The Intelligent Investor By Benjamin Graham, revised edition of 1973.<\/span><\/i><\/p>\n In The Intelligent Investor, Graham talks about two main ways people act in the stock market: investing and speculating. He says investing is when you carefully study and expect your money to be safe and make a good profit. Speculation is when you don’t meet these conditions. In Wall Street language, everyone who puts money in the markets is often called an “investor,” but Graham makes it clear that there’s a big difference. He doesn’t say speculation is bad, but he strongly recommends not doing both investing and speculating with the same money.<\/span><\/p>\n After a time of strong inflation starting in 1965, many finance experts thought that bonds were not as good an investment as stocks. Graham in The Intelligent Investor disagrees with this idea. He says it’s silly to claim that stocks, even high-quality ones, are always better than bonds, no matter what the market is like. It’s just as silly to say the opposite. While stocks have sometimes done better than bonds in the past, there’s no guarantee that the stock market isn’t too expensive and won’t give a weaker return than the bond market. Anything is possible!<\/span><\/p>\n Graham also shows that the belief that moderate inflation is good for company profits is wrong when you look at historical numbers. He talks about the common practice of buying gold to fight inflation. He says it was good that the US banned this from 1935 to 1972 because, during that time, gold only went up by 35%. Also, the person who owned the gold didn’t get any profit on their money during that whole period. Putting the money in a savings account would have been a better idea.<\/span><\/p>\n In this chapter of The Intelligent Investor, Graham looks at how the Dow Jones (DJIA) and the S&P 500 behaved from 1900 to 1970. He sees three main phases:<\/span><\/p>\n From 1900 to 1924, there were ups and downs that lasted 3 to 5 years each. The average yearly return was about 3%.<\/span><\/p>\n Then came a market high and the Great Depression of 1929. Until 1949, the market went up and down irregularly, with an average performance of 1.5% per year.<\/span><\/p>\n In 1949, not many people were excited about buying shares. But from then until 1969, the market went up! There were two short recessions in 1956-57 and 1961-62, but they bounced back quickly. The average performance of the DJIA from 1949 to 1969 was 11% per year, not counting dividends, which were around 3.5% per year. In 1969, everyone thought this would keep going, but then the DJIA fell by 37%! The S&P 500’s performance from ’49 to ’71 was 9% per year.<\/span><\/p>\n Additionally, corporate profits mostly kept rising, except for two down decades (1891-1900 and 1931-1940), supporting the idea of having some long-term share investments.<\/span><\/p>\n Looking at the price\/profit ratio per share of the indexes, it was just 6.3 for the S&P 500 in June 1949, while the dividend was 7%. But in March 1961, the ratio was 22.9 for a dividend of 3%. This means you could buy shares for much less in 1949 than in 1969. Meanwhile, bond rates went up from 2.6% in 1949 to 4.5% in 1961.<\/span><\/p>\n This shows a big change in attitude towards shares between the two periods. People were willing to pay much more for S&P 500 profits in 1961 than in 1949. This extreme change should make an investor cautious because it might mean the stock market is overvalued.<\/span><\/p>\n At the end of the chapter of The Intelligent Investor, Graham gives his opinion on the market in 1972, predicting a stock market drop (which turned out to be right with the recession of 1973-1974).<\/span><\/p>\n Graham doesn’t aim to set a specific target for portfolio returns. He thinks the earnings will depend on how smartly the investor works on building their portfolio. So, if you want a safe and calm approach, you might get modest earnings. But if you’re more adventurous and use your smarts and skills, you could earn more.<\/span><\/p>\n Graham also gives advice in The Intelligent Investor on how to divide your money between bonds and shares. For a defensive investor, he suggests a basic split of 50% bonds and 50% high-quality shares. However, when the stock market seems high, like it did in the 1970s with high price\/earnings and low dividends, you might want to shift to 75% bonds and 25% shares. This is easier said than done because, during high market times, there’s often a feeling of excitement. Similarly, after a market fall, if shares are paying more than bonds, you can increase your share portion.