The Intelligent Investor – by Benjamin Graham

The Intelligent Investor reveals that investors successful over a lifetime don’t require a stratospheric IQ, unusual business insights or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding the framework. Benjamin Graham, the original ‘Father’ of Value Investing and mentor to Warren Buffet, delivers serious financial wisdom.

In The Intelligent Investor you’ll learn how to value a company (so you know when it is under or below it’s fair value), understand how stocks work and how to diversify a portfolio to best manage risk, sound investment philosophies (such as understanding the different between investment and speculation), and powerful questions to ask yourself when making an investment.

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The Intelligent Investor Summary

To invest successfully over a lifetime, you don’t need a stratospheric IQ, unusual business insights or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding the framework. The Intelligent Investor provides sound advice on the basic and outlines two roads each investor can take.

  Investment vs Speculation:  Graham advises that investors need to keep investment and speculation separate – and know the difference between the two. You should allocate only 10% of your investment funds to what he deems speculation. Speculation involves decisions on the market price, hoping that someone will pay more than you did at a later date. There is such thing as intelligent speculation, which can be a good thing. For example, speculation is required for companies like Amazon who can’t raise the initial capital for expansion, and are running at severe losses for several years before turning profitable. 

  Speculation involves day trading in the market, short term selectivity buying stocks with an anticipated increase in earnings, or long term selectivity with emphasis on past growth assuming it is likely to continue. 

Inflation: If you receive a 2% raise in a year where inflation runs at 4%, you’ve taken a 2% pay cut. Inflation is a good thing for government debt, as it cheapens with inflation. Completely irradiating it runs against the government’s self-interest that regularly borrows money. The key thing about inflation to the investor is, that inflation must be taken into consideration to understand the real returns. 

The Intelligent Investor shows the value of any investment is a function of the price you pay for it: In the 1990s, tech inflation was low, corporate profits were booming and the world was at peace. However, that doesn’t mean that the stocks were worth buying at any price (which many investors did). The Chicago Bulls bought the greatest NBA player of all time for $34 million, but that doesn’t mean they’re justified paying $300 million per season. The key lesson from Graham is to understand that good assets can be overpriced, and poor assets can be underpriced. To understand the intrinsic value, there are key metrics we should look at, most notably the P/E ratio.

Looking at the P/E: The measure of the profit to earnings ratio is a simple tool for taking the market’s temperature. If for instance, a company earned $1 per share, and it’s stock is at $9 per share, it’s price / earnings would be 9. However if the stock is $70, then the P/E is 70

In general: P/E <10 is very low and cheap, P/E>20 is expensive. 

The Defensive Investor

The defensive investor is unwilling to put in the time and effort. Instead of the active approach, the investor seeks a portfolio that requires minimal effort, research and monitoring. The investor will not expand their potential investing universe beyond stable conservative choices.  

The Defensive Investor and Stocks: The advantages of stocks are that you are protected against inflation and are offered a higher rate of return than bonds or cash in the long run. Graham provides two key pieces of advice for aspiring defensive investors. 

Include adequate diversification: There should be between 10-30 issues (today you can get an Index fund which makes this achievement simple). You should also stick to large outstanding and conservative copmanies that have 20 years of dividend payments and the  price on earnings ratio should be less than 20.  Why diversify? In the huge market hay stack, only a few needles ever go on to generate truly gigantic gains. The more of the haystack you own, the more likely to get the needle.

Abandon growth stocks: Growth stocks have a speculative element, in that in order to justify the investment the stock should increase in value over time. The defensive investor will have to abandon growth stocks – they are usually expensive and risky. 

The Enterprising Investor

The main difference between the Defensive and the Enterprising Investor, is the investors willingness to make the required effort to invest more aggressively. The Enterprising Investor has the time and experience (or proper guidance) in investing to expand the possible universe of opportunities beyond conservative investments. It is an active approach that requires constant attention and monitoring. He or she are willing to put forth the extra effort required for dynamic portfolio management, research, and selection of individual investments.The goal of the enterprising investor is to achieve a higher than average rate of return. 

Diversification: Where the defensive investor would stick close to a 50% stock, 50% bond or cash plan, the enterprising investor has more leeway to take valuation into account. Portfolio rebalancing can be adjusted based on the attractiveness of an asset’s valuation. The Intelligent Investor sets an equity allocation minimum of 25%, maximum of 75%, based on the attractiveness of valuations.

Growth stocks: For the enterprising investor to buy a growth stock, she will usually have to find a larger company that is currently unpopular. The price of a growth stock usually reflects the expected growth, and that growth is, many times, over estimated by the markets.

The Intelligent Investor shows that buying bargain issues means finding stocks that are selling for less that their intrinsic value You might concentrate on large companies that are going through a period of unpopularity.. while small companies can be undervalued for similar reasons, the large companies have the resources and power to carry them through the hard times.

A stock may be undervalued due to disappointing earnings or general disfavor. The best bargain would be a well established company priced well below its average historical price and it’s past average price/earnings ratio.

The enterprising investor must have the training and judgement (or guidance) to both measure and maintain a margin of safety standard. If you are not willing to make the effort you should be a defensive investor.