Intelligent Investor – Benjemin Graham

Preface to the Fourth Edition, by Warren E. Buffett

  • To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. This book precisely and clearly prescribes the proper framework. You must supply the emotional discipline.
  • If you follow the behavioral and business principles that Graham advocates—and if you pay special attention to the invaluable advice in Chapters 8 and 20—you will not get a poor result from your investments. (That represents more of an accomplishment than you might think.) Whether you achieve outstanding results will depend on the effort and intellect you apply to your investments, as well as on the amplitudes of stock-market folly that prevail during your investing career. The sillier the market’s behavior, the greater the opportunity for the business-like investor. Follow Graham and you will profit from folly rather than participate in it.

the remembrance by Warren – BENJAMIN GRAHAM 1894 – 1976

  • Several years ago Ben Graham, then almost eighty, expressed to a friend the thought that hoped every to do “something foolish, something creative and something generous.”
  • The inclusion of that first whimsical goal reflected his knack for packaging ideas in a form that avoided any overtones of sermonizing or self-importance. Although his ideas were powerful, their delivery was unfailingly gentle.

A Note About Benjamin Graham by Jason Zweig

  • I was struck by Graham’s certainty that, sooner or later, all bull markets must end badly.
  • His core principles:
  • A stock is not just a ticker symbol or an electronic blip; it is an ownership interest in an actual business, with an underlying value that does not depend on its share price.
  • The market i s pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is an realist who sells to optimists and buys from pessimists.
  • The future value of every investment is a function of its present price. The higher the price you pay, the lower your return will be.
  • No matter how careful you are, the one risk no investor can ever eliminate is the risk of being wrong. Only by insisting on what Graham called the “margin of safety” – never overpaying, no matter how exciting an investment seems to be – can you minimize your odds of error.
  • The secret to your financial success is inside yourself. If you become a critical thinker who takes no Wall Street “fact” on faith, and you invest with patient confidence, you can take steady advantage of even the worst bear markets. By developing your discipline and courage, you can refuse to let other people’s mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave.

INTRODUCTION:

  • No statement is more true and better applicable to Wall street than the famous warning of Santayana:” Those who do not remember the past are condemned to repeat it.”
  • Obvious prospects for physical growth in a business do not translate into obvious profits for investors. [airline and car-maker stocks]
  • The experts do not have dependable ways of selecting and concentrating on the most promising companies in the most promising industries.
  • The lesson Graham is driving at is not that you should avoid buying airline stocks, but that you should never succumb to the “certainty” that any industry will outperform all others in the future.
  • The habit of relating what is paid to what is being offered is an invaluable trait in investment. … We advised the readers to buy their stocks as they bought their groceries, not as they bought their perfume.
  • Allied to the foregoing is the record of the published stock-market predictions of the brokerage houses, for there is strong evidence that their calculated forecasts have been somewhat less reliable than the simple tossing of a coin.
  • Through all their vicissitudes and casualties, as earthshaking as they were unforeseen, it remained true that sound investment principles produced generally sound results. We must act on the assumption that they will continue to do so.

Commentary on The Introduction

  • This kind of intelligence has nothing to do with IQ or SAT scores. It simply means being patient, disciplined, and eager to learn; you must also be able to harness your emtions and think for yourself. This kind of intelligence, explains Graham, “is a trait more of the character than the brain.”
  • In 1998, Long-Term Capital Management L.P., a hedge fund run by a battalion of mathematicians, computer scientists, and two Nobel Prize-winning economists, lost more than $2 billion in a matter of weeks on a huge bet that the bond market would return to “normal”. But the bond market kept right on becoming more and more abnormal- and LTCM had borrowed so much money that its collapse nearly capsized the global financial system. – Roger Lowenstein, When Genius Failed (Random House, 2000)
  • And back in the spring of 1720, Sir Issac Newton owned shares in the South See Company, the hottest stock in England. Sensing that the market was getting out of hand, the great physicist muttered that he “could calculate the motions of the heavenly bodies, but not the madness of the people.” Newton dumped his South See shares, pocketing a 100% profit totaling £7,000. But just months later, swept up in the wild enthusiasm of the market, Newton jumped back in at a much higher price-and lost £20,000 (or more than $3 million in today’s money). For the rest of his life, he forbade anyone to speak the words “South See” in his presence. – John Carswell, The South Sea Bubble (Cresset Press, London, 1960). Also see www.harward-magazine.com/issues/mj99/damnd.html.
  • Being an intelligent investor is more a matter of “character” than “brain.”
  • The highest 20-year return in mutual fund history was 25.8% per year, achieved by the legendary Peter Lynch of Fidelity Magellan over the two decades ending December 31, 1994. Lynch’s performance turned $10,000 into more than $982,000 in 20 years.
  • By the time everyone decides that a given industry is “obviously” the best one to invest in, the prices of its stocks have been bid up so high that its future returns have nowhere to go but down. … make sure you remember this: The people who now claim that the next “sure thing” will be health care, or energy, or real estate, or gold, are no more likely to be right in the end than the hypesters of high tech turned out to be.
  • The intelligent investor realizes that stocks become more risky, not less, as their prices rise-and less risky, not more, as their prices fall. The intelligent investor dreads a bull market, since it makes stocks more costly to buy. And conversely (so long as you keep enough cash on hand to meet your spending needs), you should welcome a bear market, since it puts stocks back on sale.

