The Intelligent Investor Summary
The Intelligent Investor
In today’s post, I will summarize and discuss the top takeaways from the book, “The Intelligent Investor” by Benjamin Graham.
Warren Buffet, one of the most successful investors the world has ever known has this to say about the book.
The best book on investing, ever written.
Warren Buffet
Investment vs. Speculation
Graham defines investment as:
One which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting those requirements are speculative
Benjamin Graham
Investment is breaking down into three parts.
- Fundamental analysis
- Diversification
- Seek steady returns
Why is investing important? Investing is important because of inflation.
Inflation is defined as an increase in prices and the fall in the purchasing value of money.
In 2019, the inflation rate is 1.81%. Why is this rate important?
Let’s say you invested $10,000, with an inflation rate of 1.81% you have this:
$10,000 - $181 = $9,819
So, with the initial $10,000, you’re able to buy $10,000 dollars worth of goods. Unfortunately, due to inflation, next year you’re only able to buy $9,819 dollars worth of goods.
For this reason, Graham described investment success is measured not just by what you make, but by how much you keep after inflation.
How to invest as an enterprising investor
The best way to beat inflation is to put your money into the market. Well, isn’t investing in stocks risky you might ask?
The best approach to this is to invest in high-quality stocks or index funds.
My personal preference is leaning toward index funds.
Always invest with a level head, don’t buy into the hype of a strong bull market because ultimately economic booms are followed by recessions or periods of flat economic growth.
Graham, along with John Bogle and Taylor Larimore recommended against listening to so-called financial experts and try to time the market.
Their job is to sell their newsletters or information to you. And most of the time, their recommendations are busts anyways.
Basically, do not attempt to time the market.
However, if you want to attempt you must have:
- patience
- discipline
- eagerness to learn
- lots of time
The intelligent investor must avoid growth stocks. Why? The investment decision is based relatively more on future earnings, and future earnings are less reliable than current valuations.
Defensive Investor Principles
The decision about how to be a defensive investor should not be based on your appetite for risk but your willingness to put in the time and effort into your portfolio.
Your risk appetite should not be based on your age but based on your circumstances. Are people depending on you for income? Are you self-employed? And how much you can afford to lose?
Graham recommended for you to keep:
- Minimum of 25% in bonds
- Maximum of 75% in stocks
Keep in mind that no stocks are worth investing all your money in. In other words, don’t keep all your eggs in the same basket.
Otherwise, the consequences can be severe.
When you’re an intelligent investor, investing can become methodical and boring, almost like you’re on autopilot.
However, this is exactly how you should invest. Just like how Taylor Larimore emphasizes in his book: The Bogleheads’ Guide to Investing,
“Tune out the noises.”
Don’t let the speculative nature of trading seduce and urge you to abandon your strategy and become a speculator.
Investment rules to follow according to Graham
- Avoid day trading
- IPO (initial public offering) should really stand for it’s probably overpriced
- Price matters, you don’t want to be stuck with buying high and selling low
- Opportunities arise when the market is depressed and undervalued
- Diversify (10-30 companies is enough & not just in one industry)
- Large companies (generating more than $100 million in yearly sales, which is equivalent to $700 million in today’s value)
- Conservatively financed (current ratio of 200%, meaning its assets is twice as big as it’s liabilities
- Dividends have been paid to investors in the last 20 years
- No earnings deficit in the last 10 years
- At least 2.9% growth annually over the last 10 years
- Price of stock should not be higher than 1.5 times its net asset value (net asset value can be calculated by subtracting liabilities from assets)
- Don’t let the p/e ratio be higher than 15 when using the last 12 months earning
Index Funds
Benjamin Graham recommends you to invest in index funds as an alternative to actively owning stocks. Warren Buffet, John Bogle, Taylor Larimore agrees. Why?
- Low expense ratios
- Diversification
- Passive investment
Margin of safety
Your investment strategy should be based on research and data. A margin of safety minimizes the risk of being wrong.
The price and value of a company are not always the same.
According to Graham, the price of a company cannot exceed two-thirds of its calculated value.
The book offers a formula to help you calculate
value = current (normal) earnings x (8.5 + 2 x epected annual growth rate
The growth rate should be equal to the expected yearly growth rate of earnings for the next 7 to 10 years.
Meet Mr. Market
Imagine that you have ownership of company X worth $10,000.
Every day, a person known as Mr. Market (bipolar) comes to your home with an opinion about how much your part of a business is worth.
He will one day tell you that your ownership is worth $15,000 and the next day tell you that it is now only worth $5,000.
Should you trust Mr. Market? Mr. Market often times does not accurately assess the true value of a business. And Mr. Market can at times be overly optimistic and at other times be overly pessimistic.
Leading to the underpricing or overpricing examples discussed above.
Graham recommends that an intelligent investor should invest only when they are willing to hold the stock in the future without being affected by the fluctuating prices.
According to Graham, you surely can deal with Mr. Market, especially when the terms are favorable. Essentially, it boils down to selling high and buying low.
Risk and reward are not always correlated
Rate of return which an investor can expect must be proportional to the degree of risk that he’s willing to accept. Risk is measured as the volatility of the returns on investment.
Graham doesn’t believe in this statement. He argues that the return an investor can expect is a function of how much time and effort he put in in pursuit of finding a bargain target.
The minimum return will go to the defensive or (passive) investor, while the maximum return goes to the enterprising investor who exercises maximum intelligence and skills.
Final Thoughts on The Intelligent Investor
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The Intelligent Investor is a classic investing book recommended by a lot of investors and personal finance experts.
However, investing in individual stocks is risky and is not recommended for most investors.
I want to quote John Bogle-founder of Vanguard and author of “The Little Book of Common Sense Investing.”
Don’t look for the needle-just buy the haystack.
John Bogle
For most investors investing in index funds makes the most sense. Active investing is reserved for the enterprising investor as coined by Graham.
Meaning you have to do your due diligence and follow his advice on how to be both an intelligent investor and an enterprising investor.
If you’re interested in getting more in-depth details on The Intelligent Investor by Benjamin Graham, it’s available both in an audible version and paper copy through Amazon.
Additionally, I also recommend John Bogle’s book: The Little Book of Common Sense Investing to get Bogle’s take on investing.