Chapter 14 - Development Of Your Own Investment Program

The earlier chapters in this book have been designed to acquaint you, in a somewhat panoramic fashion, with the entire range of marketable securities and the workings of the marketplace. With this background of information you should, by now, be quite well prepared to appraise the usefulness and function of each class of security and, more specifically, to design a long-range investment program suitably tailored to your own individual needs.

Three Types of Investment Programs

The type of security account you should be working toward depends of course on your own particular objectives and goals. You will probably find that the program you prefer will fall into one of three main categories: (1) conservative investment primarily for income; (2) a less conservative portfolio of securities combining lower yields with greater potential for capital gain (a so-called businessman's risk program); or (3) a program minimizing income and laying major stress on capital gains, usually from long-term retention of "growth" securities.

In all three of these programs certain fundamental investment procedures should be observed. First, any and every security decision made must be based on facts not on rumor, hearsay, or a "tip." Get from your broker, or from an investment service or analytical report, the complete information about the company and security in question capitalization, trend and consistency of earning power, quality of management, balance sheet position, research program, dividend record, price range, etc. If possible, compare the security you have in mind with a similar one in the same industry. Satisfy yourself so far as possible that this particular security will accomplish the purpose for which you are purchasing it.

Diversification

In launching your program, start off with quality securities. Buy the best in the category you have decided on. Then consider diversification. This is a rather overworked word and the principle can be overdone. Sensible diversification calls for spreading your investments over a sufficient number of individual issues so that if one stock does not work out well, it will not seriously impair the market value or the income return of the entire list. Originally, diversification was entirely a defensive concept to insulate against loss by spreading the risk. More recently, however, diversification has been thought of in a more positive way, namely, the spreading of investment over a number of issues to assure broader representation among dynamic industries.

Either way you view the matter, diversification is a sound principle and you should follow it, but not make a fetish of it. If your list totals less than six figures, then 8 to 12 individual issues should provide a quite practical degree of diversification. A compact list of securities is easier to follow, and too many issues needlessly clutter up your bookkeeping and create "scatter-fication" rather than intelligent diversification.

Practically, diversification is used to divide investment holdings among the major groups utilities, railroads, financial companies, oil, chemicals, steels, Pharmaceuticals, merchandising, publishing, minerals, and mining, etc. Industrial trends at the time of purchase are important. For example, in the early 1900's, railroads were a dominant factor in our economy, and a stock list without railway securities in it would have been almost unthinkable. There is no such insistence on railway issues today, and their attraction is more in high dividend return than in concepts of dynamic growth. Oils, in late 1956, displayed a significant flattening out in earning power; and in the period 1957 to 1960, oil shares were among the poorest market performers. So there are fashions in finance which should be observed. In 1915, trolley stocks and bonds were in great favor. Where are they today?

Sample Portfolios

Having set down the basic criteria for building your own investment portfolio, it might be well to outline some sample programs in line with the three different types listed earlier. Please bear in mind, however, that these lists are merely illustrations and in no sense to be regarded as recommendations or indorsements of individual securities.

I. Conservative Income Program Sample Portfolio of Common Stocks

Standard Oil of N. J.
American Telephone and Telegraph Commonwealth Edison
Niagara Mohawk Power
American Tobacco Company
First National City Bank
Norfolk and Western Railroad American Express Company
Procter and Gamble
This will give you some ideas about quality selection and diversification. For guidaince in your consideration of securities primarily for dependable income, you should obtain a list published by the New York Stock Exchange of stocks which have paid dividends regularly for 25 to 50 years. A similar list of long dividend-paying-over-the-counter issues is published semi-annually by the Commercial and Financial Chronicle.

II. Investment Program Stressing Income Less, and Capital Gains More (Businessman's Risks)

American Home Products
Monsanto Chemical
International Business Machines
Weyerhaeuser Lumber
American Marietta
General Dynamics
C. I. T. Financial
General Electric
El Paso Natural Gas
American Electric Power

III. Investment Program for Capital Gains from Long-Term Growth

Minnesota Mining
Texas Instruments
Cenco Instruments
Connecticut General Life Insurance
Valley National Bank (Arizona)
McLouth Steel
Hercules Powder
Prentice-Hall
Eli Lilly
Owens-Corning Fiberglas

Remember, these lists are sample ones with no recommendation of any security intended or implied. But they should guide you along sensible lines. After you have purchased a list of stocks, you're not through. Any list requires watching and review. Earnings change from year to year and whole industries may become static or retrogressive, in which case you'll want to move out. Keep vigilant and informed.

About timing, most people buy stocks when they have surplus funds; and more surplus funds are, of course, available in prosperous times. This means that a great deal of buying takes place when stocks are relatively high-priced simply because that's the time when people have the money. So some caution must be exercised lest you pay so high a price for stock that you have to wait for years before it can show a major price gain.

