The Intelligent Investor: A Froogal Stoodent review
The Intelligent Investor by Benjamin Graham – Notes and Quotes
Ninth in a series of book reviews by The Froogal Stoodent
No doubt thanks in part to Warren Buffett’s recommendation, Benjamin Graham’s classic The Intelligent Investor remains highly regarded by investors everywhere.
Now, I can say that I have read it for myself. Twice, in fact.
So, do I recommend that you read it too? Surely, if it’s good enough for the greatest investor alive, it’s good enough for you, right?
Let’s read on and see.
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First, I must explain which version I used: the 4th edition of The Intelligent Investor was published in 1973, just 3 years before Graham’s death.
But I didn’t read some musty 50-year-old tome. No, I read the re-published version from 2003, with footnotes – and a commentary after each chapter – added by veteran financial journalist Jason Zweig.
If Warren Buffett, the wealthiest investor alive, says that this is “by far the best book on investing ever written” (as he writes in the preface) then it must indeed be the best. Right?
Well…for a beginner? Definitely not!
For an advanced investor who already has a strong understanding of how to read corporate financial statements? Maybe so.
If you’re not already interested in this stuff, The Intelligent Investor will probably put you to sleep. But if you are interested in investing, you can find quite a bit of wisdom between these covers.
To illustrate with Graham’s own words from the Introduction: “The purpose of this book is to supply, in a form suitable for laymen, guidance in the adoption and execution of an investment policy. Comparatively little will be said here about the technique of analyzing securities…” Which makes sense, because Graham and David Dodd co-wrote a textbook called Security Analysis, published in 1934.
I actually found the post-chapter commentary from Jason Zweig more useful, in most chapters. And definitely more interesting! Graham provided plenty of insight, but it was so dense and academic that it took a more skilled writer (but, surely, less skilled investor) to make it readable.
I’ve been reading voraciously my entire life, and am used to finishing most books in a day or two. But this one took me well over a week! Maybe Graham would have benefited from co-writing this book with a professional writer, to make his ideas more palatable for the aforementioned laymen.
So what was Graham’s biggest insight in The Intelligent Investor?
It’s actually summarized best by Buffett in an appendix: an investor should buy a dollar for forty cents. This is the basic principle behind value investing.
Graham does explain how to do that; it involves looking at a company’s financial statements to determine the overall value of a given company (based on its assets minus its debts), and then looking at the share price (considering both common and preferred shares) times the number of shares available, to determine the market’s total valuation of that company. Then you compare the two to look for an undervalued company. But the investor is still not done; he or she must also evaluate the overall position of the company within its industry, and determine whether that company has potential to grow.
An example: say Corporation QRS has issued 1 million shares of common stock (and no preferred stock), and each share sells for $10. That means the market values the company at $10 million. If your analysis reveals that the company has $15 million worth of product and equipment (that is, the ‘liquidation value’ of the company if it were to cease operations immediately), then the current share price appears to be a bargain.
Should you buy? Well, that depends on why it’s a bargain.
Graham notes that market participants frequently behave irrationally. For example, a securities analyst for Big Worldwide Bank is looking at Corporation QRS. This analyst expects QRS to increase its 2nd-quarter revenue by 2% over the second quarter of last year.
If he finds that the year-over-year growth for QRS was actually 1.7%, rather than the expected 2%, he might downgrade QRS and recommend that stockholders sell some shares. Since this analyst works for Big Worldwide Bank, a large international investment bank that holds millions of dollars’ worth of shares of QRS, his opinion matters a great deal.
Based on their analyst’s recommendation, Big Worldwide Bank decides to sell some of its shares.
But this analyst has probably discussed matters with other analysts, including those who work for other major shareholders of QRS. If the other big shareholding institutions also decide to sell some of their holdings because of their own analysts’ recommendations, these actions will likely cause a noticeable decline in the share price of QRS.
This decline could trigger a number of pension funds and brokerages to sell some of their own shares, which could cause still further panic-selling.
And all this, despite the fact that QRS’ sales have increased from Q2 of last year to Q2 of this year!
In such an event, you might decide that it’s a good company in a good sector, and that the share price is simply undervalued for silly reasons. So, following Graham’s advice, you’d buy shares in QRS.
But that’s just one possibility. Maybe QRS is valued so low because the management is continually doing stupid things. Maybe they acquire companies in totally unrelated fields (think of an oil company buying a fashion retailer, or a luxury car manufacturer buying a timber company).
Or perhaps QRS is spending extravagantly to build fancy new factories and award huge bonuses to their executives, even while the whole sector is falling on hard times.
In scenarios like these, Graham suggests that you avoid buying shares in QRS because it’s being run into the ground by incompetent buffoons.
Graham walks the reader through some examples and case studies to illustrate how to think productively about such common conundrums.
He also peels back the curtain on a variety of tricks employed by corporate finance teams. Even in the 1950s and 60s, management used some pretty sophisticated gimmicks to fool investors into thinking a company was stronger than it really was.
I have no doubt that companies still employ some of those tricks, as well as a host of new ones. So this book is well worth a read if you’re interested in corporate governance or the agency problem.
Of course, Graham’s entire book is predicated on the notion that you’re buying shares in individual stocks.
In 1949, when the first edition of The Intelligent Investor was published, folks like you and me had little choice. The low-cost index funds that people rave about simply weren’t available at that time.
If you had enough money to invest, you may have been able to buy shares in a nicely-diversified mutual fund, but they were fairly expensive (since someone had to go through and do the kind of exercises that Graham discusses in this book, and of course, that person wanted to get paid). Moreover, they weren’t terribly popular, since the Great Depression was still fresh in people’s minds, along with the nausea-inducing ~80% decline in the stock market from 1929-32.
