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.

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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.

Investing Guidelines

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.

Summary

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

 

Book Review: The Outsiders by William N. Thorndike, Jr.

The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success by William N. Thorndike, Jr. details the commonalities among the 8 CEOs (also referred to in this book as the outsiders) who significantly outperformed their peers. William stated the commonalities right off the bat and used the remaining chapters to go over each outsider’s experience much more in-depth.

You can tell that a lot of work went into this book. Many interviews were conducted and a lot of financial data were analyzed and presented.

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Capital Allocation

Capital allocation: the process of deciding how to deploy the firm’s resources to earn the best possible return for shareholders

CEOs have 2 key responsibilities: running their operations effectively and deploying the cash generated by those operations

CEOs generally have 5 choices for deploying capital:

  1. Investing in existing operations
  2. Acquiring other businesses
  3. Issuing dividends
  4. Paying down debt
  5. Repurchasing stock

And 3 options for raising it:

  1. Tapping internal cash flow
  2. Issuing debt
  3. Raising equity

The outsiders are focused primarily on making capital allocation decisions and usually delegate running the company operations to a trusted partner. When making capital allocation decisions, these CEOs are very aware of the various tax implications. And contrary to their peers, they did not avoid repurchasing stocks and also did not pay any meaningful dividends.

There is no right option for deploying capital. The key message here is to evaluate all the available options and its implications for your organization.

Develop and Trust Your Analytical Skills

One of the key differences between the outsiders and their peers is that the outsiders trust and act on their own analytical skills. They do not fall prey to the Wall Street’s conventional wisdom and their decisions aren’t impacted by the public opinion. The outsiders have their own method of determining whether a business including their own is under or overvalued. Once they determine a business is underpriced, they are able to act swiftly and acquire the business or its shares if it’s the best capital allocation option.

William examined the stock repurchases events made by the outsiders and these events all happened when the share price was undervalued. On the other hand, when the shares were expensive, they often used it to buy other companies or to raise inexpensive capital to fund future growth.

Decentralized Organization

There is a fundamental humility to decentralization, an admission that headquarters does not have all the answers and that much of the real value is created by local managers in the field.

Besides allocating financial resources, CEOs also need to allocate human resources. The outsiders all emphasized decentralization except when it comes to capital allocation decisions. They hire the best people and give them the responsibilities and authority to do their job. The goals set for the local managers are clear and if they meet their goals they often won’t hear from the headquarters.

Turnovers are costly. So when you hire great people, let them do what they do best. Giving them the responsibility and opportunity to learn and grow will be one of the best ways to retain your talent.

Investor Temperament

In both insurance and investing, Warren Buffett believes the key to longterm success is “temperament”, a willingness to be “fearful when others are greedy and greedy when they are fearful”.

What set the outsiders apart from their peers is their temperament. There are numerous CEOs who have the analytical skills who make poor capital allocation decisions. Like in life, it’s one thing to know what the right thing to do is, it’s another thing to do it. Going against the public opinion isn’t easy and this is what the outsiders have done throughout their careers.

Often times, the popular decision is the wrong decision. Be able to evaluate the options yourself and understand that your job is not to please the public but to bring value to your company and its shareholders.

Summary

The book is very organized and does not stray away from the key messages. However, I also find that too many examples are used to convey the same key messages. It’s not a book I’ll recommend but if you are interested in the insights I discussed and the numbers behind it then this is a book you might enjoy reading.

 
I’m currently reading The Intelligent Investor by Benjamin Graham.