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The Intelligent Investor - Benjamin Graham


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[amazonsearch]The Intelligent Investor - Benjamin Graham[/amazonsearch]

 

A quick overview of Graham's famous book.*

 

The Intelligent Investor is an excellent book and is absolutely worth reading. The key chapters are eight and twenty, regarding Mr. Market and the concept of Margin of Safety, respectively.

 

Summary of Chapter 8: The Investor and Market Fluctuations

When referring to the markets from 1850 – 1950, Graham notes that, “Nearly all bull markets had a number of well defined characteristics in common, such as:

- A historically high price level

- High P/E ratios

- Low dividend yields as against bond yields

- Much speculation on Margin

- Many offerings of new common-stock issues of poor quality.”

 

Following this Graham notes that a stock is not a sound investment simply because it can be bought close to its asset value, but that an investor should require in addition to a good P/E ratio, a strong financial position and the ability for a company to maintain it earnings for a number years into the future.

 

Later in this chapter Graham introduces the irrational character Mr. Market. He comes to you everyday and offers securities at a certain price. Sometimes, Mr. Market is overly optimistic offering high prices, and other times he is down right depressed and wants to sell at a large discount.

 

Graham stresses the importance of Mr. Market’s irrationality. Stating that one shouldn’t buy simply because a stock has gone up or sell imply because a stock has gone down, but to “acquire and hold suitable securities at suitable prices.” In this sense, movements are important only because “they create low prices at which to buy and high prices at which to sell.”

 

Summary of Chapter 20: “Margin of Safety” as the Central Concept of Investment

In this chapter Graham emphasizes the importance of Margin of Safety when buying a security.

 

By definition Margin of Safety is, “A favorable difference between price on the one hand and indicated or appraised value on the other. That difference is the margin of safety.” Stating that this is key to “absorbing the effect of miscalculations or worse-than-average luck.”

 

In a similar vein, he encourages investors to be weary in times where business conditions are favorable because purchasers “view the current good earnings as equivalent to ‘earning power’ and assume that prosperity is synonymous with safety.” Later he says that during these times, “common stocks of obscure companies can be floated at prices far above tangible investment value, on the strength of two or three years of excellent growth.” Implying that these securities do not offer a sufficient margin of safety for a prudent investor.

 

At the of the chapter Graham ends with a few business principles – two that stuck with me:

[*]Keep away from business ventures in which you have little to no gain and much to lose.

[*]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.

 

Table of Contents:

Chapter 1: Investment versus Speculation: Results to Be Expected by the Intelligent Investor

Chapter 2: The Investor and Inflation

Chapter 3: A Century of Stock Market History: The Level of Stock Market Prices in Early 1972

Chapter 4: General Portfolio Policy: The Defensive Investor

Chapter 5: The Defensive Investor and Common Stocks

Chapter 6: Portfolio Policy for the Enterprising Investor: Negative Approach

Chapter 7: Portfolio Policy for the Enterprising Investor: Positive Approach

Chapter 8: The Investor and Market Fluctuations

Chapter 9: Investing in Investment Funds

Chapter 10: The Investor and His Advisers

Chapter 11: Security Analysis for the Lay Investor: General Approach

Chapter 12: Things to Consider about Per-Share Earnings

Chapter 13: A Comparison of Four Listed Companies

Chapter 14: Stock Selection for the Defensive Investor

Chapter 15: Stock Selection for the Enterprising Investor

Chapter 16: Convertible Issues and Warrants

Chapter 17: Four Extremely Instructive Case Histories

Chapter 18: A Comparison of Eight Pairs of Companies

Chapter 19: Stockholders and Managements: Dividend Policy

Chapter 20: “Margin of Safety” as the Central Concept of Investment

 

 

*This is from my site www.bottomupanalysis.com.

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This book is naturally one of the best investment books ever written and an easy read for the novice investor.

 

http://en.wikipedia.org/wiki/The_Intelligent_Investor

 

Here are some excerpts from the book appendixes:

 

"The Superinvestors of Graham-and-Doddsville"

is an article by Warren Buffett promoting value investing, published in the Fall, 1984 issue of Hermes, Columbia.

