The famous Intelligent Investor book written by Columbia Professor Benjamin Graham was first published in 1949. Establishing the basis for what is now called value investing, this book set out a different way of thinking about stock market investing than what was prevalent in Wall Street at the time.
Even today, when most people think about stock market investing, their initial thoughts are line graphs about stock prices, daily percentage changes and people needlessly yelling on CNBC. This type of investing is technical analysis. Technical analysis on shares of AAPL (the ticker for the Apple company) means analyzing the trends of how the stock price has moved up within the last week, month, year, etc. But technical analysis says little about the quality of the actual company. Graham reminds us that when we are buying shares of a company, we are not merely buying a piece of paper that randomly goes up or down but we are buying actual ownership pieces of a live and functioning business. Buying a share of GOOGL means that over the long-term if Google does well, so will the stock.
While there are many lessons to potentially learn from reading this book, I present my 7 big takeaways from the book.
1. Differentiate present vs reality.
When a value investor buys a stock, they are not as interested in what the future of the company COULD be. They are more interested in knowing how the company is doing NOW and with slightly less importance, how it’s done in the past. An ‘intelligent investor’ would rather buy a company with a track record and currently favorable balance sheet than a company that has yet to prove itself and can bring you major losses. Graham emphasizes that there’s a very clear line between future speculation and present reality, and that we should keep a close eye on the current reality of any company.
2. Don’t believe that price has anything to do with quality.
If the price of a company is rising, it does not necessarily mean that the quality of the company is actually rising. Inversely, if the company’s stock price falls 20% within a day, it does not necessarily mean that the actual company has lost 20% of its total value within a day. Closely following the trends of the stock price movements to ascertain whether it’s a good company can be an easy way to misread the actual quality of the company. The market is irrational in the short-term and should not be seen as a guide for long-term investing. It is better to understand the meaning behind the company’s qualitative and quantitative position rather than its price position.
3. We really have no idea what is going to happen in the future.
To claim with certainty that a company will rise astronomically in the future or crash can be riddled with error. In truth, anything can happen. Graham, having grown up through multiple financial hardships and depressions was a firsthand witness to the realities of economic change. Because anything can happen, the best we can do is understand the position of the companies we have ownership of and spread our risk among multiple companies (otherwise known as diversification). Market timing can be dangerous.
4.”Getting good returns is easier than it looks but getting great returns is harder than it looks.”
This idea was shared in the context of ‘active’ vs ‘passive’ investing. As a passive investor, you buy a broad range of companies under the assumption that over the long-term the total economy as a whole will improve, meaning so will your financial position. But Graham states that if you try to beat the market, known as being an ‘active investor’, it’s going to take a lot of work. Graham also has a very interesting difference on how he sees risk. In finance academia, it is normally taught that to get more investment return, more risk needs to be taken on. Graham saw risk as a measure of how much work you did on researching your investments. From a value-investors perspective, it is possible to achieve higher investment return with lower risk.
5. Look beyond surface appearances and delve further.
Large public companies are fully aware and capable of manipulating how numbers will appear on earnings reports. Graham strongly urges reading company reports backwards, as management will hide everything they don’t want you to read near the end. Graham also recommends that investors conduct in-depth analysis by developing their own valuation of the company’s assets and stability of earnings rather than taking numbers at face value. By building your own independent thesis, you can catch issues or even opportunities that other investors might miss from just taking the numbers as is.
6. Always invest with a “margin of safety”.
‘Margin of safety’ is buying with a small to moderate ‘safety net’ on your investment. Even if negative results occur with your stock, you will ideally be protected by a strong book value or a strong business model or conservative assumptions on the company’s growth rates. Because stocks are being bought in such conservative ways, in the event of a market downfall, value investors would fare the best as they buy in such a price-conscious way.
7. Believe in yourself and your judgement, even if others hesitate or differ in tough market conditions.
Graham ends the book with an uplifting message reminding you to believe in yourself. Provided that you have your reasoning, data and experience to support your investing decisions, you should stick with your decision, even if the market is doing poorly in the short-term. The emotional fortitude to have differing opinions from others in times of stress, is incredibly important to succeed at investing in the long-term.
Overall, Graham presented a very lucid and rational perspective on investing, illustrating principles that still remains relevant many decades later. I utilize value investing principles like these for my own client’s portfolios.