Though mutual funds were definitely known in 1949, they were not as widely available as they are today. If you wanted to buy into a mutual fund, you would have had to contact a brokerage firm, and it probably would be a relatively small shop unless you lived in New York City or Chicago. And then you would have to hope your brokerage found a good fund, run by a skilled and disciplined manager.
So, Graham was initially speaking to an audience that didn’t have the advantages that we do today. Though his book didn’t really discuss it, I’m told that, toward the end of his life, Graham became a bigger and bigger fan of mutual funds (especially low-cost versions, like index funds) for most ordinary investors.
Were Graham alive today, I suspect that his advice would be similar to Bogle’s or Malkiel’s. Or Paul Merriman. Or even amateurs like Mr. Money Mustache, or JLCollinsNH, or the Froogal Stoodent :)
However, Graham did draw an important distinction in investing styles. He noted that the defensive (or passive) investor makes transactions infrequently and seeks to avoid major mistakes, while the enterprising (aka active, or aggressive) investor is willing to spend much more time and effort on finding good investments at appealing prices.
You might reflect that it would be far easier to be an active investor these days, given all the financial information that’s readily available on the Web. Just visit a site like Yahoo finance, set up a few filters, and buy whatever companies made it through your filters.
On the other hand, there are plenty of people who have already done exactly that. In fact, a number of advanced investors did something similar back when I was still in elementary school! Plus, you have to pick the right filters in the first place. So in 2022, that approach isn’t likely to be as fruitful as you might think.
In his 4th edition, published in 1973, Graham gives his analysis of the situation for defensive vs. enterprising investors: “We have some doubt whether a really substantial extra recompense is promised to the active investor under today’s conditions.”
He was prescient, as stagflation ravaged the American economy for the next ten years or so. Still, some value-oriented investors managed to beat the market during this timeframe. Think of names like Peter Lynch, Walter Schloss, Bill Ruane, and, of course, Warren Buffett.
With that caveat – that it’s possible, though not likely, to beat the market – I would echo Graham’s admonition. I have some doubt whether it’s worthwhile to be an active investor.
And, fortunately, innovations over the past 50 years have made investing much easier for us passive (or “defensive”) investors. I suspect Graham would be delighted about that.
Verdict: I would recommend The Intelligent Investor to investors with an interest in the history of the field, or to those with interest in corporate governance, or to those active investors who have an inkling that they might be able to beat the market.
But, for most investors, I would not recommend this book. While Graham does have plenty to teach, there are others who give similarly wise counsel in an easier-to-read format.
If you really want to follow Graham’s value-investing approach, do note that various value-oriented mutual funds are available from many major investment firms. While those value funds are more costly than true index funds, you can find good ones with an expense ratio well under 0.50%. My advice would be to go that route; I myself have small positions in such funds.
The most enterprising of Graham’s “enterprising investors” might want to strike out on their own with selecting individual securities anyway, in which case I wish them good fortune – and counsel them to carefully consider Graham’s advice.
Notes and Quotes
Graham’s own words will be followed by: (Graham, page xx).
Zweig’s notes will be followed by:Zweig, page xx).
The Froogal Stoodent’s own notes will be below the quote, indented, in a different font
“…while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster.” (Graham, page 5)
“It was, of course, easy to forecast that the volume of air traffic would grow spectacularly over the years. Because of this factor their shares became a favorite choice of the investment funds. But despite the expansion of revenues—at a pace even greater than in the computer industry—a combination of technological problems and overexpansion of capacity made for fluctuating and even disastrous profit figures. In the year 1970, despite a new high in traffic figures, the airlines sustained a loss of some $200 million for their shareholders…The record shows that even the highly paid full-time experts of the mutual funds were completely wrong about the fairly short-term future of a major and nonesoteric industry.
On the other hand, while the investment funds had substantial investments and substantial gains in IBM, the combination of its apparently high price and the impossibility of being certain about its rate of growth prevented them from having more than, say, 3% of their funds in this wonderful performer...Furthermore, many—if not most—of their investments in computer-industry companies other than IBM appear to have been unprofitable. From these two broad examples we draw two morals for our readers:
1. Obvious prospects for physical growth in a business do not translate into obvious profits for investors.
2. The experts do not have dependable ways of selecting and concentrating on the most promising companies in the most promising industries.” (Graham, page 7)
“Our main objective will be to guide the reader against the areas of possible substantial error and to develop policies with which he will be comfortable. We shall say quite a bit about the psychology of investors. For indeed, the investor’s chief problem—and even his worst enemy—is likely to be himself.” (Graham, page 8)
“The really dreadful losses of the past few years (and on many similar occasions before) were
realized in those common-stock issues where the buyer forgot to ask ‘How much?’” (Graham, page 8)
“…we shall suggest as one of our chief requirements here that our readers limit themselves to issues selling not far above their tangible-asset value.” (Graham, page 9)
Froogal Stoodent notes: As explained in Zweig’s footnotes, tangible-asset value refers to net asset value, book value, or net worth. To find this figure, look at a company’s quarterly (or annual) report, take “total shareholders’ equity” and subtract all intangible assets, like patents, goodwill, trademarks, etc. Then divide by the fully diluted number of shares outstanding – that will give you a book value per share, or a tangible-asset value per share. Note that some services already provide this calculation.
