June and September. H & R Block, likewise, usually reaches its lowest price of the year just after its big tax preparation season in April. General market bottoms often occur in early June and in October or November. Markets tend, on average, to rise slightly on the last trading day of a month or before a holiday, and in the first four trading days of a month, more than on other days. On Mondays prices tend to fall more often than on other days, making Tuesday often the best day to buy and Friday the best to sell. Of course, these observations are only statistical averages, not strong enough either to overcome market trends or to use for quick in-and-out trading, but using this information can enhance the value of trades that would be made for other reasons.

59

VII.

Conclusion

The foregoing chapters suggest an approach to investing which emphasizes a healthy, stable balance among different approaches and methods, a steady emotional balance toward the vicissitudes of investment results, consideration for other people, and a long-term and forward-looking plan, based on careful and objective analysis of the realities of the investment world and its connections with the rest of the world. Such an approach requires preparation, patience, and waiting more of the time than action. It emphasizes preservation of capital and balancing the inevitable risks, with a maximum use of knowledge, leaving as little as possible to chance. It seeks to benefit from the power of compounding. It notes that there are two forms of hedging: (1) buying insurance and paying for it, which is expensive if long continued (a totally hedged portfolio in this sense can achieve no gains); and (2) investing in securities whose characteristics will tend to make one gain more when another is gaining less, or at least independently of the other, so gains somewhere will tend to overcome losses elsewhere. Of course here, too, one cannot gain if the account is perfectly counterbalanced, unless a method is used to provide at least some gain both ways. Thus the balanced portfolio mentioned earlier. These few examples and thousands more that could be given show that the two guiding principles of the Tao Te Ching, expressed by an eastern poet 25 centuries ago, apply equally well to the practice of financial securities investing in todays world. The principles of external cosmic harmony or harmony with reality and of internal harmonious balance, both in the emotions and in the portfolio, as well as between portfolio and investor, aid in attaining investment objectives as in other aspects of life. So do the corollaries of these basic principle: patience, self-control, economy of action, modesty, honesty, generosity of spirit, steadfastness in plan, and agility in actions. These principles and corollaries are really only rules of common sense and common experience. They lead in part to the usual rules of conduct recognized by the perceptive and sensible of the world for millennia. Yet reminding oneself of them may help maintain perspective and a prudent course.

60

Appendix I. Interpretation and Application of Each Verse

This appendix sets forth an application to investment of each verse or section of the Tao Te Ching. Several translations and the original have been compared. In the authors opinion, the best version is the simple, unpretentious, and charming translation by Gia-Fu Feng and Jane English, which is at once clear, true to the original, simple, supported by inclusion of the actual Chinese content, and illustrated with photographs of misty natural scenes. The material below is not a translation but an application of the principles set forth, followed in some cases with pertinent aphorisms, many of which are already in wide use. 1. What is basic to investing is the same as what is basic to everything. A buzzword name or slogan does not help. Labels lead to fragmented thinking but reality is whole and indivisible. Look beyond the labels. What is needed is sound philosophical understanding. 2. Every coin has two sides. Opportunity and risk are the two sides of one coin. Prices and values rise and fall forever. Hence absolute stability and safety are unattainable. The prudent investor balances emotion and investments, observes reality, positions himself so that waves will benefit him. He is patient and does not shift with every little ripple of trivial opinion or daily price wriggles. To look only at opportunity or risk alone is like listening for the sound of one hand clapping. 3. Ignore reputations and focus on realities and substance. Ignore emotion and pettiness to focus on major objectives. Envy none, flaunt nothing, follow no one. 4. Basics last and manifest themselves forever. They do not wear out. But sound principles are not simple rules of thumb. Look below the surface, beyond the daily ephemera. A truly sound approach is not used up or outmoded. Balance in strategy, patience in execution, control of emotion. 5. Reality has no mercy. Volatility cannot be avoided, but can be used. The soaring will fall and the falling may rise again. Hold fast to the center (= keep a balanced perspective). Observe the crowd from a distance. Take information from all, opinion from none. Sheep get fleeced. 6. Adapt, accept what is, do not fight reality. Glide downstream. Use the trend. Do not expect the world to move to your will; rather fit your choices to its observed course. The trend is your friend. Patience and timing are crucial. Deciding not to buy or sell on each day helps as much as doing so on another day. Gains come from the change in price between transactions, not from the transactions themselves; the value of a bowl lies not in its rims, but in the space enclosed. The valley is not necessarily the grave; buy straw hats in the winter. 7. Keep a large perspective: research carefully, discover the larger trends, build a sound strategy, and adhere to it for a reasonable time. Wild speculation in search of quick and spectacular gains usually loses all. Slow and steady wins the race. Do not overreach; it is too grasping and often leads to losses. Do not, for example, strain to attain the very top or the very bottom, or to squeeze out the last eighth of a point in trading, lest the prices make a major turn against you while you are quibbling over a minor gain. Do not reach for the last morsel; leave a bit on the plate. Leave the last bite lest you be bitten. Pigs get slaughtered.

