The Intelligent Investor

Benjamin Graham

📚 GENRE: Business & Finance

📃 PAGES: 640

✅ COMPLETED: February 25, 2020

🧐 RATING: ⭐⭐⭐⭐⭐

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Short Summary

In one of the classic investing books of all time, Benjamin Graham reveals the fundamentals of value investing, helping readers avoid catastrophic errors and develop sustainable long-term market strategies. 

Key Takeaways

1️⃣ Keep Your Cool — When the market is falling, that’s the time to pick up quality companies at good prices. Don’t panic and sell at a loss just because other people are doing it. As turbulent as they can be, market drops ultimately open up good opportunities to add quality companies to your portfolio.

2️⃣ Consider Dollar Cost Averaging — Dollar Cost Averaging (DCA) involves investing an equal amount of money in an index or mutual fund in regular intervals (every week, month, etc.). Depending on how the market is performing, the same dollar amount may get you more or fewer shares each time you invest. DCA takes the guess work out of investing and helps you avoid poor timing.

3️⃣ Do Your Homework — Never invest your hard-earned cash without first doing some research. Ideally, you want companies to have a sound balance sheet and income statement with clear opportunities for growth and expansion. If you can find these companies and pick them up at fair prices, do it.

Favorite Quote

"Those who do not remember the past are condemned to repeat it."

Book Notes 📑

Introduction

  • The sillier the market, the greater the opportunity for the wise investor. 
  • Bad Approach — Buying a stock because it is going up or selling a stock because it is going down.
    • This is what most people tend to do.
  • This book was written in 1949, with revisions every five years. 
  • This book is for two types of investors: 
    1. Defensive — More passive. Emphasis on not making big mistakes. Meant for people who don’t want to have to make a ton of decisions or analysis with their portfolio. 
    2. Enterprising — Aggressive. Willingness to devote time to selecting good investments. 
    • Today, both approaches work well. Enterprising investors used to do better, but now the patient and defensive investor also does very well. 
  • The art of investing is in finding industries most likely to grow in the future, then identifying the leading companies in those industries.
  • This book recommends putting money into stocks that are in proven and stable industries, rather than chasing gains in newer or glamorous industries that can be unpredictable. 
    • The book recommends a simple investment approach that includes the purchase of high-grade bonds and a diversified list of leading common stocks.

Introduction Commentary

  • This book will teach three key lessons:
    1. How to minimize the risk of huge losses 
    2. How to maximize chances of sustainable, good gains 
    3. How to control self-defeating behavior that hurts most investors
  • There’s a big emphasis on avoiding big losses in this book. 
    • Stocks and bonds will always go down a little bit at times, but we want to avoid huge, irreversible losses.
  • An intelligent investor is one that is patient, disciplined, and eager to learn.
  • Never try to play the market. It’s way too risky.
  • Big developments that have happened in the past years and decades:
    • The worst market crash since the Great Depression (2000-2002).
      • US stocks lost 502% of their value.
    • Huge drops in stock price for top companies in the 1990s — AOL, Cisco, QUALCOMM. 
    • Accusations of big fraud at the largest, most respected financial institutions in the United States.
    • Relentless decline in interest rates that has left investors with no better option than stocks. 
    • Terrorism and war threats affecting the markets.
  • Late 1990s/Early 2000s — Internet stocks were surging. Everyone hyped them up and bought them. They came crashing down a few years later after the bubble popped.
    • If you buy a stock after everyone else has, the stock’s value has nowhere to go but down. 
    • Unless you invest very early, you’ll likely lose money on an unproven industries stock. 
    • Don’t follow the crowd and buy high. Don’t just buy at any price because everyone else is.
  • Stocks become riskier as the price rises, and less risky as they fall. 
  • As an investor, you should welcome a Bear Market over a Bull Market.
    • Bear Market — Stocks go on sale.
    • Bear Market — Stocks are costlier to buy.