“When the young author [i.e. Graham himself] entered Wall Street in June 1914 no one had any inkling of what the next half-century had in store. (The stock market did not even suspect that a World War was to break out in two months, and close down the New York Stock Exchange.) Now, in 1972, we find ourselves the richest and most powerful country on earth, but beset by all sorts of major problems and more apprehensive than confident of the future. Yet if we confine our attention to American investment experience, there is some comfort to be gleaned from the last 57 years. Through all their vicissitudes and casualties, as earth-shaking as they were unforeseen, it remained true that sound investment principles produced generally sound results. We must act on the assumption that they will continue to do so.” (Graham, page 10)
Indeed, hindsight shows that Graham was, as usual, correct.
“There’s proof that high IQ and higher education are not enough to make an investor intelligent. In 1998, Long-Term Capital Management L.P., a hedge fund run by a battalion of mathematicians, computer scientists, and two Nobel Prize–winning economists, lost more than $2 billion in a matter of weeks on a huge bet that the bond market would return to “normal.” But the bond market kept right on becoming more and more abnormal—and LTCM had borrowed so much money that its collapse nearly capsized the global financial system.” (Zweig, page 13)
For more detail on this, check out my review of When Genius Failed.
“And back in the spring of 1720, Sir Isaac Newton owned shares in the South Sea Company, the hottest stock in England. Sensing that the market was getting out of hand, the great physicist muttered that he ‘could calculate the motions of the heavenly bodies, but not the madness of the people.” Newton dumped his South Sea shares, pocketing a 100% profit totaling £7,000. But just months later, swept up in the wild enthusiasm of the market, Newton jumped back in at a much higher price—and lost £20,000 (or more than $3 million in today’s money). For the rest of his life, he forbade anyone to speak the words ‘South Sea’ in his presence.” (Zweig, page 13)
“In short, if you’ve failed at investing so far, it’s not because you’re stupid. It’s because, like Sir Isaac Newton, you haven’t developed the emotional discipline that successful investing requires.” (Zweig, page 13)
“What do we mean by ‘investor’? Throughout this book the term will be used in contradistinction to “speculator.” As far back as 1934, in our textbook Security Analysis, we attempted a precise formulation of the difference between the two, as follows: ‘An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” (Graham, page 18)
“In most periods the investor must recognize the existence of a speculative factor in his common-stock holdings. It is his task to keep this component within minor limits, and to be prepared financially and psychologically for adverse results that may be of short or long duration.” (Graham, page 20)
“It turned out, therefore, that true ‘cash equivalents’ [that is, US savings bonds, short-term corporate bonds, or savings accounts] proved to be better investments in 1964 than common stocks—in spite of the inflation experience that in theory should have favored stocks over cash…This is just another of an endless series of experiences over time that have demonstrated that the future of security prices is never predictable.” (Graham, page 24)
Take it from one of the greatest investors ever, and the mentor of Warren Buffett – the future of security prices is never predictable. Never.
“…we are skeptical of the ability of defensive investors generally to get better than average results—which in fact would mean to beat their own overall performance. (Our skepticism extends to the management of large funds by experts.)…only rarely can one make dependable predictions about price changes, absolute or relative.” (page 28)
In the very next paragraph, Graham actually suggests that defensive investors consider “well-established investment funds” instead of a hand-selected portfolio of individual securities, and dollar-cost average into such funds. Hmm, that sounds familiar…
“It is no difficult trick to bring a great deal of energy, study, and native ability into Wall Street and to end up with losses instead of profits.” (Graham, page 29)
“Why do you suppose the brokers on the floor of the New York Stock Exchange always cheer at the sound of the closing bell—no matter what the market did that day? Because whenever you trade, they make money—whether you did or not. By speculating instead of investing, you lower your own odds of building wealth and raise someone else’s.” (Zweig, page 35)
“…even high-quality stocks cannot be a better purchase than bonds under all conditions—i.e., regardless of how high the stock market may be and how low the current dividend return compared with the rates available on bonds. A statement of this kind would be as absurd as was the contrary one too often heard years ago—that any bond is safer than any stock.” (Graham, page 48)
Bonds are essentially loans—to corporations, to the government, whoever issued the bond. As such, in the event of bankruptcy, bondholders do have a greater legal standing to recover their funds than stockholders. Bondholders may not recover all their funds if the entity goes bankrupt, but they’re more likely than stockholders to recover at least a portion of their money.
So, in a sense, it’s not entirely wrong to say that bonds are generally safer than stocks. But that’s beside Graham’s point here; a bond in a troubled company is not necessarily safer than shares of stock in a rock-solid company. And, as some would argue, that safety is already priced into bonds, in the form of lower rates of return in the long run.
Inflation is a hot topic in 2022. So here are Graham’s findings on the matter: “The cold figures demonstrate that all the large gain in the earnings of the DJIA unit in the past 20 years was due to a proportionately large growth of invested capital coming from reinvested profits. If inflation had operated as a separate favorable factor, its effect would have been to increase the ‘value’ of previously existing capital; this in turn should increase the rate of earnings on such old capital and therefore on the old and new capital combined. But nothing of the kind actually happened in the past 20 years…The only way that inflation can add to common stock values is by raising the rate of earnings on capital investment. On the basis of the past record this has not been the case.” (Graham, page 52)
Basically, Graham determined that sometimes, inflation does seem to help the rate of return on stocks…but other times, a little bit of ‘helpful’ inflation actually hurts matters. In general, Graham found that there is no clear relationship between inflation and investment performance.