61 8. Fit investments to the contour of reality and profit will flow in. It flows to places the majority have avoided, or where necessity will take it. Conform investments to the needs and nature of people and the real world in which they live. Keep close to basics; think deeply, be considerate, honest, and fair; be competent. Rest easily with a dependable strategy. Time your actions carefully, in accordance with what the market actually does, rather than fighting it. Observe the trends and use them. Do not reach for falling daggers (= do not buy a falling stock). 9. Do not overextend; when the market and portfolio rise unusually well, pull back and balance, bracing for possible need to retreat. A good general keeps reserves available. Do not overreach: take a profit or a good position rather than lose it while seeking to squeeze out a tiny bit more. The brimful cup spills. Vaunt not; todays guru is tomorrows fool. Pride goeth before the fall. 10. Retain perspective; neither soar nor despair. Judge objectively; neither love nor despise an investment. Adapt to what is real; wait not for what is wished. Accept opportunity when it comes rather stretching to transact. Pick the plum when it is ripe, not when you are hungry. Dam the river to guide it, not to stop it. Observe all; wait for the time to act. 11. The value of a bowl is the enclosure of space; the rim only captures the soup. The value of an investment is the enclosure of time; purchase and sale only capture the rise in value. Profit is anticipated in opening transactions and realized at closing transactions, but accomplished while waiting. Sometimes patient waiting for the right moment accomplishes more than frenzied response to each breeze in the market. Slow and steady wins the race. Patience and steadiness win the prize. Make time work for you. 12. Appearances dazzle, daily news muddles, so the prudent investor, aloof and alone, seeks true value and solid trends. Look below the surface, beyond appearances, through trivia, to persistent reality. 13. Nothing ventured, nothing gained; a price can rise or fall again. Bear the fall in calm and grace none gain sans loss in every trade. 14. Stay with a sound strategy. Hold fast to fundamentals. Though hidden; theyll yet have their way. Principles proven from the past again will rule today. 15. Be cautious, watchful, alert, considerate, adaptable, agile, honest, simple, plain, receptive, analytical, unprejudiced, and patient, able to wait for the dust to settle, for the occasion to act. 16. Fix the eye on goal and trend; the eye stays on the goal and the trend, unscattered by boiling events without end. Staying the course leads to the goal; yielding to panic spills the bowl. 17. Think well; invest well; profit well; claim no credit for doing so. 18. Pursue truth; beware sham. 19. Rely on no gurus opinion or wishful thought, but count on simple sense and sight you ought. Risk not for too big a score compound interest and growth bring more. 20. Do not follow the herd opinion, yet stay open for new perspectives, new insights, new tactics, while keeping to sound principles. Sheep are soon fleeced. Fads, mass euphoria and despair must leave me unmoved and always skeptical, adaptable but firm, unique, sustained by the basics, feet on the ground.

62 21. Reality is always complex and murky, hiding shoals and taking sudden turns, yet its nature drives it on firm along hidden trails. Note the order dimly seen through cloudy chaos. Take refuge in the changeless laws of change. 22. Rise the tide and use the trend; the trend really is your friend. Use the trends of interest rates, prices, and history, nor catch the falling dagger. Keep something in reserve at the choicest time. You need not fear to be a lagger. Never too sure; never too busy; never too narrow. 23. All trends change. Price wont rise (or fall) forever. Dont marry one investment. Accept loss as part of the process that yields gain. Gain and loss share one mother; she neer bears one without the other. 24. He who stands on tiptoe is not steady. He who strides too hard cannot maintain the pace. Excess feeds danger; excessive margin debt, buying at peaks, chasing a fast-running price, massing investments in a narrow niche or time all these are the investors vice. Prudence eschews them all. 25. The principles of reality last, including those of prudent investing. Adherence to principle utilizes the natural flow of reality. But sound principles are hard to discover and harder to define. 26. Sound strategy produces favorable results. Adhere constantly to principle, unmoved by fads and flitting views, euphoria or despair, and tiny daily ripples in price level. Be patient. Keep resources and emotions marshaled, ready, and under firmly balanced control. 27. Ignore no aspect of a soundly balanced strategy. Learn from all; rely on none. 28. At the time for action, act; otherwise, be patient. Have courage in adversity, but caution in success. Stay on the track, unswerved by elation or despair. Open your eyes like a child to see what others ignore. Keep the long strategy in mind; avoid excessively convoluted or complex strategies or excessive transactions. Stay with the major market trends. Using every little hillside hump and swale will lengthen the journey. The best tailor cuts little. 29. I cannot change the nature of reality in general, or that of investment markets in particular. It has its ups and downs; sometimes any particular investor or investment will advance, sometimes retreat. There is no true stability or safety without risk (or risk-free course or investment). Therefore the prudent investor seeks balance among risks, and avoids excesses, extremes, complacency, and despair. 30. Trying to corner, overwhelm, or manipulate the market leads to loss. Achieve results and enjoy gains without overestimating your acumen. Pride and complacency precede a fall. Humility provides strong armor, and a light step avoids pitfalls. 31. Seek a good price but not a grasping one; seize not the last bit but leave a morsel on the tray. Straining for the very lowest buy or to sell at the very top can lose opportunity altogether. The goal must be reasonable gain, not impoverishing the trading partner. We need that partner. A healthy economy provides mutual benefit; war destroys, whether it is military or economic, and is to be avoided. We are all in the same boat; dont sink it. 32. Thought they are never fully delineated or encompassed by any investment style, following sound principles based on reality brings a gentle fall of gains into the investors lap. Observe and utilize the actual flow of prices and other events, rather than what ought to be or would be preferred. Names and descriptions are not always useful for every aspect of reality. Excessive

63 reliance on rules of thumb and slogans leads to missteps. The prudent investor must constantly reexamine events, trends, economics, science, politics, markets the whole scope of reality. Learn the psychology of the market other investors motivations and behavior patterns but also know oneself: strengths, weaknesses, psychological tendencies, error tendencies. Persevere, but know when to close a position; do not overreach or overextend. The market plays no favorites and follows its own rules. It does as it must. None can escape its sting or always foretell its next move, but, watched carefully, it yields sweet nourishment. Great achievements come from small, sound steps steadily advanced. Sound, steady investment strategy seems dull; it tests patience, courage, and forbearance. The bear follows the bull. A fall follows a rise. Stretching resources can lead up to losses. Overconfidence trips us up. Do not go beyond your depth, in resources or understanding. Hedge with balance. Dont overtrade or respond to impatience. Keep mind and emotion at peace. Move only to ride opportunity or escape downtrends. The rest of the time, let the trends serve without meddling. Focus on the goal, not the moments paper gain or loss. Focus on the trend, not the daily fluctuations. Focus on the earnings, not opinions and media attention. Focus on reality, not appearance. Focus on the principles, not the trade. Focus on the fruit, not the flower. What lasts is soundly based. What flies may crash. Quick paper profit may quickly blow away. Do not be overconfident in success or in reliance on forecasts. Humility protects. Surprises will occur. Steady, cautious advance brings success. All trends change. All prices move. Risk cannot be shed. Be patient but alert. Notice old cycle patterns; something like them may come again. The prudent investor searches deeply for pattern, trend, and tendency, and constantly applies the lessons learned. The average investor is aware of these things but occasionally departs from them in the excitement of the moment. The foolish laugh at principle as outmoded or too slow. Opportunity comes when fear or despair prevails; danger lurks in euphoria. What all follow is no advantage. What all know is useless knowledge. Value which the market has not valued yields the most potential gain. Hence the prudent course runs opposite to the emotions, off the popular track, is not obvious, but fattens the portfolio. Step by step a prudent strategy, chosen before the first investment, builds a harmonious balance of multiple parts, combining growth with income with minimal credit risk in healthy degree and proportion. Gain requires risk and risk yields loss. Hence loss must go with gain. Fate will bludgeon him who tries to bludgeon fate. Better to accept a little loss and move on than hang onto a sinking ship or average down repeatedly. Accept what is and use it; you cannot change it. Ride the trend and be patient. Let the gains flow in. Jumping in and out every day or week wont help. Deliberate patience outdoes churning. Maintain perspective. A walker must fall slightly forward to take the next step. Excessive fear of little losses will produce great ones. Bargaining too hard may lose the trade. A focus on reasonable goals will evade grief over pebbles on the path. Safety lies in moderation.