Chapter 1

  • Investment vs. speculation
    • Investment — promises safety and a good return.
    • Speculation — anything that does not promise safety and a good return.
  • Quote: “Those who do not remember the past are condemned to repeat it.”
  • There is always risk with any investment. It’s about limiting the risk of losing big.
  • Unintelligent Speculation:
    1. Speculating when you think you’re investing.
    2. Risking more money in speculation then you can afford to lose.
  • Speculation is gambling. It’s exciting but risky. It’s OK to do in very small doses.
    • Ex. Investing in some hot commodity. It’s speculation. 
  • A 50-50 split in bond and leading common stock portfolio is recommended.
    • Never have less than 25% of your portfolio in bonds, but never have more than 75% in bonds either.
      • Same rule goes for common stock.
    • You can adjust the splits based on market developments.
      • If you feel like stock prices are low at the time, you can increase the split in common stock. Vice versa.
  • Usually if the market is doing really well, it is bound to come back to earth.
  • Historically, bond prices have fluctuated much less than stock prices.
    • Interest and principal payments on bonds are much safer and protected than dividends and price appreciation of stocks. 
  • To find the percentage increase in the Dow Jones, take the difference between its starting position at the beginning of the year and end of the year and divide that number by the number it was at the beginning of the year. 
  • It’s impossible to predict stock market trends and prices.
    • Don’t go for the new, hot stock. 
    • Invest in reliable companies with long record of profitable operations and finances.
  • For Enterprising Investor to do well:
    • Short Selling — Sell issues that you don’t own and have borrowed. Objective is to benefit in the decline of the stock by buying back at a price lower than what you sold them for. 
    • Short-term Selectivity — Buying shares from companies rumored to report high earnings. 
    • Long-term Selectivity — Banking on a company that has shown good, steady growth. Banking on that continuing or banking on a newer company doing well based on its product or outlook. 
  • Finding undervalued stocks is the way to make big gains. This is very difficult to do, however.

Chapter 1 Commentary

  • Thoroughly research a company and its business before investing in it. 
  • Never expect huge gains. Strive for marginal, consistent gains over time. 
  • Investors judge the market price by looking at the underlying business. 
    • Speculators judge value based on market price. 
  • Investing is a long-term thing. You can do very well in investing properly and patiently. 
  • Late 1990s — Millions of people were trading online. Day trading exploded. Stock turnover was really short. It was almost looked at like a video game. 
  • You need to look into a company and determine its record of profitability before investing.

Chapter 2

  • Inflation — The shrinkage of the purchasing power of the dollar. 
  • Inflation has historically happened and will continue to happen. 
  • 3% rate of inflation is usually expected.
  • Common stock has typically outperformed bonds historically.
  • Inflation or deflation doesn’t necessarily equal increase or decrease in the stock market.
  • Large scale inflation is always possible and that could affect investors.
    • No guarantee that a heavy stock portfolio will counter severe inflation effectively, but it does provide better protection than bonds during inflation.
    • Having all bonds would leave you very vulnerable to inflation swings.

Chapter 2 Commentary

  • Inflation — Rise in the price of goods and services.
    • Inflation averaged less than 2% from 1997 to 2002.
    • Inflation hasn’t been very high in recent decades.
  • Inflation eats away at your cash.
  • It’s important to measure what you make in the stock market after inflation.
  • Some countries have had years where inflation was at 25%.
  • Inflation allows the government to cheapen the dollar and pay off debt.
    • In this way eliminating inflation goes against the government’s economic self-interest.
  • Buying stocks is common answer to protecting versus inflation. But it not always effective.
    • The stock market lost money in 8 of 14 years where inflation was greater than 6% from 1926-2002.
  • Moderate inflation is OK. Stocks do pretty well. But high inflation is bad on stocks.
    • Mild inflation allows companies to pass increased costs of the raw materials on the customers.
    • High inflation means havoc, leading customers to buy less and reducing activity in the economy.
  • Two inflation fighters:
    • REIT — Real estate investment trust
      • Own and collect rent from residential and commercial properties.
      • Often bundled into real estate investment mutual funds.
      • The Vanguard REIT Index Fund is a great choice. The Fidelity Real Estate Investment Fund is also solid.
    • TIPS — Treasury inflation protected services
      • Government issued bonds, introduced in 1997, that automatically go up in value when inflation rises.
      • All Treasury products are safe from default because they have the full backing of the United States government.
      • The IRS considers gains when inflation rises as taxable income.
        • Because of this, TIPS only really make sense for a tax deferred retirement account, like an IRA or 401(k). They will not jack up taxable income here.
      • Do not trade TIPS. They are volatile. They should be kept for life. Allocating 10% of retirement funds to TIPS is a great way to keep a portion of your money completely safe.

