The Intelligent Investor. Benjamin Graham

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What do I love about: The Intelligent Investor?

This is Graham’s classic. If you are in the investment world you will hear people throw around value investing, margin of safety and a host of terms derived from this book. The book continues to be refined with the latest information as well as clarifications made in the footer. Graham was one of Warren’s mentor and a lot of what Warren learnt came from him. This book really speaks to the psychology of investing and what it truly means to be a value investor. This is definitely one of the greatest reads on value investing.

What do I not love about: The Intelligent Investor?

This read is long and convoluted. Filled with details that will boggle your mind and sometime leave you uninterested. I avoided this issue by skipping pages where Graham gets too technical or provides details beyond my comprehension.

Who should read: The Intelligent Investor?

If you are passionate about learning the principles of value investing and truly understanding what it means. In addition I would recommend readers also read Warren Buffet and the interpretation of financial statements.

Who should not read: The Intelligent Investor?

If you have no interest in investing and/or get discouraged with detailed information then this may not be for you.

Notes from The Intelligent Investor

Chapter 1: Investment versus speculation

Who is the defensive/passive investor ?

• He will place his chief emphasis on the avoidance of serious mistakes or losses. His second aim will be freedom from effort, annoyance and the need for making frequent decision.
• The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condition.
• The defensive investor can purchase shares of well-established investment funds as an alternative to creating his own common-stock portfolio.
• The defensive investor should utilize dollar-cost averaging which means simply that the practitioner invests in common stocks the same number of dollars every month.

Graham’s definition of investment: An investment operation is one in which, upon through analysis, promises safety of principal and an adequate return

Chapter 2 and 3: The Investor and Inflation & the history of stock prices

• The intelligent investor avoids investing in gold directly with its high storage and insurance cost, instead, seek out a well-diversified mutual fund specializing in the stocks of precious-metal companies and charging below 1% in annual expenses
• You got to be careful if you do not know where you are going, because you might not get there
• By the rule of opposites, the more enthusiastic investors become about the stock market in the long run, the more certain they are to be proved wrong in the short run.

Stock market performance depends on 3 factors:

1. Real growth (the rise of the companies’ earnings and dividends)
2. Inflationary growth (the general rise of prices throughout the economy)
3. Speculative growth or decline (any increase or decrease in the investing public’s appetite for stocks)

Chapter 4 & 5: The defensive investor and common stocks

• When you leave it to chance, then all of a sudden you do not have any more luck
• Rule of thumb: Subtract your age from 100 and invest that percentage of your assets in stocks with the rest in bonds/cash (A 28 year old would put 72% of her money in stocks and an 81 year old will put 19% there)
• Graham’s guideline of owning between 10 and 30 stocks remains a good starting point for investors who want to pick their own stocks but you must make sure that you are not overexposed to one industry.
• After you set up such an online autopilot portfolio, you find your self-trading more than twice a year or spending more than an hour or 2 per month on your investments then something has gone badly wrong.
• The knowledge of how little you can know about the future coupled with the acceptance of your ignorance, is a defensive investors most powerful weapon.

Chapter 6 & 7: Portfolio policies for the enterprising investor

• Preferred stocks: If a company must pay high rates of interest in order to borrow money,  that is a fundamental sign that it is risky.
• Research has shown that corporations choose to offer new shares to the public when the stock market is near a peak. An intelligent investor must resist the blandishments of salesmen offering new common stock issues during bull market.
• When humans estimate the likelihood or frequency on event, we make that judgement based not on how often the event has actually occurred but on how vivid the past examples are.
• The more enthusiastic the public grows about it, and the faster its advance as compared with the actual growth in its earnings, the riskier a proposition it becomes.