33.

34. 35. 36.

37. 38.

39.

40. 41.

42.

43. 44.

64 45. Steady progress may not thrill, yet it lasts and builds upon itself. Compound growth wont bring instant fortune, yet a portfolio bigger every year will never be used up. Slow and steady wins the race. 46. Accept enough and have enough. Impatience and greed are traps. Reaching for the last crumb may cost a hand. The pig is slaughtered. 47. Pick a strategy that reaches the goal with the least effort and the greatest simplicity. Let the natural trends feed you; do not try to force the market or trick or outmaneuver it or rely on exerting more agility than others. 48. Bit by bit we learn the markets rule and, yes, a loss contributes to this school. Cast your bread upon the waters it cannot else return. Risk investing hard-won funds to tap the gain for which you yearn. The best strategy allows decreasing activity. 49. The prudent investor looks outside himself at the needs of the many and what they really do, not inward for what he wants. He invests in what profits, not in what glistens. Need measures value better than glamor or fad, since value is the future flow of profit. Be considerate of others, for the loss of any diminishes all. This, too, is a form of investment, karma, which has its return. Follow the golden rule, and treat as you would be treated. Be humble, cautious, observant as a child. 50. So manage and balance your investment portfolio that no event can ruin you. Avoid excessive vulnerability to any one event: have stocks for inflation and growth, bonds for deflation and depression, cash equivalents for emergencies, a bit of land for refuge, a bit of gold for conquest, insurance for misfortunes, geographical and categorical diversity for narrow disasters, gains for losses, skills for earning, and open and informed mind for new dangers. 51. Financial securities seem abstract and unreal, but all are ultimately based on the real actions and needs of real people. We all need food, drink, clothing, housing, medicine. In practice almost all of us use external energy (outside the tropics) and we communicate. We dispose of our dead and must somehow cope with production of waste. All these require physical matter, which is limited. Reality obeys "laws of nature, i.e., the patterns, regularities, and tendencies of what is real. These patterns govern everything, including investment returns. The environment influences their particular manifestations. We must remember the reality basis for all these. A society cannot live by exchanging services alone we need to produce these basic needs. We cannot eat by taking in each others washing. A great mass of elderly cannot amass enough money to survive without the help of the next generation. We cannot eat, drink, wear, live in, or prescribe money. Money is only a social creditor claim on someone else to produce these things, but the money can be traded for those things only if enough people are able and willing to produce those things at the times when they are needed. When a company has captured the world market for something, that company cannot grow except by producing something else or squeezing more return from the same products. Physical reality places limits on, and otherwise influences, financial securities, especially stocks. The prudent investor never forgets this, and watches for its application.

65 52. Remember what is real the real, physical sources of market value. Observe this reality carefully. Fit ones course to it. Proceed constantly with one eye on phenomena and the other on basic cause and principle. 53. Stay on the main road, the major trend; do not be side-tracked. Robber barons impoverish the land. Too much wealth in too few hands weakens the nation frozen it stands. 54. Observe reality closely and apply the lessons it teaches, consistently, at every level of complexity. Cultivate habits of prudent, realistic thought and action in accordance with these lessons. 55. Like a child be open, unprejudiced, and alert to new perceptions; forever learn, forever advance. Maintain enthusiasm to adapt and risks will not destroy. Keep whole original capital. Stay in harmony with internal and external reality. This harmony supports constancy and constancy is the prudent, successful course. Too much activity causes strain and stress; too many transactions produce churning, a course which wastes resources and opportunities. Too much risk is imprudent. Fortunes too quickly made are quickly lost. 56. Commentators do not necessarily know. Knowers do not necessarily comment. Do not follow the loudest voice or the biggest headline. Stay balanced. Keep strategy simple. Fit the road to the terrain, the strategy to reality. Transcend the swirling opinions of others, the inconstant ebbs and flows of daily market restlessness. 57. Invest steadily, with prudence and good sense. Choose opportunities which others do not yet fully recognize. Buy what other buyers are neglecting. You can only sell what others want. Too involved a plan, too frequent sallies into and from the market, too much massage of the portfolio spoils a good strategy. Be patient and choose the time and place to buy, the time and place to sell. Wealth grows during the wait, not during the transaction. When growth ends, move on. 58. Invest in real value, not gimmicks. Real value lies in food, fuel, and other goods, in needed service, not in structure or restructuring, not in accounting changes or Potemkin villages. Devoted employees, suppliers, neighbors, and customers help an enterprise to proper; manipulated or abused employees, suppliers, neighbors, or customs will not show devotion. Prudence lies in care, patience, balance, not in prescience or hunch. 59. Exercise restraint and keep reserves. The foundation of restraint is objectivity in evaluating ones own and others opinions and forecasts, adjusting expectations and responses to the continual revelations of reality. Rely on facts and numbers, not emotion or wish. Compound growth, over the years, knows no limit. Sink deep roots and build a sound foundation. Prudence is a lifelong plan. 60. Behave according to the Way of Prudence, and misfortune will be held at bay. Risk and adverse market moves will still occur, but they will not destroy the portfolio. Seek not advantage over others but wise investment for oneself. Each investors good fortune helps all the rest. My neighbors success will also benefit me. 61. Adapt to reality; move carefully and economically (sparely); wait patiently. Ride the tide. Power over ones economic destiny comes from fitting ones course to reality, not preference. Each can serve the others need. Wealth comes from fair dealing and mutual gain, not from grasping overreaching.