CHAPTER 8 The Investor and Market Fluctuations

  • The investor should know about these possibilities (price fluctuates) and should be prepared for them both financially and psychologically.
  • If you want to speculate do so with your eyes open, knowing that you will probably lose money in the end; be sure to limit the amount at risk and to separate it completely from your investment program.
  • We lack space here to discuss in detail the pros and cons of market forecasting. A great deal of brain power goes into this field, and undoubtedly some people can make money by being good stock-market analysts. But it is absurd to think that the general public can ever make money out of market forecasts. … Timing is of great psychological importance to the speculator because he wants to make his profit in a hurry. The idea of waiting a year before his stock moves up is repugnant to him.
  • Nearly all the bull markets had a number of well-defined characteristics in common, such as  (1) a historically high price level, (2) high price/earnings rations, (3) low dividend yields as against bond yields, (4) much speculation on margin, and (5) many offerings of new common-stock issues of poor quality.
  • The longer a bull market lasts, the more severely investors will be afflicted with amnesia: after five years or so, many people no longer believe that bear markets are even possible. All those who forget are doomed to be reminded; and, in the stock market, recovered memories are always unpleasant.
  • There is a similarity between the experience of those adopting the formula-investing approach in the early 1950s and those who embraced the purely mechanical version of the Dow theory some 20 years earlier. In both cases the advent of popularity marked almost the exact moment when the system ceased to work well. We have had a like discomfiting experience with our own “central value method” of determining indicated buying and selling levels of the Dow Jones Industrial Average. The moral seems to be that any approach to moneymaking in the stock market which can be easily described and followed by a lot of people is by its terms too simple and to easy to last. Spinoza’s concluding remark applies to Wall Street as well as to philosophy:” All things excellent are as difficult as they are rare.”
  • *Many of these “formula planners” would have sold all their stocks at the end of 1954, after the U.S. stock market rose 52.6%, the second-highest yearly return then on record. Over the next five years, these market-timers would likely have stood on the sidelines as stocks doubled.
  • See Jason Zweig, “Murphy Was an Investor,” Money, July, 2002, pp.61-62
    and “New Year’s Play,” Money, December, 2000, pp. 89-90.
  • The whole structure of stock-market quotations contains a built-in contradiction. The better a company’s record and prospects, the less relationship the price of its shares will have to their book value. But the greater the premium above book value, the less certain the basis of determining its intrinsic value—i.e., the more this “value” will depend on the changing moods and measurements of the stock market. Thus we reach the final paradox, that the more successful the company, the greater are likely to be the fluctuation in the price of its shares. This really means that, in a very real sense, the better the quality of a common stock, the more speculative it is likely to be— at least as compared with the unspectacular middle-grade issues.
  • The price of IBM fell from 607 to 300 in seven months in 1962-63; after two splits its price fell from 387 to 219 in 1970. Similarly, Xerox— an even more impressive earnings gainer in recent decades— fell from 171 to 87 in 1962-63, and from 116 to 62 in 1970. These striking losses did not indicate any doubt about the future long-term growth of IBM or Xerox; they reflected instead a lack of confidence in the premium valuation that the stock market itself had placed on these excellent prospects.
  • A caution is needed here. A stock does not become a sound investment merely because it can be bought at close to its asset value. The investor should demand, in addition, a satisfactory ratio of earnings to price, a sufficiently strong financial position, and the prospect that its earnings will at least be maintained over the years. … As long as the earning power of his holdings remains satisfactory, he can give as little attention as he pleases to the vagaries of the stock market. More than that, at times he can use these vagaries to play the master game of buying low and selling high.
  • There are two chief morals to this story. The first is the stock market often goes far wrong, and sometimes an alert and courageous investor can take advantage of its patent errors. The other is that most businesses change in character and quality over the years, sometimes for the better, perhaps more often for the worse. The investor need not watch his companies’ performance like a hawk; but he should give it a good, hard look from time to time.
  • But note this important fact: The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holding is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment.
  • But it is self-deception to tell yourself that you have suffered no shrinkage in value merely because your securities have no quoted market at all.
  • The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices.
  • It is far from certain that the typical investor should regularly hold off buying until low market levels appear, because this my involve a long wait, very likely the loss of income, and the possible missing of investment opportunities. On the whole it may be better for the investor to do his stock buying whenever he has money to put in stocks, except when the general market level is much higher than can be justified by well-established standards of value.
  • As in all other activities that emphasize price movements first and underlying values second, the work of many intelligent minds constantly engaged in this field tends to be self-neutralizing and self-defeating over the years.
  • The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored. He should never buy a stock because it has gone up or sell one because it has gone down. He would not be far wrong if this motto read more simply:”Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop.”
  • (1) the effectiveness of a company’s management and (2) the soundness of its attitude toward the owners of the business.
  • dictum: “The more it changes, the more it’s the same thing.”

