Summary: ‘The Intelligent Investor’ by Benjamin Graham

Today’s finan­cial mar­kets are vast­ly dif­fer­ent from their state in 1949 when Ben­jamin Gra­ham penned The Intel­li­gent Investor. Stock val­u­a­tions have sig­nif­i­cant­ly risen, and the sav­ings bonds that Gra­ham com­mend­ed are no longer appeal­ing invest­ments. Gra­ham illus­trat­ed the mar­kets through a char­ac­ter named “Mr. Mar­ket,” an imag­i­nary fig­ure who pro­vid­ed investors with a dai­ly price at which he would either buy their stock or sell them more. In gen­er­al, Gra­ham rec­om­mend­ed that investors pay no heed to Mr. Mar­ket. Nev­er­the­less, present-day investors are engag­ing in “1,500 times as much busi­ness with him as they did near­ly half a cen­tu­ry ago,” result­ing in many investors dis­re­gard­ing this valu­able counsel.

“What the gen­uine investor in com­mon stocks requires is not an exten­sive amount of brains and knowl­edge, but rather some excep­tion­al qual­i­ties of character.”

Gra­ham would like­ly have viewed today’s sur­feit of spec­u­la­tive trad­ing with skep­ti­cism. He would def­i­nite­ly have cen­sured the tran­si­tion from own­ing stocks to leas­ing them, as short-term stock pos­ses­sion pro­vides investors with min­i­mal moti­va­tion to exer­cise respon­si­ble super­vi­sion. Nonethe­less, Gra­ham’s insights regard­ing “defen­sive” and “enter­pris­ing” investors remain accu­rate. He also fore­saw the inca­pac­i­ty of fund man­agers to achieve a return exceed­ing the mar­ket average.

“Invest­ment is at its most astute when con­duct­ed in a busi­nesslike manner.”

His focus on long-term own­er­ship indi­cates that he would have sup­port­ed the con­cept of an index mutu­al fund. Pri­or to his pass­ing, in an inter­view, he advo­cat­ed that investors should strive to obtain at least the aver­age mar­ket return from a fund. Gra­ham con­ced­ed that his notions might not stand the test of time; nonethe­less, some of his prin­ci­ples endure, such as his belief that spec­u­la­tion usu­al­ly leads to loss­es. Con­tem­po­rary investors would ben­e­fit from his urg­ings to pur­chase when oth­ers are keen on sell­ing and to sell when oth­ers are eager to buy, and to con­duct ade­quate research before investing.

“Noth­ing in finance is more absurd and detri­men­tal… than the firm­ly entrenched atti­tude of com­mon stock investors and their Wall Street advis­ers regard­ing mat­ters of cor­po­rate management.”

The Intelligent Investor

Investors – as opposed to spec­u­la­tors – fall into two main categories:

• Defen­sive – This type of investor aims to safe­guard cap­i­tal, min­i­mize errors, reap favor­able returns, and hedge against infla­tion. Defen­sive investors seek safe­ty and inde­pen­dence, hence they are rec­om­mend­ed to allo­cate up to 40% of their funds in sav­ings bonds and a sig­nif­i­cant por­tion in com­mon stocks, both as pro­tec­tion against infla­tion and as an oppor­tu­ni­ty to earn div­i­dends and ben­e­fit from stock appreciation.
• Enter­pris­ing (or aggres­sive) – This investor endeav­ors to pur­chase secu­ri­ties below their intrin­sic val­ue. Enter­pris­ing investors may seek prof­its by trad­ing based on mar­ket aver­ages, select­ing stocks that out­per­form the mar­ket, opt­ing for growth stocks, iden­ti­fy­ing bar­gains, and over­all, buy­ing when the mar­ket is pes­simistic and sell­ing when it is opti­mistic. Efforts to out­pace the mar­ket aver­age and select win­ning stocks lean more towards spec­u­la­tion than invest­ing, but the oth­er meth­ods are gen­uine invest­ment strate­gies. Acquir­ing under­val­ued secu­ri­ties that offer a “mar­gin of safe­ty” might be the most secure path to wealth, pro­vid­ed you devote time and effort to becom­ing an invest­ment authority.

