Review: The Intelligent Investor by Benjamin Graham

Hello Readers,

In this review, I highlight the main points that I learned from Graham’s book The Intelligent Investor.

Key Points

  • Defining the two types of investors, enterprising and passive.
  • Highlight the main things I learned after completing the book.
  • Next book to be read.

Who Is Benjamin Graham?

Benjamin Graham is renowned as the father of value investing. He wrote The Intelligent Investor and Security Analysis. His most notable student was Warren Buffet, who is today’s modern day legendary investor.

Source: Benjamin Graham Wikipedia Photo

The Intelligent Investor

Graham starts out plainly that investing does not require brains or luck to be successful. Although both would be helpful, he simply reiterates throughout the book that it requires patience and consistency.

Furthermore, he advises you to invest only if you would feel comfortable to hold the stocks in the future without seeing the fluctuating prices as a concern.

He explains the importance of not deviating from your investment plans, as results will become mediocre overtime. Instead, he encourages investors to choose one type of investment strategy which he categorizes under defensive vs enterprising.

The Two Types Of Investors

In Benjamin Graham’s book The Intelligent Investor, he starts off by categorizing two types of investors. There is the defensive (passive) and enterprising (active) investor, both have their own unique takes on investing.

It is important to choose one strategy or the other, as incorporating both into your portfolio will provide mediocre results.

Source: Smartifyurlife

This picture from smartifyurlife provides a great snapshot of what each investing strategy aims to do. Below, I will go in detail on what to expect when utilizing either strategy and what classifies you as one or the other.

Defensive Investor

Photo by sl wong on Pexels.com

I am utilizing defensive investing as my investment strategy, as I find it more attractive and less demanding compared to an enterprising investor. It is a great method for amateur investors to take this route, as you are less susceptible to being swayed by your emotions.

Defensive investors focus on long term growth, high dividend yields, and prioritizing stress-free activities when handling their personal finances. Albeit, investing is always a stressful discussion when your companies are not performing well.

However, with this in mind Graham effectively explained the importance of why defensive investing is a strategy every investor can master. It requires very little time and consistency to achieve average results.

How To Invest As A Defensive Investor

Graham explains clearly that the defensive investor should allocate their portfolio 50% stocks and 50% bonds. In the case that your ratio is uneven, rebalance your portfolio until it reaches equilibrium.

There are other popular ratios such as 80% stocks and 20% bonds, he simply puts 50-50 as the best number due to simplicity. He advises against 100% stocks as the bonds are there for your safety net.

Graham’s requirements for choosing stocks as a defensive investor

  • Diversify: 10 to 30 companies is the sweet spot.
  • Large companies: Ensure the companies have up to $700 million sales revenue.
  • Conservatively financed: Ensure their balance sheet is a ratio of 200%, assets to liabilities.
  • Dividend: No missed dividends in the last 20 years.
  • No earnings deficit: In the last 10 years.
  • Earnings Growth: At least 2.9% annually for 10 years.
  • Cheap assets: When purchasing, make sure that the price of the stock is not overly priced.
  • P/E Ratio: Avoid P/E ratios that are higher than 15 when using the last 12-month earnings.

I have done my best to ensure that my current portfolio meets most, if not all of Graham’s requirements before investing in them. The primary focus on this should be diversification and high quality companies.

Enterprising Investor

Photo by fauxels on Pexels.com

Many new investors are attracted to the idea of making a quick buck by utilizing the stock market as a gambling outlet.

Graham does not classify an enterprising investor as someone who is easy going as a defensive investor. Instead, he draws the picture of enterprising investors as people who are willing to put in the time and effort in researching industries they believe have the best growth potential for above average returns.

The primary goal of this investment strategy is to attain above average returns compared to the stock market. This is much more difficult than it might sound as many investors will agree upon.

How To Invest As An Enterprising Investor

Contrasting to a defensive investor, this route has less restrictions when deciding which companies to purchase. Graham’s recommends having some of your investments in bonds as you should always have a safety net.

  • Diversify: Some diversification.
  • Conservatively financed: Ensure their balance sheet is a ratio of 150%, assets to liabilities.
  • Dividend: No missed dividends this year.
  • No earnings deficit: In the last year.
  • Earnings Growth: At least greater than 0% for 5 years.
  • Cheap assets: When purchasing, make sure that the price of the stock is not overly priced.
  • P/E Ratio: Applying your own limitation.

The primary focus of this investment strategy is finding potentially high growth companies to achieve above average returns. Patience, eagerness to learn, and consistency will be the best assets you have in this strategy.

Understanding Mr. Market

Graham lays out the basics to investing in the beginning chapters. He explains how the market is random and will always be random. Anyone claiming that they have the ability to predict the market should be taken with a grain of salt.

Mr. Market is depicted as someone who is either optimistic or pessimistic about the market on a given day. Graham explains that Mr. Market is simply there for people who are willing to take the opportunities presented by him. You are never forced to trade with him unless you want to. Which is why his optimistic or pessimistic view can be taken as an advantage.

Optimistic outlooks can be viewed as selling opportunities, while pessimism can be viewed as a bargain. Your ability to detach your emotions from trading will assist you in making the right financial decisions.

