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Robert Abbott
Robert Abbott
Articles (254)  | Author's Website |

'The Intelligent Investor': A Guide for Beginners

Exploring the introduction to what Warren Buffett called 'the best book about investing ever written'

June 13, 2018

Value investors may have their disagreements about one thing or another, but practically all would agree they share a platform created by legendary investor and communication wizard Benjamin Graham.

At GuruFocus, his importance is highlighted by having a screener named after him, the Benjamin Graham Net-Net Working Capital Screener.

Because of his importance, I plan to profile each chapter in his seminal book, “The Intelligent Investor” (subject to reader interest). In this first article, we will go over the ideas presented in Graham’s introduction to his final edition of the book. This 1973 edition, the last of multiple editions, also includes a preface by Warren Buffett (Trades, Portfolio) and commentary by Jason Zweig (the latter republished this edition, along with his own commentary, in 2003).

“The purpose of this book”

Graham writes that he aims to produce a book for laymen, non-experts, a book that will guide them in adopting and executing an investment policy. It is not a book about analyzing securities, it is about investing at a more abstract level (although he will reference securities occasionally to make a point).

And, he proposes to explore the historical patterns of financial markets. As Graham says, if you plan to invest intelligently, you must know how various bonds and stocks have behaved in different conditions over the years.

Investors versus speculators

The second topic compares investors and speculators (also called traders by Graham). Of the speculators, he dismissingly says, "In our own stock-market experience and observation, extending over 50 years, we have not known a single person who has consistently or lastingly made money by thus 'following the market.' We do not hesitate to declare that this approach is as fallacious as it is popular.” He also takes on the notion that dollar-cost averaging is a sure way to riches, pointing to a famous investor and businessman of the 1920s whose advice to do so turned out to be very wrong after the passage of 20 years.

Overall, Graham is making the point that there are no free passes, that investors must not only know about stocks and bonds, but must understand how they have acted and interacted over the years. It's an interesting point when considered from a 2018 perspective: the bull market has gone well past its typical five- to seven-year span, and bonds have almost disappeared from the radar of most investors. One further point, in the first pages of the introduction he warns readers that his is not a book about making a million dollars.

Updating for the times

The 1973 version also serves to update the previously most recent edition (Graham says major revisions have appeared roughly every five years). Some of the changes, in the early 1970s, include advances in the interest rate on high-grade bonds, a collapse of about 35% in the prices of leading common stocks and a persistent inflation of wholesale and consumer prices. Those changes, he says, will mean changes in conclusions and emphasis from the previous (1965) edition. Note that he is not changing his investing principles; instead, he is changing the application of these principles to suit the times.

Perhaps in this observation, Graham has an unintended message for today. Referring to a recent stock meltdown, he says, "Evidently it is not only the tyro who needs to be warned that while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster."

Defensive and enterprising investors

Graham makes a basic distinction between defensive (or passive) investors and enterprising (or active) investors. Defensive investors emphasize the avoidance of serious mistakes or losses, while enterprising investors emphasize spending time and care to finding above average securities.

He goes on to challenge the idea that the art of successful investing lies in finding growth industries and identifying the most promising companies within those industries. From this point, he goes on to offer "two morals" for readers:

  1. “Obvious prospects for physical growth in a business do not translate into obvious profits for investors.”

  2. “The experts do not have dependable ways of selecting and concentrating on the most promising companies in the most promising industries.”

Finally

Winding up the chapter, he further elaborates on his goals for the book. One involves helping readers avoid serious mistakes and to create policies with which they will be comfortable. A second involves encouraging readers to measure or quantify the "habit of relating what is paid to what is being offered is an invaluable trait in investment." Third, Graham says he will offer a "positive program for common-stock investment," with recommendations for both defensive and enterprising investors.

And then there's the matter of beating the averages by being clever. In discussing this, Graham aims his criticism at those who think just a little bit of extra knowledge, combined with a representative list of securities, will make them better than average investors. He notes the number of smart people who try this and fail is surprisingly large. Instead, just create a simple portfolio policy--high-grade bonds plus a diversified list of leading common stocks.

Finally, Graham looks back on his 57 years in the investment industry. While all sorts of unexpected good news and bad news came and went, "it remained true that sound investment principles produced generally sound results. We must act on the assumption they will continue to do so."

Comments of others

In his commentary to the Introduction, Zweig takes on this key question: What is an “intelligent” investor? He says Graham defined the term in the first edition of the book to mean someone who is patient, disciplined and eager to learn. In addition, intelligent investors harness their emotions and think for themselves. Zweig quotes Graham as saying this kind of intelligence “is a trait more of the character than of the brain.”

Further in that vein, Buffett writes in the preface that successfully investing over a lifetime does not require a high IQ, special business knowledge or inside information. Instead, investors need a sound intellectual framework and the ability to control their emotions.

Personally, as the writer of this review, I’m struck by several elements in the Introduction:

  • Graham is embarking on a voyage of what we now mostly call “behavioral finance” many years before that idea became embedded in standard investment advice.
  • He also introduces us to a historical perspective on securities, pointing out that while stocks may be this cycle’s flavor, it’s quite possible bonds may be the flavor of the next cycle. For 2018, it is a reminder that stocks may be replaced by bonds in an upcoming cycle.
  • While his principles remain intact cycle after cycle, his application of the principles needs to change to suit the seasons, so to speak.
  • Like the rest of us, Graham is influenced by the times and the book often reflects the events of the early 1970s. Similarly, Zweig’s commentary (his edition was published in 2003) reflects the lead-up to and consequences of the dot-com crash. And, we read it with the mindset of people living in 2018.

“The Intelligent Investor” is easy to read and contains the key kernels of value investing. I encourage readers of this article to read the book; it is available at many booksellers.

About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995, and in 2010 added options, mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the Unseen Revolution. In Big Macs & Our Pensions: Who Gets McDonald's Profits?, he looks at the ownership of McDonald’s and what that means for middle class retirement income.

In an eclectic career, Robert Abbott was a radio news writer and announcer, a newsletter writer and publisher, a farmer, a telephone operator, and a construction worker. When not working, he has been a busy volunteer, which includes more than a decade of leadership roles at the Airdrie Festival of Lights, one of North America’s leading holiday light displays. He lives in Airdrie, Alberta, Canada.

Visit Robert Abbott's Website


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