The Intelligent Investor
Warren Buffett credits Benjamin Graham with writing “by far the best book about investing ever written,” The Intelligent Investor. It holds a mythical status among value investors. Graham produced four editions from 1949 to 1973. I read the revised edition, which is Graham’s 1973 edition with added material from Jason Zweig in 2003 to explain parts of the book and to add more modern examples.
For anyone planning to read this book, I recommend Zweig’s revised edition. Graham’s writing is at times subtle and indirect, and assumes knowledge of historical context that may be unfamiliar to readers so many decades later. Zweig does an excellent job of clarifying Graham’s meaning at critical points.
This book is filled with Graham’s widely-quoted ideas, including the distinction between investors and speculators, the Mr. Market parable, and margin of safety. I won’t explain these ideas here.
The most remarkable part of the book is in Graham’s 1973 Introduction:
What intellectual honesty! He is saying that while his methods worked in the past, they may not work any more because markets have changed. A few years later (1976), Graham was more certain about the demise of his value investing ideas:
One may ask what value this book has if its author no longer believes in its ideas. One answer is that some parts of the book are relevant to investors who have no intention of picking individual stocks, particularly Zweig’s added material. Another answer is that readers who decide to pursue value investing despite Graham’s warnings will benefit. They may not beat the market, but Graham’s ideas will help them limit downside risk.
In an appendix, Buffett convincingly defends the existence of superior investors (who were Graham’s students) against claims that efficient markets eliminate this possibility. This material comes from a speech Buffett made in 1984, well after Graham gave up on his stock-picking methods. One way to reconcile this seeming contradiction is that Graham’s best students found ways to grow beyond his teachings to outperform through stock picking in later, more difficult markets.
This fact may give the modern aspiring value investor hope. However, each new decade has seen a big increase in competitiveness of markets. Even the great Buffett seems unable to outperform any more. It may be that he is working with too much money or that he’s too old now. But it might be that markets keep getting harder and harder to beat. Even if Buffett is still a superior investor in today’s competitive markets, other value investors have to question whether they are elite enough to beat the market. And if they can’t, they are getting zero compensation (or even negative compensation) for their extra effort compared to just buying index funds.
Anyone can “equal the performance of the market averages” by “owning a representative list” (index investing). But Graham warned: “If you merely try to bring just a little extra knowledge and cleverness to bear upon your investment program, instead of realizing a little better than normal results, you may well find that you have done worse.” Unfortunately, the definition of “just a little extra knowledge” has grown substantially as markets have become more competitive.
One area that Graham warned investors to avoid was Initial Public Offerings (IPOs). He said they come out in force in bull markets and investors get burned. The tech bubble in the late 1990s showed that not much has changed.
Some of Graham’s teachings are relevant to all stock investors whether they pick individual stocks or not. “It is absurd to think that the general public can ever make money out of market forecasts.” Investors shouldn’t allow themselves “to be stampeded or unduly worried by unjustified market declines.”
Some of the best quotes in the book come from material added by Zweig:
On Jim Cramer’s stock picks: “By year-end 2002, one in 10 had already gone bankrupt.” “Perhaps Cramer meant that his stocks would be ‘winners’ not ‘in the new world,’ but in the world to come.”
On the Motley Fool: “The Foolish Four … was one of the most cockamamie stock-picking formulas ever concocted.”
On asset allocation percentages: “Once you set these target percentages, change them only as your life circumstances change. Do not buy more stocks because the stock market has gone up; do not sell them because it has gone down.”
When a company is “paying a fat dividend on its preferred stock,” “you should approach its preferred shares as you would approach an unrefrigerated dead fish.”
On Peter Lynch’s “buy what you know”: “To his credit, Lynch insists that no one should ever invest in a company, no matter how great its products or how crowded its parking lot, without studying its financial statements and estimating its business value.”
“You and no one but you, must investigate (before you hand over your money) whether an advisor is trustworthy and charges reasonable fees.”
On index investing: “By enabling you to say ‘I don’t know and I don’t care,’ a permanent autopilot liberates you from the feeling that you need to forecast what the financial markets are about to do–and the illusion that anyone else can.”
“Day trading–holding stocks for a few hours at a time–is one of the best weapons ever invented for committing financial suicide.”
“The single best choice for this lifelong holding is a total stock-market index fund. Sell only when you need the cash.”
“Late in his life, Graham praised index funds as the best choice for individual investors, as does Warren Buffett.”
On what it takes to pick stocks: “begin by downloading at least five years’ worth of annual reports.” “Then comb through the financial statements.” This should be enough for most individual investors to realize that they’re not really stock-pickers. “If the steps in this chapter sound like too much work to you, then you are not temperamentally well suited to picking your own stocks.”
On mutual fund studies: “mutual funds, on average, underperform the market by a margin roughly equal to their operating expenses and trading costs.” This “has been reconfirmed so many times that anyone who doubts them should found a financial chapter of The Flat Earth Society.”
On covered call strategies: “For individual investors, covering your downside is never worth surrendering most of your upside.”
“For most investors, diversification is the simplest and cheapest way to widen your margin of safety.”
Despite being revered by value investors, it’s doubtful that this book will help anyone beat today’s markets. However, anyone who intends to try to beat the markets should consider this book to be mandatory reading, if for no other reason than to limit losses. Graham gave up on his stock-picking methods, and so should almost all individual investors.
