• Jan De Ost

The Intelligent Investor

Updated: Jan 28, 2019

This book is considered by Warren Buffett, the greatest investor of all time, to be:

"By far the best book on investing ever written."

The Intelligent Investor was written by the "dean of Wall Street": Benjamin Graham.

Starting in the early last century, Benjamin Graham worked as an analyst/asset manager. The stock market crash of 1929 made him suffer severely and left a great impression on him. He became professor at Columbia University and remained an active investor for many decades. He was an intellectual, a voracious reader and had a wide interest in many fields, including the ancient Greek and Latin writings.

The greatest investor of all time, Warren Buffett, went to and studied under him. (Warren Buffett was the only student ever to be awared an A+ by Graham.) After graduation, and some years later, Warren Buffett worked for Benjamin Graham as an analyst.

The most fundamental principles that made Warren Buffett's succes so phenomenal are found in this book. Thus still after many decades hence, Mr. Buffett repeats: "By far the best book on investing ever written". Quite the imprimatur...

Many editions exist. Our recommended version is the 1973 edition, edited in 2003 by Jason Zweig, a Wall Street Journal investing columnist.

The book is about 600 pages long, composed of written investing gold. A great many aspects are covered, but essentially, the book teaches you the rational mindset that is required for investing success. Specifically, chapters 8 and 20 contain the most fundamental principles about investing ever written.

Chapter 8: "The Investor and Market Fluctuations".

In essence, it instructs you to buy stocks when their prices (or whole financial markets) fall down deeply and consider selling when prices are seemingly sky-rocketing without ceiling in sight. Seems all too logic, doesn't it? Yet, only very few investors have the rationality to do so and are able to detach their emotions from their brains.

This chapter offers many insights to induce rational rather than emotional behaviour. It also highlights the basic advantages a stockholder possesses:

"Since common stocks ... are subject to recurrent and wide fluctuations in their prices, the intelligent investor should be interested in the possibilities of profiting from these pendulum swings. There are two possible ways by which he may try to do this: the way of timing and the way of pricing... We are sure that if he places his emphasis on timing, in the sense of forecasting, he will end up as a speculator and with a speculator’s financial results."

"In any case the investor may as well resign himself in advance to the probability rather than the mere possibility that most of his holdings will advance, say, 50% or more from their low point and decline the equivalent one-third or more from their high point at various periods in the next five years.

A serious investor is not likely to believe that the day-to-day or even month-to-month fluctuations of the stock market make him richer or poorer."

"The holder of marketable shares actually has a double status, and with it the privilege of taking advantage of either at his choice. On the one hand his position is analogous to that of a minority shareholder or silent partner in a private business. Here his results are entirely dependent on the profits of the enterprise or on a change in the underlying value of its assets... On the other hand, the common-stock investor holds a piece of paper ... which can be sold in a matter of minutes at a price which varies from moment to moment..."

"As long as the earning power of his holdings remains satisfactory, he can give as little attention as he pleases to the vagaries of the stock market. More than that, at times he can use these vagaries to play the master game of buying low and selling high."

"But note this important fact: 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. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage."

The truly greatest metaphor ever used to explain how stock prices are set -in the short term- is the image of Mr. Market as written in chapter 8:

"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."

"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 the operating results of his companies."

Chapter 20: "Margin of Safety as the Central Concept of Investment".

This is the cornerstone of investing.

Simply put, it describes that one should invest in quality only and only after a thorough investigation. It also makes a thorough distinction between investing and speculating. Investing equals knowing, speculating equals hoping.

"... to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY."

"We suggest that the margin-of-safety concept may be used to advantage as the touchstone to distinguish an investment operation from a speculative one."

"Investment is most intelligent when it is most businesslike."

"“Know what you are doing—know your business.” For the investor this means: Do not try to make “business profits” out of securities—that is, returns in excess of normal interest and dividend income—unless you know as much about security values as you would need to know about the value of merchandise that you proposed to manufacture or deal in."

"In particular, keep away from ventures in which you have little to gain and much to lose. For the enterprising investor this means that his operations for profit should be based not on optimism but on arithmetic. For every investor it means that when he limits his return to a small figure ... he must demand convincing evidence that he is not risking a substantial part of his principal."

"Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it— even though others may hesitate or differ. (You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.) Similarly, in the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand."

"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks."

We cannot help adding one more quote from the book, as quoted from Spinoza:

"All things excellent are as difficult as they are rare."

In conclusion:

We find this book the truly most fundamental book about investing ever written. Even more remarkable is the fact that is was written half a century ago and still stands out far above all other writings about investing.

Nevertheless, we must dispel a broadly held belief that Benjamin Graham teaches us only to invest in very cheap stocks, the so-called "value investing approach". He does indeed, in general, write about low P/E (price/earnings) stocks of which he mentions, in the postscript, that this has resulted for him in annualized returns of about 20%, which are very high returns indeed.

Yet one of the biggest (and most profitable) lessons was learned by himself only at the very end of his career: He invested 20% of his total holdings in one "growth stock", which was GEICO. Of this investment he writes:

"... the new business interest ... prospered.

In fact it did so well that the price of its shares advanced to two hundred times or more the price paid... The advance far outstripped the actual growth in profits, and almost from the start the quotation appeared much too high in terms of the partners’ own investment standards. But... they continued to maintain a substantial ownership of the shares despite the spectacular price rise."

"The aggregate of profits accruing from this single investment decision far exceeded the sum of all the others realized through 20 years of wide-ranging operations in the partners’ specialized fields, involving much investigation, endless pondering, and countless individual decisions."

" lucky break, or one supremely shrewd decision—can we tell them apart?—may count for more than a lifetime of journeyman efforts. But behind the luck, or the crucial decision, there must usually exist a background of preparation and disciplined capacity. One needs to be sufficiently established and recognized so that these opportunities will knock at his particular door. One must have the means, the judgment, and the courage to take advantage of them."

This lesson was well learned by Warren Buffett together with Charlie Munger. Their motto became:

"It is far better to buy a wonderful business at a fair price, than a fair business at a wonderful price."

We try to do the same.

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