Chapter 3

  • It’s really difficult to predict future stock market performance based on the past.
  • Generally, the higher the market, the higher the risk.
    • Late 1990s — Stock market was consistently high. Market went on crash hard in 2000-2002
    • 2000 — Dow Jones at 11,887.
      • End of 2002 — Dow Jones at 8,300
  • When all investors come to believe stocks will make them money, the market is driven up and stocks become overpriced. Once that happens, how can future returns possibly be high?
    • You have to pay what you want to pay for a stock. Don’t let the overpriced market or other people persuade you into overpaying.
  • Stock market performance depends on three factors:
    • Real Growth — The rise of a company’s earnings and dividends
    • Inflationary Growth — The general rise of prices throughout the economy
    • Speculative Growth or Decline — Any increase or decrease in the public’s appetite for stocks
  • The yearly growth in corporate earnings per share has averaged 1.5-2%, not counting inflation.
  • 2003 — Inflation was running at about 2.4% annually.
    • Dividend yield on stocks was 1.9% in 2003.

Chapter 4

  • The rate of return you get on your portfolio in part depends on your level of effort.
  • If you pay attention and do research, you will know the right time to lower the percentage of stocks in your portfolio and when to increase the number of stocks in your portfolio.
    • Drop the percentage of stocks — Bull market as prices are being driven up.
    • Increase the percentage of stocks — Bear market as prices are dropping.
  • For bonds, you have two main questions to consider:
      1. Should I buy tax-free bonds or taxable bonds?
      2. Should I buy shorter or longer term bonds/maturities? 
  • For the tax or tax-free bonds decision, do some math.
    • Find the difference in yields as compared to your tax bracket.
    • Municipal bonds = Tax-free bonds
    • Ex. 1972 — Choice of 7.5% Grade AA corporate bonds or 5.3% tax free bonds
      • 5.3 / 7.5 = 0.70. There’s a 30% difference between the yields on these two types of bonds. If the investor is in a max tax bracket greater than 30%, he would get more by choosing municipal, tax free bond. He would want the corporate bond if his tax bracket was under 30%. 
  • For many years in the past, most sensible bonds were the US savings issues.
    • These were very safe and gave a better return. They had a money back option. These are still solid bonds.
  • Other quality bonds:
    • United States Savings Bonds — Series E and Series H.
      • Interest is paid semiannually.
    • State and Municipal Bonds — Exempt from federal income tax.
    • Corporate Bonds — Subject to federal and state tax.

Chapter 4 Commentary

  • You should only buy tax free municipal bonds outside of your retirement fund.
    • The only place it makes sense to own taxable bonds is inside your 401(k), where you won’t owe any current tax on their income.
  • Interest rates rise and bond prices for interest rates fall, bond prices rise. 
    • Interest rates and bond prices have an inverse relationship.
    • To avoid issues, buy 5-10-year maturity bonds. Otherwise, you have to guess interest rates to buy short- or long-term bonds.
  • Doesn’t make a lot of sense to buy individual bonds. Buy bond funds instead.
    • Bond funds offer cheap and diversified bonds. You also get monthly income from bond funds.

