The Intelligent Investor: The definitive Book On Value Investing by Benjamin Graham and Jason Zweig

 

The Intelligent Investor puts special emphasis on teaching:


1. Risk management through asset allocation and diversification.


2. Maximizing probabilities through valuations analysis and margin of safety.


3. A disciplined approach that will prevent consequential errors to a portfolio.

Investment vs. Speculation Chapter 1


One of the most important and basic rules is to keep the activities of investment and speculation totally separate. They should be kept in separate accounts and compartmentalized in your mind. If you must speculate, Graham admonishes investors to limit their allocation to no greater than 10% of investment funds.

Just as there is intelligent investing, there is intelligent speculation. Intelligent investing involves:


1. Analysis of the fundamental soundness of a business.


2. A calculated plan to prevent a severe loss and


3. The pursuit of a reasonable return.

Speculation involves basing decisions on the market price, hoping that someone will pay more than you at a later date. Unintelligent speculation would include speculating when you believe you are investing, speculating actively without the knowledge or skill to do so properly, and speculating with money you cannot afford to lose.

This means a successful speculator must constantly stay ahead of the latest trend. This is the opposite of intelligent investing which involves fundamental analysis that does not fluctuate with each passing trend.

The bottom line is that any speculation should be reserved for a small and separate portion of your funds (no more that 10%). This rule of separation protects your investment funds from catastrophic losses caused by speculation.

The Investor and Inflation Chapter 2.


Inflation must be a concern for investors because it lowers real wealth as it erodes the purchasing power of profits and principal. As the cost of living rises it especially hurts the principal of fixed income securities.

Investors must be vigilant for the unanticipated. That means there is never a perfect time to be in only one asset category (don’t put all your eggs into one basket). The intelligent investor must minimize risk by anticipating the unforeseen.

Diversification is the foundation of such a strategy.

In the commentary, Jason Zweig noted two relatively new investment options are available. Real Estate Investment Trusts (REITs) and Treasury Inflation Protected Securities (TIPS) provide some protection against inflation. Within a diversified portfolio, both of these may be appropriate for the intelligent investor concerned about inflation.

A Century of Stock Market History Chapter 3.


Every investor should have a satisfactory understanding of stock market history. In order to analyze stock investments you must have discernment pertaining to the relationship between stock prices and their earnings, cash flow, and dividends.

Zweig notes in the commentary that market fluctuations will be dependent upon real growth (increases of companies earnings and dividends), inflationary growth, and the amount of speculation (increase or decrease) the public is putting on stocks at the current moment.


General Portfolio Policy: The Defensive Investor Chapter 4.


The popular view is that investors should tailor the amount of risk they are willing to take to their risk tolerance. Graham has a different outlook: the amount of risk one should accept should depend on the amount of intelligent effort the investor is able and willing to expend.

The defensive investor can divide his portfolio equally between stocks and bonds/cash. Portfolio rebalancing can be reserved for times when valuations bring asset allocations significantly out of the 50-50 target.

The Defensive Investor and Common Stocks Chapter 5


The two main advantages of stocks are that they provide protection against inflation and offer a higher rate of return than bonds/cash in the long run. These advantages can be squandered if the investor pays too high a price for his stock.

Graham suggested four rules for the defensive investor:


1. Adequate diversification Graham suggested between 10 and 30 different issues.


2. Stick to large, outstanding (top 1/3 of industry group), conservative companies.


3. Each company should have 20 years of continuous dividend payments.


4. Limit the price you are willing to pay to 25 times average earnings over the last 7 years and 20 times earnings for last 12 month period

The defensive investor will most likely have to abandon growth stocks. Growth stocks will usually be too expensive; and consequently, excessively risky for the defensive investor.

Stock Selection for the Defensive Investor Chapter 14


Graham provides a set of standards by which a defensive investor can obtain quality and quantity.


1. Adequate Size of the Enterprise approximately

2 billion in current dollars


2. Strong Financial Condition current assets should be at least twice current liabilities long term debt should be less than working capital.


3. Earnings Stability 10 years of positive earnings.


4. Dividends 20 consecutive years of dividend payments.


5. Earnings Growth

At least a 33% gain of earnings over the past 10 years using three-year averages.


6. Moderate Price/Earnings Ratio not more than 15 times average earnings of past 3 years


7. Moderate Ratio of Price to Assets price to book value should be less than 1.5 or price/earnings ratio times 1.5 should not exceed 22.5

Stock Selection for the Enterprising Investor Chapter 15


The enterprising investor can begin his search by looking for companies that meet the following criteria. Unlike the defensive investor, the enterprise investor has no minimum limit on the size of the company.

1. Strong Financial condition: current assets at least 1.5 times current liabilities total debt to net current assets ratio less that 1.1


2. Earnings Stability positive earnings for at least 5 years


3. Currently pays a dividend


4. Current earnings greater than years ago


5. Stock price less than 120% of net tangible assets


Convertible Issues and Warrants Chapter 16

Graham points out the fallacy of such an argument. The convertible bond buyer is usually giving up yield and accepting greater risk in exchange for the conversion right. The company is possibly giving up common shareholders benefits of future growth.

Zweig points out in the commentary that convertible bonds have historically provided less total return, but more income, and less risk than stocks. Compared to bonds, their total return is greater, but provide less income with greater risk. In reality they have been more correlated with stock prices than bond prices.

A Comparison of Eight Pairs of Companies Chapter 18


Zweig points out, there are good and bad companies, there is no such thing as a good stock; there are only good stock prices, which come and go.

Stockholders and Managements Chapter 19
Graham urged shareholders to take an active role in being owners of the company. He thought management with good results should be rewarded, and management with poor results should be questioned and challenged.

Exponentially Higher Returns
The margin of safety for an investment is the difference between the real or fundamental value and the price you pay. The goal of the value investor is pay less (hopefully, much less) than the real value.

The greater the margin the more leeway you have for negative conditions before you lose money. On the other hand, if conditions are as you expected or better, profits are exponentially higher the greater the original margin.


Chapter 20
Function of Margin of Safety.

The function of having a margin of safety is to make accurate forecasts of the future unnecessary. In other words, having a safety buffer allows for inaccurate forecasts. It gives you leeway for conditions that are less than optimum because that is usually what happens.

The Price Paid
The amount of safety is completely contingent upon the price paid. Every investment (there are few exceptions) has a price where the margin of safety would be sufficient for purchase. Determining what your purchase price is, and having the discipline to only buy at or below that price, is where the difficulty rests.

Diversification
Diversification is a key companion of safety. Diversification is the margin of safety for your portfolio as a whole.