For anyone planning to read this book, I recommend Zweig’s revised edition. Graham’s writing is at times subtle and indirect, and assumes knowledge of historical context that may be unfamiliar to readers so many decades later. Zweig does an excellent job of clarifying Graham’s meaning at critical points.
This book is filled with Graham’s widely-quoted ideas, including the distinction between investors and speculators, the Mr. Market parable, and margin of safety. I won’t explain these ideas here.
The most remarkable part of the book is in Graham’s 1973 Introduction:
“The determining trait of the enterprising (or active, or aggressive) investor is his willingness to devote time and care to the selection of securities that are both sound and more attractive than the average. Over many decades an enterprising investor of this sort could expect a worthwhile reward for his extra skill and effort, in the form of a better average return than that realized by the passive investor. We have some doubt whether a really substantial extra recompense is promised to the active investor under today’s conditions. But next year or the years after may well be different. We shall accordingly continue to devote attention to the possibilities for enterprising investment, as they existed in former periods and may return.”
What intellectual honesty! He is saying that while his methods worked in the past, they may not work any more because markets have changed. A few years later (1976), Graham was more certain about the demise of his value investing ideas:
“I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook ‘Graham and Dodd’ was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost.”
One may ask what value this book has if its author no longer believes in its ideas. One answer is that some parts of the book are relevant to investors who have no intention of picking individual stocks, particularly Zweig’s added material. Another answer is that readers who decide to pursue value investing despite Graham’s warnings will benefit. They may not beat the market, but Graham’s ideas will help them limit downside risk.
In an appendix, Buffett convincingly defends the existence of superior investors (who were Graham’s students) against claims that efficient markets eliminate this possibility. This material comes from a speech Buffett made in 1984, well after Graham gave up on his stock-picking methods. One way to reconcile this seeming contradiction is that Graham’s best students found ways to grow beyond his teachings to outperform through stock picking in later, more difficult markets.
This fact may give the modern aspiring value investor hope. However, each new decade has seen a big increase in competitiveness of markets. Even the great Buffett seems unable to outperform any more. It may be that he is working with too much money or that he’s too old now. But it might be that markets keep getting harder and harder to beat. Even if Buffett is still a superior investor in today’s competitive markets, other value investors have to question whether they are elite enough to beat the market. And if they can’t, they are getting zero compensation (or even negative compensation) for their extra effort compared to just buying index funds.
Anyone can “equal the performance of the market averages” by “owning a representative list” (index investing). But Graham warned: “If you merely try to bring just a little extra knowledge and cleverness to bear upon your investment program, instead of realizing a little better than normal results, you may well find that you have done worse.” Unfortunately, the definition of “just a little extra knowledge” has grown substantially as markets have become more competitive.
One area that Graham warned investors to avoid was Initial Public Offerings (IPOs). He said they come out in force in bull markets and investors get burned. The tech bubble in the late 1990s showed that not much has changed.
Some of Graham’s teachings are relevant to all stock investors whether they pick individual stocks or not. “It is absurd to think that the general public can ever make money out of market forecasts.” Investors shouldn’t allow themselves “to be stampeded or unduly worried by unjustified market declines.”
Some of the best quotes in the book come from material added by Zweig:
On Jim Cramer’s stock picks: “By year-end 2002, one in 10 had already gone bankrupt.” “Perhaps Cramer meant that his stocks would be ‘winners’ not ‘in the new world,’ but in the world to come.”
On the Motley Fool: “The Foolish Four … was one of the most cockamamie stock-picking formulas ever concocted.”
On asset allocation percentages: “Once you set these target percentages, change them only as your life circumstances change. Do not buy more stocks because the stock market has gone up; do not sell them because it has gone down.”
When a company is “paying a fat dividend on its preferred stock,” “you should approach its preferred shares as you would approach an unrefrigerated dead fish.”
On Peter Lynch’s “buy what you know”: “To his credit, Lynch insists that no one should ever invest in a company, no matter how great its products or how crowded its parking lot, without studying its financial statements and estimating its business value.”
“You and no one but you, must investigate (before you hand over your money) whether an advisor is trustworthy and charges reasonable fees.”
On index investing: “By enabling you to say ‘I don’t know and I don’t care,’ a permanent autopilot liberates you from the feeling that you need to forecast what the financial markets are about to do–and the illusion that anyone else can.”
“Day trading–holding stocks for a few hours at a time–is one of the best weapons ever invented for committing financial suicide.”
“The single best choice for this lifelong holding is a total stock-market index fund. Sell only when you need the cash.”
“Late in his life, Graham praised index funds as the best choice for individual investors, as does Warren Buffett.”
On what it takes to pick stocks: “begin by downloading at least five years’ worth of annual reports.” “Then comb through the financial statements.” This should be enough for most individual investors to realize that they’re not really stock-pickers. “If the steps in this chapter sound like too much work to you, then you are not temperamentally well suited to picking your own stocks.”
On mutual fund studies: “mutual funds, on average, underperform the market by a margin roughly equal to their operating expenses and trading costs.” This “has been reconfirmed so many times that anyone who doubts them should found a financial chapter of The Flat Earth Society.”
On covered call strategies: “For individual investors, covering your downside is never worth surrendering most of your upside.”
“For most investors, diversification is the simplest and cheapest way to widen your margin of safety.”
Despite being revered by value investors, it’s doubtful that this book will help anyone beat today’s markets. However, anyone who intends to try to beat the markets should consider this book to be mandatory reading, if for no other reason than to limit losses. Graham gave up on his stock-picking methods, and so should almost all individual investors.
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