Chapter 10: The Investor and His Advisers
**Quick update** Thanks for reading, I’ve compiled this entire series into an electronic copy that you can take offline → here
Welcome back to the Intelligent Investor series. In this chapter of The Intelligent Investor, Graham turns his attention to those that will often influence the investor’s buying and selling decisions. Whether you’re an enterprising investor, or a defensive investor, being an Intelligent Investor also means understanding the motives, knowledge and credentials of those that help you make your investment decisions. Here’s the list of preceding posts if you’d like to get caught up:
- Intro and Chapter 1 , Chapter 2, Chapter 3, Chapter 4, Chapter 5, Chapter 6, Chapter 7, Chapter 8, Chapter 9
Graham uses this chapter to set the stage for Chapter 11 which has a technical focus on stock analysis. Although this chapter is relatively short , there are a number of fundamental takeaways within it that boil down to the following: The Answers You Seek and Where Answers Are Found.
The Answers You Seek
The first thing Graham does is point out the reason you’re looking for answers, and the fact that you may not be looking for the right answers in the first place.
If the reason people invest is to make money, then in seeking advice they are asking others to tell them how to make money.
He then goes on to remark that “Businessmen seek professional advice on various elements of their business, they do not expect to be told how to make a profit… When they, or nonbusiness people, rely on others to make investment profits for them, they are expecting a kind of result for which there is no true counterpart in ordinary business affairs.”
I think making this distinction up front is one of the wisest things Graham has written thus far. It encourages the reader to realize that they themselves are the ones who will make the impact on their own fortune at the end of the day. The Intelligent Investor knows he is in the driver’s seat of his own financial destiny. Even though it is tempting to pay a premium price for someone or something to tell you exactly what to invest in, you still make the decision, and whether you win or lose is dependent on your understanding of the material those influential opinions are based on.
Where Answers Are Found
Graham states that the investor can find answers in the following five areas. I’ve updated item four with internet and television given the popularity for investors and speculators alike to use these mediums as a means to help form their investment decisions.
Advice can be found from :
- A relative or a friend, presumably knowledgable in securities
- A local (commercial) banker
- A brokerage firm or investment banking house
- A financial service or periodical, internet and television
- An investment counselor
Graham tackles advice from “Investment Counsel and Trust Services of Banks” first. He believes that their biggest value-add to their customers is that they typically shield their customers from themselves. The point he makes here is that these firm’s have the primary goal of protecting their customers’ principal; not exactly to try and return massive percentages. Zweig adds some commentary here that, today, many of these types of advisory firms cater primarily to $1M+ investors. He feels that to the detriment of the customer, “diversification” has replaced “quality” as the standard of safety. While Graham may agree that diversification can play a hearty role in a wise investment policy, I doubt he’d emphasize diversification over quality.
More information can be gleaned from “Financial Services” that specialize in producing informative reports and guidance for those directing their own financial affairs or are advising others themselves. Graham remarks that firms that only specialize in using “technical” methods are to be disregarded as “their work does not concern “investors” as the term is used in this book”. Graham appears pretty cynical about the value these “Financial Services” offer, he focuses on the fact that the average speculator-investor in the market mainly wants to be informed by someone (often anyone) with some type of authority about what the market will do. Since this need exists, the “Financial Services” businesses are there to satisfy the demand. He delves deeper by remarking that what these firms do best is highlight the need humans have to be told what to do , and how to make money by someone else. In short:
The intelligent investor will not do his buying and selling solely on the basis of recommendations received from a financial service. Once this point is established , the role of the financial service then becomes the useful one of supplying information and offering suggestions.
Graham moves on to looking at gaining advice from Brokerage Houses. He defines this type of knowledge acquisition as a Brokerage House client gaining insights into investment picks and information directly from the Brokerage House through their “registered representative”. Typically, much of the investing public falls into this category and there are definitely ways for the public to use the information to their advantage; as long as they are clear about their objectives to invest, not to speculate. Graham remarks that because most of the profitable customers want speculative advice and suggestions , the thinking and activities of the typical firm are geared for a day-to-day trading in the market, which is positively not the type of advice Graham would give. He doubles down on this belief when he calls attention to the fact that the “registered representative” typically gets paid on commission, therefore, the representative is biased to be speculative-minded. Fortunately, the following advice is given to capitalize on the wealth of knowledge held in these institutions:
…the security buyer who wants to avoid being influenced by speculative considerations will ordinarily have to be careful and explicit in his dealing with his broker; he will have to show clearly, by word and deed, that he is not interested in anything faintly resembling a stock-market “tip”. Once the customer’s broker understands clearly that he has a real investor on his hands, he will respect this point of view and cooperate with it.
Moving into the realm of working with Investment banks, Graham expounds on their ability to do something admirable: moving money into markets with potential to grow and positively impact society. Certainly, this section of the reading is interesting to those of us that are stringent followers of Free Market philosophy so, I’ll leave the reader to focus their own attention on those remarks within the text. Although he states the following in the section on Investment Banks, I think this advice applies to all portions of this chapter:
The intelligent investor will pay attention to the advice and recommendations received from investment banking houses, especially those known by him to have an excellent reputation; but he will be sure to bring sound and independent judgement to bear upon these suggestions — either his own, if he is competent, or that of some other type of adviser.
A note about a CFA
Graham does shed light on the accreditation of a security analyst who has earned the distinction of a Certified Financial Analyst. The CFA certification is awarded by the Association of Investment Management and Research only after the candidate has completed years of rigorous study and passed a series of difficult exams. Zweig breaks in here to offer results from a study that indicate that unfortunately, most CFAs ignore Graham’s emphasis on quality of earnings, risks, dividend policy in determining P/E ratios , instead focusing their buy rating on recent price than the long-term outlook for the company. The intelligent investor should remember that most analysts do not analyze businesses, instead they engage in guesswork about future stock prices.
Advising for the Defensive and Aggressive investor
We’ve now seen the different avenues each investor has at his disposal to gain information and advice about their investment decision. Graham breaks down how he thinks the Defensive investor should leverage the information that’s available to him.
He believes that, because the defensive investor works in the realm of a more passive investment strategy, he’s unlikely to challenge or give healthy review to his advisor’s recommendations. Rather, he would do well to follow the prescription of high-grade bonds and the common stocks of leading corporations that can be purchased a levels that are considerably low based on the perceptions of experience and analysis. Leveraging a security analyst, he should be able to procure a listing of these types of common stocks and be confident that the existing price levels of those recommendations are reasonably conservative based on the analyst’s past experience.
The aggressive investor should work in tandem with his advisers. He should leverage them to make suggestions , and to do the heavy lifting of finding rather suitable issues and then insist on making his own judgement on those findings. Therefore, the aggressive investor should be comfortable, and confident in taking lead of his own judgement of these issues, being able to validate , or deny any recommendation from his advisers. This means the aggressive investor is required to be at least at the same level of knowledge of his advisers, but not necessarily of the exact mindset and philosophy of those advisers as he is the one who will make the final buy decision. Very rarely, and only in extenuating circumstances and through the previous demonstration of the competence of his advisers will the aggressive investor act on the advice of his advisers without understanding and approving the decisions being made. I would hazard to guess few investors should ever find themselves in such a situation. Leverage your advisers for their knowledge, let them do the heavy lift of finding a good list of potential investments then, with your own arsenal of investment knowledge make the final valuation analysis and decision.
As I continue to work through the chapters, my goal is to post on each chapter’s central tenets. If you find something out of place, or care to strike up a discussion feel free to comment or find me on twitter @DavidCappelucci.
Recommend the article if you found value in it and would like to follow along.
-David
