10 lessons we took from value classic The Intelligent Investor
Should you be seeking inspiration for books to take on holiday this year, The Value Perspective continues its short series on value investing classics and the lessons we personally took from reading them
Over the last couple of months, our value investing holiday reading tips have comprised two great introductions to the subject – The Most Important Thing and Margin of Safety – and the behavioural finance classic Thinking Fast and Slow.
For those of you lucky people still yet to jet off, this time we are bringing out the big gun, with our latest idea for an extra book to throw into your suitcase widely considered to be the bible of modern value investing.
The Intelligent Investor
The Intelligent Investor (1949) is by Benjamin Graham, who is not only seen as the father of value investing but, for good measure, was also Warren Buffett’s mentor. One of the two most celebrated books he wrote on the subject – the other being Securities Analysis – The Intelligent Investor still strikes a chord with investors today, despite the first edition being written almost 70 years ago.
That said, as we also note in The Value Perspective’s selection of reading suggestions, the book is perhaps less for people seeking an introduction to value investing as for those already familiar with the discipline who want to hear from the man who did so much to shape it.
As ever, rather than offering a traditional review of the book, we will instead touch on the lessons we personally took from it. So what were they?
Lessons from the book
- Process, process, process: Investors need a sound intellectual framework for making decisions and also the ability to prevent their emotions from corroding that framework. This is actually an observation from Buffett’s preface to the fourth edition of The Intelligent Investor – not to mention something we focus heavily on, here on The Value Perspective. It signals the importance, above all things, of process, process, process.
- Market behaviour: The more irrational the market’s behaviour, the greater the opportunity for the disciplined investor.
- Value and price: The future value of every investment is a function of its present price. The higher the price you pay, the lower your return will be.
- Margin of safety: No matter how careful you are or how disciplined your process, the one risk no investor can ever eliminate is the risk of being wrong. Only by insisting on what Graham called the “margin of safety” – never overpaying for an investment, no matter how exciting it may appear to be – can you minimise your chances of making a mistake
- Your worst enemy: As an investor, your principal problem – one might even say, your worst enemy – is likely to be you yourself.
- Future projections: Mathematical valuations that are dependant on anticipating the future – and less tied to a figure demonstrated by past performance – are more vulnerable to possible miscalculation and serious error. Unfortunately, a significant part of the value of a ‘high-multiplier’ stock is derived from future projections, which – except, perhaps, in the growth rate itself – differ markedly from past performance.
- Bargain issues: Can one really make money in ‘bargain issues’ without taking a serious risk? Answering his own question, Graham writes: “Yes indeed, if you can find enough of them to make a diversified group, and if you don’t lose patience if they fail to advance soon after you buy them. Sometimes the patience needed may appear quite considerable. In our previous edition we hazarded a single example which was current as we wrote. It was Burton Dixie Corp, with stock selling at 20, against net current asset value of 30, and book vale of about 50. A profit on that purchase would not have been immediate. But in August 1967 all the shareholders were offered 53.75 for their shares, probably at just above book value. A patient holder, who had bought the shares in March 1964 at 20 would have had a profit of 165% in 3.5 years – a non-compounded annual return of 47%.”
- Contrarian thinking: The intelligent investor understands a stock becomes more risky – not less – as its price rises, and less risky – not more – as its price falls. By the same token, since it makes stocks more costly to buy, you should dread a bull market. Conversely – and so long as you keep enough cash to hand to meet your spending needs – you should welcome a bear market as it puts stocks back ‘on sale’.
- Look beyond yield: Stocks do well or poorly in the future because the businesses behind them do well or poorly – and for no other reason. As such, no matter how desperate they might be for income, no intelligent investor would ever buy a stock on the basis of its dividend yield alone – the company’s underlying business must be solid and its share price must be reasonable.
- Sources of undervaluation: There are two principal reasons why the wider market will undervalue a stock: currently disappointing results; and protracted neglect or unpopularity. As such, Graham writes, an investor “should require an indication of at least reasonable stability of earnings over the past decade or more … plus sufficient size and financial strength to meet possible setbacks in the future.” Such considerations form a significant part of our own investment process, here on The Value Perspective.