Contents of this article
An Overview of The Intelligent Investor
The Intelligent Investor is regarded as essential bedside reading for most investors in financial markets in general and the stock market in particular. If you plan to invest, whatever the field, first invest in solid knowledge: only with firm roots can you stand for long, especially through bouts of unusual volatility in the stock market. The Intelligent Investor covers ways of thinking about finance, along with methods for investing in stocks safely.
About the Author – Benjamin Graham
Just as the physicist Isaac Newton is widely seen as the father of the science of gravity and motion, the economist Benjamin Graham, famous for his book The Intelligent Investor, is known as the father of value investing, one of the investment schools most widely followed by the world’s best investors. During the stock market bubble of the 1920s, when many people rushed madly into stocks as if the market were a casino, Graham did a great deal to change that mindset through value investing methods.
The core principle of value investing is that, to make money, investors must choose stocks worth more than the price they pay for them. It sounds simple, yet it is considered the backbone of investing in the stock market.
Key Content of The Intelligent Investor
The Origins of The Intelligent Investor
After graduating from Columbia University in 1914, Graham went to work on Wall Street. Over 15 years in his career, he built up a sizeable personal sum to invest. Unfortunately, like many others, Graham lost most of his money in the stock market crash of 1929 and the Great Depression that followed.
Those experiences taught Graham to reduce risk by investing in companies whose shares traded far below the company’s liquidation value. Put simply, his goal was to buy a dollar’s worth of assets for just 50 cents. To do this, he used market sentiment, and investors’ fear of the market, to his advantage. These ideals inspired him to write Security Analysis, published in 1934 with co-author David Dodd. The book was written in the early 1930s, when both authors were professors at Columbia University’s business school, and it set out Graham’s methods of security analysis.
What Can You Learn from The Intelligent Investor?
Graham, together with David Dodd, began teaching value investing as an investment method at Columbia Business School in 1928. In 1949, Graham published The Intelligent Investor. Below are some of the book’s key concepts.
Mr. Market
Graham’s favorite allegory is that of Mr. Market. This imaginary person, “Mr. Market”, comes to a shareholder’s office every day offering to buy or sell his shares at different prices. Sometimes the prices make sense; at other times they are far removed from current economic reality.
Individual investors are free to accept or reject Mr. Market’s offers on any given day, which gives them an edge over those who feel compelled to invest all the time, regardless of the current valuation of the securities. The best advice for an investor is to focus on the real performance of their companies and the dividends they receive, rather than on Mr. Market’s changing moods, when judging the value of a stock. An investor is neither right nor wrong because others agree with them; only facts and analysis can make them right.
Value Investing
Value investing means capturing the intrinsic value of a common stock independently of its market price. Analyzing a company’s assets, earnings and dividend payments can help determine a stock’s intrinsic value, which can then be compared with its market price. When intrinsic value exceeds market value – in other words, when the stock is undervalued by the market – the investor should buy and hold until mean reversion occurs. Mean reversion theory holds that, over time, market price and intrinsic value will converge. At that point, the share price reflects the stock’s true worth.
Buy only stocks trading at two-thirds of their net current asset value. Net-net is a value investing technique developed by Benjamin Graham in which a company is valued solely on its net current assets.
When an investor buys a stock below its intrinsic value, they are essentially buying it at a discount. Once the stock is actually trading at its intrinsic value, they should sell.
Margin of Safety
Graham also advocated investing with a margin of safety – room for human error – for the investor. There are several ways to achieve this, but buying undervalued or out-of-favor stocks is the most important. Investor irrationality, the inability to predict the future and stock market swings can all provide a margin of safety. Investors can also gain safety by diversifying their portfolio and buying shares of companies with a high dividend yield and a low debt-to-equity ratio. This margin of safety aims to limit the investor’s losses should a company go bankrupt.
The Benjamin Graham Formula
Typically, Graham bought only stocks trading at two-thirds of their net-net value, as a way of establishing his margin of safety. Net-net is another value investing technique developed by Graham, in which a company is valued solely on its net current assets. Benjamin Graham’s original formula was designed to find a stock’s intrinsic value. Graham later revised it to include a risk-free rate of 4.4% (the average yield on high-grade corporate bonds in 1962) and the current yield on AAA corporate bonds, represented by the letter Y.
Dividend Stocks
Many of Graham’s investment principles are timeless – they remain as relevant today as when he wrote them. Graham criticized companies whose confusing financial statements made it hard for investors to get an accurate picture of how a business was performing. He later wrote a book on how to interpret financial statements, from the balance sheet and income statement to financial ratios. Graham also favored companies paying dividends to their shareholders, rather than keeping all their profits as retained earnings.
Our Thoughts on the Book
Of The Intelligent Investor, legendary investor Warren Buffett once said it was “by far the best book on investing ever written”. In fact, after reading it at 19, Buffett enrolled at Columbia Business School to study under Graham, with whom he formed a lifelong friendship. He later worked for Graham at the author’s investment firm, Graham-Newman Corporation, until Graham retired. Graham’s students each went on to develop their own strategies and philosophies, but all shared the key principle of building in a margin of safety.
Broadly, Buffett follows value investing principles, looking for securities priced low relative to their intrinsic value. He also looks at a company’s operating efficiency, debt and profit margins, whether its products are popular, and how dependent it is on raw materials and their prices.
Buffett’s strategy differs from Graham’s in that he stresses the importance of business quality and preaches the virtue of holding stocks for the long term. Buffett is not chasing capital gains. Instead, his goal is to own quality companies capable of generating very high earnings; he is not worried about whether the stock market takes a long time to recognize a company’s value. Even so, Buffett says nobody has ever lost money following Graham’s methods.
The Intelligent Investor is an excellent book for stock market investors, not least because it has been continually updated and revised since its first edition in 1949. It is considered a must-read for new investors trying to learn the basics of how markets work. The book is written for long-term investors. For readers looking for something newer and more fashionable, The Intelligent Investor may not be the right fit. But it offers a wealth of valuable advice, rather than teaching us how to make quick profits through day trading or other frequent trading. Portfolio managers can read it to find guiding principles that improve their strategy and investment performance.
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