The Definitive Book on Value Investing – A Book of Practical Counsel
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Do you want to invest in the stock market while minimizing risks to your money? The Intelligent Investor aims to help you do that. Benjamin Graham has created a simple guide to investing for beginners. It focuses on longer-term and more risk-averse approaches. Graham focuses on investments (based on research) rather than speculations (based on predictions). The Intelligent Investor provides guidance on how to get involved in value investing. It helps you stop the market from dictating your financial decisions. Learn how to overcome inflation and invest wisely based on your circumstances.
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About Benjamin Graham
Benjamin Graham is often called “the father of value investing.” He wrote two of the founding texts in neoclassical investing: Security Analysis (1934) and The Intelligent Investor (1949). Graham attended Columbia University before starting a career on Wall Street. He then founded the Graham-Newman partnership and employed Warren Buffett. Warren Buffett benefited greatly from Graham’s approaches. He subsequently wrote the foreword for this book. Graham’s investment philosophy was based on investor psychology, minimal debt, buy-and-hold investing, concentrated diversification, and buying within the margin of safety.
Now you can learn the secrets to Benjamin Graham’s investment strategies!
StoryShot 1: Understand the History of the Stock Market and Market Fluctuations
The stock market is subject to various cycles of boom and bust. It is important to understand these cycles. You shouldn’t base investment decisions solely on short-term market fluctuations.
Many new investors use historical data to forecast the future. But the value of any investment is a function of the price you pay for it. These are the most common reasons that people mistakenly extrapolate previous stock prices:
- buying into the hype of strong “Bull” markets,
- not doing their own research,
- relying on “experts” who aren’t necessarily experts,
- and not staying humble when their stocks are performing well.
These are key pitfalls to avoid if you want to be an intelligent investor. Instead, you should focus on value investing principles and analyze the stock market yourself.
StoryShot 2: Be Mindful of Inflation
Money becomes less valuable over time. A dollar ten years ago was worth more than a dollar today. Therefore, instead of holding onto cash, invest it to beat inflation.
The majority of investors do not take inflation into account. Psychologists call this “the money illusion.” A 2% raise in salary is effectively a cut in our available money if inflation has increased at 4%. Despite this, people generally prefer this scenario to taking a 1% pay cut during a year when inflation is zero.
So, measure your long-term investing success by how much you keep after inflation. Don’t judge it solely on how much you are making from your investments.
StoryShot 3: Stocks Can’t Reliably Overcome Inflation
Inflation can have a significant impact on stocks and the overall investment landscape. Inflation erodes the purchasing power of money over time. High inflation can lead to higher interest rates. This reduces the current value of future cash flows and potentially impacts stock valuations.
Stocks tend to outpace inflation 80% of the time. That said, most stocks do not react well to high levels of inflation. For example, the stock market lost money in 8 of the 14 years that inflation has exceeded 6%. Slight inflation is good for stock prices, as it allows companies to raise prices. But high inflation forces consumers to stop purchasing. So, investing in stocks is a good option when inflation is not overwhelmingly high. Awareness of inflation is essential for risk management in investing.
StoryShot 4: REITs Can Overcome Inflation
One investment product that is safe regardless of inflation is real estate investment trusts (REITs). REITs are companies that own and rent out buildings. REITs may specialize in investing in specific property types, such as medical or commercial properties. The type does not matter too much, though. All REITs are relatively good at combating inflation.
REITs allow you to participate in real estate markets without directly owning properties. They typically distribute a significant portion of their income as dividends to shareholders, making them attractive for income-oriented investors.
StoryShot 5: Don’t Let Age Influence Your Investing
Base your investment approach on your circumstances and your willingness to put time and effort into your portfolio. It should not be dependent on your appetite for risk or your age. Here are some examples to show how factors other than age should steer your investments:
- An 89-year-old with 3 million dollars, an adequate pension, and several children would be foolish moving most of their money into bonds. This individual has enough money already, and their children would inherit their stocks.
- A 25-year-old man saving for his wedding and a house deposit should never be putting all their money into stocks.
Both of these scenarios challenge the general advice of moving money from stocks to bonds as you age. Instead, other factors are more important. Before choosing how you invest, you should consider the following factors:
- Are you single or married? Does your partner work, and how much money do they earn?
