Warren Buffett started learning about investing when he was seven or eight. I know a late bloomer. Buffett’s father started a small investment firm, and a young Warren started his investing journey. He picked up different books lying around, becoming bitten by the investing bug.
Fast forward to eleven years old, and Buffett went to the local library to read every investing book. But one book, The Intelligent Investor, stood out above the others, which changed his life.
The Intelligent Investor, written by Benjamin Graham, influenced Buffett and became the investing manual sparking the value investing school.
“Intelligent investment is more a matter of mental approach than technique,” writes Graham. “Sound mental approach toward stock fluctuations is the touchstone of all successful investment no matter the conditions.”
In today’s post, we will learn:
- Chapter Summary of the Intelligent Investor – Highlights
- What Does the Intelligent Investor Teach Us?
- Is the Intelligent Investor for Beginners?
- Is the Intelligent Investor Outdated?
- Investor takeaway
Okay, let’s dive in and learn more about the seminal book, The Intelligent Investor.
Chapter Summary of the Intelligent Investor – Highlights
This section will highlight some major themes from the different sections of each book chapter, but these ideas should not take away from reading the book; please do yourself a favor and try it.
Warren Buffett singles out two chapters in any discussions about the book. The two chapters are eight and twenty, which we will cover in-depth. Both cover two important topics; a margin of safety and Mr. Market.
Market History, Inflation, Investment, and Speculation
Chapters 1, 2, and 3 discuss the above topics in depth. Chapter 1 focuses on the idea of investment versus speculation. Graham feels we need to separate the two ideas: investing is the serious study of a company’s fundamentals, and buying or selling its stock based on those assessments.
Where speculation is more like gambling, it bases decisions on market prices and fluctuations, hoping that anyone will pay more than you later.
If you will speculate, do it intelligently, such as attempting to stay ahead of the curve and anticipating when the momentum will change against your trade.
Graham understands that speculation will happen but encourages investors to limit it to 10% of their investments.
Chapter 2 discusses the impacts of inflation and how investors should protect themselves against the erosion of their buying power. Graham felt good companies paying dividends could lessen the long-term impact of inflation.
In the commentary from Jason Zweig, Wall Street Journal columnist mentions two products helping lessen inflations impact today, such as REITs (real estate investment trusts) and TIPS (treasury inflation-protected securities).
These vehicles helped reduce inflations impact and were unavailable during Graham’s time.
Chapter 3 focuses on the market history and the impacts on investors’ returns. Graham felt having at least a working understanding of the market’s history would help any investor.
He felt that any investor who wants to analyze companies must understand the relation to stock prices and earnings, cash flows, and dividends.
Chapters 4, 5, and 14 focus on a defensive investor. A defensive investor is someone who is more risk-averse and doesn’t want to spend the time and effort it takes to be a stock picker.
Investigating and thinking deeply about stocks takes a lot of time and effort. And not everyone cares or wants to put in the effort required to succeed at stock picking. Graham understood this and outlined his ideas to enable those inclined towards this stock investment style.
Instead, the defensive investor is looking for a more passive approach and a portfolio that requires minimal effort, research, or monitoring. In Graham’s day, this meant focusing on more conservative investments such as railroads, insurance companies, and bonds. Being a defensive investor is far easier with the increased popularity of index funds and ETFs.
To learn more about the defensive investor, check out the below link:
Chapters 6, 7, and 15 focus on the idea of an enterprising investor. Graham defined an enterprising investor as someone willing to spend the required time and effort to invest more aggressively. It is a far more active approach that takes constant attention and portfolio monitoring. An enterprising investor is willing to spend the time and effort for active portfolio management, due diligence, and individual stock choices.
To learn more about the enterprising investor, check out the link below:
Chapter 8 is one of the more important writings in investment education. Warren Buffett has repeatedly said that Chapter 8 is one of the “must-reads” of the book.
Let’s look at Graham’s words to describe Mr. or Mrs. Market to make them more relevant today.
“Imagine that in some private business, you own a small share that costs you $1,000. One of your partners, Mr., or Mrs. Market, is very accommodating. Every day they tell you what they think your interest is worth and furthermore offer either to buy you out or sell you an additional interest on that basis. Sometimes their idea of value appears plausible and justified by business developments and prospects as you know them. On the other hand, Mr. or Mrs. Market often lets their enthusiasm or fears run away with them, and the value they propose seems to you a little short of silly.”