“This atti­tude is cap­tured in the phrase: ‘If you are dis­sat­is­fied with the man­age­ment, divest your stocks’.”

Invest­ing is a busi­ness, and investors should treat it as one. Numer­ous busi­ness pro­fes­sion­als who exhib­it pru­dence in their endeav­ors seem to aban­don this dis­ci­pline when con­front­ed with Mr. Mar­ket. Intel­li­gent investors are not nec­es­sar­i­ly bril­liant, clever, or insight­ful, but they per­ceive the mar­ket as a busi­ness. Achiev­ing suc­cess in invest­ing is more about char­ac­ter than intel­lect. An investor must pos­sess the for­ti­tude to resist impuls­es to spec­u­late, seek quick gains, and fol­low the herd.

“Com­pe­tent man­age­ments result in a favor­able aver­age mar­ket price, where­as inept man­age­ments lead to unfa­vor­able mar­ket prices.”

Market Trends

Spec­u­la­tors aim to prof­it from mar­ket fluc­tu­a­tions. Con­verse­ly, investors aim to pro­cure qual­i­ty stocks at favor­able prices and retain them. Mar­ket move­ments are sig­nif­i­cant sole­ly because they present prices at which it becomes wise for the investor to buy or sell. The typ­i­cal investor should not wait for the mar­ket to decline before acquir­ing stocks. As long as prices are not unrea­son­ably inflat­ed, you should strive to con­struct a stock port­fo­lio through judi­cious buy­ing pat­terns such as averaging.

“Only in rare cas­es, where the integri­ty and com­pe­tence of advi­sors have been thor­ough­ly demon­strat­ed, should the investor act on the advice of oth­ers with­out com­pre­hend­ing and approv­ing the deci­sion made.”

Many investors attempt to pin­point stocks that will sur­pass the mar­ket in the short term. This is too akin to spec­u­la­tion to war­rant rec­om­men­da­tion. The stock price incor­po­rates infor­ma­tion regard­ing fore­casts of high­er or low­er prices (both con­stant­ly exist in the mar­ket, for any stock) and reflects the cumu­la­tive effect of these per­spec­tives. The val­ue investor can dis­re­gard dai­ly price fluctuations.

“The intel­li­gent investor (requires) an abil­i­ty to resist the allure of sales­per­sons offer­ing new com­mon-stock issues dur­ing bull markets.”

Portfolio Strategies: Defensive, Aggressive, and Enterprising

Finan­cial advi­sors can be ben­e­fi­cial but do not rely entire­ly on them for guid­ance on how to prof­it. Pro­fes­sion­als can aid in achiev­ing a min­i­mal risk lev­el and con­ser­v­a­tive income, and finan­cial insti­tu­tions can fur­nish eco­nom­ic and mar­ket data – yet do not place exces­sive empha­sis on their mar­ket pro­jec­tions. Bro­ker­ages are more akin to enter­pris­es than pro­fes­sion­al estab­lish­ments, such as law firms. Invest­ment bankers are sales­per­sons who view clients as poten­tial pur­chasers for the secu­ri­ties they underwrite.

“Some of these issues may turn out to be excel­lent pur­chas­es – a few years down the line, when there is min­i­mal inter­est in them and they can be acquired at a small frac­tion of their actu­al value.”

The method of uti­liz­ing advice and advis­ers hinges on whether you are a defen­sive or enter­pris­ing investor. Defen­sive investors should restrict their secu­ri­ty acqui­si­tions to rel­a­tive­ly low-risk, high-qual­i­ty bonds and stocks. They mere­ly need rel­a­tive­ly basic, uncom­pli­cat­ed advice con­cern­ing which stocks match their cri­te­ria and whether prices are rea­son­ably aligned with his­tor­i­cal averages.

“A pri­ma­ry indi­ca­tor of a com­pe­tent ana­lyst is their capac­i­ty to dif­fer­en­ti­ate between sig­nif­i­cant and insignif­i­cant facts and fig­ures in a giv­en scenario.”

On the oth­er hand, enter­pris­ing investors should col­lab­o­rate with advis­ers and seek detailed jus­ti­fi­ca­tions and rec­om­men­da­tions. A well-diver­si­fied stock port­fo­lio is not over­ly haz­ardous for a defen­sive investor. While stock prices fluc­tu­ate, the investor does not incur loss­es mere­ly due to the mar­ket price decline. The investor tru­ly incurs a loss only by sell­ing at a low­er price than the pur­chase price.