Chapter 5

  • Four rules for common stock in your portfolio:
    1. Adequate but not excessive diversification
      • Between 10 and 30 stocks
    2. Each company selected should be large and prominent and well financed
    3. Each company should have a long record of dividend payment
    4. Investor should have some limit on the price he will pay for a stock in relation to its average earnings over the past seven years
      • 25 times such average earnings would be the goal
  • Growth Stock — Stock that has increased its per-share earnings in the past at well over the rate of the most common stocks and is expected to continue
    • These stocks are exciting because of their rate of growth, but are vulnerable to big crashes
    • When the stock price rises well over the profit line, it’s a growth stock.
    • These are usually more speculative.

Chapter 5 Commentary

  • You need to do your homework before investing in a company’s stock.
    • Study a company’s financial statements.
  • Mutual funds are a relatively simple way of diversifying your portfolio.
    • An analyst picks and monitors a group of stocks for you.
    • Mutual funds and ETFs are great for passive and defensive investors.
  • Dollar Cost Averaging — Allows you to put a fixed amount of money into an investment at regular intervals. 
    • Every week, month (or whatever you decide) you buy more of a stock or mutual fund, regardless of its price.
    • This allows you to avoid dropping a big sum into a stock at a bad time in the market. It spreads out the investment with small additions over time.
    • The best way to do this is into index funds, which on good bonds and stocks of good variety.
    • Ex. You have $500 per month to spare towards investments each month. By dollar cost averaging that money into three index funds — $300 into one that holds the total United States stock market, another $100 into one that holds foreign stock, and the last $100 into one that holds United States bonds — you ensure that you own almost every investment on the planet worth owning.

Chapter 6

  • Junk bonds, which have high yield and high risk, should not be invested in.
  • Never buy bonds just for the yield. Don’t get sucked into bad quality bonds because they have high yields.
    • The higher the yield, the worse the quality of the bond usually. This is because the low-quality issuer has to compensate the investor for taking a risk by lending to a shaky company. 
      • To attract buyers, low-quality issuers have to post high yields.
      • Usually unstable companies are offering these high-yield bonds. If they end up having financial issues, you’re screwed.
  • Day trading is terrible.
    • The costs and commission/broker fees eat away at your returns. And most of your day trading won’t even be successful.
    • Also, long-term investing in which you hold your stock for over a year is taxed at the capital gains rate (15%) when you sell rather than being taxed at your normal tax bracket rate.
  • IPO — Initial Public Offering.
    • When a company goes public and first offers at stock.
    • Most IPO are bad investments, with the exception of Microsoft.
    • Most high returns on IPOs go to big investment banks and fund houses, which get to buy shares at the initial underwriting price before the stock hits the public market.
      • This drives up to stock’s price before the public gets a chance to buy the overvalued stock.
    • IPO should mean “It’s probably overpriced.”

Chapter 7

  • Aggressive investors should focus on picking growth stocks.
    • Unless you get them early, growth stock prices are usually overvalued.
    • Investment companies that focus on picking growth stocks don’t even do that well.
      • The intelligent investor stays away from the risk of growth stocks.
  • Good Approach — Invest in big, successful companies that are going through a temporary struggle that might’ve caused their stock price to go down and be undervalued.
    • The key to this strategy is picking big and stable companies that are likely to bounce back.
    • Look for companies that have an undervalued stock price compared to good and consistent past earnings.

Chapter 7 Commentary

  • When a stock’s P/E ratio is above 25, the odds of it sustaining or being a good option get worse.
  • It’s advisable to put money into mutual funds that hold foreign stocks.

Chapter 8

  • Timing and pricing are the two ways investors can take advantage of fluctuations in the stock market.
    • Timing — Buy stocks when the market is down and sell when the market is high.
    • Pricing — Buy stocks when they are undervalued.
  • What to look for before buying a stock:
    • P/E ratio is satisfactory.
    • The company is in strong financial position.
    • Earnings record is very strong and has a strong likelihood of growing in the future.
  • The intelligent, defensive investor focuses on acquiring good and stable companies at good prices and hold his position for the long term.
    • The speculator tries to take advantage of market fluctuations too much by buying and selling too frequently.

