Warren Buffett started learning about investing when he was seven or eight years old, a late bloomer. Buffett’s father started a small investment firm, and a young Warren picked up different books lying around, becoming bitten by the investing bug.
Fast forward to eleven years old, and Buffett was going to the local library and reading every book on investing in the library. But one book stood out above the others, The Intelligent Investor, which changed his life.
The Intelligent Investor, written by Benjamin Graham, a former Columbia Business School professor, and first published in 1949, was destined to influence Buffett and became the investing manual that sparked the value investing school.
“Intelligent investment is more a matter of mental approach than it is of 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- Is the Intelligent Investor Outdated?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
My goal with this section is to highlight some major themes from the different sections of each chapter of the book, but these ideas should not take away from reading the book; please do yourself a favor and give it a try.
Warren Buffett singles out two chapters in any discussions he has 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 that 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 along the gambling lines, it bases decisions on market prices and fluctuations, hoping that anyone will pay more than you later.
If you will speculate, do it on an intelligent basis, 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 he 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 that good companies that paid a dividend could lessen the long-term impact of inflation.
In the commentary from Jason Zweig, the Wall Street Journal columnist mentions that two products that help lessen inflation’s impact exist today, such as REITs (real estate investment trusts) and TIPS (treasury inflation-protected securities). Both of these vehicles help reduce inflation’s impact and were not available during Graham’s time.
Chapter 3 focuses on the market history and the impacts on investors’ returns. Graham felt that at least a working understanding of the history of the market would help any investors. 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 the idea of 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 be successful at stock picking. Graham understood this and outlined his ideas to enable those inclined towards this type of investment style in stocks.
Instead, the defensive investor is looking for a more passive approach and looks for a portfolio that requires minimal effort, research, or monitoring. In Graham’s day, this meant focuses on more conservative types of investments such as railroads, insurance companies, and bonds. With the increased popularity of index funds and ETFs, being a defensive investor is far easier.
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 monitoring of the portfolio. 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 all of investment education. Warren Buffett has repeatedly said that Chapter 8 is one of the “must-reads” of the book.
Let’s look at Graham himself’s words to describe Mr. or Mrs. Market to make them more relevant to today’s world.
“Imagine that in some private business, you own a small share that cost you $1,000. One of your partners, named Mr. or Mrs. Market, is very obliging indeed. Every day they tell you what they think your interest is worth and furthermore offers either to buy you out or to 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. Often, on the other hand, Mr. or Mrs. Market lets their enthusiasm or their 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.
To me, the analogy helps explain the ebbs and flows of the market. Imagine buying a company, and the next day it drops 5% for no imaginable reason; there is no news related to the company that would explain the drop; it is just the manic movement of the market. Same idea 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’ topic and the use of investment funds.
In Graham’s time, the inclusion of investment funds was not as prevalent as today; Vanguard, for example, was not on the scene at that time. He covers the idea that using investment funds is 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, providing 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 advisors that are conservative, guarded, and diligent 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 make sure 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, and that should be the focus on the company’s future value. He also lays out the framework to consider when looking at the future value:
- Long-term prospects
- Competence of management
- Financial strength
- Capital structure
- Current dividend rate
Chapter 12 covers the idea of focusing on short-term earnings and 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 use of the comparisons is 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. To me, the case studies and comparisons are great case studies to examine 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, along with Chapter 8, is the top of the mountain. If you read any chapters in the book, those must be at the top of the list.
In Chapter 20, Graham discusses in depth the idea of a margin of safety.
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, 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, and when you buy a company that is 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 dot-com 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?
There are multiple ideas we can learn from The Intelligent Investor. To be an intelligent investor, we must be diligent, patient, and a learning machine. We also need to be rational, 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 when you buy a company without understanding how they make money, or even what they do is a form of gambling. Investing is far more educated. It doesn’t mean you have to be an expert to Warren Buffett’s level; if you buy low-cost ETFs and consistently add money to those investments, you are an intelligent defensive investor.
Throughout the book, he discusses the idea of deciding whether you are a defensive investor or a stock pick (enterprising investor), and once you decide what works best for you, then staying the course and sticking to what works for you is 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 the investments we make. Over a long period, the investments we make will turn out well, but patience is something that Mr. Market doesn’t want us to exhibit.
The big idea of a margin of safety is the most commented portion of the book by investors. The idea of 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 that a margin of safety is the idea of building a bridge that can hold trucks weighing 40,000 pounds and then only driving 10,000-pound trucks over the bridge.
That 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 is long on investing ideas and concepts, short on technical details. There are finance terms such as earnings per share that you will need to learn, but if you are going to be 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 investing, and enterprising investing. These topics cover the area of behavioral finance, which is a newer area of finance in the last ten to twenty years. But Graham understood that not everyone wants to manage a portfolio, read financial reports, and calculate financial metrics. He knew that some investors wanted to get the benefits of investing without all the effort, and to do that, he created the idea of defensive investing.
This dichotomy in the investing world makes some investors look down on those that use index funds or ETFs as lesser investors. But the harsh reality is that many active investors fail to beat the market, while those who invest using index funds match the market returns, which over the past 100 years is around 10%.
The idea behind investing in the stock market is to earn more money than you start with, without the risk of losing that capital. And whichever method you choose is up to the individual; it is not a race to see who gets the most or who is the smartest. Instead, it is a process of growing your money’s value to allow you to do things you want.
The bottom line is the ideas and concepts that Graham discusses throughout the book work for both beginners and seasoned pros.
Is the Intelligent Investor Outdated?
The Intelligent Investor is still relevant to today’s investing world; the idea of wild market fluctuations is still 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 are 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 much faster, and a ton cheaper, than in 1945.
Take Google, for example. The capital requirements for them to scale up their business is far smaller than it would have been for Standard Oil during Graham’s time. Therefore the margins or profits that Google earns compared to their costs 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 are still relevant today, and using those concepts to become a better investor is why he wrote the book.
Some of the things that Graham is most famous for are his use of metrics such as earnings per share, and book value per share, for example. He also included several formulas throughout both of his books, but he was constantly updating those formulas with each new edition of the book.
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 are still relevant to today’s investors.
The Intelligent Investor is one of the must-reads, especially for anyone interested in being an active investor or picking stocks. There are many different concepts that we have 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, it is a good idea to be educated about investing to a certain degree. That is the mark of an intelligent investor.
As part of my investing journey, I re-read the book every year, starting in January. It is 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 Chapter 8 and 20 and listen several times in a row. A bonus is the newer edition contains commentary from both Warren Buffett and Jason Zweig, which makes it that more valuable.
It is a great book to help me ground myself in the ideas of patience, a margin of safety, and remembering why I am investing and my goals, which for me is to attain freedom.
With that, we will wrap up our discussion of The Intelligent Investor.
As always, 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 be of any further assistance, please don’t hesitate to reach out.
Until next time, take care and be safe out there,