66 62. Reality is the source of everything; cosmic harmony with it yields treasure and security. Good practice and good basic advice are better than frivolous gifts and hot tips. Investing is not so much a matter of distinguishing the good from the bad as of assigning each its proper role in the overall plan. The prudent Way attracts because it lets the investor find what he seeks and mitigates the unavoidable mischances. 63. Achieve maximum results with minimum effort, maximum gain with minimum risk. Seek the unglamorous, unnoticed, unexciting. Use the hidden power of compounded growth. Achieve great gain by small advances. Solve major problems by foreseeing and hedging them when they are small. The prudent investor avoids seeking the big kill, and so finally wins big. Excessive risk is avoided by recognizing the risks in every course. What seems too good to be true probably is not true. 64. A sound policy prepares for misfortune. Small, constant steps go great distances. Hedge and balance; gradual, orderly entry to and exit from a market; avoidance of vacillating and stretching all these protect the portfolio. Do not lose steadfastness at the point of success. The end sought is only achieved if the start is sound. The prudent investor makes investment decisions on the basis of external opportunity and risk, not on the basis of his own internal desires and emotions. He observes more than acts and does not stay attached to what no longer confers benefit. 65. The goal is not to outbargain or to rely on anothers foolishness. The greater fool method generally snares the trapper. (The greater fool investment tactic is to buy though overvalued because of expectation that someone else will pay still more before the bubble bursts. In practice, there may be no greater fool than one who relies on the foolishness of another.) Look for neglected real value and rely on its fruition. 66. Why is the sea greater than all the rivers? Because it lies below them so it receives all their efforts. It lies where their tendencies take them. Great profit, too, lies closer to what is real, mundane, earthly, necessary, basic, ordinary. Food and waste companies proper; airlines falter. Reach not too far and none will bite the hand. 67. Dare to differ; only in difference is there distinction. From kindness and consideration of others comes courage and steadfastness. From saving comes the well of generosity. From humility and caution comes daring to differ. From differing comes investment gain. 68. Reaching for too much loses more. Chasing too hard falls behind. Choose the right opportunity only when it presents itself and benefit from the trend. 69. Do not ignore risks. Overconfidence loses. 70. Prudence is not flashy; it does not impress. Yet its value lasts. 71. To realize the limits of ones knowledge brings benefit. Not to make the best of the information available is a fault. To be aware of ones own faults is to transcend them. If one is by habit too cautious one must act though in fear; if the natural tendency is foolhardy, refrain though impatient. One way to do so is to require or limit certain kinds of transactions to a set number during a certain period of time (per day, week, month, quarter, or year), or a certain relationship with another part of the portfolio (speculations versus solid growth versus income investments, or in portion to the total portfolio, or in proportion to cash, etc.).

67 72. Overconfidence courts disaster. Prudence balances humility with steadfastness. Do not emphasize (overweight) even the best opportunity. 73. Courage and emotion yield a killing or ruin. Courage and calmness preserve and grow. The prudent investor does not stretch to transact when opportunity is limited or unusually risky nor overextend available resources nor chase prices. Patient waiting brings opportunity to the door. Time ones transactions carefully. 74. A balanced portfolio does not fear a market shift. Trivial daily price vagaries do not panic a longterm investor. Excessively complex tactics will entangle the feet and burn the fingers. 75. If company management takes too much and allows the workers too little (in such things as wages, opportunity for creativity, etc.), the workers will become disloyal, underproductive, and rebellious, and the creative will leave. Avoid investing in such a company. A manager who seeks to enrich himself by impoverishing others will ruin both. 76. Flexibility yields growth; rigidity leads to loss. The young, green, flexible companies grow. The growing tend to grow more; the sinking tend to sink more. The sick often die; the phoenix is only a legend. Beware the expectation that old age precludes death (e.g., Western Union, PanAmerican Airways once great companies in decline tend to continue declining until they expire). 77. In most countries and in most times, the wealthy and powerful grind down the commoners to enhance their own wealth and power still more. The result is poverty, political instability, a sick and backward economy, and danger to the wealthy and powerful themselves. Where the wealthy and powerful let go some wealth and power, sharing a little for the common good, the economy improves, the politics become orderly and their own safety and wealth grow faster. A company that degrades its workers to enrich the managers will ultimately serve poorly the interest of either. Letting go a little brings much; sharing brings success. A company that tries to injure and coerce its customers will be driven from the market place. A company which bullies or harms its neighbors may be driven from its home base. 78. Water erodes stone: flexibility surpasses stubbornness. Accepting the fact of loss (closing an unprofitable position when the fundamentals of a company no longer make it a bargain) may benefit more than holding on in hope of high prices when value continues to sink. Accept the responsibility to deserve the profit. 79. Keep your word; perform your contract; but be not too exacting of others, to maintain relations and peace. 80. Stick to human basics. 81. Truth does not always sound impressive or beautiful; impressive presentations do not always tell the truth. The most complicated tactics and theory are neither necessary nor always best. Choose a course fitting the trends; let natural growth, seasons, and other trends do the work. Observe closely; reason carefully; act sparingly.

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Appendix II. Market Aphorisms

Balance
Dont put all the eggs in one basket. Save a penny for a rainy day. A one-legged stool falls. What is the sound of one hand clapping?

Cosmic harmony = conformity with reality; see Reality conformity, below. Compound interest (see also Constancy):
Great oaks from little acorns grow, If tended fondly through heat and snow.

Constancy
Slow and steady wins the race.

Falls from a height

Two (or three) steps and a stumble.

Familiarity
The way to go is the way you know.

Fit between investor and investment strategy

Feet climb mountains; wheels travel roads; boats cross water; balloons fly. Tight shoes pinch.

Greater fool strategy

The greatest fool is the person who relies on the expectation of a greater fool.

Honesty
Honesty is the best policy.