With this finding in mind, do you want the Froogal Stoodent’s advice on the best inflation hedge? Diversification. Some stock funds, bond funds, real estate funds, and maybe even a little bit of precious metals and/or cryptocurrency, if you’re so inclined. [‘Little bit’ being the key words here, especially when it comes to crypto, which Graham would assuredly see as an instrument of foolish speculation rather than a sound investment that will preserve the investor’s capital.]
“Just because of the uncertainties of the future the investor cannot afford to put all his funds into one basket—neither in the bond basket…nor in the stock basket…The more the investor depends on his portfolio and the income therefrom, the more necessary it is for him to guard against the unexpected and the disconcerting in this part of his life.” (Graham, page 56-57)
“…the intelligent investor must never forecast the future exclusively by extrapolating the past. Unfortunately, that’s exactly the mistake that one pundit after another made in the 1990s.” (Zweig, page 80)
A common amateur move that continues unabated today, in 2022. On the one hand, such extrapolation can make a powerful case in favor of investing, especially if you’re trying to persuade a young person to get started.
On the other hand, it can make for embarrassingly wrong predictions. Worse, it can mislead and excite people into taking foolish actions that could bankrupt them.
I recall in 2021, when a single Bitcoin traded for about $60,000 [it peaked in November 2021 at over $67,500], ‘experts’ issued reports, press releases, interviews, and even YouTube videos predicting that Bitcoin would hit at least $100,000 by the end of 2021! People thought, “Well gee, if these experts are right, the current price must be a bargain!!! I don’t have an extra $60,000 right now, so let me borrow that money so I can get in right now and lock in that $40,000 profit!”
Oops.
Did those same people think what could happen if these experts are wrong?…
On Wall Street, there’s a common saying: “Bulls make money. Bears make money. Hogs get slaughtered.” I think there might be a lesson about bubbles and market psychology somewhere in all of this…
“The value of any investment is, and always must be, a function of the price you pay for it…Since the profits that companies can earn are finite, the price that investors should be willing to pay for stocks must also be finite.
Think of it this way: Michael Jordan may well have been the greatest basketball player of all time, and he pulled fans into Chicago Stadium like a giant electromagnet. The Chicago Bulls got a bargain by paying Jordan up to $34 million a year to bounce a big leather ball around a wooden floor. But that does not mean the Bulls would have been justified paying him $340 million, or $3.4 billion, or $34 billion, per season.” (Zweig, page 83)
“Even though investors all know they’re supposed to buy low and sell high, in practice they often end up getting it backwards.” (Zweig, page 84)
Reminders like this are precisely why I like to read books written by older, experienced people. The elders can provide hard-earned wisdom and valuable perspective, serving as an antidote to the enthusiasms of the moment.
Everybody’s quick to sell you this “exciting new opportunity, but only if you act now!”—regardless of what the ‘opportunity’ may be. An ‘opportunity’ to buy some overhyped piece of junk to make an enthusiastic salesperson richer? How exciting!…
“Considering how calamitously wrong the “experts” were the last time they agreed on something, why on earth should the intelligent investor believe them now?” (Zweig, page 84)
“With every new wave of optimism or pessimism, we are ready to abandon history and time-tested principles, but we cling tenaciously and unquestioningly to our prejudices.” (Graham, page 100)
“Your very refusal to be active, your renunciation of any pretended ability to predict the future, can become your most powerful weapons. By putting every investment decision on autopilot, you drop any self-delusion that you know where stocks are headed, and you take away the market’s power to upset you…” (Zweig, p. 130)
“Let’s say you can spare $500 a month. By owning and dollar-cost averaging into just three index funds—$300 into one that holds the total U.S. stock market, $100 into one that holds foreign stocks, and $100 into one that holds U.S. bonds—you can ensure that you own almost every investment on the planet that’s worth owning.” (Zweig, page 130)
“According to Ibbotson Associates, the leading financial research firm, if you had invested $12,000 in the Standard & Poor’s 500-stock index at the beginning of September 1929, 10 years later you would have had only $7,223 left. But if you had started with a paltry $100 and simply invested another $100 every single month, then by August 1939, your money would have grown to $15,571! That’s the power of disciplined buying—even in the face of the Great Depression and the worst bear market of all time.” (Zweig, page 131)
“Somewhere in the middle of the bull market the first common-stock flotations make their appearance. These are priced not unattractively, and some large profits are made by the buyers of the early issues. As the market rise continues, this brand of financing grows more frequent; the quality of the companies becomes steadily poorer; the prices asked and obtained verge on the exorbitant. One fairly dependable sign of the approaching end of a bull swing is the fact that new common stocks of small and nondescript companies are offered at prices somewhat higher than the current level for many medium-sized companies with a long market history… it is probably bad policy to get mixed up in this sort of business. Of course the salesman will point to many such issues which have had good-sized market advances—including some that go up spectacularly the very day they are sold. But all this is part of the speculative atmosphere. It is easy money. For every dollar you make in this way you will be lucky if you end up by losing only two.” (Graham, page 142-143)
Graham’s point among all this text is: avoid IPOs; they almost always end badly. A precious few have seen astounding growth (Microsoft or Amazon are notable examples), but an intelligent investor can’t rely on hopes and dreams.
“After going up like a bottle rocket on that first day of trading, VA Linux came down like a buttered brick. By December 9, 2002, three years to the day after the stock was at $239.50, VA Linux closed at $1.19 per share.