Chapter 8: The investor and market fluctuations

• Never buy into a lawsuit remains a valid rule for all but the most intrepid investors to live by
• Whenever you see the word “truth” in an article about investing, brace yourself many of the quotes that follow are likely to be lies.
• Growth stock are worth buying when their prices are reasonable, but when the Price to Earnings ratio go much above 25 or 30 the odds get ugly
• The intelligent investor however gets interested in big growth stocks not when they are the most popular but when something goes wrong
• Putting up to a third of your stock money in mutual funds that hold foreign stocks including those in emerging markets helps insure against risk that our own backyard may not always be the best place in the world to invest.
• Most of the stocks you own will gain atleast 50% from their lowest price and lose at least 33% from their highest price-regardless of which stocks you own or whether the market as a whole goes up or down. If you cannot live with that or you think your portfolio is somehow exempt from it then you are not entitled to call yourself an investor
• Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop
• The happiness of those who want to be popular depends on others; the happiness of those who seek pleasure fluctuates with moods outside their control but the happiness of the wise grows out of their own free acts.
• The investor who permits himself to be stampede or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage.
• Remember the pain of financial loss is twice as intense as the pain of financial gain

Margin of Safety: Never overpay, no matter how exciting an investment seems to be can help minimize your odds of error

What is within your control?

1. Your brokerage cost: by trading rarely, patiently and cheaply
2. Your ownership costs: by refusing to buy funds with excessive annual fees
3. Your expectations: by using realism, not fantasy, to forecast your returns
4. Your risk: by deciding how much of your total asset to put in the stock market
5. Your tax bills: by holding stocks for atleast one year to lower your capital gains liability
6. And most of all your behaviour

Chapter 9 &10: Investing in investment funds

If you are not prepared to stay married, you should not get married. Fund investing is no different. If you are not prepared to stick with a fund through at least 3 lean years you should not buy it in the first place. Patience is the fund investors single most powerful ally

To Invest in investment funds, most buyers look at:

• Past performance: Remember it is only a pale predictor of future returns as yesterday’s winners can become todays losers and yesterday’s losers almost never become tomorrows winners
• The manager’s reputation: Are the managers major shareholders that dare to be different, don’t hype their returns, and have shown a willingness to shut down before they get too big for their britches,
• Riskiness of the fund and finally the funds expense which should not have more than 1% of annual operating expenses

Chapter 11: Security analysis for the lay investor

Elements to consider when deciding the company to invest in

1. The company’s general long term prospects
2. The quality of its management
3. Its financial strength and capital structure
4. Its dividend record and current dividend rate

Problems to watch for

1. The company is a serial acquirer
2. The company is an OPM addict, borrowing debt or selling stock to raise boatloads of other people’s money
3. The company is a Johnny-On-Note relying on one customer (or a handful)
4. A merger in which a tiny firm took over a big one

Investment by the intelligent investor

The intelligent investor will invest in companies with

1. Adequate size: to exclude small companies stay away stocks with total market value of less than $2billion. However you can own small stocks by owning investment funds
2. A sufficiently strong financial condition with current asset at least 1.5 times current liabilities and debt that can be paid with 3-5 years worth of free cash flow
3. Continued dividends for atleast the past 20 years
4. No earnings deficit in the past 10 years
5. 10 year growth of at least one-third in per share earnings
6. Price of stock no more than 1.5 times net asset value
7. Price no more than 15 times average earnings of the past 3 years (price/earnings)
8. Moderate price to book of 1.5

Dividends

• When prime emphasis is not placed on growth the stock is rated as an income issue and the dividend rate retains its long held importance as the prime determinant of market price. At the other extreme, stocks clearly recognized to be in the rapid-growth category are valued primarily in terms of the expected growth rate over say the next decade and the cash-dividend rate is more or less left out of the reckoning.
• Most managers are wrong when they say they can put your cash into better use than you can. Paying out a dividend does not guarantee great results, but it does improve the return of the typical stock by yanking at least some cash out of the mangers hands before they can either squander it or squirrel it away.
• For technical results, options increase in value as the price fluctuations of a stock grow more extreme. But dividend dampen the volatility of stock’s price. So if the managers increased the dividend they would lower the value of their own stock options. Dividends dampen makes stock less volatile by providing a stream of current income that cushion shareholders against fluctuations in market value. Research has shown that the major companies with stock buyback programs is atleast twice as volatile as that of companies that pay dividends

Conclusion:

In making decisions under conditions of uncertainty, the consequences must dominate the probabilities