The bewildered owner of a small portfolio of common stocks sat shaken one recent afternoon, when the stock market had taken a precipitous decline, and wondered out loud whether the market was any place for the small investor anymore.
A reasonable question, it would seem, given the way computerized program trading is causing the stock market these days to bounce around like a new tennis ball. In program trading, institutional money managers hedge their bets on the direction of the major stock market indexes with purchases or sales of stocks underlying those indexes. If you were a money manager, for example, your computerized trading program might notice that the futures contract on the 20-stock major market index, which trades on the Chicago Board of Trade, was selling at a premium to the value of its underlying stocks, all of which trade on the New York Stock Exchange. At that point you would sell short the overpriced index and buy the underlying stocks, knowing that ultimately the discrepancy would have to be reconciled, either by a fall in the index or a rise in the stocks. You could then book a profit whichever way it went.
Played repeatedly, at a much faster pace and with variations, that is the game called program trading. With all that buying and selling, it has been adding massively to the volume of shares traded and to the price movements of some stocks--mainly the big companies that make up the major indexes.
But is program trading any reason for the individual investor to lose heart? Not at all. Like most of the furious activities of the big investing institutions, who move their $1.4 trillion of assets in and out of stocks and bonds, the computerized programs are just another trading game. "They are mechanistic, built on where the market is at a point in time," says David Dreman, dismissively. Dreman is managing director of Dreman & Embry investment counselors and author of "The New Contrarian Investment Strategy."
Mechanistic it may be, but Chrysler Corp., one of the stocks most affected by the program trading last week, fell 12.5% from $46 to $40.75. What does Dreman say to that? He says it is an opportunity to buy Chrysler, which is now selling at less than five times earnings in a market where the average price-earnings ratio is 14. Dreman, because he believes in the fundamentals of Chrysler's position in the U.S. auto market, sees comparative value. And buying value at a low price and waiting, for years if necessary, for other investors to recognize that value and reward your vision is the essence of investing as the late Benjamin Graham defined it years ago.
Graham, who made millions--his first before age 35--in a Wall Street career spanning from 1914 until his death in 1976, at age 82, laid out his principles for determining value in "The Intelligent Investor"--first published in 1949. "Current assets should be at least twice current liabilities," wrote Graham. Further, his criteria required that a company have low debt, show earnings increases for the last 10 years and dividends for the last 20.
Do the criteria sound faintly out of date? Well, if you search the Standard & Poor's Stock Guide, as Graham liked to do, or the Value Line Investment Survey, you would find some companies even at this stage in the bull market that would qualify. IBM, for instance, meets almost every one of Graham's criteria.
Chrysler, because of its high debt, would not meet those criteria, and Graham undoubtedly would not buy it.
The point for the individual investor, however, is to give an indication of how master investors seek comparative value in equity investments, not to give tips on auto stocks or IBM. Put another way, if you can keep your head when investing institutions all around you are losing theirs, you can still make a dollar as an individual investor in the stock market.