Weighing the evidence objectively, the intelligent investor should conclude that IPO does not stand only for “initial public offering.” More accurately, it is also shorthand for:
It’s Probably Overpriced,
Imaginary Profits Only,
Insiders’ Private Opportunity, or
Idiotic, Preposterous, and Outrageous.” (Zweig, page 154)
“As an investor you cannot soundly become “half a businessman”…the majority of security owners should elect the defensive classification. They do not have the time, or the determination, or the mental equipment to embark upon investing as a quasi-business…they should stoutly resist the recurrent temptation to increase this return by deviating into other paths.” (Graham, page 176)
“As the Danish philosopher Søren Kierkegaard noted, life can only be understood backwards—but it must be lived forwards. Looking back, you can always see exactly when you should have bought and sold your stocks. But don’t let that fool you into thinking you can see, in real time, just when to get in and out. In the financial markets, hindsight is forever 20/20, but foresight is legally blind. And thus, for most investors, market timing is a practical and emotional impossibility.”(Zweig, page 180)
“’Put all your eggs into one basket and then watch that basket,’ proclaimed Andrew Carnegie a century ago. ‘Do not scatter your shot…The great successes of life are made by concentration.’…What Carnegie neglected to mention is that concentration also makes most of the great failures of life. Look again at the Forbes ‘Rich List.’ Back in 1982, the average net worth of a Forbes 400 member was $230 million. To make it onto the 2002 Forbes 400, the average 1982 member needed to earn only a 4.5% average annual return on his wealth—during a period when even bank accounts yielded far more than that and the stock market gained an annual average of 13.2%.
So how many of the Forbes 400 fortunes from 1982 remained on the list 20 years later? Only 64 of the original members—a measly 16%—were still on the list in 2002. By keeping all their eggs in the one basket…all the other original members fell away. When hard times hit, none of these people—despite all the huge advantages that great wealth can bring—were properly prepared. They could only stand by and wince at the sickening crunch as the constantly changing economy crushed their only basket and all their eggs.” (Zweig, page 185)
Think long and hard about this. Then read it again. 84% of the wealthiest Americans, as identified by the Forbes 400 in 1982, failed to stay on that list for 20 years. But if they had put all their money into a savings account, that would have been enough to keep them on the list!
“If you live in the United States, work in the United States, and get paid in U.S. dollars, you are already making a multilayered bet on the U.S. economy. To be prudent, you should put some of your investment portfolio elsewhere—simply because no one, anywhere, can ever know what the future will bring.” (Zweig, p. 187)
“[The investor’s] longer-term bonds may have relatively wide price swings during their lifetimes, and his common-stock portfolio is almost certain to fluctuate in value over any period of several years.
The investor should know about these possibilities and should be prepared for them both financially and psychologically. He will want to benefit from changes in market levels…This interest on his part is inevitable, and legitimate enough. But it involves the very real danger that it will lead him into speculative attitudes and activities. It is easy for us to tell you not to speculate; the hard thing will be for you to follow this advice. Let us repeat what we said at the outset: If you want to speculate do so with your eyes open, knowing that you will probably lose money in the end; be sure to limit the amount at risk and to separate it completely from your investment program.” (Graham, page 188)
“Without bear markets to take stock prices back down, anyone waiting to ‘buy low’ will feel completely left behind—and, all too often, will end up abandoning any former caution and jumping in with both feet. That’s why Graham’s message about the importance of emotional discipline is so important. From October 1990 through January 2000, the Dow Jones Industrial Average marched relentlessly upward, never losing more than 20% and suffering a loss of 10% or more only three times…this was the second-longest uninterrupted bull market of the past century; only the 1949–1961 boom lasted longer. The longer a bull market lasts, the more severely investors will be afflicted with amnesia; after five years or so, many people no longer believe that bear markets are even possible.” (Zweig, footnote, page 193)
“The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation…Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings…would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment.” (Graham, page 203)
Wise words of experience. Insights like this are why Graham remains so well-respected today! Zweig believes this might be the most important paragraph in the whole book.
“Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.
If you are a prudent investor or a sensible businessman, will you let Mr. Market’s daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.
The true investor is in that very position when he owns a listed common stock. He can take advantage of the daily market price or leave it alone, as dictated by his own judgment and inclination.” (Graham, page 205)
This is the famous “Mr. Market” tale spread among long-term investors. Again, Graham’s wisdom shines through. If you think of the market quotations not as THE OFFICIAL VALUE® of your holdings, but instead as the opinion of a business partner who is often prisoner to his own emotions, then you will be far more likely to make a wise and businesslike decision regarding your own holdings. A tremendously useful parable, from a superb value investor.
“Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.” (Graham, page 205)
Spoken like a quintessential value investor!
“The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices.” (Graham, page 205)
“If you listen to financial TV, or read most market columnists, you’d think that investing is some kind of sport, or a war, or a struggle for survival in a hostile wilderness. But investing isn’t about beating others at their game. It’s about controlling yourself at your own game.” (Zweig, page 219)
“No one’s gravestone reads HE BEAT THE MARKET.” (Zweig, page 220)
“…the mutual fund was introduced in 1924 by a former salesman of aluminum pots and pans named Edward G. Leffler. Mutual funds are quite cheap, very convenient, generally diversified, professionally managed, and tightly regulated under some of the toughest provisions of Federal securities law. By making investing easy and affordable for almost anyone, the funds have brought some 54 million American families (and millions more around the world) into the investing mainstream—probably the greatest advance in financial democracy ever achieved.
But mutual funds aren’t perfect; they are almost perfect, and that word makes all the difference…The intelligent investor must choose funds with great care…” (Zweig, page 242)
Indeed, mutual funds are a superb innovation to democratize investing! Index funds (a special type of mutual fund that tracks an entire market) are generally the cheapest, best way to go for the long run.