- Do you have children? If not, do you want children? When will high costs, such as college education, kick in?
- Will you inherit money at some point? Or, will you have to spend money keeping a parent in a care home?
- Is your job secure?
- If you are self-employed, how long do similar companies generally survive?
- Do you need your investments to supplement your cash income for you to survive? If so, you should have more money in bonds.
- How much money can you afford to lose on investments?
StoryShot 6: Adopt an Evidence-Based Approach to Investing
Investing is evidence-based. Without evidence, you are merely speculating. Speculation does not have the same level of scrutiny as an effective investment should. Investing requires analysis, a principle of safety, and an adequate return. If your investment does not meet these requirements, you are speculating rather than investing.
There are two approaches to engaging with a genuine investment. You can either be a defensive investor or an enterprising investor. A defensive investor is mainly interested in safety and freedom from effort. To become a defensive investor, you must be willing to deal with emotional demands, such as detaching yourself from market panic. In comparison, an enterprising investor places a large amount of their time and effort into investments. So, enterprising investors have to be physically and intellectually invested.
It is not the case that you can never speculate economically. However, you should allocate no more than 10% of your investment funds to your “Mad Money Account.” You should keep these speculation funds separate. Never let them leak into your investment funds.
Both defensive and enterprising investors have to be intelligent investors. An intelligent investor will never dump a stock based on its share price. Instead, consider the value of the company and decide based on that.
StoryShot 7: Learn How to Be a Defensive Investor
Defensive investors should have a minimum of 25% of their savings in bonds. A maximum of 75% of savings should be put into stocks. Avoid buying lots of stocks in tiny increments over many years. Diversification is essential. But buying so many stocks in such small amounts will make tax returns challenging. So, if you are not prepared to keep an in-depth record of all your investments, you should not be investing. Try to invest in 10–30 stocks at the start, and make sure you invest in multiple industries.
When choosing stocks, as a defensive investor, assess the following factors about each company:
- How large is the enterprise? Choose larger and less volatile companies.
- Assets should be at least 2x liabilities, and long-term debt should be less than net current assets.
- Positive earnings should be recorded for the past ten years.
- Dividends should have been paid out without interruption for the past 20 years.
- The per-share earnings should have a minimum increase of at least one-third over the past ten years.
- The price-to-earnings (PE) ratio should be no more than 15 times the average earnings of the past three years.
- The ratio of price to assets should not be more than 1.5 times the book value last reported. Plus, the PE ratio x price-to-book (PB) ratio should not be more than 22.5.
StoryShot 8: Learn How to Be an Enterprising Investor
Graham recommends these key considerations for enterprising investors looking into companies:
- The company’s current assets should be at least 1.5 times current liabilities. They should not have debt that is more than 110% of net current assets.
- There should be no earnings deficit in the last five years.
- There should be a dividend.
- Last year’s earnings should have been more than those of the year before.
- The price of the stock should be less than 120% of net tangible assets.
StoryShot 9: Learn How to Invest in Stocks
Here are key tips for investing in stocks:
- Avoid day trading, as it is extremely risky.
- Initial Public Offerings (IPOs) are not a good investment as they are often overpriced.
- Treat cheap bonds with skepticism.
- Only buy foreign bonds if you are incredibly confident.
- A great company is not an excellent investment if you are overpaying for the stock.
- Big firms grow slower, so avoid companies with price/earnings ratios over 25-30.
- Look out for temporary unpopularity. The market quickly forgets, and this stock will probably rebound if you get it at a reasonable price.
StoryShot 10: You Can Make Lots of Money From Market Volatility
Market volatility can be scary, but it is also an opportunity to make lots of money. Limit your risk of losing money through volatility by making evidence-based investment decisions. You also shouldn’t sell your stocks in a panic.
It is a paradox that the more successful a company is, the greater its fluctuations in share prices. So, you should be aiming to buy successful companies’ stocks when they hit a low. You might even want to avoid successful companies altogether, as they are more speculative than investments.