COMMENTARY ON CHAPTER 8

  • 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. —Marcus Aurelius
  • Most of the time, the market is mostly accurate in pricing most stocks. … But sometimes, the price is not right; occasionally, it is very wrong indeed.
  • Would you willingly allow a certifiable lunatic to come by at least five times a week to tell you that you should feel exactly the way he feels? Would you ever agree to be euphoric just because he is -or miserable just because he thinks you should be?
  • When asked what keeps most individual investors from succeeding, Graham had a concise answer:” The primary cause of failure is that they pay too much attention to what the stock market is doing currently.” See “Benjamin Graham: Thoughts on Security Analysis” [transcript of lecture at Northeast Missouri State University Business School, March, 1972], Financial History magazine, no. 42, March, 1991, p. 8.
  • Investing isn’t about beating others at their game. It’s about controlling yourself at your own game. The challenge for the intelligent investor is not to find the stocks that will go up the most and down the least, but rather to prevent yourself from being your own worst enemy-from buying high just because Mr. Market says “Buy!” and from selling low just because Mr. Market says “Sell!”
  • After all the whole point of investing is not to earn more money than average, but to earn enough money to meet your own needs.
  • humans are pattern-seeking animals. Psychologists have shown that if you present people with a random sequence-and tell them that it’s unpredictable-they will nevertheless insist on trying to guess what’s coming next. Likewise, we “know” that the next roll of the dice will be seven, that a baseball player is due for a base hit, that the next winning number in the Powerball lottery will definitely be 4-27-9-16-42-10- and that this hot little stock is the next Microsoft.
    Groundbreaking new research in neuroscience shows that our brains are designed to perceive trends even where they might not exist. After an event occurs just two or three times in a row, regions of the human brain called the anterior cingulate and nucleus accumbens automatically anticipate that it will happen again. If it does repeat, a natural chemical called dopamine is released, flooding your brain with a soft euphoria. Thus, if a stock goes up a few times in a row, you reflexively expect it to keep going-and your brain chemistry changes as the stock rises, giving you a “natural high.” You effectively become addicted to your own predictions.
    The neuroscience of investing is explored in Jason Zweig, “Are You Wired for Wealth?” Money, October, 2002, pp. 74-83, also available at http://money.cnn.com/2002/09/25/pf/investing/agenda_brain_short/index.htm.
    See also Jason Zweig, “The trouble with Humans,” Money, November, 2000, pp. 67-70.
  • See Jason Zweig, “Here’s How to Use the News and Tune Out the Noise,” Money, July, 1998, pp. 63-64.