The Intelligent Investor by Benjamin Graham is widely cited as a must-read for anyone interested in finance and investing. In fact, none other than Warren Buffett himself says it is “by far the best book on investing ever written” (he read it at the age of 19). I assumed I had indirectly learned about the principles of the value oriented approach laid out in this book through school and other finance books, but thought I’d be doing myself a disservice by never actually reading the book, so I finally went ahead and did.
First published in 1949, it had later been updated several times through 1970. The version I read was published in 2003, which contains commentary by Jason Zweig, a Wall Street Journal personal finance columnist. Although helpful, it was admittedly difficult at times to get through examples dating back to 1920’s as they were no longer relatable, but that aside, the “learning lesson” in each case is still applicable today as it was back then, and Zweig included more up-to-date examples that felt a bit more relevant.
Graham spends the first 200 pages or so discussing whether it is appropriate for the average investor to even engage in “stock picking,” given the fact that many fail to even match the performance of benchmark indices like the S&P 500 and DJIA, let alone outperform them. As such, he says the average person is better off dollar-cost averaging an index fund and be done with it, while maintaining a portfolio of equity and bond exposure where neither asset class falls below a minimum of 25% or maximum of 75% of total holdings. As for bonds, funds tracking US government obligations will suffice, and depending on the investor’s tax bracket, they may want to look into those specializing in municipal securities as they offer certain tax advantages (although they may be taxed at the state level depending on where they’re issued).
After this 200-page disclaimer of sorts, Graham begins his discussion on what criteria to use should an investor have the time (and desire) to go about selecting individual securities, thus eschewing the index fund approach. If you had to summarize his investment philosophy in three words, they would be margin of safety.
Having learned about discounted cash flows, weighted average cost of capital, the capital asset pricing model, beta and covariances in the not-to-distant past, I was surprised to hear those terms mentioned zero times by Graham. Instead, he’s a strong believer in value- getting what you pay for, preferably in the form of a bargain. What he primarily takes into consideration when evaluating companies are 7 things:
Adequate size (size of revenues and total assets)
Sufficiently strong financial condition (amount of current assets relative to current liabilities)
Earnings stability (strong record of earnings over a long period of time)
Strong dividend record
Reasonable earnings growth over time
Moderate P/E ratio
Moderate ratio of price to assets
If you applied these criteria to today’s companies, all of the companies everyone talks about would be out. Amazon. Google. Netflix. Tesla (especially Tesla). That’s not to say they’re bad companies- far from it- but from an investor’s point of view, buying shares of these concerns at their current prices amounts to speculating (see: gambling) that their earnings will not only continue at the growth rates implied by their prices, but beat them. That’s not Graham’s style, and if you heeded his guidelines, you would have avoided the 90’s tech boom that eviscerated many people’s portfolios.
By using this criteria, what you’re left with instead are what many would consider boring companies. You would need to look no further than Berkshire Hathaway to get an idea of the types of companies you’d be considering- Geico (insurance), BNSF (railroad) and Fruit of the Loom (clothing). What they have in common is stable earnings, bargain share prices, and strong dividend records (and peace of mind). Throw in diversification and you’ll have a higher likelihood of not only wealth preservation, but wealth appreciation, and lower likelihood of catastrophic loss.
Although the book is a bit long (almost 600 pages) and at times dry (the section on warrants is not really relevant now), it is definitely a worthwhile read for anyone who seeks to engage in stock selection on their own account.