<\/span><\/p>\n The balance between shares and bonds depends on the investor’s personality, and the suggested strategy is just a general guideline.<\/span><\/p>\n Stocks are a good addition to a portfolio because, over long periods, they often perform better than bonds, offering better protection against inflation. Another advantage is that when you own stocks, some of the profits are reinvested in the company, growing over time. In contrast, bonds provide a fixed rate regardless of what happens to a company’s profits.<\/span><\/p>\n For a defensive investor (someone who prefers a safer approach), choosing stocks is straightforward. Graham suggests four rules:<\/span><\/p>\n In The Intelligent Investor, Graham also recommends a strategy called <\/span>monthly investment averaging from the bottom:<\/b> buy more shares when the price is low and fewer when it’s high. This approach works well even with small amounts over time.<\/span><\/p>\n He emphasizes that the chosen stocks for a defensive investor aren’t risky in the sense of losing all invested capital. Risk, in this context, refers to the chance of permanently losing all the invested money, not the regular ups and downs of the stock market.<\/span><\/p>\n For the more daring investor, they should start with the same basic principles as a cautious investor, deciding how to divide their money between high-quality bonds and solid company shares at reasonable prices. The key difference is that this investor is open to exploring other investment options, but any deviation from their main strategy should be backed by good logical reasoning. The possibilities for this type of investor are vast and depend on their skills and temperament.<\/span><\/p>\n However, there are some things they should generally avoid. They’d steer clear of lower-quality bonds and convertible securities unless they can get them at a maximum of 70% of their face value for higher coupons or a much lower price for lower coupons. They wouldn’t buy foreign bonds, no matter how tempting the interest rates might be. Newly issued instruments (like initial public offerings, convertible securities, new bonds, etc.) and shares whose dividends have only recently performed exceptionally well are also on the “avoid” list.<\/span><\/p>\n When it comes to bond investments, the daring investor should act similarly to their more cautious counterpart. The risk of a quality bond defaulting is not worth taking because a decrease in its face value could be disastrous, possibly resulting in the investor losing their money. Graham warns against approaches suggesting buying a collection of low-quality bonds (known as “junk bonds”) under the assumption that the overall set will offer a better yield than high-quality bonds. They forget to mention that an investor can’t buy all the “junk bonds” on the market. Graham doesn’t even bother checking if this conclusion is accurate or not.<\/span><\/p>\n Investors should also avoid initial public offerings because many worthless companies tend to be introduced to the market at very high prices, especially during bullish markets and periods of high excitement.<\/span><\/p>\n In The Intelligent Investor, when it comes to bonds, Graham suggests that the daring investor should consider certain US State bonds with coupons ranging from 5% to 7.25%, depending on the types.<\/span><\/p>\n For stocks, the adventurous investor aims to:<\/span><\/p>\n However, there are challenges. Determining whether the market is high or low isn’t straightforward. Selecting growth stocks can be tricky because they often come with high price tags, introducing an element of speculation.<\/span><\/p>\n To achieve above-average results, the daring investor needs a unique and logical approach that differs from the majority. Following the crowd usually leads to similar outcomes.<\/span><\/p>\n Graham recommends three approaches based on his experience and shares it in The Intelligent Investor:<\/span><\/p>\n The author doesn’t delve into special operations in “The Intelligent Investor,” but shares personal experience. Despite the fierce competition in the field, the described approach has yielded a return on investment (ROI) of over 40% annually for nearly nine years at a personal level. Whether this intelligent investment method will continue to be successful remains to be seen.