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By Root 2750 0

valid reason for selection—that is something for the speculators to play around with. The second has validity, but within limits. Can the past growth and the presumably good prospects of Emery Air Freight justify a price more than 60 times its recent earnings?1 Our answer would be: Maybe for someone who has made an in-depth study of the possibilities of this company and come up with exceptionally firm and optimistic conclusions. But not for the careful investor who wants to be reasonably sure in advance that he is not committing the typical Wall Street error of overenthusiasm for good performance in earnings and in the stock market.* The same cautionary statements seem called for in the case of Emerson Electric, with a special reference to the market’s current valuation of over a billion dollars for the intangible, or earning-power, factor here. We should add that the “electronics industry,” once a fair-haired child of the stock market, has in general fallen on disastrous days. Emerson is an outstanding exception, but it will have to continue to be such an exception for a great many years in the future before the 1970 closing price will have been fully justified by its subsequent performance.

By contrast, both ELTRA at 27 and Emhart at 33 have the earmarks of companies with sufficient value behind their price to constitute reasonably protected investments. Here the investor can, if he wishes, consider himself basically a part owner of these businesses, at a cost corresponding to what the balance sheet shows to be the money invested therein.* The rate of earnings on invested capital has long been satisfactory; the stability of profits also; the past growth rate surprisingly so. The two companies will meet our seven statistical requirements for inclusion in a defensive investor’s portfolio. These will be developed in the next chapter, but we summarize them as follows:

Adequate size.

A sufficiently strong financial condition.

Continued dividends for at least the past 20 years.

No earnings deficit in the past ten years.

Ten-year growth of at least one-third in per-share earnings.

Price of stock no more than 1½ times net asset value.

Price no more than 15 times average earnings of the past three years.

We make no predictions about the future earnings performance of ELTRA or Emhart. In the investor’s diversified list of common stocks there are bound to be some that prove disappointing, and this may be the case for one or both of this pair. But the diversified list itself, based on the above principles of selection, plus whatever other sensible criteria the investor may wish to apply, should perform well enough across the years. At least, long experience tells us so.

A final observation: An experienced security analyst, even if he accepted our general reasoning on these four companies, would have hesitated to recommend that a holder of Emerson or Emery exchange his shares for ELTRA or Emhart at the end of 1970—unless the holder understood clearly the philosophy behind the recommendation. There was no reason to expect that in any short period of time the low-multiplier duo would outperform the high-multipliers. The latter were well thought of in the market and thus had a considerable degree of momentum behind them, which might continue for an indefinite period. The sound basis for preferring ELTRA and Emhart to Emerson and Emery would be the client’s considered conclusion that he preferred value-type investments to glamour-type investments. Thus, to a substantial extent, common-stock investment policy must depend on the attitude of the individual investor. This approach is treated at greater length in our next chapter.

Commentary on Chapter 13

In the Air Force we have a rule: check six. A guy is flying along, looking in all directions, and feeling very safe. Another guy flies up behind him (at “6 o’clock”—“12 o’clock” is directly in front) and shoots. Most airplanes are shot down that way. Thinking that you’re safe is very dangerous! Somewhere, there’s a weakness you’ve got to find. You must always check six