69 Truth will out.

Independent analysis
Sheep get fleeced. If it looks too good to be true, it is probably false. Todays guru is tomorrows goat. Buy straw hats in winter.

Overreaching = grasping
Leave a crumb on the table. Bulls stumble, bears fall behind, sheep get fleeced, and pigs get slaughtered.

Preservation of capital
Never dip into capital; use only its return. The grandparents plants the seed; the grandchild enjoys the shade.

Prudence (see Reality conformity) Reality conformity (see also Seasonality, Trends)
Look, listen, touch, smell, and taste; say little. If in doubt, make sure. What it does speaks so loudly I cant hear what they say to the contrary. Cut losses; let gains run. Those who do not learn the lessons of history are obliged to repeat them.

Seasonality
Buy straw hats in winter and coal in summer.

Sentiment (= market sentiment)

The market climbs a wall of worry and slips on a slide of self-assurance.

Trends
The trend is your friend.

70 Look steadily ahead or fall quickly behind. Cut losses; let gains run. Dont fight the tape. Avoid catching falling knives and jumping on spikes. The chronically ill often die; the phoenix is only a legend. Senility does not preclude death. A broken trend is no longer the trend.

The grandparent plants the seedling; the grandchild enjoys the shade.

71

Appendix III. Common Securities Acronyms and Other Abbreviations

A ACQ ACRS SEC regulation allowing simplified registration for small issues of securities. Exchange acquisition (ticker tape symbol) Accelerated Cost-Recovery System: system of accelerated depreciation under the Internal Revenue Code. According to the fifth edition [Cottle, Murray, and Block] of Graham and Dodds Security Analysis, this method applies only to assets placed in service between 1980 and 1986. American Depository Receipt: receipt indicating beneficial ownership of a certain number of fraction of share(s) in a foreign corporation, held in nominal ownership by some American bank. These are traded freely in the United States, usually over the counter. also means accelerated depreciation range, and refers, in that meaning, to a method of accelerated depreciation permitted by the Internal Revenue Service for assets put into service between 1970 and 1981. Allowance for equity funds used during construction: an accounting method, sometimes used by public utility companies, involving the treatment as a capital asset of funds used for construction, against which future depreciation can be taken. American Institute of Certified Public Accountants. Assumed Interest Rate: for a variable annuity, where the actual interest rate is unknown in advance, the hypothetical interest rate used for explanatory purposes, and as a base for forecasting the payout ratio in a variable annuity.

ADR

ADR

AFUDC

AICPA AIR

AMBAC Insurer of municipal securities. AMT AON Alternate minimum tax: a tax imposed on persons whose preference income would excessively reduce their tax liability. All or none: in a securities-transaction order, an instruction to execute the entire order or no part of it. For example, if the order is to sell 300 shares at 31, this instruction would prevent the sale of 200 shares one day and 100 the next, producing extra commissions. Differs from fill or kill (FOK) in that FOK cancels the order in the absence of immediate, complete execution, while AON leaves the order in force until the whole order can be executed or the order expires. Accounting Principles Board: former accounting standards committee, replaced by FASB. Boston Stock Exchange (ticker tape symbol) Bond-anticipation note: a short term public debt, to be paid off by the proceeds of a planned bond issue. Bid wanted: an OTC market maker is seeking bids for the particular stock. An entry substituting for a quotation. Cincinnati Exchange (ticker tape symbol) Chicago Board Options Exchange Chicago Board of Trade (also CBOT)

APB B BAN BW C CBOE CBT

72 CBOT CFTC CLADR Chicago Board of Trade (also CBT) Commodities Futures Trading Commission Accelerated depreciation system: according to the fifth edition of Graham and Dodds Security Analysis (published 1988), this is the current tax-permitted method and stands for class life asset depreciation range. Current Market Value Certified Public Accountant Credit Register Cincinnati Stock Exchange (initiated an automatic order execution system) Committee on Uniform Securities Identification Procedure: also the identification number assigned by or according to the procedures of this group. Detroit Exchange (ticker tape symbol); also, SEC rule governing sale of unregistered stock. DBCC DISC DIST DJIA DK DNI DNR DPP DR EBIT EBT EE EE District Business Conditions Committee Domestic International Sale Corporation: a corporation formed in the United States to make sales outside the United States and enjoying certain legal privileges and preferences. Exchange distribution (ticker tape symbol). Dow Jones Industrial Average Dont know: a notice from one broker or dealer to another, indicating a disagreement with a confirmation received from the other broker. Do not increase: similar to the DNR term of an order, where appropriate. Do not reduce: an instruction included in an order that a buy price should not be reduced to offset dividend payouts. Direct participation plan. Debit Register Earnings before interest and taxes, i.e., operating and other earnings. Earnings before taxes, i.e., EBIT minus interest expense. Discount bonds with interest below market during early years. Available only to individuals in limited amounts. also means Excess equity, i.e., that amount of excess of assets over liabilities in a securities margin account which is not required to meet either current minimum maintenance margin requirement or minimum initial margin requirement for a new purchase and may therefore be placed in the SMA (special memorandum account) for use in other purchases. Efficient-Market Hypothesis: the theory that information and judgment are so widely and quickly dispersed that the market always keeps prices where they must be, so no one can outsmart the market. Earnings per share.

CMV CPA CR CSE CUSIP D

EMH

EPS

73 ERISA ETC Employment Retirement Income Security Act. Equipment Trust Certificate: a debt security secured by equipment, normally transportation equipment such as aircraft, rail cars, etc. Considered quite safe and having a good payment record. Financial Accounting Standards Board. Financial Guarantee Insurance Corporation: an insurer of municipal securities and municipal unit trusts. Federal Housing Authority. First in, first out. Federal National Mortgage Association, commonly called Fannie Mae: A NYSE-traded corporation which buys conventional and guaranteed mortgages. Fill or kill: an instruction in an order that, if the entire order cannot be immediately executed, the entire order is to be cancelled. Federal Open-Market Committee of the Federal Reserve Boards. Federal Reserve Board. Federal Reserve Board regulation of lending by others than banks or brokers on the security of financial securities. Generally accepted accounting standards. Gross Domestic Product. Government National Mortgage Association, commonly called Ginnie Mae. Gross National Product. General Obligation Bond: a municipal bond backed by the full faith and credit of the local government, i.e., by the promise to pay from tax revenues. General partner, i.e., a person accepting all the normal obligations of a partner. Personally liable for partnership debts. Good-till-cancelled order. Interstate Commerce Commission: regulates railroads and truckers. Industrial Development Bond, issued as a municipal debt but to build a facility to be leased to a private company, which often becomes the primary debtor. Treated as preference income in computing AMT. Intangible drilling costs: costs of services in drilling an oil or gas well. International Monetary Fund: international, government supported, bank-like organization created in 1944 to stabilize currencies, facilitate international debt payment, etc. International Monetary Market: trading in currencies, CDs, U.S. Treasury bills, and Eurodollar deposits on the Chicago Mercantile Exchange. Indication of interest in a new issue of securities accepted during the cooling-off period before effective registration.