Chapter 8 Commentary

  • You could sell and take a loss on stocks to use towards your taxes. The IRS allows you to use up to $3,000 losses in stocks towards lowering your taxable income each year. 
    • This is one of the reasons November and December are rough months for stocks. People sell off their losses to claim the tax break before the new year hits.

Chapter 9

  • Mutual funds are relatively cheap and diverse and well managed.
    • The downside to mutual funds is that they typically charge fees and could be managed poorly.
      • The higher a mutual fund’s expenses, the lower its return to the investor.
  • One of the reasons mutual funds don’t consistently perform well is because when it performs well, tons of people start buying it, which forces the fund manager to have to manage more money. If he puts the additional money into the fund’s current stocks, he drives the price of those stocks up too much so they are overpriced and will likely crash. If he uses the new money to invest in new stocks, he has to do a bunch of research and make sure that the new stocks are not too risky.
  • The cost of running a fund is usually 1.5%. When you add that to 2% trading costs (on average), the fund has to outperform the market by about 3.5% just a break even every year.
  • When a fund is succeeding, fund managers get more conservative and take less risks than what they did to get the fund performing well.
    • Fees for running the fund also go up typically when the fund is succeeding.
  • Index funds, therefore, are better than mutual funds as they beat most mutual funds in the long run because of low fees and expenses.
    • Index funds include all of the stocks in an industry or category.
      • The Dow Jones and S&P 500 index funds are examples.
    • Index funds are better because they don’t try to pick the best stocks in a category. They include all of them.
    • Operating costs and trading cost fees are much lower than mutual funds too.
  • The only downside to index funds is that they are boring. They take a long time to gain significant numbers, but they will always do well.
    • As the years go by, you will make big gains with index funds. Add money to them every month or week via dollar cost averaging.
    • Warren Buffett and Benjamin Graham both say that index funds are the best option for individual investors.
  • Morningstar.com gives good ratings on mutual funds.
  • ETF — Exchange Traded Fund
    • These are very low-cost funds. No managers involved.
  • If you invest in any type of fund, you need to be patient. Unless you have to, you should not sell a fund for at least three years.

Chapter 11

  • Management of a company is very critical when deciding to buy a stock. The CEO and leadership matters.
  • Also important to look at the company’s financial strength in capital structure when evaluating.
    • Companies that have a cash surplus are a better purchase than those that are using debt to get by.
  • Dividend record is another thing to look at when evaluating a company or stock.
    • Continuous dividend payment over the last 20 years is a great sign.
      • Limiting your stock purchases to companies that meet this criteria is wise.

Chapter 11 Commentary

  • Look at the last five years of a company’s financial reports (Form 10K) from the Edgar Database (www.SEC.gov).
    • Answer this: “What makes the company grow? Where do/will it’s profits come from?”
  • Positive Signs (income statement gives insight into these things): 
    • Strong brand identity (Coke, Harley Davidson)
    • Monopoly on the market
    • Economies of scale
    • Resistance to substitution
      • Ex. Utility Companies — electricity will always be needed. 
  • The income statement will tell you if revenue and earnings have grown steadily or not.
    • Growth of 10% before taxes is sustainable. Companies growing at 15% annually or more might fade.
  • Look at the balance sheet to see how much debt a company has.
    • Long-term debt should be under 50% of total capital.
    • In the footnotes, determine if the long-term debt is a fixed rate with constant interest payments, or variable with payments that fluctuate. 
      • The latter could be bad if interest rates rise.

Chapter 12

  • Don’t judge a company by a single year of earnings. Look for trends.

Chapter 12 Commentary

  • Many companies use accounting tricks to make their numbers look better than they are.
  • Read financial statements backwards. Start with the last page and work your way to the front.
  • Always read the footnotes.
  • Always compare numbers to other companies in the same industry.

