I’m going to try and summarise some of the book “The Intelligent Investor”, the classic text that Warren Buffett has described as "by far the best book about investing ever written". The book was written by Benjamin Graham, but Warren Buffett and Jason Zweig also made short but important contributions to the book. Zweig is the editor of the revised edition of the book. Buffett wrote the Preface and Appendix 1, and Zweig added useful notes at the end of each chapter.
Zweig has been writing a personal finance advice column called The Intelligent Investor every Saturday for The Wall Street Journal since 2008. He was a senior writer for Money magazine and a guest columnist for Time magazine and CNN.com. He has his own website at www.jasonzweig.com and it’s very useful also. He’s clearly a big fan of Graham’s approach.
1. Preface to the book, written by Warren Buffett
1.1. Requirements for successful investing
. sound and logical policy for making investment decisions – this is provided by Graham’s book, especially Chapters 8 and 20, which provide invaluable advice.
. the ability to keep your emotions from corroding the policy that you have chosen.
1.2. Requirements for outstanding investment results
The excellence of the results is directly related to two factors:
. the amount of effort and research and brain power that you put into your investing
. the amount of fluctuation in the market, and the greater the fluctuation, the greater the opportunity for the investor.
2. Appendix 1 of the book, written by Warren Buffett
(Lyle’s note: the actual appendix comes near the end of the book, of course, but I’ve put it here so that I could summarise both of Buffett’s contributions together).
Appendix 1 of the book is the text of a talk given by Buffett at Columbia University in 1984 about Graham’s “value-based approach”, which is:
. look for values with a significant margin of safety relative to prices
Forget the Efficient Market Hypothesis, forget investment advisors who claim that some days / months / seasons are better than others, forget covariances, Capital Asset Pricing models, and betas,
and focus on only two things: VALUE AND PRICE.
If you focus on these two things when you select shares to invest in, it’s like “buying dollar bills for forty cents”. This concept either grabs people right away, or they never get it at all. Buffett gives nine examples of investors he knows who “get it”, and he he says “while they differ greatly in style, all of these investors are, mentally, always buying the business, not the shares in it”.
Another way of saying this is that if you are considering investing in a company’s shares, you should put as much effort into your research before investing as you would if you were going to buy the whole company.
2.1 Risk
The greater the difference between value and price there is, the less risk there is. The difference is the margin of safety. Note: “beta” is not a useful indicator of risk. Buying a dollar for 40 cents has a higher beta than buying one for 60 cents!
Do not cut it close. LEAVE YOURSELF AN ENORMOUS MARGIN OF SAFETY, don’t try to buy an 83 million dollar business for 80 million.
2.2 Conclusion
The more people Buffett converts to the “value approach”, the greater the chance that the difference between value and price in attractive shares will decrease. That would reduce his profits, so why did he give this talk?
It’s because he thought that there wouldn’t be enough “converts” to the approach to make a big difference because he had seen no trend towards “value investing” in the 35 years that he himself had been practising it, and the academic world had actually backed away from it from 1954 onwards.
3. Biography of Graham
(Lyle’s note: there’s a biography of Graham before the Introduction, but I won’t summarise it here. My summary of Graham’s book itself starts after the dotted line)
...............................................................................................................................................................
4. Introduction
4.1 Purpose of the book
The purpose of the book is to supply the layman with guidance on the adoption of an investment policy.
4.1 Overview of the contents
. mainly about investment principles and investor attitudes
. considerable amount of historical analysis of market patterns
. some information about techniques of security analysis.
4.3 “Defensive” and “enterprising” investors
The aims of the defensive investor are: (a) the avoidance of serious mistakes and losses, (b) freedom from effort and freedom from having to make frequent decisions.
On the other hand, enterprising (also called “active”, or even “aggressive”) investors are willing to devote time and effort and care in selecting investments that are both more attractive than average and also a sound investment at the same time.
4.4 Stock picking by industry
One investment method claims to select the most promising growth industries, and then the most promising companies within these industries.
Graham gives historical examples from the airline business and the computer business to show why he doesn’t like this method.
He states two principles:
a. Obvious prospects for organic growth in a business do not necessarily translate into obvious profits for investors.
b. Even experts do not have dependable ways of selecting the most promising companies in the most promising industries, so how can the amateur do it dependably?
4.5 Investment results versus investment effort
(Lyle’s note: Graham makes the same point here that Buffett made in section 1.2., that one of the two main factors in the excellence of investment results is the amount of effort and research and brain power that you put into your investing.)