 

The Superinvestors of Graham-and-Doddsville @ Columbia Business School, NYC

http://www7.gsb.columbia.edu/alumni/news/hermes/print-archive/superinvestors

 

PDF-file of "The Superinvestors of Graham-and-Doddsville" @ Columbia Business School, NYC

http://www4.gsb.columbia.edu/null?&exclusive=filemgr.download&file_id=522

 

"The Superinvestors of Graham-and-Doddsville" article @ Wikipedia

http://en.wikipedia.org/wiki/The_Superinvestors_of_Graham-and-Doddsville

 

"The Superinvestors of Graham-and-Doddsville" reprint @ TilsonFunds.com

http://www.tilsonfunds.com/superinvestors.html

 

 

 

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  • 2 months later...

One comment is that if you get the latest edition read the commentary with a grain of salt as it is written by an efficient markets guy.  I don't understand how an efficient markets guy was chosen for the II commentary while such good commentators were chosen for Security Analysis 6th edition.

 

Packer

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I had the same thoughts the first time I read through II.  Giving current day examples was great, but too much was left to Zweig's views as a journalist.

 

I thought for the scope and relevance of the Intelligent Investor they could get someone with more real world clout.  Your reference to Security Analysis 6th was perfect. 

 

A former Graham student or Klarman etc.

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  • 3 weeks later...

When I read the book I actually liked the commentary by Zweig.  I'll even admit to a heresy on this board, I own some index funds and a few mutual funds.  I think what Zweig adds is showing the difficulty in beating the market, often people will get interested in investing and believe that buying CAT, PEP and JNJ they'll clobber the market and be some sort of investing genius.  The reality is much different there's a large knowledge base necessary, and a lot of experience needed as well.

 

What I always think about is that a good portion of mutual fund managers don't beat their respective index.  These are all very smart people, I realize there are AUM limitations etc but still all things considered these are people with years of experience and knowledge and they still fail to beat the index.  So as an individual investor I will look at sectors that I just don't have the time or inclination to become an expert on and will buy an index (bonds for example).  I'm also content to buy an index for large caps because this is an area of the market that's over covered and over played.  Often there are niche pockets of value (tech sector right now) but I just can't compete in the large cap space.

 

I try to handicap success, so for me this means buying investments I can understand, and where I might have an edge (often small caps).  If I can't do this I don't mind buying an index and doing other things like spending time with my family or relaxing.

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Oddballstocks, it is true that for people who aren't ready to commit all the way and aren't confident in their skills, settling for average returns is the best thing to do; they can probably lose more money trying to outperform than by doing anything else.

 

But something you've written doesn't make much sense to me. You write:

 

So as an individual investor I will look at sectors that I just don't have the time or inclination to become an expert on and will buy an index (bonds for example).  I'm also content to buy an index for large caps because this is an area of the market that's over covered and over played.  Often there are niche pockets of value (tech sector right now) but I just can't compete in the large cap space.

 

If these areas are outside of your circle of competence or if you think they are too efficiently priced to gain an edge, why even own anything in those areas? Isn't it diworsification? Why not concentrate where you think you have an edge?

 

If someone put a gun to my head and said that I had to own something in some industry or country that is outside of my circle of competence, I'd buy an index. But I don't have to own anything I don't really want...

 

So I'm just wondering why you feel you need to own something in those areas? Thanks.

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Oddballstocks, it is true that for people who aren't ready to commit all the way and aren't confident in their skills, settling for average returns is the best thing to do; they can probably lose more money trying to outperform than by doing anything else.

 

But something you've written doesn't make much sense to me. You write:

 

So as an individual investor I will look at sectors that I just don't have the time or inclination to become an expert on and will buy an index (bonds for example).  I'm also content to buy an index for large caps because this is an area of the market that's over covered and over played.  Often there are niche pockets of value (tech sector right now) but I just can't compete in the large cap space.

 

If these areas are outside of your circle of competence or if you think they are too efficiently priced to gain an edge, why even own anything in those areas? Isn't it diworsification? Why not concentrate where you think you have an edge?