“Unfortunately, in the financial markets, luck is more important than skill. If a manager happens to be in the right corner of the market at just the right time, he will look brilliant—but all too often, what was hot suddenly goes cold and the manager’s IQ seems to shrivel by 50 points…This is yet another reminder that the market’s hottest market sector—in 1999, that was technology—often turns as cold as liquid nitrogen, with blinding speed and utterly no warning. And it’s a reminder that buying funds based purely on their past performance is one of the stupidest things an investor can do.” (Zweig, page 243)
Again, use index funds. Many salespeople are quick to point to the performance of their pet fund over the last year, or two years, or five years—whatever term best suits their purpose. Their purpose, of course, being to sell you something, and thereby earn a commission for themselves.
But the past five years tell you nothing about the future. As Zweig points out, the hottest funds frequently turn cold with no warning.
Graham is a leading value investor. He points out numerous times throughout this book that you’re better off buying an ice-cold investment as long as the fundamentals are good. It’s like getting a premium luxury brand on sale! But unlike luxury brands, investments don’t take up space. They generate income for you instead. Getting a good deal on a strong investment is much more exciting [and profitable!] than a bargain on some depreciating consumer goods!
“As the investment consultant Charles Ellis puts it, “If you’re not prepared to stay married, you shouldn’t get married.” Fund investing is no different. If you’re not prepared to stick with a fund through at least three lean years, you shouldn’t buy it in the first place. Patience is the fund investor’s single most powerful ally.” (Zweig, page 256)
For years the financial services have been making stock-market forecasts without anyone taking this activity very seriously. Like everyone else in the field they are sometimes right and sometimes wrong. Wherever possible they hedge their opinions so as to avoid the risk of being proved completely wrong. (There is a well-developed art of Delphic phrasing that adjusts itself successfully to whatever the future brings.) (Graham, page 260)
“The intelligent investor will not do his buying and selling solely on the basis of recommendations received from a financial service.” (Graham, page 261)
“Much bad advice is given free.” (Graham, page 270)
“Many of these [growth stocks] have sold at such high prices in relation to past and current earnings that those recommending them have felt a special obligation to justify their purchase by…[c]ertain mathematical techniques of a rather sophisticated sort…However, we must point out a troublesome paradox here, which is that the mathematical valuations have become most prevalent precisely in those areas where one might consider them least reliable.” (Graham, page 281)
I’m reminded of the oft-unheeded advice that complex mathematics are seldom to be trusted.
“…it appears to be almost impossible to distinguish in advance between those individual forecasts which can be relied upon and those which are subject to a large chance of error. At bottom, this is the reason for the wide diversification practiced by the investment funds. For it is undoubtedly better to concentrate on one stock that you know is going to prove highly profitable, rather than dilute your results to a mediocre figure, merely for diversification’s sake. But this is not done, because it cannot be done dependably.” (Graham, page 290)
“[Assuming you’re an ‘enterprising investor’ who wants to put time and effort into purchasing individual securities] comb through the financial statements, gathering evidence to help you answer two overriding questions. What makes this company grow? Where do (and where will) its profits come from? Among the problems to watch for:
The company is a serial acquirer…
The company is an OPM addict, borrowing debt or selling stock to raise boatloads of Other People’s Money…
The company is a Johnny One-Note, relying on one customer (or a handful) for most of its revenues…” (Zweig, page 303-304)
“As you study the sources of growth and profit, stay on the lookout for positives as well as negatives. Among the good signs:
The company has a wide “moat,” or competitive advantage…Several forces can widen a company’s moat: a strong brand identity (think of Harley Davidson, whose buyers tattoo the company’s logo onto their bodies); a monopoly or near-monopoly on the market; economies of scale, or the ability to supply huge amounts of goods or services cheaply (consider Gillette, which churns out razor blades by the billion); a unique intangible asset (think of Coca-Cola, whose secret formula for flavored syrup has no real physical value but maintains a priceless hold on consumers); a resistance to substitution (most businesses have no alternative to electricity, so utility companies are unlikely to be supplanted any time soon).
The company is a marathoner, not a sprinter. By looking back at the income statements, you can see whether revenues and net earnings have grown smoothly and steadily…the fastest-growing companies tend to overheat and flame out…
The company sows and reaps. No matter how good its products or how powerful its brands, a company must spend some money to develop new business. While research and development spending is not a source of growth today, it may well be tomorrow…” (Zweig, page 304-305)
Does all this sound like too much work to you? You may be tempted by the possibility of better-than-average returns, plus the triumphant feeling of outwitting Wall Street at its own game. But quite a bit of research has demonstrated that even professional hedge-fund and mutual-fund managers have trouble doing this—and they have much better access to information than you’re likely to have. Plus, they can buy some extremely powerful computers to crunch a lot of data, as well as the money to hire experienced programmers and mathematicians to develop new ways of slicing the data.
I’ll repeat Graham’s own admonition from the Introduction: “We have some doubt whether a really substantial extra recompense is promised to the active investor…” (Graham, page 6)
“Companies should buy back their shares when they are cheap—not when they are at or near record highs. Unfortunately, it recently has become all too common for companies to repurchase their stock when it is overpriced. There is no more cynical waste of a company’s cash—since the real purpose of that maneuver is to enable top executives to reap multimillion-dollar paydays by selling their own stock options in the name of ‘enhancing shareholder value.’