Graham additionally remarks that “a little knowledge can be a dangerous thing”, that a little effort and research and brain power is not enough and can even produce poorer results than a defensive portfolio policy, it really takes a lot of effort and time and brain power to produce outstanding results.
a. Simple investment policy (for defensive investors)
A mixture of:
. high-grade bonds
and
. a diversified list of leading shares
(Lyle’s note: “leading shares” = shares in blue-chip companies)
b. “Value-based approach” (for enterprising investors)
This approach requires an understanding of:
. your own temperament
. the difference between investment and speculation
. the difference between price and value.
5. Zweig’s notes on the Introduction
Graham announces from the start that his book will NOT tell you how to “beat the market”. No truthful book can. Instead, this book will teach you three powerful lessons:
• how you can minimize the odds of suffering irreversible losses;
• how you can maximize the chances of achieving sustainable gains;
• how you can control the self-defeating behavior that keeps most investors from reaching their full potential.
But no matter how careful you are, the price of your investments will go down from time to time. While no one can eliminate that risk, Graham will show you how to manage it—and how to get your fears under control.
Both Graham and Buffett underline the need for a very large amount of effort and time and brain power if the “intelligent investor” wants outstanding investment results.
Zweig then asks a vitally important question: what exactly does Graham mean by an “intelligent” investor? Back in the first edition of his book, Graham defined the term—and he made it clear that this kind of intelligence has nothing to do with IQ or exam scores. It simply means being patient, disciplined, and eager to learn; you must also be able to harness your emotions and think for yourself. This kind of intelligence, explains Graham, “is a trait more of the character than of the brain”. In addition, Zweig gives two examples to show that intelligence and IQ and a higher education alone are no guarantee of investment success:
a. Sir Isaac Newton, the famous mathematician, lost 20,000 pounds in the “South Sea Bubble”, which would be equivalent to a two million pound loss in today’s money. For the rest of his life, he forbade anyone to speak the words “South Sea” in his presence.
(The South Sea Company was a British joint stock company that traded in South America during the 18th century. Founded in 1711, the company was granted a monopoly to trade in Spain's South American colonies as part of a treaty during the War of Spanish Succession. In return, the company assumed the national debt England had incurred during the war. Speculation in the company's stock led to a great economic bubble known as the South Sea Bubble in 1720, which caused financial ruin for many.)
b. In 1998, Long-Term Capital Management L.P., a hedge fund run by a battalion of mathematicians, computer scientists, and two Nobel Prize–winning economists, lost more than $2 billion in a matter of weeks on a huge bet that the bond market would return to “normal.” But the bond market kept right on becoming more and more abnormal—and LTCM had borrowed so much money that its collapse nearly capsized the global financial system.
...........................................................................................................................................................
That’s the end of the Introduction of the book. Only twenty more chapters to go.
Zweig has been writing a personal finance advice column called The Intelligent Investor every Saturday for The Wall Street Journal since 2008. He was a senior writer for Money magazine and a guest columnist for Time magazine and CNN.com. He has his own website at www.jasonzweig.com and it’s very useful also. He’s clearly a big fan of Graham’s approach.
1. Preface to the book, written by Warren Buffett
1.1. Requirements for successful investing
. sound and logical policy for making investment decisions – this is provided by Graham’s book, especially Chapters 8 and 20, which provide invaluable advice.
. the ability to keep your emotions from corroding the policy that you have chosen.
1.2. Requirements for outstanding investment results
The excellence of the results is directly related to two factors:
. the amount of effort and research and brain power that you put into your investing
. the amount of fluctuation in the market, and the greater the fluctuation, the greater the opportunity for the investor.
2. Appendix 1 of the book, written by Warren Buffett
(Lyle’s note: the actual appendix comes near the end of the book, of course, but I’ve put it here so that I could summarise both of Buffett’s contributions together).
Appendix 1 of the book is the text of a talk given by Buffett at Columbia University in 1984 about Graham’s “value-based approach”, which is:
. look for values with a significant margin of safety relative to prices
Forget the Efficient Market Hypothesis, forget investment advisors who claim that some days / months / seasons are better than others, forget covariances, Capital Asset Pricing models, and betas,
and focus on only two things: VALUE AND PRICE.
If you focus on these two things when you select shares to invest in, it’s like “buying dollar bills for forty cents”. This concept either grabs people right away, or they never get it at all. Buffett gives nine examples of investors he knows who “get it”, and he he says “while they differ greatly in style, all of these investors are, mentally, always buying the business, not the shares in it”.
Another way of saying this is that if you are considering investing in a company’s shares, you should put as much effort into your research before investing as you would if you were going to buy the whole company.