FASB FGIC FHA FIFO FNMA FOK FOMC FRB G GAAP GDP GNMA GNP GO GP GTC ICC IDB

IDC IMF IMM IOI

74 IPO IRA IRR IRS ITC Initial public offering or primary marketing of securities. Individual Retirement Account. Internal rate of return: discount rate at which the present value of future cash flow equals the cost of investment. Internal Revenue Service. International Trade Commission: despite the name, this is a national institution, an arm of the United States government.

JTWROS Joint tenants with right of survivorship. K-1 LIFO LOI LP A schedule assigning income, expense, etc., of partnership to individual partners. Attached to partnership return. Last in, first out. Letter of intent to purchase enough shares in an open-end investment company (mutual fund) to qualify for a reduced sales commission load by reason of a break point. Limited partner or limited partnership. A limited partner is really a special partner in a limited partnership who agrees with the general partner that the latter will be liable for all partnership debts in lieu of the special partner. Notice to the public through official filing is required under the Uniform Limited-Partnership Code, which applies in all states except Louisiana. Midwest Stock Exchange; also 1,000 in Roman numeral system, used to represent $1,000 worth of bonds. Money, narrowly defined as coins, currency, demand deposits (checking accounts), and NOW accounts. Money, more broadly defined to include M1 and certain time deposits, savings accounts, and non-institutional money-market holdings. Money, most broadly defined to include M2 and large time deposits, institutional moneymarket holdings, short-term repos (repurchase agreements), etc. Municipal Bond Insurance Association: an insurer of municipal bonds. Municipal Securities Rule-Making Board. Net available for common equity. National Association of Securities Dealers

M M1 M2 M3 MBIA MSRB NACE NASD

NASDAQ National Association of Securities Dealers Automated Quotation System. NATC NAV NH NHA NMS NO Net available for total capital. Net asset value: the closing price of all securities held by mutual fund or investment company. Not held: market order allowing broker discretion about price or timing of the transaction. New Housing Authority. National Market System: the most prominent stocks on the NASDAQ system. The accompanying report was previously but erroneously listed this way (ticker tape symbol).

75 NYSE O OB OCC OID OP OPD OPEC OTC OW P PE PHX PN POP Pr PSE Q RAN REIT RELP Repo New York Stock Exchange. Instinet: the fourth market, i.e., an electronic system allowing institutions to trade directly with each other without any brokerage. Or better: synonym for limit order, because the order is to obtain a specified price or better for the client. Options Clearing Corporation. Original-issue discount bond, i.e., a bond originally issued at a discount from face value. Offering price of a mutual fund (including the sales load, if any). Opening delayed (ticker tape symbol). Organization of Petroleum Producing Countries. Over-the-counter: trading not on any exchange. Offer wanted: OTC market-maker is seeking offers in a particular issue. Pacific Stock Exchange (ticker tape symbol). Price-to-earnings ratio. Philadelphia Stock Exchange (which also trades options, etc.). United States Project Notes. Public offering price of a mutual fund (which, for a front-end load fund, includes the sales commission load). Preferred stock (ticker tape symbol). Pacific Stock Exchange. In bankruptcy proceedings (tape symbol); also, Federal Reserve Board regulation limiting interest rate payable on savings and other time deposits. Revenue anticipation bonds. Real estate investment trust. Real estate limited partnership. Repurchase agreement: a method of short term finance or borrowing, usually to finance international trade. This is the usual meaning in the securities business. (In the collection agency business it also means repossession, taking possession of a pledge item of personal or real property.) Return on equity, i.e., the percentage which profits constitute of the common stock holders equity as shown on the balance sheet. Rules of Fair Practice of the NASD Return on average total capital. Rights (ticker tape symbol).

ROE ROFP ROTC RTS

76 S Tape symbol meaning that the quantity listed is in tens rather than the usual hundreds. Tens are the normal trading round lot for this stock. These are not odd lots. The symbol is meant to represent a section or article sign (= ). Shares of beneficial interest. Securities Exchange Commission. Simplified employee pension plans. Qualified tax deferral retirement system allowed by the IRS for small employers. Instead of creating really separate systems, contributions are made to IRAs. The limits are the same as under a 401(k) plan. Sale listing delayed: a tape symbol meaning that the following trade listing is reported late and out of sequence. Sales load expressed as a percentage of the offering price. Special memorandum account: a number, authorized by SEC regulations, which represents the line of credit which the broker may extend to a margin account client. It represents the large excess equity which the account has had, increased by dividends, deposits, and long sales, and reduced by withdrawals, purchases, and other increases of margin debt. Special bid (a form of block transaction). Special offer (a form of block transaction). Self-regulatory organization: an organization or association of those subject to regulation, empowered by authorities to regulate themselves. OTC trades in listed stocks (ticker tape symbol); also Federal Reserve Board regulation limiting lending by brokers to customers for purchase or on pledge of financial securities. Tax anticipation notes. Latest number and direction of trades in Dow Jones list (calculated as the TIKI below, but for all 65 stocks). Number and direction last price move of Dow Jones Industrial Stocks (for example, positive 12 means that among the latest price changes in the DJIA stocks, 12 more were upward then downward). Tax and revenue anticipation notes. Federal Reserve Board regulation limiting bank lending on securities. Unit Investment Trust: like a mutual fund but, instead of a continually changing, managed portfolio, the portfolio is essentially stable and permanent. Previously reported trade (indicated as erroneous by NO) is corrected to read as now shown. When issued: refers to securities, not yet issues, while being traded on a when, as, and if issued basis. Same as above (ticker tape symbol). Philadelphia-Baltimore-Washington Stock Exchange (tape symbol). Yield to call: same theory and method of calculation as yield to maturity (see below), but (potential) call date is used instead of maturity date.

