Book Review: The Intelligent Investor by Benjamin Graham
I have been working full time for over a year and a half since I graduated and my income so far has mainly been stashed away in my savings account. It’s not that investing has never come to my mind, it’s more so that I lack the financial knowledge to know where and how to begin. If you are like me, understanding all the financial lingo and the thought of analyzing a financial report is a thought in itself daunting enough to prevent you from exploring any investment options.
I then came across the Intelligent Investor by Benjamin Graham. This book was published in 1973 and later revised with additional commentary by Jason Zweig in 2003. Although it was written decades ago, the core investing principles still stand true to this day. With my limited financial and investing knowledge, my review won’t do the book justice. However, I’ll share with you the core investing insights that you can apply right away.
Graham’s Core Investing Principles
1. A stock is an ownership interest in an actual business, with an underlying value that does not depend on its share price
In the latest edition of The Intelligent Investor, Graham shortened the “The Investor as Business Owner” section. It was suggested by Jason Zweig in his commentary that Graham perhaps had given up on getting investors to use their rights as shareholders to keep corporate managers accountable. It’s still a right that shareholders need to be aware of but above all understand that the underlying value of a business can’t be inferred by its share price.
2. The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists.
Graham used a great analogy and described the stock market as Mr. Market. Mr. Market tells you every day what he thinks your share is worth. Sometimes he seems very reasonable but other times he is irrational. If you are an intelligent investor, you won’t let Mr. Market’s opinion impact your investing decisions. You will instead sell to him when his opinion of your stock is too high and buy additional shares from him when his opinion of your stock is too low. And just like how you will treat Mr. Market, that’s how you should approach the stock market. Don’t follow the market but instead take advantage of the market price when it’s not priced correctly.
3. 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.
Always take the present price into account no matter how promising a business is. Even if you have insights into which companies are promising, if the general public shares your outlook your insights will have no value as the share price would have already factored in the optimism. So do your homework and analyze the business to see if it’s over or undervalued.
4. Only by insisting on “the margin of safety” – never overpaying, no matter how exciting an investment seems to be – can you minimize your odds of error.
You can never know with certainty whether a stock is over or underpriced. The point, however, is to look for bargain opportunities and be patient. By analyzing the business thoroughly, which includes studying financial statements and earning multipliers, you can get better at spotting any discrepancies between a companies’ market price and its underlying value. Businesses that are having bad press often times produce bargain opportunities if the issues can be addressed promptly.
5. 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. How your investments behave is much less important than how you behave.
Following the market is never a good long-term investment strategy. Be disciplined enough to believe in your own analysis, to ignore the public noise, and to stick with your investing principles.
Investing vs Speculating
An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.
Many investment mistakes come from not understanding the difference between investing and speculating. If you see lots of people buying Starbucks coffee and decide to buy Starbucks solely based on its popularity, you are speculating and not investing. If you buy a weed stock solely because it belongs to a fast-growing industry, you are speculating and not investing. If you buy a stock solely because your social circle is high on the stock, you are speculating and not investing. Just like you won’t gamble with the majority of your savings, you shouldn’t speculate with the majority of your savings as well. Have a clear budget for your investment funds and don’t mix it up with your speculative funds.
Every security has a speculative component which affects its market price. A business can see it’s market price fluctuate greatly due to public opinion while its underlying value remains the same. So be mentally prepared and patient when the share price is behaving unexpectedly.
Dollar-cost averaging: an investor devotes the same dollar amount each month to buying one or more common stocks
For most investors, Graham said the ideal way to invest is via dollar-cost averaging. This can limit the impact of any bad investment decisions (ex. investing too much when the market price is too high) as you will be investing the same amount each month. Along with dollar-cost averaging, Graham stated that one of the best ways to own common stocks is through an index fund that charges minimal fees. By owning index funds, you are therefore removing yourself from the process and will have returns that match the market your index fund is tracing.
Based on Graham’s studies, most professional investors did not outperform the returns by dollar-cost averaging into an index fund. However, the downside to investing in an index fund is that it’s boring. You are not choosing specific stocks, therefore the human nature aspect of wanting to choose your own stocks and outperform your peers won’t be satisfied. If you still have the desire to choose your own stocks, you can supplement your index funds investment with a small portion allocated for the stocks you handpicked. You can then further adjust the portion you put in index funds based on the results of your investment portfolio.
The Intelligent Investor is widely regarded as one of the best investment books. It is very thorough and Graham not only broke down the technical aspect of investing but the human nature aspect as well. There are lots of materials that I didn’t cover which includes bond investment, so I’ll highly recommend you to give the book a read if you want to learn more about investing.
I’m currently reading The Lean Startup by Eric Ries