<\/span><\/p>\n When an investor puts money into good quality bonds that mature in a relatively short time, let’s say less than 7 years, they won’t be greatly affected by changes in the market. Bonds that take longer to mature are more likely to go up and down, and it’s a fact that stock prices will change over time. The investor needs to be fully aware of this and be ready both mentally and financially.<\/span><\/p>\n Because all stocks, even the good ones, will go through significant price changes, the investor should make the most of it. There are two well-known methods: “timing” and “pricing.”<\/span><\/p>\n “Timing” involves buying when you think prices will go up and selling (or not buying) when you expect a drop.<\/span><\/p>\n “Pricing” involves buying shares in a company for less than what they’re truly worth and selling them when they’re worth more.<\/span><\/p>\n While “timing” often turns an investor into a speculator (someone who takes more risks), Graham suggests focusing on “pricing.” Some speculators might get good results, but that’s not the case for the average person. With “pricing,” the average investor has a better chance of getting very good results simply by buying shares at a low price and selling them at a high price, without worrying too much about market movements.<\/span><\/p>\n For a long time, there was a theory that said to buy when markets are down and sell when they’re up, considering the market’s valuation (using the Price\/Earnings ratio). Graham explains that although this idea isn’t bad, no one can really predict how the market will behave in the future. The bull market between 1949 and 1969 challenged this theory because there was no significant market correction during that time. Not buying any shares throughout that period wouldn’t have been beneficial for any investor.<\/span><\/p>\n The lesson here is that it’s better not to buy just any share. Regardless of market conditions, you should be picky and selective in your choices.<\/b><\/p>\n A serious investor should not let short-term changes in the market, like those happening over a few months, dictate whether they feel richer or poorer. However, many of us find ourselves caught up in emotions when a stock’s price goes up: “I’m richer now! Great!” or “The price is too high, time to sell!” or “I regret not buying more when it was cheaper!” or even “I need to buy more because everything is going up in this bullish market!”<\/span><\/p>\n To counter these emotional reactions, Graham suggests adopting a mechanical approach to investing in stocks traded below or at a price similar to the company’s tangible assets’ value. Other factors, like a reasonable Price\/Earnings ratio (PE), can also be considered.<\/span><\/p>\n In The Intelligent Investor, Graham illustrates this with the example of A&P, a company introduced to the stock market in 1929. Its share price reached $494, dropped to $104 in 1933, and further to $36 in 1938 during a bearish market. Despite being the largest chain of stores in the USA, Wall Street considered A&P worth more dead than alive due to fears of upcoming taxes and temporary obstacles.<\/span><\/p>\n Suppose an investor bought A&P in 1937 for $80, at 12 times its average profits per share over 5 years. The drop to $36 would naturally concern them. However, Graham advises a meticulous check to ensure no calculation errors. If satisfied, the investor can then ignore market fluctuations. In fact, if they have funds and conviction, they might even strengthen their position at a low cost.<\/span><\/p>\n In 1939, A&P’s share price rose to $117.50, a common occurrence. But by 1961, it reached $705, 30 times the profits in that year, reflecting high growth expectations. The lesson here is that the market often makes mistakes, and an intelligent investor can benefit from these errors.<\/span><\/p>\n Crucially, an investor is not obligated to sell shares to cover losses. Learning not to take market fluctuations too seriously is key to success.<\/span><\/p>\n Graham examines how investment funds perform and observes that most of them don’t perform as well as the overall stock market. It’s not the fault of the fund managers; it’s because they have so many funds to handle that their portfolios end up looking a lot like a broader index, such as the S&P 500.<\/span><\/p>\n Graham also looks at open funds and closed funds during his time and decides that it’s generally more advantageous to buy closed funds when their price is 10 to 15% lower than their net assets. As for the other funds he talks about from his era, he doesn’t think they are particularly worthwhile.