The Intelligent Investor review | The classic book on value investing
While sections of the original edition of Benjamin Graham's Intelligent Investor deal with specific stock recommendations and portfolio strategies that are understandably dated, the bulk of the book’s content provides foundational investing insights. Graham outlines principles that are remarkably just as valid today as they were when Graham penned the book.
In fact, when he was writing in 1949, Graham was looking back over the previous 49 years of stock market history and concluded that sound investment principles produce generally sound results. He goes on to propose that “we must act on the assumption that they will continue to do so.”
Six key principles of intelligent investing
Graham details six key principles of “intelligent investing”:
Know the business you’re investing in.
Know who runs the business.
Invest for profits over time, not for quick buy-and-sell transaction profits.
Choose investments for their fundamental value, not their popularity.
Always invest with a margin of safety.
Have confidence in your own analysis and observations.
As defined by Graham, an “intelligent investor” approaches investing the same way he/she would look at buying into a business or partnership. Until you have a good feel for a firm’s competitive environment, its challenges and opportunities, and its strengths and weaknesses, you don’t really know enough to be investing in that business. And since you won’t be in the position to operate the business yourself, you need to know the company is headed by a management team that will run the business competently, efficiently and honestly.
In simpler terms, before investing in a business, you should make sure you understand and believe in the “what” and “who.” The same should be true of investors, hence Graham’s key principles #1 and #2.
Principle #3 is to invest in companies you believe will generate profits through their ongoing business operations. In contrast to speculators — who acquire shares at what they consider to be a favorable price and then sell off as soon as possible for a profit — investors acquire and hold securities that they believe will grow in value over time as the businesses succeed. That means intelligent investors look to dividends and business growth as the source of their gains. This growth may or may not result in higher stock prices over time.
The fourth principle, which is heavily covered in Graham’s book, is that fundamental analysis is vital and is the responsibility of the investor. To succeed as an intelligent investor, you must learn how to value companies on the basis of sound financial analysis. It is only when you have systematically and thoroughly gone into the financials in detail that you can assess the business, understand the potential and compare the merits of investing in one company’s stock rather than another.
Should you seek out investment advice?
So, if fundamental analysis is vital, why is it also the sole responsibility of the investor himself? Graham has much to say about understanding and seeking investment advice:
- Professional investment advisors will give you counsel and charge substantial annual fees. The best firms don’t make extravagant claims to brilliance but are careful, conservative and competent with an aim to conserve your principal value and make a conservative return each year. Their main value is they will help shield you from costly mistakes.
- Financial services firms make forecasts of the overall market direction developed by “technical” methods and tend to recommend a stock based on the strength of favorable near-term prospects regardless of the current price. The problem is “security analysts are forced to determine both average future earnings and projected market capitalization. In both cases he is turning himself into a prophet without the benefit of divine inspiration.”
- Advice from brokerage firms. Here, the flaw is that these firms make their money from brokerage commissions, and it is in their interest to get you to buy and sell often. “An intelligent investor will readily see they are too aligned with day-to-day marketplace trading to be able to offer any viable long-term investment suggestions.”
Graham’s fifth principle deals directly with the investor’s need to both understand and minimize inherent risk. This margin-of-safety concept further differentiates investing from speculating.
By Graham’s definition, speculators always believe the odds are in their favor even when they do something outside normal investment practices. Investors, by contrast, do everything conceivable to increase their chances of success by calculating their margin of safety “by figures, by reasoning and by reference to a body of factual data.” Their goal is to preserve their investment capital and generate some income from their holdings rather than focusing on share price appreciation for profits.
Why you should beware Mr. Market
Graham’s last principle is to have confidence in your investing decisions and beware “Mr. Market,” a now-famous parable Graham invented to illustrate the dangers of getting caught up in market sentiment that causes share prices to rise and fall on investor emotions driven by panic, euphoria and apathy, rather than fundamental analysis.
Daily fluctuating share prices can be largely ignored because, in reality, the underlying value of a company doesn’t vary dramatically from day to day. Base your buy-and-sell decisions on your own analysis of the company’s business prospects rather than the short-term movements in the share price.
When you’ve done the fundamental analysis and invested accordingly, you will have the confidence that your own reasoning is valid, which enables you to stick to your plan. And so principle #6 flows naturally out of the first five principles.
Don’t worry about what others are saying, because you can never tell whether they’ve done their own analysis or are just repeating what they heard someone else say. He goes on to propose that anyone — by just buying and holding a representative mix of value stocks — can equal the performance of the market average and forgo the difficulty of (and fruitless activity inherent in) trying to beat the averages. In his words, “The proportion of smart people who try this and fail to beat the market is surprisingly large. Even many of the investment funds — with all their experienced personnel — have not performed as well over the years as the general market.” Studies released over the past seven decades support Graham’s conclusion made so many years ago.
Graham emphasizes the virtues of a simple portfolio of value companies, and his overall message for the “intelligent investor” is real money is not made by buying and selling or timing the market, but by owning and holding securities and receiving dividends that grow in value over time. Certainly, this seems as valid today as when he penned it in 1949.
The Intelligent Investor should be read by all investors as a foundation to developing a sound investing plan. Graham’s principles certainly seem to have stood the test of the last 70 years, as well as the 50 years preceding the publication of his book.
I think one of the biggest contributions of Graham’s work is his clear distinction between a speculator and an investor. This should cause many to realize they’re really speculators masquerading as investors. The result: frustrated attempts to follow an investor’s plan in theory, which is undermined by the reality of their underlying speculator mentality.
While market timing is of great importance to speculators, investors must do the boring fundamental analysis, develop a solid long-term investment plan, choose investments for their value rather than popularity, invest with a margin of safety, and stick with their plan regardless of temporary market fluctuations caused by “Mr. Market.”
Graham didn’t see any evidence that the average money manager could obtain better results than the market indices over the long run. Trying to beat the market is a fool’s game… “In effect, that would mean that the stock market experts as a whole could beat themselves — a logical contradiction.”
Important takeaways: You have to make your own investment decisions based on doing the analysis — nobody else can do it for you, not even those professionals who offer their recommendations to you. When you do turn to professional advisors, you should be content with earning the market’s return, not more.