SBI SEC SEP

SLD SL% SMA

SP BID SP OFF SRO T TAN TIK TIKI

TRAN U UIT WAS WI W/I X YTC

77 YTM Yield to maturity: a calculation of the effective continuous yield on a bond to its maturity date. Because of continuous theory of the calculation, it is complex and normally looked up in a table. It may, however, be approximated by dividing the average return per year by the average price over the whole period.

Numbered Items 8-K HR-10 Report required to be filed with the SEC in special situations Same as Keogh plan. Qualified retirement plan under IRS permitting set aside of 25% of income (actually, 20%, since computation is done on part left immediately taxable) for employer and employees, up to $30,000 (including up to $7,000 voluntary contribution by employee). Quarterly financial report required by the SEC. Statutory retirement plan authorizing deferral of taxes on income set aside by self-employed person (and persons employees) up to 15% by employer and 25% altogether (but not over $300,000 total or $7,000 voluntarily by employee).

10Q 401(k)

78

Appendix IV. Formulas for Fundamental Analysis Bond Analysts Capitalization Ratios
(based on Balance Sheet items, though analyst may adjust them; diagonal lines and long horizontal underlines represent division; capital letter introduces new item; hyphenated expressions refer to one item; subtraction shown by long dash). Bond Ratio = _Long-term debt_______ Total capitalization (= Equity + Bonds)

= Debt Ratio = Percent of total capital provided by debt Common Stock Ratio = Common stock + Capital in excess of par + Retained earnings Total capitalization =_ Equity___ Total Capitalization Preferred Stock Ratio = Preferred stock___ Total Capitalization

Debt to Equity Ratio = Total long-term debt Equity

Corporate Debt Ratios

Bond-Interest Ratio = = Times Interest Ratio Income before interest and taxes Annual interest charges

Bond Ratio (see under Bond Analysts Capitalization Ratios, above) Debt-service coverage ratio (for revenue bond evaluation) = Net Fixed Assets per Bond Annual net revenue of project Annual debt service = Net fixed assets_________ Number of bonds in funded debt

Other Safety Measures

Net asset value per bond = Net tangible assets Current liabilities Number of bonds = EBIT___ Interest

Bond Interest Coverage =

Earnings before interest and taxes Annual bond interest

79 = = = times-interest-earned ratio fixed-charge coverage ratio times-fixed-charge-earned ratio = EBIT I+P = interest coverage ratio

Debt-Service Ratio

where EBIT = Earnings before interest and taxes, I = Interest on the debt, and P = Periodic principal-payment obligation, each computed on an annual or other uniform basis. Working Capital = Current Ratio Quick Assets Acid-Test Ratio = = = Current assets Current liabilities _Current assets_ Current liabilities Current assets Inventory __Quick assets__ Current liabilities = Quick Asset Ratio

Cash-Assets Ratio=

Cash and marketable securities Current liabilities

Efficiency Ratio
Inventory Turnover Ratio = _Cost of goods sold_ Year-end inventory

Profitability Ratios
Margin-of-Profit Ratio = Net-Profit Ratio Return on Equity = = Operating profit Net sales Net income (after taxes) Net sales Net income (after taxes) Stockholders equity

Return on Common Equity = Net earnings available to common Stockholders equity

Collection Ratio

Receivables x 360 Net sales

Stock Valuation Ratios

Book Value per Share = Net Tangible Assets = Assets Intangibles Liabilities Preferred stock value Number of Common Shares Outstanding Assets Intangibles Liabilities Preferred stock value Number of Common Shares Outstanding

80 Dividends per share Price/Earnings ratio Current Yield Dividend-Payout Ratio = Earnings per share primary = Annual dividends/Share of common Earnings/Share Earnings per present number of outstanding common shares = = = Annual dividends Number of Shares Outstanding __Current market price__ Earnings/Common shares Annual dividend/Share Market value/Share

Earnings per share after dilution = Total corporate earnings as they would be if all warrants, company-issued options, rights, and convertibles were converted to common shares, divided by the number of common shares that would be outstanding if all warrants, rights, company-issued options, and convertibles (either bonds or preferred stocks or both) were converted to common shares HIR Ratio = Expected profit/growth rate Earnings/Share

Balance-Sheet Formula
Assets = Liabilities + Equity

Earnings-Statement Formula
Revenues Expenses = Net income

Cash-Flow Formula
Revenues actually received Expenses actually paid = Cash flow, hence Income + Depreciation Payments on Debt principal expenses capital investments = net cash flow

Rights Formulas
Value of a Stock Right when stock trade cum (with) rights: = Market price of stock Subscription price Number of rights required + 1

Value of a Stock Right when stock trade ex (without) rights: = Market price of stock Subscription price Number of rights required to buy one share

Parity Formulas where another security is convertible to common shares

Parity Price of Common = Market price of convertible

81 Number of common shares to which convertible Parity of Convertible = Market price of common times conversion ratio

Taxable Equivalents
Taxable equivalent yield of tax-exempt bond = Municipal bond interest rate 1 Tax rate for this taxpayer For a person in the 28% tax-rate bracket, multiply the municipal-bond rate by 1.3889, i.e., = Municipal bond rate x 1.3889 Tax-exempt equivalent yield of taxable bond = (1 Taxpayers tax rate) x Taxable-bond rate Hence, for a person in the 28% tax-rate bracket, multiply the taxable-bond interest rate by 0.72, i.e., = Taxable-bond rate x 0.72

Treasury Bill Formulas (prices in % of par = Actual / 100)

Real Yield = Annualized appreciation Purchase price

= (Par Purchase price) x Annual turnover Purchase price But in the secondary market, inconsistently, the quotation is given as Discount Yield = (Par Purchase Price) x 360 Days remaining