<\/span><\/p>\n Contrary to common beliefs, an advisor cannot guarantee their client a better investment return than the general market by using their services. The role of an advisor is to rely on their experience to guide investors and prevent them from making serious mistakes, whether the advisor is a friend, an amateur, or a professional.<\/span><\/p>\n Prominent investment consulting firms do a commendable job without making extravagant promises regarding returns. Brokers, however, may have conflicts of interest when providing recommendations because they might be inclined to encourage clients to engage in speculative activities. Therefore, it’s crucial to ensure that the analyst at the brokerage firm you’re dealing with is inclined toward value investment before following their advice. Exercise caution with advice from investment banks as well, as they have a vested interest in selling their services. Investors should use their own judgment alongside the recommendations given.<\/span><\/p>\n Regardless of the advisor chosen, investors must be confident in their integrity and professional competence before entering into a working relationship. Quality advice comes at a cost, and it’s unrealistic to expect much from free advice.<\/span><\/p>\n An analyst looks at the past, present, and future of a company before giving recommendations on its stocks or bonds. They examine the business, financial performance, strengths and weaknesses, possibilities, and risks. Their goal is to determine whether it’s a good time to invest.<\/span><\/p>\n In the past, analysts didn’t use the same standards for stocks as they did for bonds. Oddly, mathematical analyses applied to stocks focus heavily on the future, even though it’s the most uncertain aspect. The analyst questions the usefulness of rigorous mathematical reasoning based on uncertain assumptions.<\/span><\/p>\n Analyzing a company bond is straightforward: check if the annual interest cost is well-covered by the company’s average profits over a certain period, like 7 years. Alternatively, you can consider the lowest profits during that period to add a touch of pessimism and enhance investment security. Different industries may have specific profit-to-interest ratio criteria, for example, 2.1 times for an energy supplier, 2.65 for railways, and so on. You can also consider the company’s size and asset value.<\/span><\/p>\n While the future is uncertain, following these standards, based on extensive experience, helps navigate uncertainties and safeguard investments.<\/span><\/p>\n When it comes to stocks, Graham, using the example of Value Line in The Intelligent Investor, suggests that analysts who predict the future are often wrong. For lay investors, he recommends focusing on the past and only considering long-term future perspectives broadly. Factors such as management, financial health, longevity, and current dividend rates are essential.<\/span><\/p>\n For growth companies, Graham provides a conservative formula to estimate their value:<\/span><\/p>\n Value=Normalized current profits\u00d7(8.5+2\u00d7annual expected rate of growth)<\/span><\/p>\n Being extremely conservative in estimating the annual expected growth rate over 7 to 10 years is crucial. This formula can also help determine the expected market growth of a company by replacing the Value with the Market Price. This aids in assessing whether expectations are too high. For instance, in 1963, the market predicted annual profit growth of 32.4% for Xerox but only 2% for General Motors. Despite this, Xerox met expectations until 1969.<\/span><\/p>\n The earnings per share that companies announce may not give a true picture of their actual profitability. Sometimes, companies announce profits that don’t include certain expenses known as “special.” For instance, ALCOA reported earnings of $5.20 per share in 1970, a slight decrease from $5.58 per share in 1969. However, if you look closely, you’ll find that after factoring in special expenses, the earnings were actually $4.19 per share for the year and $0.70 per share for the final quarter.<\/span><\/p>\n To understand the real earnings, you need to consider the fully diluted earnings, which are related to the number of shares that would be in circulation if all options and warrants were exercised. Additionally, examining these special expenditures is crucial. In ALCOA’s case, these costs were associated with future site closures, credit branches, and the expenses needed to complete a contract.