The Intelligent Investor by Benjamin Graham
Highly recommended by Warren Buffet as the best book about investing ever written, The Intelligent Investor by Benjamin Graham outlines an intelligent investing framework that takes a long-term and more risk-averse approach to the stock market.
The book describes the distinction between speculator and investor. Speculators buy into the hype, rumor, and excitement of the crowds. They blindly follow the moods of “Mr. Market”.
Intelligent investors ignore “Mr. Market”, keep their emotions out of the market, and use thorough analyses for making decisions in order to secure safe and steady returns. They do this by looking for:
- Adequate size of the enterprise (eg >$700m sale)
- Sufficiently strong financial conditions (eg asset >= liability*2)
- Earning stability (eg no earning deficit in the last 10 years)
- Dividend record (eg no missed dividend in the last 20 years)
- Earning growth (eg 33% growth in the last 10 years or average of 2.9% annual growth)
- Moderate Price/Earning ratio (eg <15)
- Moderate ratio of Price to Asset (eg <1.5)
As an intelligent investor, you buy a stock only if you believe there is a “margin of safety” between what you pay and what you will earn as the company grows. “Price is what you pay, Value is what you get”.
According to Graham, there are two types of investors: defensive and enterprising. The defensive investors are passive and should have a defensive and well-diversified portfolio with proper asset allocation (stocks and bonds) and rebalancing based on the risk profile. They should invest regularly (dollar cost averaging) in index funds with low expense ratio and try to avoid picking stocks or time the market.
The enterprising investors are active investors and require patience, discipline, eagerness to learn to be experts, and a lot of time. Even with all the requirements the odd of being wrong are still there; the dot-com bubble is a prime example. But, the odd of being right increases as serious works are put into finding the bargain stocks that have reasonable margin of safety.