Where to find a book that will change the world.

Investing is like building a house. Without a plan, it is a disaster and it won’t end well.

The question is therefore: where do I find the plan?

In my opinion, there is one book that provides the start of a blueprint to shape and guide your investment approach. That book is The Intelligent Investor by Benjamin Graham.

This is a book that Warren Buffett has described as ‘by far the best book on investing ever written’. Need any more be said? The book was initially published in 1949 and still remains as important and invaluable today. It is the cornerstone of value investing. I still remember when I finished reading it the first time. It created a paradigm shift in how I looked at how companies operate and how they are valued. Reading it was such an enjoyable and memorable experience. Part of me wishes I could re-live that feeling of reading it for the first time again.

The Intelligent Investor is one of two seminal investment books written by Benjamin Graham. The second is Security Analysis, which was written with the assistance of David Dodd. There is much debate as to which of Graham’s two books are the most valuable and they both have their strengths.

Security Analysis is methodical and more of a text book on valuing and analysing all types of securities, such as bonds, preferential shares and common stock. It is a much drier read and more academic.

The Intelligent Investor is much more accessible and is written with this intention in mind. It aims to illustrate and demonstrate an approach to investing that looks at what underlies an investment. It focuses on learning how to value these securities in order to assess whether it should be purchased or not.

Graham distinguishes between what he considers to be ‘investors’ and ‘speculators’. Most people, from my experience, fall into the latter category. They make investment decisions without analysis or understanding of the actual value of the underlying company or security. They invest based on the ‘hot stock’ that is attracting media attention or on the basis of a product that is in vogue, rather than the underlying financials. They view shares as not part ownership of a company but rather something that is transient and separable.

In his distinction, Graham sets clear parameters as to where this line is drawn. He says that “an investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative”. Ask yourself, how many people do you know (including yourself) that would meet this definition of an investor.

Graham goes on to talk about enterprising and defensive investors. Enterprising investors, also referred to as active or aggressive investors, are those with a willingness to devote time and care to the selection of investments that are both sound and more attractive than the average. Defensive, or passive, investors will focus primarily on avoidance of serious mistakes and losses (spoiler alert: they should invest in index funds).

The book looks at approaches for both types of investors and gives guidance. It looks at comparisons between examples of different companies.

Without digressing into a summary of the entire book, there are two further subjects that Graham covers that I believe are essential to understanding value investing and keys to becoming a successful investor. These are ‘Mr Market’ and the ‘Margin of Safety’.

Mr Market is introduced in Chapter 8 — The Investor and Market Fluctuations — and is analogy of changes in market value for a particular investment. Graham asked the reader to imagine that they are the part-owner of a small business and that share is worth $1,000. One of your business partners is Mr Market. Every day, Mr Market bursts into your office and, with him being a forthcoming sort of individual, he tells you what he thinks your share of the business is worth and offers to either buy you out or sell you some or all of his share. Some days his valuation of your $1,000 stake is reasonable and justified. However, quite often, Mr Market gets caught up and lets his enthusiasm or fear guide him. Consequently, the value he proposes verges between unrealistic to ludicrous. The question Graham then poses to the reader is whether Mr Market opinion should dictate your view of how much your share of the business is worth. Well you should let it if you agree with his valuation or in circumstances where you want to make a deal. You might be happy to accept a high price for your share on one of his exuberant days. Likewise, you might be eager to buy from him when he is being pessimistic. Any other time, you would be better off to form your own valuation based on all the available relevant financial and other information.

Mr Market is an example of how investments can fall in and out of favour. At the extremes, this can lead to stocks being under- or over-valued. This presents opportunities for investors. It also challenges the commonly accepted efficient market theory that you cannot beat the market because the market always efficiently adjusts the price of shares based on all the relevant information available.

The Margin of Safety is an indispensable element of being a value investor. It is such a crucial concept that it hard to do it justice in a couple of paragraphs. Famous value investor Seth Klarman has written an entire (and now out of print and subsequently very rare and expensive) book on the subject and how it can be applied in different circumstances. Graham refers to the Margin of Safety as ‘the secret of sound investment’. The Margin of Safety is a buffer which protects the investor from losses. It is the principle of buying an investment at a discount to its intrinsic value. It provides both downside protection but also opportunities for high returns. For example, using the Mr Market allegory from above, if Mr Market was having a down day and offered to sell his share of the business at a 50% discount to what you have calculated to be the intrinsic value, then that discount would be the margin of safety. You are protected by the discount if your calculations are wrong. If you are right, then it is likely that the market will recognise the undervaluation providing you an opportunity to make a 100% gain. As Charlie Munger says “no matter how wonderful [a business] is, it’s not worth an infinite price. We have to have a price that makes sense and gives a margin of safety considering the normal vicissitudes of life.”

The Margin of Safety is not just a principle or concept. It is an investment motto that value investors live by.

I have the Revised Edition of the book which I highly recommend for several reasons:-

1. It comes with commentary from Jason Zweig that provides contemporary examples to further explain Graham’s teachings. Zweig is a very successful value investor in his own right and is a key writer in behavioural economics. His book ‘Your Money and Your Brain’ is another read that I would highly recommend.
2. It comes with a Preface from Warren Buffett.
3. It includes an article called ‘The Superinvestors of Graham-and-Doddsville’ written by Buffett. This article is worth its weight in gold and I would recommend everyone who is interested in value investing to read this, as it explains the common thread between this investing style and many successful investors.

In the book ‘The Education of a Value Investor’, author and investor Guy Spier talks about when he first bought and read The Intelligent Investor:

“I could not put it down. Graham spoke eloquently of owning a stock not as a piece of paper to trade, but as a share in a real business. He also talked of treating “Mr. Market” like a manic depressive and taking advantage of his shifting moods. As the market veers between fear and greed, investors can profit richly by focusing in a clear headed way on the intrinsic value of a company and exploiting the discrepancy between the price and the value. Sometimes you know in your bones that something is true. To me, this value-investing philosophy made so much sense that it was self-evident” (my emphasis).

The Intelligent Investor was a game-changer for me. If you haven’t read it I would encourage you to do so. It will either grab you or it won’t. But I suggest you give it a go.

Lastly, The Intelligent Investor introduced me to a particular value approach called ‘net-net’. What these are and how to find them will be discussed very soon.