Ben Graham's book will repay its purchase price a hundred times over.
Having started this series on classic books with Peter Lynch's One Up On Wall Street, let's nip across the hall to revisit The Intelligent Investor by Benjamin Graham, which was first published in 1949.
You see, Graham's book is everything that Lynch's tome is not.
Whereas One Up On Wall Street is packed with anecdotes and puns, Graham talks dourly of 'stock market operations' and 'defensive investors'. His occasional dry asides are priceless, but they're as rare as the value stocks he searched for.
Similarly, where excitable Lynch is interested in everything from a company's name to what is hot in his local mall, Graham is sceptical about profiting from such observations.
In fact, whereas Lynch urges us to establish the story of a stock, for Ben Graham it's the numbers -- the intrinsic value of the business represented by the balance sheet, and its variance from the price put on it by the market -- that tell us everything we can reliably hope to know.
The intellectual investor
This contrast is ironic given the personalities of the two men.
Peter Lynch made hundreds of millions of dollars after getting his first job caddying for an established fund manager.
In contrast, despite being superficially nerdy in The Intelligent Investor, Benjamin Graham doesn't seem to have cared much about money, except as a way of keeping score. A true Renaissance man, after flying through Columbia University, he was asked by each of the English, Philosophy and Economics departments to stay on.
Instead Graham entered Wall Street, seemingly for the sport. He viewed finding cheap stocks as an intellectual challenge, and unlike his famous protégé Warren Buffett, he doesn't seem to pursued vast riches.
True, very little of Graham's interest in history, art, and literature (he even wrote a Broadway play) is evident in The Intelligent Investor.
Then again, perhaps all of it is. Because whereas most investment writing is gimmicky and fairly shallow, Graham's book -- whilst riddled with dated examples and speculation long gone into history -- is as unique for its spirit of intellectual enquiry as its once-revolutionary insights into evaluating companies.
Indeed, if all philosophy is a footnote to Plato, we might say all fundamental investment writing follows Graham.
Enduring insights
Many of the ideas Ben Graham popularised are now so widely appreciated that they may strike readers as unremarkable:
- A share being part-ownership of a business -- Having lived through periods where stocks were viewed as little more than lottery tickets (including the years before the 1929 crash), Graham stressed an investor was buying part-ownership of a business for a portion of its future profit.
- P/E ratios -- One way to evaluate a company is to compare its price to its earnings. Graham considered the average earnings over several years, as well as dividend streams. Low P/E ratios are less risky, he noted, because future profits are unproven.
- Price to book value -- Another way to value the business is its assets. Back in Graham's time, stocks often traded for less than the cash and easily-traded assets on their books. His ideal stock is worth less than its net short-term assets -- the money-making business comes free.
- Margin of safety -- Earnings might dip. The balance sheet might not accurately reflect reality. By looking for a discount and waiting for a bargain, you're investment is safer still.
- Diversification and asset allocation -- Diversification protects you from individual stock blow-ups, while dividing your portfolio between a variable allocation of equities and bonds can insulate you from market dislocations.
- Market psychology -- You need such protection because, as a group, investors are like the schizophrenic business partner Graham christened 'Mr Market', lurching between optimism and pessimism. You can take advantage of this.
- Index investing -- Passive tracker funds didn't arrive in Graham's lifetime, but there's no doubt he'd have urged them upon readers. The doyen of value investing repeatedly stresses how difficult beating the market really is.
60 years and going strong
Given how widely Graham's ideas have spread, there may seem little point in reading The Intelligent Investor, especially now his beloved deep value stocks have all but vanished during normal times.
I'd argue the book still has plenty to offer. Re-visiting it I'm struck by Graham's intellectual vigour -- reading him is like an Oxbridge tutorial, with 'The Dean of Wall Street' anticipating your objections and challenging them.
For instance, despite being pigeon-holed as a 'cigar butt investor', always looking out for a cheap company offering one last puff, Graham understood and outlined the attraction of growth investing -- he just didn't see it working. To stretch that analogy with philosophy, it's like how Marx is considered a seminal thinker on capitalism.
The brilliance of Graham's writing is made clearer by the up-to-date commentary accompanying recent imprints.
While this contemporary Boswell does a competent job of reflecting upon the master's wisdom, the new sections already seem dated and sensationalist; Graham reminiscing about railroads in the 1930s is more enduring than the modern journalist drawing parallels with a decade-dead dotcom meltdown.
Deep value
Ultimately, Buffett went beyond Graham's methods to incorporate an evaluation of business quality into his investing approach.
And given the legions of analysts scouring the market for value opportunities today, any investor following Graham's methods exactly would probably be left on the sidelines for years -- and be offered little more than microcaps when opportunities do crop up.
Yet this dearth of deep value shares is a testament to Graham's greatness and influence, rather than a flaw. And the past decade of market gyrations show his insights on investor psychology remain as pertinent as ever.
Most importantly, to absorb The Intelligent Investor is to understand the difference between investing and speculation, the stock market and the racetrack, and value versus price. And that's a lesson that will be valuable forever.
You can buy this book at the Fool Bookshop.
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