<\/span><\/p>\n The question arises: Are these costs truly exceptional, or are they regular expenses for a large company like ALCOA? Graham suggests that it’s normal for a company of such size to undergo regular reorganization and fulfill its contracts. Perhaps these costs are more like actual cash outlays that could happen again. Shouldn’t the reported results include both profitable and non-profitable operations?<\/span><\/p>\n To address this, Graham recommends that a lay investor focus on the average earnings over a relatively long period rather than getting swayed by short-term variations. Similarly, when considering growth, he suggests relying on long periods in the past, say 10-12 years, rather than recent spikes in growth. This approach helps in gaining a more stable and realistic perspective on a company’s performance.<\/span><\/p>\n Graham compares four listed companies: Eltra, Emhart, Emerson, and Emery. Eltra and Emhart have PEs (Price to Earnings ratios) of 10 and 11.9, PBs (Price to Book values) of 1 and 1.22, and dividend yields of 4.45% and 3.65%, respectively. On the other hand, Emerson and Emery have PEs of 30 and 38.5, PBs of 6.37 and 14.3, and dividend yields of 1.78% and 1.76%.<\/span><\/p>\n Despite being in good financial health with low debt and experiencing long-term profit growth, analysts favored Emerson and Emery over Eltra and Emhart. Emery showed rapid growth, while Emerson had slower growth.<\/span><\/p>\n Graham refrains from making predictions about stock performance but suggests that Eltra and Emhart possess the qualities that would make them suitable for a defensive investor’s portfolio. These qualities include adequate size, good financial health, consistent dividend payments for the past 20 years, no losses in the last decade, profits growing by more than 33% over the past ten years, a share price lower than 1.5 times the net asset value after debt, and a price lower than 15 times the average profit over the past three years.<\/span><\/p>\n The defensive investor, faced with two options, can either invest in an entire stock index like the DJIA or select individual stocks that meet specific criteria outlined in the previous chapter. These criteria emphasize stable profits and moderate prices in relation to earnings and net debt-free assets.<\/span><\/p>\n When Graham applied these criteria to all DJIA stocks, only 5 stocks met the standards. It’s important to note that applying these filters significantly narrows down the available stocks for investment. Graham suggests a quantitative approach, aiming to eliminate emotional influences often associated with qualitative considerations.<\/span><\/p>\n The defensive investor is advised against trying to pick the single best stock among the cheapest options, as there’s no guarantee of outperforming others in this regard. Graham advocates for a diversified approach. While an investor skilled in selecting the best stocks might not need diversification, this isn’t typically the case for the defensive investor. Despite the seemingly restrictive criteria, the defensive investor should have a sufficient number of stocks to choose from, allowing for diversification based on personal preferences without feeling limited.<\/span><\/p>\n For the enterprising investor aiming for superior performance, choosing stocks is not a straightforward task. Despite professional funds struggling to outperform the S&P 500, there is hope, as demonstrated by the success of the Graham-Newman funds over their existence from 1926 to 1956.<\/span><\/p>\n The Graham-Newman funds engaged in operations such as arbitrage, involving buying one instrument and selling others due to events like restructuring or mergers, and liquidation, which meant buying shares in companies undergoing liquidation. These operations needed to meet specific criteria:<\/span><\/p>\n Correlated hedging involved buying convertible instruments while simultaneously short-selling the corresponding stock. Buying net-net shares meant investing in companies trading below the value of current assets released from all debt. Graham and Newman, with a portfolio of over 100 such companies, found success in this approach.<\/span><\/p>\n While Graham is cautious about recommending these strategies to lay investors due to their complexity, he suggests the enterprising investor consider stocks with the following criteria:<\/span><\/p>\n While there isn’t a single criterion for choosing stocks, Graham’s experience indicates that investing in large companies with low PE or a diverse group of net-nets can lead to satisfactory results over extended periods.