 

If someone put a gun to my head and said that I had to own something in some industry or country that is outside of my circle of competence, I'd buy an index. But I don't have to own anything I don't really want...

 

So I'm just wondering why you feel you need to own something in those areas? Thanks.

 

Good questions, so the idea is this...  Some things like Australia I'd like to have money there, yet right now I just don't have time to investigate good stocks there, so I bought an ETF.  I also want exposure to large caps and mid caps, but as I've explained I just don't think I'm going to be the one to uncover a ton of value there, so I'm content to buy an index fund.  I'm not sure if it's a circle of competence thing, if I wanted I could dive in and read and understand, but I'd rather not, I want to focus my energy on an area I know better, but at the same time I do want the broad market exposure.

 

The other thing is I have money in a 401k that has to be in funds (my only option), so I just allocate there as I'd want sector-wise.  In my taxable account I only hold one fund which is a global fund, I've held it for years it seems to do well and I feel that they can plug holes I might not find myself. 

 

Does this clarify at all?  I understand some people really understand insurance and banks so they might have a portfolio of 10-15 bank and insurance companies.  The problem for me is I want some broad market exposure, and I just don't have the time to manage a portfolio to get a good amount of exposure.  I think this really isn't an issue for someone who does it full time either professionally or just managing their own funds.

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Fair enough, but one question remains in my mind: Why do you feel you have to be in those sectors at all? I see two options: Either you think they'll perform as well (risk/reward) as the stocks you are hand-picking, or you are doing it as a way to diversify broadly.

 

I kind of doubt #1, otherwise why even go to the trouble of picking stocks at all if you can get the same risk/reward with indices.

 

#2 is a personal preference. I'm the exact opposite of diversified. I focus very heavily on the few securities that I feel are the safest and most undervalued and/or have the best potential for growth. I could certainly reduce volatility by diversifying, but I think I would also reduce returns significantly, and not really increase safety much over the long-term.

 

Anyway, I don't want to seem like the spanish inquisition or anything, I just like to understand people's approach to see if they're doing something that I should be doing.

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Liberty,

 

You're not missing anything each investor has to find a style they're comfortable with.  Some of it is diversification, some is just being lazy.  I'll use an example.

 

So I want to be in Europe, the market in general is at an attractive P/E10.  So I put some of our funds in an IRA into a European index, I can forget about it for 5-10 years.  On the other hand in an account that allows international trading I'm buying European equities that I think are extremely attractive on an individual level.  The problem is I can only trade in eight markets over there, but I want the performance of the whole continent so the index is the answer.  I'm doing the same thing in Japan, I have an index fund to capture the market but I do some net-net's as well in my international account.

 

I guess when you boil it down a lot of it is due to account limitations.  In my 401k and IRA's I can't easily trade international stocks, yet I still want to capture some of that performance.  I have an international small cap ETF in my IRA, this is something I can't grab in my IRA in any meaningful way in individual issues.

 

As I said I have a taxable account where I can invest in 12 markets cheaply, and in theory anywhere in the world for about $80 a trade.  In that account I only have one fund that's about 7% of the account value.  I own three active mutual funds, and my theory with those is I really like the manager, and I trust them to manage a portion of my money.

 

There's a lot to be said about just capturing the market return it takes no time.  I think what's often lost on this board is the opportunity cost of researching investments especially if you don't get paid for it.  As an individual I probably grossly underperform the market if you impute my personal time.  I love doing this stuff so I don't care, but on a dollar for dollar basis I'd probably be better off billing all my research hours for work where I get a guaranteed hourly payout.  For this to make sense you either need a lot of money under management, or need to spend very little time researching.  On a $750k account you'd need a 15% return or higher to make $100 an hour.

 

As a cynic I think this is why a lot of smart investors go into fund management.  It's a lot easier to get $25m and scrape 1% for $250k than to invest for a 15% year in year out return.  Managing a fund investors are happy if you only lose 10% when the market's down 25%, managing for myself I can't live off negative returns.  Now scale this up, a manager with $1b AUM, that 1% is $100m of which they might get $1m to run the fund, that's a $1m return guaranteed.

 

 

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