The allegory of using a manic character such as Mr. or Mrs. Market is a perfect analogy for the market’s behavior.
The analogy helps explain the ebbs and flows of the market. Imagine buying a company, and the next day it drops 5% for no reason; no news related to the company would explain the drop; it is just the manic movement of the market. The same idea is on the other side; the price explodes upward for no apparent reason.
As intelligent investors, our job is to ignore Mr. or Mrs. Market and their manic behavior instead of focusing on what we can measure and our thoughts about the investment. If the price fits our decision, then, by all means, take advantage, but if not, pass on the offer. But don’t worry because they will be back tomorrow with another offer.
Advisors and Investment Funds
In chapters 9 and 10, Graham dives into investment advisors’ topics and the use of investment funds.
In Graham’s time, investment funds didn’t have the same prevalence as today; Vanguard, for example, didn’t exist. He explains that using investment funds remains a great choice for defensive investors, remembering that the performance will match the market’s returns.
As defensive investors choose to be less active, the investment funds might be a great choice for those investors, provided they choose the most reputable, stable funds with the lowest fees.
Graham advises that anyone seeking investment advice choose those with good character and skin in the game. Also, look for conservative, guarded, and diligent advisors in their efforts. He also mentions that you get what you pay for, and any investment advice for free is probably worth the price. Expect to pay but check to ensure those fees are commensurate with your portfolio’s performance.
In chapter 11, Graham lays out his framework for the average investor to begin security analysis. His framework is for the investor who doesn’t have training in analyzing stocks; he also stresses that using longer time frames is a better framework for making decisions.
He also introduces the idea of a margin of safety, which means you buy the company for less than its stated value, and the bigger the gap, the more the margin of safety.
Graham also discusses buying future earnings, which should focus on the company’s future value. He also lays out the framework to consider when looking at future value:
- Long-term prospects
- Competence of management
- Financial strength
- Capital structure
- Current dividend rate
Chapter 12 focuses on short-term earnings, results, and the risk connected with that focus. Instead, Graham suggests looking at normalized earnings over a seven to ten-year horizon to help lessen the impact of special charges, dilution factors, and many others that can lead to earnings manipulations.
Chapter 13 outlines the process he recommends using four different companies—all the metrics, averages, and other ideas he champions throughout the book. The comparisons are a great teaching tool as a step-by-step tool to analyze companies.
Thoughts on Value
Chapters 16, 17, 18, and 19 explore many different ideas:
- Convertible warrants and issues
- Case histories
- Comparison of eight companies
- Management and shareholders
Each of these topics is valuable in and of itself. The case studies and comparisons are great for examining Graham’s method for selecting securities or stocks.
It helps see the master in action and his thought process as he works through the case studies.
Margin of Safety
According to Warren Buffett, chapter 20 and Chapter 8 remains at the top of the mountain. If you read any chapters in the book, chapters 8 and 20 must remain at the top.
In Chapter 20, Graham discusses the idea of a margin of safety in depth.
Graham refers to the margin of safety as “the secret of sound investment” and “the central concept of investment.” Graham mentions that the margin of safety is the thread that runs throughout the concepts covered in the book. It is the most important idea to take away from the book.
The margin of safety is the idea of buying something for less than the stated value of a company. Any investor’s goal is to buy for less than the value; hopefully, think of it as on sale.
There are many margins of safety levels, and the price is the most discussed, but Graham also talks about using diversification as a means of the margin of safety. By buying different assets that are not correlated, you acquire a measure of safety, along with the different types of securities you choose.
If you buy more conservative investments, you are buying with a margin of safety, as those investments afford a measure of safety by their defensive nature.
The margin of safety also allows for price appreciation, which helps boost returns. The price we pay matters; when you buy a company at the top of its price, it might take decades to return to that price level again.
Ask the investors of Cisco, Coke, and Microsoft about the importance of the price you pay, as both Cisco and Microsoft took over a decade to return to their previous heights after the dotcom bust.
Again, this is only an overview of the book, and I hope it whets your appetite to read the whole book.
What Does the Intelligent Investor Teach Us?
We have multiple ideas we can learn from The Intelligent Investor. We must remain diligent, patient, and a learning machine to become intelligent investors. We also need to remain rational and unemotional and think for ourselves.
Graham feels that investment success depends far more on our character than our IQ.