A substantial amount of anecdotal evidence, in fact, suggests that managers who talk about “enhancing shareholder value” seldom do. In investing, as with life in general, ultimate victory usually goes to the doers, not to the talkers.” (Zweig, page 309)
“And, in earlier days, a company that drastically diluted its shares…was said to have ‘watered’ /its stock. This term is believed to have originated with the legendary market manipulator Daniel Drew (1797–1879), who began as a livestock trader. He would drive his cattle south toward Manhattan, force-feeding them salt along the way. When they got to the Harlem River, they would guzzle huge volumes of water to slake their thirst. Drew would then bring them to market, where the water they had just drunk would increase their weight. That enabled him to get a much higher price, since cattle on the hoof is sold by the pound.” (Zweig, footnote on page 312)
“Corporate accounting is often tricky; security analysis can be complicated; stock valuations are really dependable only in exceptional cases. For most investors it would be probably best to assure themselves that they are getting good value for the prices they pay, and let it go at that.” (Graham, page 318)
Again, with the accounting tricks Graham described in Chapter 12 as well as many newer gimmicks, “we have some doubt whether a really substantial recompense is promised to the active investor…”
“In our own attitude and professional work we were always committed to…getting ample value for our money in concrete, demonstrable terms. We were not willing to accept the prospects and promises of the future as compensation for a lack of sufficient value in hand. This has by no means been the standard viewpoint among investment authorities…Thus this matter of choosing the ‘best’ stocks is at bottom a highly controversial one. Our advice to the defensive investor is that he let it alone. Let him emphasize diversification more than individual selection.” (Graham, page 365)
Hence why so many experts recommend index funds. Graham was wise and prescient in many respects!
“How should you tackle the nitty-gritty work of stock selection? Graham suggests that the defensive investor can, ‘most simply,’ buy every stock in the Dow Jones Industrial Average. Today’s defensive investor can do even better—by buying a total stock-market index fund that holds essentially every stock worth having. A low-cost index fund is the best tool ever created for low-maintenance stock investing—and any effort to improve on it takes more work (and incurs more risk and higher costs) than a truly defensive investor can justify.” (Zweig, page 367)
“In 1999 and 2000, high-tech, bio-tech, and telecommunications stocks were supposed to provide ‘aggressive growth’ and ended up giving most of their investors aggressive shrinkage instead. But, by early 2003, the wheel had come full circle, and many of those aggressive growth stocks had become financially conservative—loaded with working capital, rich in cash, and often debt-free.” (Zweig, page 369)
As usual, the cycle turns, around and around. People (including company managers) get greedy and take on too much debt, a massive crash cleans out the weakest companies (and some investors’ accounts), and the stronger companies much more conservative with their financial dealings. Then, eventually, memories get short and people get greedy and take on too much debt…
“The best values today are often found in the stocks that were once hot and have since gone cold. Throughout history, such stocks have often provided the margin of safety that a defensive investor demands.” (Zweig, page 371)
Here, he’s talking to investors who are inclined to select individual stocks [which, of course, he doesn’t recommend. And neither do I. But some folks enjoy the challenge nonetheless]. The same principle applies just as well to buying shares in a total-market index fund. After the market has crashed and everybody’s moaning about how far the market has dropped, that’s typically a good time to plow even more money into the market—because, as the price drops due to cyclical factors, the value improves. [If the price of a company drops because it exhibits poor fundamentals or because they got caught cheating, that’s a different matter]. Understanding the difference is crucial for an intelligent value investor.
“…we must consider the possibilities and the means of making individual [stock] selections which are likely to prove more profitable than an across-the-board average.
What are the prospects of doing this successfully? We would be less than frank, as the euphemism goes, if we did not at the outset express some grave reservations on this score…there is considerable and impressive evidence to the effect that this is very hard to do, even though the qualifications of those trying it are of the highest. The evidence lies in the record of the numerous investment companies, or ‘funds,’ which have been in operation for many years.” (Graham, page 376)
In Chapters 14 and 15, Graham lays out some ground rules for investing in individual stocks. These are:
Financial condition
Earnings stability
Dividend record
Earnings growth
Price
I will not include further detail because a) I don’t want to give away all of Graham’s secrets [read the book yourself if you want to know!] and b) I don’t really want to encourage the selection of individual stocks for novice investors.
But these criteria are good ones, borne of Graham’s own long and successful experience, for the enterprising investor who wishes to wisely select individual stocks.
“When the going is good and new issues are readily salable, stock offerings of no quality at all make their appearance. They quickly find buyers; their prices are often bid up enthusiastically right after issuance…Wall Street takes this madness in its stride, with no overt efforts by anyone to call a halt before the inevitable collapse in prices…When many of these minuscule but grossly inflated enterprises disappear from view, or nearly so, it is all taken philosophically enough as ‘part of the game.’ Everybody swears off such inexcusable extravagances—until next time.” (Graham, page 392)
“Unlike most people, many of the best professional investors first get interested in a company when its share price goes down, not up.” (Zweig, page 397)
The same goes for index funds. Just saying…
“[Bonds that are convertible to stock have] more income, less risk than stocks: No wonder Wall Street’s salespeople often describe convertibles as a ‘best of both worlds’ investment. But…convertibles offer less income and more risk than most other bonds. So they could, by the same logic and with equal justice, be called a ‘worst of both worlds’ investment. Which side you come down on depends on how you use them…You could call convertible bonds ‘stocks for chickens.’” [Zweig, page 419]
In general, in Chapter 16, Graham is not enthusiastic about convertible bonds, as on page 409-410, when he says “Our general attitude toward new convertible issues is thus a mistrustful one…the investor should look more than twice before he buys them.” But he is absolutely scathing in his evaluations of stock-option warrants later in the same chapter. (Mercifully, according to Zweig, stock-option warrants have almost completely faded out of the market. Though I wonder how long it will be until some slimy salesman tries to bring them back).