Chapter 13

  • Seven criteria for selecting common stocks:
    1. Adequate size 
    2. Strong Financial Position
      • Current assets are at least twice the current liabilities. So, 8:1 current ratio.
      • Long-term debt should not exceed current assets / working capital.
    3. Earnings Stability
      • Company has made a profit every single year for the past 10 years.
    4. Dividend Record
      • Uninterrupted dividend payments for at least the last 20 years.
    5. Earnings Growth
      • Consistent growth in earnings every year for the past 10 years.
    6. Moderate Earnings to Price Ratio
      • The current market price should not be more than 15 times the company’s average earnings (P/E of 15) over the past three years.
    7. Moderate Price to Assets Ratio
      • The current price should not be more than 1.5 times the last reported book value.

Chapter 14 Commentary

  • Buy a total stock market index fund or ETF. It is the single best tool for a low maintenance, defensive investor.
  • Diversify to lower your risk and make steady gains.
  • Steer clear of stocks and companies with a total market capitalization under $2 billion.
  • Look for a 2:1 ratio of assets to liabilities when you analyze a company.

Chapter 15

  • Most professionals pick bad individual stocks. Be careful thinking you can do better.
    • Index funds are highly recommended.
      • It is recommended to put 90% of your common stock investing money into index funds.
  • When selecting individual stocks, Warren Buffett looks for franchise companies with strong consumer brands, easily understandable businesses, robust financial health, and near monopolies in their markets.
    • Ex. Gillette 
  • Buffett likes to pick up stocks after some sort of saga or scandal passes over the company. 
    • Ex. He picked up Coca-Cola after the company’s disastrous release of “new Coke” in the 1970s
  • Buffett likes to see managers set realistic goals and build their business from within rather than relying on acquisitions.
  • Buffett looks for consistent gains in earnings overtime.

Chapter 16

  • Convertible Bonds
    • The investor receives the safety of a bond plus an opportunity to participate in any big gains in value of the underlying common stock.
    • Issuer is able to raise capital at moderate interest. If the company succeeds, the issuer will exchange it for common stock.
  • Convertible bonds have typically done worse than common stocks, and are typically tied to inferior or subpar common stocks.
  • The ideal convertible bond is one that is strongly secured by the issuer and is linked to a strong underlying stock that has a good chance of taking off. 

Chapter 19

  • Stock Split — Restructuring the company’s common stock structure.
    • A stock split will typically offer two or three shares for everyone share that the investor already owns.
    • The purpose is to establish a lower market price for the single shares by pumping more shares into the market. 
      • When a stock splits, the price for one share drops.
  • Stock Dividend — Paid to shareholders to give them a tangible representation of specific earnings, which have been reinvested into the business for their account.
    • Stock dividends are when a company will pay you as the investor in shares, giving you more shares of their stock.
      • Ex. A 5% stock dividend paid to an investor that owns 100 shares means that the investor will now have 105 shares.

Chapter 19 Commentary

  • Read a company’s proxy statement as a shareholder of a company.
  • Historically, the greater a company’s dividend, the better chance for future profitability and earnings of the company.
    • If a company is offering a dividend, this is a great sign.
  • When a company buys back some of its shares in the open market, it reduces the number of shares outstanding. Even if its net income stays the same, the company’s earnings per-share (EPS) will rise since its total earnings will be spread out over fewer shares.
    • This will lift the stock price.
    • Unlike a dividend, a buyback is tax free to investors. 
      • Thus, it increases the value of their stock without affecting their tax bill.
  • Some companies have used stock buybacks to their advantage and not paid dividends at all.
  • If you see that a company is giving stock options to its managers, this is usually not great.

Chapter 20

  • Margin of Safety (Bonds) — Total value of the enterprise vs. the amount of debt.
    • Ex. If the business owes $10 million but is worth $30 million, there’s room for a 2/3 shrinkage in value before the bond holder will suffer a loss.

Chapter 20 Commentary

  • Pay good prices for good stocks. At the end of the day, this is the key to successful investing.
  • Good investing is managing risk, not avoiding it.