If there was ever a personal finance book that can be likened to the bible, it would be The Intelligent Investor, Benjamin Graham’s dense and detailed manual on investing. Regardless of whether you like this book or not, there is no escaping it’s influence. Warren Buffett himself, Graham’s most famous disciple, has said that The Intelligent Investor is “by far the best book on investing ever written.” So does The Intelligent Investor live up to its towering reputation? Or is this an old classic that has long since lost its relevance to the tides of time?
The long and short of it:
The first thing most people know about The Intelligent Investor is probably that it’s Buffett’s favorite investing book. The second thing they know is that it pioneered something called “value investing.” The principles of value investing, as touted by Graham in his book, can be summed up thus: the investor is a business owner and should behave as such, which means,
- selecting stock on basis of the quality of the underlying company
- evaluating whether the stock is overpriced or underpriced and timing your investment accordingly
- investing in companies whose business you understand
- taking an active interest in the details of the companies’ proceedings
How should the value investor conduct themself when investing? Graham categorizes value investors (to whom he universally refers to as “investors” in his book) in two categories; the defensive investor, and the enterprising investor. To put it in more familiar terms, today we might think of Graham’s “defensive investor” as a passive investor and “the enterprising investor” as an active investor.
The Defensive Investor should…
- Invest primarily in index funds that track the stock market, ie the Standard & Poor 500 and the Dow Jones Industrial Average
- Invest in large companies that are industry leaders with strong competitive advantage (or as Warren Buffett would say, wide moats)
- Invest in companies with a history of uninterrupted dividend yields (preferably lasting 20+ years)
- Invest in companies with a history of consistent and stable earnings, with earnings historically growing at a rate of 5-10% annually
- Invest in stocks with 15 or lower Price/Earnings (P/E) ratio
- Maintain a 50/50 bond and stock split (or potentially 25/75 to 75/25 depending on the market)
- Employ dollar cost averaging, where a fixed amount is automatically invested in the stock market every month regardless of price fluctuation
- Invest in high-grade bonds backed by the government or AAA companies
- Invest in holdings from diversified industries with more than 10 stock picks and less than 30 (can be more if its an index fund)
In comparison, the Enterprising Investor has more flexibility.
Enterprising Investors should do what the Defensive Investor does, but they can also…
- Invest in secondary (medium sized) companies at a bargain, Graham recommends waiting until the market price is at 2/3 of the company value before locking in the investment
- Invest in bonds issued by AA and A companies (or worse) at a bargain (about 2/3 of the face value, never at par)
- Invest in growth stocks, provided it fulfills this formula:
- Market Price (value) < Current (Normal) Earnings * (8.5 plus twice the expected annual growth rate)
- Invest in foreign stocks/bonds, provided it’s >10% of the overall portfolio and not overpriced
- Do thorough research on stock picks and educate themselves on how to read financial statements
- Invest in companies that haven’t tried to obfuscate their earnings and debt numbers in quarterly reports (read footnotes!)
- Be aware of market cycles
- Understand that while a company’s past performance does not indicate future growth, a company with strong past earnings is still more likely to succeed than a company with no past earnings
- Invest in net-asset-stocks (aka cigar butts), which is when the share price is lower than the company’s total assets minus total liabilities
Graham emphasizes that if you feel the urge to speculate, as is human nature, allocate a strict budget and do so in a separate account so there are no speculative (non value) investments in your main portfolio. If the speculative account does well, do not invest more. Sell the stocks so you are again within the limits of your predetermined budget.
Chapters 8 and 20 of The Intelligent Investor are particularly noteworthy, as they were reported by Buffett to be foundational to his investing philosophy. I will now take the time to go over the concepts they cover in greater detail.
Chapter 8 “The Investor and Market Fluctuations”
Graham makes an astute analogy to explain the pricing tendencies of the stock market. Say you own a share in a business, which you judge to be worth $1,000, and you have a business partner, Mr. Market, who tells you every day what he thinks your share is worth. Moreover, he offers to buy the share from you at an offered price. Some days you feel Mr. Market’s offer is quite reasonable, judging against your own evaluation of the business’s earnings, assets, and liabilities. However, Mr. Market is a nervous and excitable fellow who is prone to wild mood swings. His offer is frequently hilariously overpriced ($4,000!) or dramatically underpriced ($340!). Graham urges you not to let a hyper-sensitive Mr.Market dissuade you from the true value of your shares. Instead, keep an eye out for the price offerings that most benefit you, buying more shares when the offered price is ridiculously low and selling shares when it is outrageously high. When not planning to do business with Mr. Market (holding shares long-term), you are better off ignoring Mr. Market’s wildly inconsistent price evaluations. It would be an investor’s folly to let themselves get swept up in the hysteria of Mr. Market.
