The Intelligent Investor by Benjamin Graham
Before we begin, I would like to apologise for my delays uploading articles these past two weeks. I have not been the most punctual; however, with the amount of revision I have had to do to take on the examinations I must take, I have had little time.
Nonetheless, I would like to talk about the book that the legendary investor, Warren Buffett, claims to be “the Bible of Investing”. The book is called The Intelligent Investor, and it was written by the well-renowned Benjamin Graham, who is said to have averaged 20% in annual returns. Personally, I have a copy that has updated commentary by Jason Zweig, a journalist of The Wall Street Journal, which keeps up with the most current market trends.
The book as originally written by Graham has a lot of values that should be maintained, but given the financial world is ever-evolving – with FinTech, for instance – it must be updated.
To begin, an intelligent investor is just that: intelligent. It will not make rash decisions and act by impulse, but rather leverage all the tools – paid or free – to maximise his chances of return. The stock market is always a gamble. How many people bought thousands of pounds in shares in February, only to see it go down to half the value in March? There is always a risk.
However, by making a thorough analysis of the securities available to trade in the market, by looking at the multiple financial formulas which I will try to cover at a later date, an investor can minimise and spread the risk to the point where it is negligible. Some of these formulas include the Price to Earnings ratio, the Earnings Per Share, Net Profit, Profit Margins, Dividend Yield, Cash Flows, among others. As I will be covering most of these, make sure you subscribe now to F.S. Finance!
Fundamentally, there are 3 principles by which you should guide yourself through:
Firstly, you should analyse and assess the long-term for any company you might want to invest in. This means looking at trends in the sector and industry, the managers and directors, the way they are financed, etc. All of this will have an impact on the prospects, and it will dictate whether a company is successful or not.
Secondly, diversify. Diversify again. Seriously, diversify. Putting all your eggs into one basket, as Graham says, is a big mistake. Imagine if you had put all your money into a share, such as Tesla, and then Elon Musk was imprisoned for insider dealing, and Volkswagen launches a new line of Electric Vehicles comparable to Tesla, with the same features, at half price, collapsing Tesla into oblivion. Don’t lose your money. Diversify.
Thirdly, investments are not for short-term market gains, but for steady, lasting gains – both capital and income-wise. To try and trade like professionals is unwise, and that is far from what we should be aiming to achieve. Rather, try to invest to meet your personal needs – such as retiring comfortably.
The Intelligent Investor
The greatest investment advisor of the twentieth century, Benjamin Graham taught and inspired people worldwide. Graham's philosophy of “value investing”—which shields investors from substantial error and teaches them to develop long-term strategies—has made The Intelligent Investor the stock market bible ever since its original publication in 1949.
Vital and indispensable, The Intelligent Investor is the most important book you will ever read on how to reach your financial goals.
Another thing to consider is not just individual shares, but the market as a whole. Here, I will repeat what you hear at every single investment institution: past performance is not a determinant of future performance. And whilst this holds a lot of truth in it, I would say it is not entirely accurate. If a company has performed, financially speaking, stably and well for the past 50 years, it’s likely that it will keep performing well. The future remains unpredictable, as the company might suffer a shock and collapse – look at Lehman Brothers – but overall, if well assessed, it will remain solid and generate a good return for you.
Going back, the stock market has been relatively stable for the past 100 plus years, and it will keep on growing at a stable rate. It is also important to note that the market goes up and down like waves in the ocean, and thus you should prepare yourself psychologically against these crashes which are inevitable.
When investing, also take care to consider whether the rate of return is worth it in the long-run. Inflation is real and it happens, prices rise and therefore your real rate of return might be lower than it seems; and yes, there is an actual formula for real rate of return!
Furthermore, one of the most iconic things about Graham’s book is his description of the market as an individual. Mr Market, as he calls it, is a very moody, unpredictable, and downright dumb person. They enjoy following whatever the crowd says and goes from unsustainable optimism to unjustified pessimism in a heartbeat.
Take for instance, the share price of Zoom. After COVID-19 and its surprising success, Zoom rallied 400% and more, reaching an astronomical Price to Earnings ratio of 1,790 and now, at the time of writing, resting at a P/E of 500 or above. That P/E means the company would have to distribute 500x its current profits for investors to see their money back. Mr Market was easily influenced, and as a consequence, inflated Zoom stock to the point where at some point in the future – when things return back to normal and Zoom inevitably wears out, maybe because Google or Microsoft launch a better alternative – the share will plummet and you will lose all your money.
"Buy not on optimism, but on arithmetic."
As such, you must ignore Mr Market’s mood swings, and simply take an individual approach, something that is reliable and trustworthy – such as thorough financial analysis and conducting the right amount of research on the market conditions, company performance, and likely future trends of shares over the long-run.
Now, here is when Graham begins to make the distinction between aggressive and defensive investors. The defensive stance, as the author notes, is very passive. A split between equities and bonds should be made, investing likewise between government bonds (gilts in the UK) and blue-chip companies. Graham suggests a 50/50 split, but in today’s day and age this might not be too wise given the extremely low rates of interest from bonds. Hence, an analysis should be done on the subject matter to evaluate whether the risk/reward is up to your appetite; and as such, an investment manager should be hired in order to successfully pick the best securities.
ETFs and bond funds are phenomenal ways to easily diversify your portfolio, so investing in at least 15 of these securities can guarantee you a safe return.
Furthermore, you should always invest the same amount in the same stock portfolio every month or quarter. This will boost your long-term gains. Of course, you should also review your portfolio every 6 months, and consult with a professional every year, in order to more appropriately pick out your investments. Perhaps you should invest in more ETFs and less shares, or more bonds rather than shares. It always varies. Your situation might change as well, and you might require capital growth shares instead of income generating shares, or vice versa.
A defensive investor will, no matter what, always say “Don’t know, don’t care” when asked about their portfolio. Once you have invested, leave your portfolio to its own devices and stop caring about whether it’s performing well or poorly.
On the other hand, an aggressive investor will always be on top of their investments. Their investment manager will be more of a partner rather than a manager, and a larger portion of the portfolio will be put into shares – which although riskier, they generate larger returns. As well, an enterprising investor will not invest more than 10% of their portfolio into high-risk/high-return shares (or options), such an up-and-coming new hot shares. These can provide you with hefty returns, but you can also lose all your money and hence you need to be cautious by only making it a tiny percentage of the overall portfolio.
Nonetheless, an enterprising investor will never follow Mr Market trends and try to buy low and sell high, but rather buy under-priced stocks and selling over-priced stocks. Never following the bandwagon of the market, where stocks are priced above their intrinsic value, leads to an intelligent investor.
These are the teachings of Graham, a very intelligent investor himself, and the teachings that have guided billionaire Warren Buffett, who made his fortune through the stock market. If you are to build your wealth, then make sure to follow this guide, and of course, buy the book for yourself and read it!