<\/span><\/p>\n Convertible securities are often thought to benefit both investors and issuing companies. Investors get added protection through a bond and contribute to a rise in the share price. For the issuing company, convertibles offer a lower interest rate on borrowing and an opportunity to refinance debt at a lower cost by exchanging it for shares.<\/span><\/p>\n However, the reality may not be as ideal. Investors may have to sacrifice yield, quality, or both, and the company dilutes existing shareholders, potentially leading to dissatisfaction. The conclusion is that convertible issues, like any other instruments, aren’t inherently attractive or dismissible. Graham’s experience reveals that convertibles during bullish markets may not be very appealing and should be analyzed individually. Exchanging a share for a convertible might make sense if the share pays lower dividends and the conversion cost is minimal compared to the dividend difference.<\/span><\/p>\n In The Intelligent Investor, Graham then addresses warrants, expressing concern about their widespread use, which he considers a threat. Originally attached to bonds for share conversion at a set price, warrants were few and posed no danger. However, their proliferation can massively dilute shareholders, impacting the value of shares. Graham emphasizes that the sole issue with warrants is their abundance. Despite this, warrants can be studied like any other market instrument, estimating their intrinsic value and potentially profiting from them.<\/span><\/p>\n Graham shares four cautionary tales from Wall Street:<\/span><\/p>\n These stories highlight the importance of scrutinizing financial health, management decisions, and underlying realities before investing in a company.<\/span><\/p>\n Let’s take a look at two pairs of companies analyzed by Graham, along with a contemporary comparison between Amazon and Facebook:<\/span><\/p>\n![\"The](\"https:\/\/www.sitrakaratsimba.com\/wp-content\/uploads\/2023\/10\/1-12.jpg\")
<\/p>\nChronicle and summary of \u201cThe Intelligent Investor\u201d:<\/b><\/h2>\n
Chapter 1: Investment versus Speculation<\/b><\/h3>\n
Chapter 2: The Investor and Inflation<\/b><\/h3>\n
Chapter 3: A Century of Stock-Market History<\/b><\/h3>\n
Chapter 4: General Portfolio Policy: The Defensive Investor<\/b><\/h3>\n
![\"the](\"https:\/\/www.sitrakaratsimba.com\/wp-content\/uploads\/2023\/10\/3-1.jpg\")
<\/p>\nChapter 5: The Defensive Investor and Common Stocks<\/b><\/h3>\n
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Chapter 6: Portfolio Policy for the Enterprising Investor \u2013 Negative Approach<\/b><\/h3>\n
Chapter 7: Portfolio Policy for the Enterprising Investor \u2013 The Positive Side<\/b><\/h3>\n
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![\"the](\"https:\/\/www.sitrakaratsimba.com\/wp-content\/uploads\/2023\/10\/2-1.jpg\")
<\/p>\nChapter 8: The Investor and Market Fluctuations<\/b><\/h3>\n
Chapter 9: Investing in Investment Funds<\/b><\/h3>\n
![\"vehicle\"](\"https:\/\/www.sitrakaratsimba.com\/wp-content\/uploads\/2023\/10\/5.jpg\")
<\/p>\nChapter 10: The Investor and His Advisers<\/b><\/h3>\n
Chapter 11: Security Analysis for the Lay Investor<\/b><\/h3>\n
How to analyze a company bond<\/b><\/h4>\n
What to do when it comes to shares<\/b><\/h4>\n
![\"affirmations\"](\"https:\/\/www.sitrakaratsimba.com\/wp-content\/uploads\/2023\/10\/6-1.jpg\")
<\/p>\nChapter 12: Things to Consider About Per-Share Earnings<\/b><\/h3>\n
Chapter 13: A Comparison of 4 Listed Companies<\/b><\/h3>\n
Chapter 14: Stock Selection for the Defensive Investor<\/b><\/h3>\n
Chapter 15: Stock Selection for the Enterprising Investor<\/b><\/h3>\n
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![\"the](\"https:\/\/www.sitrakaratsimba.com\/wp-content\/uploads\/2023\/10\/4.jpg\")
<\/p>\nChapter 16: Convertible Issues and Warrants<\/b><\/h3>\n
Chapter 17: Four Extremely Instructive Case Studies<\/b><\/h3>\n
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Chapter 18: A Comparison of 8 Pairs of Companies<\/b><\/h3>\n
Pair 1: Real Estate Investment Trust (REI) vs. Realty Equities Corp (REC)<\/b><\/h3>\n
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Pair 2: Air Products and Chemicals (APC) vs. Air Reduction (AR)<\/b><\/h3>\n
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