The Intelligent Investor is not an easy book. I had wanted
to read “The Intelligent Investor” in quick succession with Graham’s original
masterpiece – “Security Analysis”. Now that I have completed the former, I have
no strength to go to the latter – at least not anytime soon.
But then I am reminded that Graham was not meant to be an
extraordinary writer. He was not known for the flair of his pen but the weight
of his thoughts. It is generous of him to share his knowledge with the world as
a teacher. Perhaps he was a better teacher in the classroom. But the concepts
of investing he shares remain the same. It does help that the book is
supplemented with commentary by Jason Zweig who makes the material easy for naïve
readers such as myself. The book cannot be called complete for the 21st
century without Jason Zweig’s commentary.
Time and again, the book throws jewels of wisdom by Graham’s
quirks. Even if you forget everything else in the book, those few lines by
Graham are never going to leave their mark on you.
‘In 44 years of Wall Street experience and study, I have never seen
dependable calculations made about common-stock values, or related investment
policies, that went beyond simple arithmetic or the most elementary algebra.
Whenever calculus is brought in, or higher algebra, you could take it as a
warning signal that the operator was trying to substitute theory for
experience, and usually also to give to speculation the deceptive guise of
investment.’
Graham makes it a point to repeatedly lay out the
differences between “speculation” and “investment”. He calls out modern day
investors for treating the stock market as a video game. Constantly and
consistently, he advises to shift the focus to “value-based investing” where
the Intelligent Investor invests on the basis of the underlying value of the
company rather than its growth potential and stock trends. Of course this means
that Graham is a traditional investor who refuses to see the growth potential
of many modern-day start-ups and businesses which rely mostly on intangible
assets. But that was his risk appetite. Considering the records of his companies and his students, I
am inclined to follow his path.
‘Buying a bond only for its yield is like getting married only for the
sex. If the thing that attracted you in the first place dries up you’ll find
yourself asking, “What else is there?” When the answer is “Nothing,” spouses
and bondholders alike end up with broken hearts.’
Graham addresses individual securities from stocks, mutual
funds, bonds, options, futures, and goes in a unique in-depth analysis avoiding
any higher maths. The most he asks you to calculate are simple ratios like
Current Ratio, Debt-Equity ratio, and Price-to-earnings ratio. Graham argues that
the best investing decisions should be easy to understand. If you don’t
understand it simply, it’s probably not a good idea to invest in it.
Graham also calls out the modern “growth-stocks” in his
quirky way.
‘If the definition of a growth stock is that it will thrive in the
future, then it is not a definition at all, but wishful thinking. It’s like
calling a sports team “the champions” before the season is over.’
I think it is pertinent to list down some of Graham’s
underlying investment ideologies in this review. Of course this cannot match
with the kind of structured thinking and discipline Graham tries to bring forth
in his book and by listing these I run the risk of giving out half-knowledge.
Some would even say that this is sacred knowledge which should not be shared
with the world lest it distorts the stock market forever. But as Warren Buffet
says, Graham’s principles have been out there for over 50 years now and the
masses refuse to take note. There is something about human nature which begs to
speculate. And in that tussle, the Intelligent Investor emerges as the victor.
Stock selection for
the Defensive Investor
1.
Annual revenue for the last 3 years should be at
least $ 100 Mn
2.
Asset Base should be at least $ 50 Mn
3.
Current Ratio should be at least 2.0
4.
Long Term Debt should be equal or lesser than
Net Current Assets
5.
Debt-Equity Ratio should stay below 2
6.
There should be Profits after tax for the last
10 years
7.
The company should have a positive dividend
history for at least 20 years
8.
Averaged out for 3 years, the earnings per share
should have grown by 33% in the last 10 years
9.
Price-to-earnings ratio should stay below 15
10. The
Market Value should be not more than 1.5 times but not less than the Book Value
of the Equity
Stock selection for
the Intelligent Investor
1.
The Market Value should not be less than the
Book Value of the Equity
2.
The Market Value should not be less than the Net
Current Assets
Principles by Warren
Buffet
1.
Look for a strong brand
2.
The business should be easy to understand
3.
The company should have a good financial health
4.
The company should have a near-monopoly in its
sector
5.
Go through the annual reports to see if the
managers sound realistic. Have they achieved their stated targets in the past
6.
Look for companies growing organically rather
than through mergers and acquisitions
7.
Look for good capital allocation
8.
Managerial remuneration and stock options should
be low
9.
The management should have a good reputation
10. Wait
for a time when the company or the sector it hit with a scandal or an adverse
news
11. Risk
(what analysts fondly call “beta”) measures the volatility of the stock. Not
the value of the business
12. Buy
a share based on the value of the company. Try to buy a 1 dollar bill for 40
cents
13. Invest
in a business. Not a stock
14. Buying
$ 83 for $ 80 is as good as having no margin at all. Buy $ 80 for $ 40. Have wide margins
2 Profound questions
to ask before any investment
1.
What is the probability of me being right?
2.
How will I react to the consequences of being
wrong?
3.
The reaction to consequences should always be
given priority over the probabilities
Other Tools for
Identification
1. Identify sectors going through 52 week lows.
Note that Graham mentions “sectors” and not “stocks”. Diversification is the
key here. Sectors are more likely to get back up or entirely transform rather
than individual stocks which are performing poorly within the sector
2.
The Finance Costs should not exceed 1/5th
of the Profit before tax and 1/2.9 times the Profit after tax
3.
Identify people’s spending patterns to see what
is upcoming in the market. Buy companies which make what you need, use, and
understand
I realize this little article in no way does justice to
Graham’s teachings. If my article made any impact on you, I’d urge you to go
read the book yourself. I daresay I might not have grasped Graham’s wisdom in
its entirety. But in all fairness, it was only the first time that I’ve read
this book. I’m sure there will be a second.