Market Barometers

No one knows what the market is going to do, and price swings are completely unpredictable. In any average year, even the highest grade stocks will vary by as much as 25% between their highs and lows. We do have certain ways of gauging the market altitude by historic comparisons. For example, the Dow-Jones Industrial Average, based on the market prices of the shares of 30 selected stocks listed on the New York Stock Exchange, is a major barometer. It reached 381 in 1929, went down to 41 in 1932, and reached 685 in January of 1960.

Two other elements are useful in determining how high the market is. One is the price/earnings ratio. Using this same list of Dow-Jones Industrials, the shares were selling at 19 times annual earnings in October, 1929, only 6 times earnings in 1932, and about 18 times earnings in December, 1959. Secondly, the market has been historically high whenever the yield on quality stocks was substantially less than on prime corporate bonds. These are some of the things to look for in determining just how high the market is. But remember, all stocks do not rise and fall together. (The oils had a bear market all their own between 1956 and 1960, when the total market was moving to all-time highs.)

The Dow-Jones Averages and the Dow Theory

For decades traders, analysts, and mathematicians have tried to develop systems that might project, or foretell with accuracy, major future trends in the stock market. Of all these attempts at price prophecy the famous (and controversial) is the Dow Theory.

There are excellent full-length books on this subject, authored by Hamilton, Wycoff, Rea, Magee, and Russell among others; and there are, even among dedicated followers of the Dow Theory, some basic disagreements about interpretations. However, the main premise is this: that the market, by its own action predicts or indicates its future direction; and by so doing, provides a quite trustworthy guide as to when to buy and when to sell stocks.

Without any attempt to outline definitely this Dow Theory it can be said to be based importantly on the number three. If a stock reaches a new high, reacts, reaches (or exceeds) the first high, recedes again, and then upsurges past the earlier highs, then you have a "bull' signal. That stock is going higher because, in three tries, it broke through a resistance point on the up side. Reverse the three-point landing theory, and if the low price (for a given movement) is hit twice and then broken on the down side, then you have a gold-plated "bear" signal. That stock is headed down!

The foregoing technique is customarily related not only to the performance of individual stocks, but, more panoramically, to the Dow Jones Average of thirty selected industrial stocks. The stocks that determine this composite average are the common stocks of the following renowned companies:

Allied Chemical                                    International Nickel
Aluminum Co.                                      International Paper
American Can                                      Johns Manville
American Tel & Tel                              Owens-Illinois Glass
American Tobacco                               Procter & Gamble
Anaconda Co.                                      Sears Roebuck
Bethlehem Steel                                    Standard Oil of California
Chrysler                                               Standard Oil of N. J.
Du Pont                                                Swift & Co.
Eastman Kodak                                    Texaco Inc.
General Electric                                    Union Carbide
General Foods                                      United Aircraft
General Motors                                    U. S. Steel
Goodyear                                             Westinghouse Electric
International Harvester                          Woolworth

Lest the trend of this Industrial Average contain by chance some warp or basis, the direction, or indicated trend, of the Industrial Average must be confirmed (correspond to) by similar action in the Dow-Jones Railroad Average.

This, in oversimplified form, will give you some idea about the Dow Theory. Many seasoned investors take little stock in it. They say that this theory gives the buy or sell signal too late often months after the up or down trend has been visibly established; and they further say that the rail list has not, since the thirties, been at all representative of basic trends in the stock market.

However much validity, or lack of it, there may be to this Dow Theory, it has a myriad of devoted followers and militant detractors. Try it for yourself  maybe it will work for you. It obviously won't help you out very much, however, in over-the-counter issues, which often go along their own merry market way, quite disdainful of the trends, apparent or real, among listed securities.

Dollar Cost Averaging

One way to flatten out market purchase prices is what is called dollar cost averaging. This merely means applying the same number of dollars each year to the purchase of a given security. For example, suppose you can set aside for investment $2,000 a year. Then you decide you will spend that much each year to buy General Motors common. In one year you may buy it at 40, in which case you'll purchase 50 shares; the next year the stock may be selling at 50, so you'll buy only 40 shares. But a year later the stock might sell, for example, at 25, so you could buy 80 shares. This method, as you can see, would enable you to buy the stock at a quite low average price, since in a year when the stock was "down" you could buy twice as many shares for the same amount of money. Purchase of stock on the Monthly Investment Plan, or of mutual funds on installments, achieve much the same results.

You will find this business of selecting stocks and building a portfolio can add zest to your life as well as augument your capital and income. Bear in mind too that the three program types listed earlier are by no means inflexible. You can make any combination of income, speculative, or growth issues you want. The important thing is to have a plan, stick to it and get the proper information before you buy.

Resume

1. Buy quality issues.

2. Diversify sensibly but don't overdo it.

3. Decide what you want high current dividend income or long-term growth.

4. Get the facts before you buy.

5. Dollar cost averaging can be useful.

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