Price and Value Are Not The Same

The value of a company does not correlate with its price on the stock market. The stock market is how the public views the company. Connecting this back to Mr. Market, would you be selling your company for a major loss simply because of the outlook that he is presenting you?

Mr. Market is not always going to be rational, which is why your ownership of the stock will not always be equal to the true value of the company.

Companies can be valuable but its stock price could be mediocre due to many reasons. Here’s a list of following reasons for why a company’s stock price might be lower than expected.

  • Public image has been damaged due to PR disaster.
  • Scandals regarding management.
  • Market downturn.
  • Company has cut its dividends.

Although these are a few temporary setbacks, the overall value of a company can be determined by its balance sheet. Looking into their revenues, earnings, future growth and return on equity, you can determine if it is worth the market value that is being presented.

Establishing A Margin Of Safety

Safeguarding yourself from financial demise is what Graham’s book does best. Minimizing risks is what every investor should prioritize while performing trades on the stock market. It would be dangerous for you to purchase stocks due to its attractive pricing without any proper research.

In the book, Graham presents us with a formula to check the margin of safety of the company.

Graham’s Margin Of Safety Formula

Value = Current (Normal) Earnings X (8.5 + 2 X Expected Annual Growth Rate)

Its worth mentioning that Graham later updated this formula at UCLA:

Value = {EPS x (8.5 +2 X Expected Annual Growth Rate) X 4.4} / Y

In adding the 4.4, he required it as the minimum rate of return. In dividing by Y, you use today’s AA corporate bond rate to adjust to today’s interest rates.

In applying this formula, you are able to estimate the intrinsic value of the company you plan on purchasing. He recommends purchasing a company that is 2/3’s or less of its intrinsic value is an adequate margin of safety.

To reiterate, developing a margin of safety is to ensure your purchases are not overly priced and poorly placed. Look for high quality companies that are struggling with temporary problems, they will offer the best returns with the safety net you are looking for.

Note: This is not a precise representation of the price but an estimation of the company’s intrinsic value.

Dollar Cost Averaging

Dollar cost averaging or formula investing is setting up a plan to invest the same amount on the same day each month or week. Establishing this plan will prevent you from being swindled into the optimistic or pessimistic views of the speculators.

If you follow this plan, you are less likely to become emotionally attached to your investments. Compared to someone who is day trading and is swindled by gains and losses. Since you are not concerned with day to day gains or losses, your portfolio’s performance will not matter until you begin withdrawing from it.

Graham suggests dollar cost averaging as the best route for investing for newer investors as you will develop a plan for your portfolio. To reiterate Graham’s main points, consistency and patience are the two most important parts about investing.

Investment Versus Speculation

Newer investors might be swindled into thinking that they can base their purchases off of prices. This thought process towards investing is practically gambling, since you are not performing your due diligence in understanding what you own.

Speculating is one of the biggest shortcomings to investors who believe in their gut over proper research. The uncertainty that you continue to develop within your portfolio, due to speculative investments will increase your risk, which would lead to huge losses if done incorrectly.

In short, Graham advises against anyone treating investing as a means of speculating. In the case that you are able to make returns from speculative endeavors, it is important to not exaggerate their outcomes. In doing so, you will continue to double down on future losses and further advance your portfolio into the red.

Next Book To Read

I am currently reading Think and Grow Rich by Napoleon Hill, my intention is to read fifty personal finance related books by the end of 2020. The next one I plan to read after this is going to be The Book on Rental Investing by Brandon Turner.

If you have any suggestions on what books to read, please feel free to reach out as I am always looking to add more into my collection.

Conclusion

If you are considering to start an account with a brokerage in the near future, I advise you to give The Intelligent Investor a read prior. Some readers think it contains outdated information, but I believe that it is a great way to get you interested in understanding the basics of investing.

Jason Zweig adds commentary in between each chapter, modernizing Graham’s writing for new investors as well. Offering quotes and insight on what Graham was trying to convey in an effective manner.

Graham reassures new investors throughout his writing that investing is simple and can remain that way if you choose defensive investing as your cup of tea. If you are willing to put in the time and effort to learn about the stock market then enterprising investing will be a challenge worth learning.

Both investment strategies are effective at providing the returns you are seeking. Consistency is key to investing as the goal is to build long term wealth. The stock market is a roller coaster ride full of emotions and your ability to remain steadfast is what will determine your success or failure in the endeavor.

Source: Medium.com

Remember that you are not competing with anyone in this race, your investment journey is a step towards obtaining financial freedom. As long as you finish the race in one piece then you have done everything right.

If you are interested in purchasing the book, feel free to use my affiliate link down below.

The Intelligent Investor by Benjamin Graham

As always, I hope you found my article informative and I look forward to next Thursday’s article. Also, if you could provide feedback on this one I would really appreciate it! It is completely different from my blog posts as I don’t really do reviews.

Stay healthy everyone and until next time!

Published by Steven Mai

Hello! My name is Steven Mai and I am currently enrolled at University of Washington. My interests are business, investments, financing, and personal development. I hope through this journey I will be able to enhance my skills as a writer and share my ideas on a public platform and gain the necessary skills in life through interactions with the community.

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