“The process of select­ing the ‘finest’ stocks essen­tial­ly boils down to a high­ly con­tentious mat­ter. Our sug­ges­tion to the defen­sive investor is to avoid it altogether.”

Aggres­sive investors should rely on their dis­cern­ment and con­sult advis­ers not for direc­tives but for sup­ple­men­tary knowl­edge to com­ple­ment their exper­tise. Two port­fo­lio man­age­ment prin­ci­ples are rel­e­vant to the aggres­sive investor: First­ly, steer clear of pur­chas­ing cor­po­rate bonds since US sav­ings bonds present near­ly equiv­a­lent returns and con­sid­er­ably low­er risks. Sec­ond­ly, avoid high-qual­i­ty pre­ferred stocks. Low­er-qual­i­ty pre­ferred stocks and cor­po­rate bonds rep­re­sent­ed below are a few pru­dent invest­ments when prices are at least one-third below par. It is advis­able to steer clear of for­eign bonds, as well as con­vert­ibles and com­mon stocks with excep­tion­al­ly high recent earn­ings per­for­mance. Fresh­ly issued stocks are deemed allur­ing invest­ments sole­ly when they fall out of favor and trade at a val­ue less than their true worth. The resource­ful investor has the poten­tial to derive gains by:

• Employ­ing “Mar­ket tim­ing” – Attempt­ing to pur­chase dur­ing a mar­ket down­turn and sell­ing when it ascends is both entic­ing and per­ilous. Future mar­ket ups and downs might not mir­ror past tran­si­tions. The soli­tary advan­tage of mar­ket tim­ing for­mu­las is that they could prompt investors to act as con­trar­i­ans, going against the main­stream buy­ing and sell­ing trends. This is a log­i­cal approach – although oth­er aspects of mar­ket tim­ing hold min­i­mal value.
• Focus­ing on “Growth stocks” – Rec­og­niz­ing stocks with a his­to­ry of supe­ri­or per­for­mance is rel­a­tive­ly straight­for­ward, but pre­dict­ing their future per­for­mance pos­es a chal­lenge. It is advis­able not to pay exces­sive­ly for growth.
• Seiz­ing “Buy­ing bar­gains” – Bonds and pre­ferred stocks may prove to be worth­while acqui­si­tions when they trade below par val­ue. Com­mon stocks can be bar­gains if their intrin­sic val­ue sur­pass­es the mar­ket price. Occa­sion­al­ly, cer­tain stocks may trade at a low­er price than their work­ing cap­i­tal val­ue. Addi­tion­al­ly, sec­ondary stocks with­in an indus­try might also be con­sid­ered bar­gains, as the mar­ket tends to over­state the risks asso­ci­at­ed with stocks that are not mar­ket lead­ers. Investors who acquire under­priced stocks can enjoy sub­stan­tial returns through high div­i­dends, earn­ings rein­vest­ment, and price appre­ci­a­tion over time or as the result of a bull­ish market.
• Explor­ing “Spe­cial sit­u­a­tions” – Instances such as bank­rupt­cies, reor­ga­ni­za­tions, merg­ers, and sim­i­lar sce­nar­ios can present prof­it prospects. Fre­quent­ly, the mar­ket under­val­ues stocks sig­nif­i­cant­ly due to con­cerns such as a com­pa­ny’s poten­tial legal entanglements.

“Insid­ers nev­er suf­fer loss from an undu­ly low mar­ket price which it is in their pow­er to cor­rect. If by any chance they should want to sell, they can and will always cor­rect the sit­u­a­tion first.”

Aggres­sive investors neces­si­tate a sig­nif­i­cant lev­el of exper­tise to engage effec­tive­ly in what essen­tial­ly amounts to an invest­ing enter­prise. There exists no mid­dle ground between a pas­sive and an active approach. Since only a lim­it­ed num­ber of investors pos­sess the req­ui­site knowl­edge and tem­pera­ment to oper­ate aggres­sive­ly, most investors should opt for a defen­sive strategy.