Chapter 20 “‘Margin of Safety’ as the Central Concept of Investment”
Graham delves into the importance of hoping for the best, but planning for the worst. There will always be an inherent risk of losing your wealth when you invest in the stock market, so a margin of safety is vital for every investor. This philosophy is built into all of Graham’s investing advice: invest in index funds, use dollar cost averaging, invest when the P/E ratio is low. Have an emergency fund. Having lived through the worst bear market of all time, i.e. the Great Depression, Benjamin Graham is stalwart in his insistence that all investors must be conservative in their investment and maintain a margin of safety.
What makes The Intelligent Investor unique?
The unfortunate reality of investing is that even legitimate investing methods frequently stop working soon after publication. The very fact that everyone is purchasing bargain stocks at reliable times drives the price up to the point where it’s not longer a bargain (see “The January Effect” for a prime example of this phenomenon). Where The Intelligent Investor differs from every other how-to-invest book is in the longevity of its investing techniques. While aspects of The Intelligent Investor no longer work as well today as it did before, the tenets of value investing remain intact. This is because the core principles behind value investing isn’t about taking advantage of predictable pockets of opportunity, it’s about having faith in the value of the underlying company and trusting in the long term growth of the economy as a whole. No matter how many people decide to adopt value investing, it will never drive up prices to the point where the fundamentals of a company no longer apply. Value investors aren’t learning about a new loophole to exploit, or new fancy equations they can use to calculate volatility, instead they’re learning how to identify value and how to be patient so the stock has time to grow. To directly quote Graham, “To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.”
Final thoughts:
My first run-in with The Intelligent Investor occurred three years ago in the midst of the pandemic. I had been looking for a book to pass the time and found out that my local library carried the approximately 350-paged 1949 edition of The Intelligent Investor. I finished perhaps two chapters of the book before promptly giving up. For this review, I found the 640-paged 1973 edition with Jason Zweig’s commentary and read considerably more. The 1973 edition is, to my surprise, drastically different from the 1949 version. Virtually all of it has been revised and Zweig’s additions helped tremendously to recontextualize Graham’s advice for the modern age. It’s a notable improvement upon the 1949 edition, so if it comes down to a choice, I suggest going for the thicker book.
Unfortunately, even Zweig’s commentary in the 1973 edition can’t fully make up for the book’s outdatedness. This manifests most clearly in the following ways:
- Graham’s advocacy for cigar butt companies (a company where assets minus liabilities is greater than the stock price, thus making the company more valuable liquidated than in operation). While cigar butts weren’t so difficult to find in the aftermath of the Great Depression, they gradually became scarcer and scarcer until it was all but impossible to make a reliable profit by investing in such companies.
- Graham never acknowledged the dangers of a value trap, in which an undervalued company remains undervalued for years before eventually filing for bankrupcy (most notably companies in dying industries).
- Graham never accounted for the unprecedented bull run which continued almost uninterrupted from March of 2009 to December of 2021. Anyone who entered the stock market in the midst of this bull run will find it remarkably easy to make money on common stocks and terribly difficult to find companies of both good quality and adheres to Graham’s requirement of a P/E ratio less-than-15.
- Bonds have long since fallen out of favor with the investing public, given their low returns compared to common stocks. Perhaps the enterprising (active) investor can effectively incorporate bonds into their portfolio, but it’s no longer recommended for the defensive (passive) investor.
So is The Intelligent Investor worth a read?
Not really.
Well. Not the entire thing anyway. What I would personally recommend for you is to pick up the 1973 edition, read Buffett’s preface, then Zewig’s “A Note About Benjamin Graham,” then go read Chapter 8 and Chapter 20. If you have a difficult time understanding (as I did), supplement these chapters with Zewig’s commentary. Then, if you find yourself curious and in possession of a few spare hours, go back to the table of contents and select for the chapters that you find most intriguing. Graham has dedicated chapters to inflation, bonds, financial advisors, and accounting sleight-of-hand. Being a financial analyst by trade, Graham also included some chapters in which he analyzed specific companies as a case study, something I’m sure those with more financial knowledge than myself would be far better positioned to appreciate.
