Foolish Special
Book Review
The Intelligent Investor, by Benjamin Graham
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By Maynard Paton (TMFMayn)
Firstly, a clarification. This review was taken from the "Fourth Revised Edition" of The Intelligent Investor, published in 1973. This revised edition is a combination of the original content from the initial 1949 publication, with updates and comment throughout by Graham from the early seventies.
Graham quickly outlines what the book expects to achieve. Not so much a book about analysing companies, but a book where attention is mainly paid to investment principles and attitudes. He's also quick off the mark when differentiating "investing" and "speculating": "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."
After setting out his initial thoughts, Graham gets down to some gritty number-crunching. Trying to read Graham tackling the effect of inflation and evaluating a century of US stock market history is no easy task. It was strange to read Graham attempting to make forecasts on market direction based on 100 years' worth of statistics. After all, his pupil Buffett criticises such endeavours. Graham's outlook from 1972, though, is worth mentioning: "the investor must be prepared for difficult times ahead perhaps in the form of another bull market fling, to be followed by a more catastrophic collapse." Not bad.
On to the Portfolio Policy. Here, Graham differs from the traditional "more risk means more reward" relationship. He instead puts forward the alternative view of reward being dependent on the "amount of intelligent effort" put into the investment task. Thus divides his investment policies into two camps: the defensive investor, who has little time, knowledge or inclination, and the opposite enterprising investor.
Graham ponders the weighting between high grade bonds and equities for the two different investors, and suggests on the portfolio's equity selection criteria. For defensive investors, Graham advocates an "adequately" diversified set of large, conservatively financed companies, perhaps bought via "dollar cost averaging". Enterprising investors are also shown the merits of buying "bargain issues" (stocks selling for below their working capital value) and arbitrage "workouts". In short, Graham advises the enterprising investors to follow "sound but unpopular" strategies, the unpopularity indicating "value" could be at hand.
Surprisingly, for a book about individual investment philosophies, Graham touches upon Investment Funds and an investor's advisers. He's not particularly critical of either, even suggesting how defensive investors could select an appropriate pooled investment vehicle. He does however, take an opportunity to dish out much deserved criticism of the late 1960's phenomenon of "performance" funds -- funds driven to disaster due to their engagement in short term speculating.
In terms of in-depth security analysis, Graham refers readers to his 1934 epic Security Analysis. Having said that, he does devote a chapter to investigating earnings per share, making various company comparisons through basic investment measures, and another chapter to various creative accounting practices of the late sixties. The "creativity" shown was remarkable, in the fact that it was, in hindsight, all rather large and obvious. One example had not reported any income tax charges for the prior 11 years, something that Graham drily suggests should have "raised serious questions as to the validity of their reported earnings".
Of course, there is a chapter on stock market fluctuations, containing the now legendary "Mr Market". Buffett has never tired of quoting the story of this imaginary character with the wildly changing mood swings, offering optimistic prices for your shares one day and depressed prices the next. Graham again takes the opportunity to reiterate the differences of investment against speculation: "The most realistic distinction between the investor and the speculator is found in their attitude towards stock market movements. The speculator's primary interest lies in anticipating and profiting from market fluctuations. The investor's primary interest lies in acquiring and holding suitable securities at suitable prices He should never buy a stock because it has gone up or sell one because it has gone down."
The real gold mine of the book is the last fifty pages, covering the last chapter and various appendices. Although it would appear strange, I consider the content of these final appendices just as significant as the book's main chapters.
The final chapter is the one Graham considers the most important. When asked to distill the secret of investment into three words, Graham ventures the three words "MARGIN OF SAFETY". He explains that with a quantified margin of safety in a stock purchase (the difference between current value and expected value), an accurate estimate of future profits using a "special degree of foresight" is unnecessary. Graham sums up the chapter by stating: "Investment is most intelligent when it is most businesslike". Sound words indeed.
(The content in this chapter is important enough to warrant a feature on its own. With this in mind, tomorrow's Qualiport, a portfolio that places an emphasis on the margin of safety when considering a company's merits, will cover this essential topic in more detail.)
Included in an appendix is a speech given by Graham in 1958. When he starts reminiscing about his early Wall Street days, and a company called Computing-Tabulating-Recording Company, his thoughts really become astounding.
Graham rues his decision in 1915 (after being told not to touch that stock "with a ten-foot pole") of not considering the company. Even after the company's name change to IBM, he still avoided the stock. When looking back, he considers the "intangible" aspect of IBM, and how it generated a superior return on capital without the significant use of traditional "tangible" assets.
"It may be well to recognize a vital difference that has developed in the valuation of these intangible factors" Graham ponders before some numerical theory. He concludes: "in an important and very real sense tangible assets have become a drag on average market value rather than a source thereof."
For 1958, this was an evolution in investment thinking. Surely it was Buffett, with his consumer franchise monopolies, who was widely recognized as developing the "intangible asset" aspect of investment? Wasn't Graham just a statistical "value" player? It appears not.
Finally, Graham can't resist a slight pop at technological companies. He investigated the fortunes of a number of stocks, his selection being only a prefix by such as Compu- or Techno- Needless to say, their fortunes three years later were not spectacular. Would a 1999 repeat using the "dot com" suffix draw the same conclusions?
Conclusions
Firstly, as an old American book, there are undoubtedly parts that are not relevant to modern-day UK investors. Graham was renowned as a "numbers" man, and the book is liberally spread with statistics and figures appropriate to the 1972 investment scene of the US (the Dow Jones at 900 etc). It's all too easy just to skip to his final comments in some chapters, avoiding lengthy investigation and hypothesising. There's also a slight niggle about arriving at "suggestions" instead of definite conclusions. In general, Graham's writing style doesn't make it the easiest of reads.
Buffett describes the book as "by far the best book about investing ever written". As keen Buffett followers know, it was Graham's investment thoughts, outlined in this book, that were the foundation for Buffett's monumental success in later years. If you've already read the multitude of books on Buffett, it's a must, but just for the "philosophy" chapters.
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