You can purchase “The Intelligent Investor” By Benjamin Graham here if you would like to read the book in full.
Table of Contents
In today’s article, we will summarise and look at the critical points from the amazing book “The Intelligent Investor” by Benjamin Graham. This is a book that aims to help people start to invest in the stock market, minimize their risks while doing so, and teach you to become an Intelligent investor.
The book focuses on low-risk strategies and long-term strategies for investing. The approach focuses on sound investment based on research rather than investments that try to speculate the market through predictions and hearsay.
Intelligent enterprising investor provide sound guidance
The Intelligent investor provides sound guidance on using value investing in the markets and reducing your risk when investing as much as possible. Successful investing is based on a sound intellectual framework for making decisions.
You do not need a brain like Einstein’s to find great opportunities for investment in the stock market, although this is what the wall street crowd wants you to believe.
Graham says in his book that to be a successful defensive investor, you need to be patient, disciplined, and keen to learn new skills. You must be able to control emotions and think for yourself.
When investing in the stock market, it’s essential that you keep a logical approach and that you always keep emotions out of the decisions you make.
Fluctuations in the stock market.
Human emotions primarily cause fluctuations in the stock market, if the stock market is controlled by actual logic and security analysis then you wouldn’t see such wild movements.
This book highlights the difference between defensive investors and speculators who buy based on emotion rather than research.
According to the book, intelligent investing consists of 3 things:
A thorough analysis of company fundamentals
Protection against severe losses
The intelligent defensive investor.
In the book, Graham points out that for an intelligent defensive investor, gains are not made investing because the price of stock seems to be going higher and higher. He proclaims the opposite is true.
Graham explains that the more the stock price increases, the riskier that stock becomes, and the lower the stock prices, the less difficult that stock is.
Throughout the book, Graham has a character that he calls “Mr. Market.”
Mr. Market represents the actual stock market.
Mr. Market represents the stock market, but is portrayed as an actual person in the book.
He uses this character to explain market speculation and how intelligent investors’ opinions can impact a stock’s price without basic logic.
Imagine that you had shares in the XYZ Building Corporation and paid $5000 for these shares.
Every day, Mr. Market comes to you and offers an opinion on what he feels your shares are worth. He offers to buy or sell your shares based on his view of the market that day.
History of the stock market as shown by Mr. Market.
During the life of the stock market, history has shown that Mr. Market’s opinion about what a company or a share is worth is pure speculation.
One day he comes to you and says that your shares are worth $7000, then another day, he comes to you and says your shares are worth $2000 even though the company’s profit has increased by 20%.
Should Mr. Market decide how much your initial $5000 investment in that company is worth from one day to the next? Well, no, this would be crazy.
But this is what investors are doing every time they invest. They are letting people tell them what the company stock is worth based on opinion and current market price rather than sound fundamentals.
Primary principal in the intelligent investor book.
One of the main principles in this book is that a stock is not just a ticker symbol and a price. It’s an ownership interest in a business.
Because Mr. Market isn’t always rational, depending on how he feels on the day, the value of the stock he is looking to buy on a given day can fluctuate wildly from one day to the next.
But that said, if Mr. Market presents you with prices that are higher than you feel a company is worth, you are not forced to buy from him. And if he offers a stock you consider a bargain, you should be happy to buy from him.
Only Invest in Stocks if you want it long term.
The advice in the book is to only invest if you would be happy to hold the stock for the long term without looking at any charts after you have bought the stock.
When this book was written, people only picked up one newspaper daily to base their buying decisions on, so Mr. Market only visited them once daily.
Now people are bombarded with news and alerts to buy or sell 24/7, and Mr. Market visits them every minute of every day with notifications on their mobile devices.
So just because Mr. Market visits you a thousand times a day, it doesn’t mean you have to trade with him 1000 a day.
Only trade with him when he presents you with an offer that is right for you and meets your investment criteria.
2 types of investors.
According to the book, there are two types of investors the active or enterprising investor and the passive or defensive investor. In the book, Graham advocates the need to be a defensive investor. This is someone who takes a low-risk, long-term approach to invest.
The defensive investor should create a portfolio with a mixture of bonds, index funds, mutual funds, or investment funds and the rest of individual stocks, with, say, 50% stocks and 50% bonds as a split.
The book recommends that you invest a set amount of money at fixed regular intervals in bonds, like monthly, straight from your paycheck. This is referred to as dollar-cost averaging, which most people should be aware of.