In Chapters 17 and 18, Graham uses case histories to provide insight into some of the market’s happenings. Zweig does the same, though his are briefer and newer. These case histories are very useful, but should be read in their entirety. They don’t lend themselves particularly well to ‘notes and quotes,’ so I will refrain from including any here. But they provide many good examples of the dangers lying in wait for stock pickers – and therefore why broad-based, low-cost mutual funds are a friend of the passive investor.
Chapter 17 discusses four different companies that had practiced various types of extremes that Graham had followed in recent years (1967 – 1971), such as a company that decided to purchase another company that was 7 times larger. This is an instructive exercise.
Chapter 18 pairs off companies with similar names (in some cases, the businesses were similar, but not always). Again, this is a good exercise to compare and contrast financials, and business circumstances as well. This exercise is well worth the read, and is possibly sufficient to justify purchasing Graham’s book, at least for someone who is interested in purchasing individual stocks.
In both chapters, Zweig’s commentary pieces follow Graham’s approach, but with more recent circumstances (and more brevity).
In Chapter 19, Graham tackles matters of corporate governance. Just in case you haven’t fallen asleep just from reading the words “corporate governance,” Graham specifically addresses takeovers, dividend policies, and stock splits. The overriding theme: “It can be stated as a rule with very few exceptions that poor managements are not changed by action of the ‘public stockholders,’ but only by the assertion of control by an individual or compact group…But the idea that public shareholders could really help themselves by supporting moves for improving management and management policies has proved too quixotic to warrant further space in this book.” (Graham, page 488-489)
Also: “It is our belief that shareholders should demand of their managements either a normal payout of earnings—on the order, say, of two-thirds—or else a clear-cut demonstration that the reinvested profits have produced a satisfactory increase in per-share earnings.” (Graham, page 492)
Zweig’s commentary on Chapter 19 covers more pages than Graham’s own words in Chapter 19! (At least, Graham’s own words in this revised 4th edition from 1973). In all honesty, if someone took Zweig’s commentary chapters and turned only those pages into a short book, even that book would probably be one of the best books for investors!
But considering Graham’s words and Zweig’s snappier illustrations makes The Intelligent Investor (2003 revised edition with commentary) a modern classic. But it’s still hardly suitable for beginners.
“…to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.” (Graham, page 512)
“…the function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future. If the margin is a large one, then it is enough to assume that future earnings will not fall far below those of the past in order for an investor to feel sufficiently protected against the vicissitudes of time.” (Graham, page 513)
“Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions. The purchasers …assume that prosperity is synonymous with safety.” (Graham, page 516)
“Investment is most intelligent when it is most businesslike.” (Graham, page 523)
“You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.” (Graham, page 524)
“To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.” (Graham, page 524)
“Successful investing is about managing risk, not avoiding it.” (Zweig, page 535)
“‘Investors don’t like uncertainty,’ a market strategist is intoning right now on financial TV or in today’s newspaper. But investors have never liked uncertainty—and yet it is the most fundamental and enduring condition of the investing world. It always has been, and it always will be.” (Zweig, page 535)
One could argue that uncertainty is the most fundamental and enduring condition of humanity itself! People generally dislike uncertainty, but that won’t make it go away. A wise person will seek a good way of handling uncertainty, rather than wishing for it to just go away.
And just how should you handle uncertainty? I’m reminded of the old saying, “Never put all your eggs in one basket.”
“It is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately with people or it doesn’t take at all…I’ve never seen anyone who became a gradual convert over a ten-year period to this approach [that is, value investing]. It doesn’t seem to be a matter of IQ or academic training. It’s instant recognition, or it is nothing.” (Warren Buffett, Appendix 1, The Superinvestors of Graham-and-Doddsville, page 544)
“If you buy a dollar bill for 60 cents, it’s riskier than if you buy a dollar bill for 40 cents, but the expectation of reward is greater in the latter case. The greater the potential for reward in the value portfolio, the less risk there is…You don’t try and buy businesses worth $83 million for $80 million. You leave yourself an enormous margin. When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000-pound trucks across it. And that same principle works in investing.” (Warren Buffett, Appendix 1, The Superinvestors of Graham-and-Doddsville, page 547)
“…the combination of precise [mathematical] formulas with highly imprecise assumptions can be used to establish, or rather to justify, practically any value one wishes…” (Graham, Appendix 4, The New Speculation in Common Stocks, page 564)
“In forty-four years of Wall Street experience and study I have never seen dependable calculations made about common-stock values, or related investment policies, that went beyond simple arithmetic or the most elementary algebra. Whenever calculus is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience, and usually also to give to speculation the deceptive guise of investment.” (Graham, Appendix 4, The New Speculation in Common Stocks, page 570)
If you’ve read this far and haven’t fallen asleep yet, you may enjoy reading The Intelligent Investor. But I still believe there are better reads for all but the most enterprising investors.
You can support this blog—at no cost to you—by buying it on Amazon here.
Or, check out my other book reviews in this series:
1. Debt: The First 5000 Years by David Graeber
2. Rich Dad Poor Dad by Robert Kiyosaki
3. The Clash of the Cultures by John C. Bogle
4. Principles (Life and Work) by Ray Dalio
5. When Genius Failed by Roger Lowenstein
6. The Practicing Stoic by Ward Farnsworth
7. Gold: The Once and Future Money by Nathan Lewis
8. The Changing World Order by Ray Dalio
9. The Intelligent Investor by Benjamin Graham
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