The “Mr. Market” parable explains how we should not panic when stocks dip and instead make our own decisions. Suppose we own small shares in a business that cost us $1,000. Our partner, Mr. Market, tells us every day what he thinks our shares are worth. Sometimes he values these stocks at a justified level based on plausible business development and prospects. That said, sometimes Mr. Market gets a bit too enthusiastic and values our stocks at ridiculous prices. If you are an intelligent investor, you will not let Mr. Market determine your stocks’ worth. Instead, you should make your own decisions based on your own research. You can then decide to sell the stocks when they are ridiculously high and buy more stocks when the price is ridiculously low.
StoryShot 11: Be Careful About Using Financial Advisors
Financial advisors are not for everybody. You have to provide at least $100,000 for investing to obtain a financial advisor. So, low-cost index funds are the best choice for individuals with less money.
For those who do have money, you have to decide whether an advisor will be useful. Many investors are more comfortable if they have a second opinion when investing. This is especially the case for people who struggle to calculate the rate of return they need to earn on their investments.
These are some of the telltale signs that you should be seeking help with your investments:
- You have suffered a significant loss of more than 40% for your portfolio.
- You struggle to make ends meet.
- Your portfolio is chaotic and not well-thought-out.
- You have just had a significant change in your life, such as retiring or becoming self-employed.
Graham claims that some advisors are fakes. They try to prevent you from researching their results further and will ultimately lose your money. Look out for these sayings that a fake investor will use:
- “This is your opportunity of a lifetime.”
- “Don’t you want to be rich like me?”
- “It would be best if you focused on performance rather than my fees.”
- “You can’t lose with my method.”
- “You have huge amounts of money to earn.”
- “This is a trick that only I know.”
- “You don’t even need to question the legitimacy of this method.”
StoryShot 12: Conduct Security Analysis
Security analysis should be conducted to estimate the value of a given stock. You can then compare this value to the stock’s actual price and decide whether the stock is an attractive purchase. Security analyses should not be complicated. They should only require basic algebra. Any other form of security analysis is most likely flawed.
Ensure you are not overpaying for a company’s stocks. Consider:
- the company’s long-term prospects,
- the quality of the company’s management,
- financial strength and capital structure,
- dividend record,
- and current dividend rate.
For bonds, note the number of times that available earnings have covered total interest charges. These charges should have been covered for at least seven years running.
StoryShot 13: Keep within the Margin of Safety
The “margin of safety” is the most critical part of your investment strategy. You should always buy a company’s stock at least 50% below its true value. This practice will minimize your downside as much as possible and maximize your opportunities for making money.
Let’s say you’ve done your research on a company called TechCorp and determined that its true value is $100 per share. However, the current market price for TechCorp’s stock is $70 per share. According to the “margin of safety” investment strategy, you should not buy the stock at this price. Instead, you should wait until the price drops to $50 per share or less. This 50% discount from the true value of the stock provides a safety cushion in case your valuation was overly optimistic or unforeseen negative events occur. If the stock price increases, you stand to make a substantial profit. But even if the stock price goes down, your potential losses are much less than if you had bought the stock at a higher price.
Final Summary of The Intelligent Investor
The Intelligent Investor is focused on making evidence-based investing decisions. By understanding your financial position and goals, you can make effective decisions about how you manage your money. For some, investing in index funds and REITs is the way forward. For others, financial advisors are the key to financial success. For each financial decision, you must consider the evidence.
Let’s go over some key advice shared by Graham:
- If you want to be an intelligent investor, don’t listen to hype or take advice blindly.
- Always take inflation into account when investing. REITs are more reliable than stocks for overcoming inflation.
- Allocate no more than 10% of your funds to your “Mad Money Account” for speculative investing. The rest should be used for evidence-based investing.
- Decide whether you want to be a defensive investor or an enterprising investor. Structure your approach accordingly.
- Do not listen to Mr Market. Make decisions based on your own research. Use evidence to take advantage of market volatility. Buy when stocks are underpriced and sell when they are overpriced.
- Conduct security analysis. Do your own research to calculate the value of a company’s stock and compare this to the market price.
- If you have more than $100,000 to invest and feel you need help with investing, consider using a financial advisor. However, choose carefully and beware of fake advisors who make promises that sound too good to be true.
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We rate The Intelligent Investor 4.5/5.
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This summary of The Intelligent Investor was first published in March 2021. It was thoroughly revised and enriched in October 2023.
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