You make regular investments of the same amount purchasing stocks no matter the price. Some days you buy more stock some days, you buy less, averaging out the investor and market fluctuations.
Buying the stock side of your portfolio.
When you are looking at buying the stock side of your portfolio, you should apply the following eight rules:
Diversify the stocks you are buying – 10 to 30 companies will suffice.
The companies you invest in should be large – identified as over $100m in annual sales, which in today’s value would be approximately $520 million.
The companies you invest in are conservatively financed. This is defined as having a ratio of 200%, which means that its current assets are at least twice as big as its current liabilities.
The companies should be dividend-paying – ensure they have not missed a dividend payout in the last 20 years.
The companies should have no average earnings deficit in the last ten years.
The company you are considering should have had at least a 33% growth in earnings during the last ten years.
The company should have cheap assets, and the stock price should not exceed 1.5 times its net asset value.
Don’t overpay for earnings either; ensure the P/E ratio is no higher than 15 when using the last 12 months’ earnings.
If, as an investor, you are happy to invest with modest returns of 9-10% annually, then you can apply all of these rules, and you will not go too far wrong.
Still, if you are looking for more gains in your investing, the book looks at how to be an enterprising investor, which we will go into next.
Beating the market is much more demanding.
To be an enterprising investor and to consistently beat the markets is much more demanding than it seems. To succeed as an enterprising investor, you need patience, discipline, a will to learn, and a great deal of time.
For those bold enough to take the challenge, there are six rules to follow the same as with a defensive investor strategy and those are:
The company assets should be at least 1.5x current liabilities.
Debt must be less than 110% of the working capital.
Earnings per share should be greater than five years ago.
The company must be paying a current dividend no matter how much that is
The company’s price-to-book ratio should be less than 1.2
The PE ratio must be less than 10
The next key takeaway from the intelligent investor is the margin of safety. The book advocates for an investment approach that provides a good margin of safety for the investor. There are a number of different ways to do this but buying undervalued favour stocks is the most important.
Irrationality of investors.
The irrationality of investors, the inability to predict the future, and the stock market fluctuations can provide this margin of safety for investors.
Investors can also achieve a margin of safety by diversifying their portfolios and purchasing stocks in companies with low debt-to-equity ratios and high dividend yields.
The margin of safety is put in place to mitigate the investors’ losses if a company goes into liquidation or the shares plummet sharply.
Formula which can be applied to stock prices.
The book reveals a formula that can be applied to a stock price to ensure that you can build a margin of safety. Typically, Graham purchased stocks trading at two-thirds of their net value, which creates a margin of safety of one-third of the value.
Net-net value is another technique developed in the book by Graham as a value investing strategy. This is where the company is valued only on its net current assets and intrinsic value.
The formula in the book for finding the intrinsic value of a stock is:
V = EPS x (8.5 + 2g)
Where EPS is the company’s previous 12-month earnings per share and g is the reasonably expected 7-to-20-year growth. The V in the formula represents the intrinsic value of the stock.
Graham later revised this formula.
Graham later revised this formula to believe that interest rates have been the greatest contributing factor to stock values (and prices) over the last decade. In 1974 he re-wrote the formula as follows:
The new value Y is the current yield on triple “A” corporate bonds. See beyond the horizon. In the short term, a market is a voting machine. In the long term, the market is a weighing machine.
People always tell you when the right or wrong time is to invest, but the truth is over the short term, there is no way of knowing what the markets will do. Over the long term, though, the market will reflect the stock’s true intrinsic value.
Find the stock which will be huge in demand.
You need to find the stocks in huge demand over the long term, buy and hold them long-term, and think in blocks of ten years rather than months at a time.
Remember, as always, it’s time “IN” the markets rather than “TIMING” the financial markets.
Graham provides timeless advice for every investor. His method is perfect to follow if you would like to become a disciplined investor with the patience to avoid the mistakes many individuals make.
Lee, now the author of Learn Life Money, has started businesses in various industries such as E-commerce to social media marketing. He is an award-winning entrepreneur having received awards from Dragons Den Theo Paphitis, and winning awards for the fastest-growing social media marketing agency in 2019, You can read his full story here. Lee helps people to start and scale their businesses using their knowledge and experience. He has a passion is to help others achieve the success he has achieved and wants to help people pave their path to financial freedom from making the right decisions with money to starting their own businesses.