January: The Intelligent Investor by Benjamin Graham

Considering that Benjamin Graham was Warren Buffet’s teacher on investments, I thought that this book would be perfect for me to learn about stock portfolio management. I ended up learning way more than I ever expected on bonds, convertible notes, common stocks, intermediate bonds, T-Bills, etc. I had to have Google Search open next to me as I began to define all the new vocabulary. A far warning, this book reads very much like a text book with solid financial modeling, historical case studies, and statistics to back every single argument. I would recommend buying the “revised edition” (http://amzn.to/1S1cjZP) where you are able to receive a modern chapter that complements every single one of Graham’s chapters. With both versions side by side, the book ended up being 536 pages. If I didn’t have both versions, I probably would not be able to grasp all the concepts in this very detailed and comprehensive investment book.

Okay. So here is my take on intelligent investing. Let me attempt to break this into four big ideas.

Big Idea 1: Don’t be like everyone else

Big Idea 2: Invest intelligently

Big Idea 3: Capitalize on tiny market opportunities

Big Idea 4: Be skeptical

Big Idea 1: Don’t be like everybody else

This idea forms the basis for the entire book.

In order to really grasp this, these two concepts are important to understand.

a. Market fluctuations

b. Being intelligent v. speculative

Market Fluctuations

All stocks look like this. The reason for the dramatic ups and downs is related to the fact that the majority of people invest based on their emotions.

The metaphor Dr. Jekyll and Mr. Hyde that Graham uses to describe this bi-polar nature of the market is brilliant. When stocks goes up, people are driven by excitement and pay more than their objective value. When they begin to tank, the mood shifts dramatically and millions of people begin to desperately dump them for less than their true worth.

This is not a good game plan. These people (the majority of people) are whom Graham calls “Speculators” and not true “Intelligent Investors”

Being Speculative v. Being Intelligent

So how does one become intelligent?

1. Practice emotional discipline
2. Thoroughly analyze the companies you invest in
3. Aspire to adequate, not extraordinary, performance

This is the same stock, but zoomed out to 10 years. Notice that despite the peaks and valleys, it still steadily increases.

Thus, an intelligent investor:

• values sustainable growth
• relies on logic instead of emotion to make decisions
• thinks long term instead of short term

Big Idea 2: Invest intelligently

Now that I drew a distinction between intelligence and speculation, I’ll go into big picture strategies that Graham promotes. The book is incredibly detailed and this post would be too long to summarize every strategy that he lays out. But after reading the book from cover to end, I picked up 2 big picture strategies. I will go into the research criteria for both that are the foundation to analyze whether convertibles, foreign bonds, etc are a good investment or not.

Two Big Picture Strategies

1. Continually research, select, and monitor a dynamic mix of stocks, bonds, or mutual funds
2. Create a permanent portfolio that runs on autopilot and requires no further effort (but generates very little excitement)

Graham calls the first approach as being very enterprising while the second approach as being defensive. The difference isn’t drawn on whether or not you are aggressive // innovative // risky but rather how much time you are willing to research to put together your portfolio.

Because remember,

Intelligent Investment Choices = Based on Research

Speculative Investment Choices = Based on Emotion

So let’s dig into the research aspect to picking stocks, bonds, and mutual funds. Graham has different strategies for each one, but for the sake of simplicity, I am going to focus on stocks.

Big idea: Stocks perform as well as the company is performing and set up to perform

Enterprising approach: You should analyze how the company is inherently doing by looking into its general long term prospects, quality of its management, financial strength and capital structure, dividend record, and current dividend rate.

Defensive approach: Own a very diversified index fund that is routinely altered by a certain percentage point and that you put in a set amount of money over a certain time period.

The key here is to go for sustainable growth over a long span of time.

For more in depth strategies, I advise reading the book further. There are 536 pages total with specific methods and evidence to back them up.

Big Idea 3: Capitalize on tiny market opportunities

The book touches upon a few windows of opportunity that can present themselves. I will go into one that I found to be very interesting. One scenario that Graham describes is when a company with a very high stock price that fits the criteria of a stable, profitable company goes through a very temporal conflict. Although it is temporal, the stock still plummets as people read the news and start to drop their stocks. This is an opportunity to buy a stock at a great price. Remember, if you are thinking about the long game, a tiny hiccup doesn’t impact your overall return.

Section 4: Be skeptical

The book is filled with deciphering key terms that companies often use to cover up their losses and to maintain their own image of a profitable, high growth company. These key terms allow them to keep their stock price, but at the price of the people who hold their stocks. Because once things get so bad that they can’t cover them up anymore, the price tanks and often the company also begins to roll down hill.

Graham also goes into an entire due diligence process to vet out any potential financial advisers as well as people who want to give you advice on your stock portfolio strategy. Very very enlightening stuff.

I find these sections extremely helpful clearing up the “unknown unknown” pieces of knowledge for me. If you are giving your money to invest, it is important to undertake fierce due diligence to make sure that you are making the investment that will give you the return you need.

Anyways, these are 4 big ideas I took from The Intelligent Investor. Remember, if you are interested in buying, get the “revised version” — you’ll need it!

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