He discusses investing versus gambling; he feels that buying a company without understanding how they make money or even what they do remains a form of gambling. Investing is far more educated.
It doesn’t mean you have to invest at Warren Buffett’s level; you are an intelligent defensive investor if you buy low-cost ETFs and consistently add money to those investments.
Throughout the book, he discusses investing as a defensive or stock pick (enterprising investor). Once you decide what works best for you, staying the course and sticking to what works for you remains all that matters.
Of course, the book also teaches us the idea of market fluctuations and Mr. Market’s manic personality. The markets are there to serve us, not confirm or deny our investments. Over a long period, our investments will turn out well, but patience and Mr. Market can tend not to mix well.
The big idea of a margin of safety is investors’ most commented portion of the book. A margin of safety has resonated with so many investors, from Warren Buffett to today’s new guns like Bill Ackman.
Buffett likens a margin of safety to building a bridge. He said a margin of safety starts with building a bridge holding trucks weighing 40,000 pounds and only driving 10,000-pound trucks over the bridge.
The margin of safety is a powerful idea, and buying a company for less than it is worth allows for errors in judgment without damaging your investments or net worth; plus, it allows for, in certain cases, serious price appreciation, which boosts your returns.
The margin of safety and Mr. Market are the two most well-known ideas from the book but hidden throughout the book are countless other nuggets.
Is the Intelligent Investor for Beginners?
In a word, yes.
The book remains long on investing ideas and concepts and short on technical details. You will need to learn finance terms such as earnings per share, but if you are a stock picker, you will have to learn them anyway.
Graham was ahead of his time with his ideas about Mr. Market, a margin of safety, defensive, and enterprising investing.
These topics cover the area of behavioral finance, which has become a newer area of finance in the last ten to twenty years. But Graham understood not everyone wants to manage a portfolio, read financial reports, and calculate financial metrics.
He knew some investors wanted the benefits of investing without all the effort, so he created the idea of defensive investing.
This dichotomy in the investing world makes some investors look down on those using index funds or ETFs as lesser investors. But the harsh reality remains that many active investors fail to beat the market, while those who invest using index funds match the market returns over the past 100 years at around 10%.
Intelligent investing aims to make more money than you start without risking capital loss.
The bottom line is that the ideas and concepts that Graham discusses throughout the book work for beginners and seasoned pros.
Is the Intelligent Investor Outdated?
The Intelligent Investor remains relevant in today’s investing world. The idea of wild market fluctuations still remains present today, plus the concept of creating a margin of safety for your investments still has relevance today.
Some of the formulas he presents in the book have become a little dated in that the movers and shakers of the market are quite different from Graham’s Day.
The internet has changed business, and how we conduct business has allowed smaller companies to scale up operations faster and cheaper than in 1945.
Take Google, for example; the capital requirements to scale up their business remain far smaller than they would have for Standard Oil during Graham’s time. Therefore, compared to their costs, Google’s margins or profits dwarf those of a railroad or oil producer.
Even though the names have changed, and the mode of business has changed, the ideas that Graham championed remain relevant today, and using those concepts to become a better investor remains his main goal for writing the book.
Some of the things that Graham remains most famous for are his use of metrics such as earnings per share and book value per share. He also included several formulas throughout his books, but he constantly updated those formulas with each new edition.
He felt the formulas needed tweaking to remain relevant to the current market conditions; he was the constant tinkerer.
The book’s biggest takeaways remain the ideas behind the mindset needed to be an intelligent investor, which is still relevant to today’s investors.
The Intelligent Investor remains one of the must-reads, especially for anyone interested in being an active investor or picking stocks.
The book contains many concepts we discussed during this post that are important to your future success as an investor.
Whether you want to manage your portfolio, use index funds, or hire an investment advisor, the mark of an intelligent investor remains to have a rounded education on how markets work.
As part of my investing journey, I re-read the book every year, starting in January. It continues as a habit I started four years ago, and I find something new every time I go through the book.
Sometimes I listen to the eBook version on Audible or put on Chapters 8 and 20 and listen several times. The new edition contains bonus material from Warren Buffett and Jason Zweig’s commentary, making it more valuable.
With that, we will wrap up our discussion of The Intelligent Investor.
Thank you for taking the time to read this post, and I hope you find something of value in your investing journey.
If I can further assist, please don’t hesitate to reach out.
Until next time, take care and be safe out there,