Per Share Ratios

Earnings per share Dividends per share Sales per share Cash flow per share Book value per share = = = = = Profits available for the common shares Weighted average common shares outstanding Total annual dividends paid to common shareholders Weighted average common shares outstanding Sales Weighted average common shares outstanding Cash flow from operations after taxes Weighted average common shares outstanding Combination of

(Book value of common equity good will most other intangible assets) Common shares outstanding at balance-sheet date Current assets per share Quick assets per share = = Current asset All claims prior to common Common shares outstanding at balance-sheet date Cash + Receivables All claims prior to common

82 Common shares outstanding at balance-sheet date Cash per share = Cash All claims prior to common Common shares outstanding at balance-sheet date

Price Ratios
Price-Earnings Ratio Earnings yield Dividend yield = = = Price per share Profits per share Earnings per share Price per share Dividend per share Price per share

Sales per dollar of common at market value = Sales Weighted average shares outstanding x stock price Price-to-book value = Price per share Book value per share

Profitability Ratios
Return on Capital Capital Turnover Earnings margin = = = Net income + Minority interest + (Tax-adjusted interest) Tangible assets (Short-term accrued payables) Sales____________________________ Tangible assets (Short-term accrued payables) Net income + Minority interest + (Tax-adjusted interest) Sales

Return on capital before depreciation = Net income + Minority interest + (Tax-adjusted interest) + Depreciation Tangible asset (Short-term accrued payables)

Return on common equity = Net income Preferred dividend requirements Common equity Goodwill Most intangibles + Deferred tax liability

Growth Ratios
Growth in sales Growth in total return Growth in earnings per share = = = Sales in final period Sales in base period Net earned on total capital in final period Net earned on total capital in base period Earnings per share in final period Earnings per share in base period

Stability Ratios
Maximum decline in coverage of senior charges

83 = Percentage decline in return on capital = Worst-year coverage Average of prior three years of coverage Worst-year coverage Average of prior three years of return

Payout Ratios
(Dividend) payout ratio Dividend / Cash-flow ratio = = Dividend paid on common shares . Net income available for common shares Dividend paid on common shares . Cash flow from operations (after taxes)

Credit Ratios
Current ratio Quick ratio Cash ratio Equity ratio (book value) Equity ratio (market value) = = = = = Current assets Current liabilities Current assets Inventories Current liabilities Cash items (and cash equivalents) Current liabilities Common-stock equity at book value Tangible asset Accrued payables Common-stock equity at market value Tangible asset Accrued payables

Coverage (by earnings) of senior charges (i.e., interest and sometimes also other fixed charges) = Pretax earnings available for payment of senior charges Senior charges Cash flow / Total Capital = Cash flow from operations after taxes + Tax-adjusted interest Tangible assets Accrued payables

Total debt-service coverage = Cash flow from operations after taxes + Rentals + Tax-adjusted interest Interest + Rent + Current maturities + Sinking-fund payments Defensive interval in days = (Cash + Receivables) x 365 Total operating expenses Depreciation Other noncrash charges

Other Ratios
Depreciation to sales Depreciation to gross plant Inventory turnover = = Depreciation expense Sales Cost of goods sold Gross plant

= Cost of goods sold Inventory (including LIFO reserve, if any) Sales Accounts Receivable

Turnover of accounts receivable =

84

Bibliography
Tao Te Ching Lao Tsu, Tao Te Ching (translation by Gia-Fu Feng and Jane English, with Chinese calligraphic text and photographs on facing pages). 1989. Vintage. Blakney, R.B., The Way of Life (translation and extensive comment). 2001. Signet Classics. Heider, John, The Tao of Leadership (a section-by-section application of the Tao to the problems of small-group leadership, but not a translation). 2013. Green Dragon Books. Capra, Fritjof, The Tao of Physics: An Exploration of the Parallels between Modern Physics and Eastern Mysticism (a philosophical-mystic discussion of the relationship between the methods of Taoism and the results of physics research). 2013. Shambhala Publications. James, Geoffrey, The Tao of Programming (a whimsical approach). 1986. Info Books. Henricks, Robert G., Lao-Tzu: Te-Tao Ching (a scholarly translation of newly discovered texts from Ma-Wang-Tui, manuscripts from early Han or before, with texts set out on facing pages, compared with each other and the more traditional texts known from later manuscripts). 2010. Ballantine Books. Economics Almost infinite numbers of economic books are available and it is probably inappropriate to identify any one as authoritative. The greatest names all suffer from blind spots. Adam Smiths Wealth of Nations is the great classic, but many others have contributed. Perhaps the most recent book to make a great mark is a cartoon book first published in Japan, which is not so much a fundamental philosophy of economics, like Wealth of Nations, but a narrower application of current specific economic thinking about Japanese economics in the contemporary world: Ishinomori, Shotaro, Japan, Inc.: Introduction to Japanese Economics (The Comic Book). 1988. University of California Press. The best approach to this aspect is to read a variety of divergent viewpoints and form ones own opinions. Financial Management Brigham, Eugene, and Michael Ehrhardt. Financial Management: Theory and Practice. 2013. Cengage Learning. Cohen, Jerome B., and Arthur Hanson, Personal Finance. 1955. Irwin (3rd ed.). Fundamental Analysis Cottle, Sidney, Roger F. Murray, and Frank E. Block, Graham and Dodds Security Analysis. (5th ed.). 1988. McGraw-Hill. Trading System Smith, Vernon L. and Arlington W. Williams, Experimental Market Economic, in Scientific American, December 1992, pp. 116 ff. (discussing university computerized and psychological experiments aimed at supporting basic economics theories it actually proved more about the influence of trading systems than about the soundness of economic theory except that the simplistic and optimistic rational valuation model proved as erroneous in experiment as it has shown itself to be in real life).

85 Technical Analysis Pring, Martin J., Technical Analysis Explained: The Successful Investors Guide to Spotting Investment Trends and Turning Points. 1991. McGraw-Hill.

[Publishers and publication dates were not included by the author; they were added by D.M. Gainer on June 8, 2013, based on information at Amazon.com. In some cases, dates and/or publishers may not accurately reflect the specific edition that the author used. The original manuscript also contained an index which is not included here.]