2.1 Risk
The greater the difference between value and price there is, the less risk there is. The difference is the margin of safety. Note: “beta” is not a useful indicator of risk. Buying a dollar for 40 cents has a higher beta than buying one for 60 cents!
Do not cut it close. LEAVE YOURSELF AN ENORMOUS MARGIN OF SAFETY, don’t try to buy an 83 million dollar business for 80 million.
2.2 Conclusion
The more people Buffett converts to the “value approach”, the greater the chance that the difference between value and price in attractive shares will decrease. That would reduce his profits, so why did he give this talk?
It’s because he thought that there wouldn’t be enough “converts” to the approach to make a big difference because he had seen no trend towards “value investing” in the 35 years that he himself had been practising it, and the academic world had actually backed away from it from 1954 onwards.
3. Biography of Graham
(Lyle’s note: there’s a biography of Graham before the Introduction, but I won’t summarise it here. My summary of Graham’s book itself starts after the dotted line)
...............................................................................................................................................................
4. Introduction
4.1 Purpose of the book
The purpose of the book is to supply the layman with guidance on the adoption of an investment policy.
4.1 Overview of the contents
. mainly about investment principles and investor attitudes
. considerable amount of historical analysis of market patterns
. some information about techniques of security analysis.
4.3 “Defensive” and “enterprising” investors
The aims of the defensive investor are: (a) the avoidance of serious mistakes and losses, (b) freedom from effort and freedom from having to make frequent decisions.
On the other hand, enterprising (also called “active”, or even “aggressive”) investors are willing to devote time and effort and care in selecting investments that are both more attractive than average and also a sound investment at the same time.
4.4 Stock picking by industry
One investment method claims to select the most promising growth industries, and then the most promising companies within these industries.
Graham gives historical examples from the airline business and the computer business to show why he doesn’t like this method.
He states two principles:
a. Obvious prospects for organic growth in a business do not necessarily translate into obvious profits for investors.
b. Even experts do not have dependable ways of selecting the most promising companies in the most promising industries, so how can the amateur do it dependably?
4.5 Investment results versus investment effort
(Lyle’s note: Graham makes the same point here that Buffett made in section 1.2., that one of the two main factors in the excellence of investment results is the amount of effort and research and brain power that you put into your investing.)
Graham additionally remarks that “a little knowledge can be a dangerous thing”, that a little effort and research and brain power is not enough and can even produce poorer results than a defensive portfolio policy, it really takes a lot of effort and time and brain power to produce outstanding results.
a. Simple investment policy (for defensive investors)
A mixture of:
. high-grade bonds
and
. a diversified list of leading shares
(Lyle’s note: “leading shares” = shares in blue-chip companies)
b. “Value-based approach” (for enterprising investors)
This approach requires an understanding of:
. your own temperament
. the difference between investment and speculation
. the difference between price and value.
5. Zweig’s notes on the Introduction
Graham announces from the start that his book will NOT tell you how to “beat the market”. No truthful book can. Instead, this book will teach you three powerful lessons:
• how you can minimize the odds of suffering irreversible losses;
• how you can maximize the chances of achieving sustainable gains;
• how you can control the self-defeating behavior that keeps most investors from reaching their full potential.
But no matter how careful you are, the price of your investments will go down from time to time. While no one can eliminate that risk, Graham will show you how to manage it—and how to get your fears under control.
Both Graham and Buffett underline the need for a very large amount of effort and time and brain power if the “intelligent investor” wants outstanding investment results.
Zweig then asks a vitally important question: what exactly does Graham mean by an “intelligent” investor? Back in the first edition of his book, Graham defined the term—and he made it clear that this kind of intelligence has nothing to do with IQ or exam scores. It simply means being patient, disciplined, and eager to learn; you must also be able to harness your emotions and think for yourself. This kind of intelligence, explains Graham, “is a trait more of the character than of the brain”. In addition, Zweig gives two examples to show that intelligence and IQ and a higher education alone are no guarantee of investment success:
a. Sir Isaac Newton, the famous mathematician, lost 20,000 pounds in the “South Sea Bubble”, which would be equivalent to a two million pound loss in today’s money. For the rest of his life, he forbade anyone to speak the words “South Sea” in his presence.
(The South Sea Company was a British joint stock company that traded in South America during the 18th century. Founded in 1711, the company was granted a monopoly to trade in Spain's South American colonies as part of a treaty during the War of Spanish Succession. In return, the company assumed the national debt England had incurred during the war. Speculation in the company's stock led to a great economic bubble known as the South Sea Bubble in 1720, which caused financial ruin for many.)
b. In 1998, Long-Term Capital Management L.P., a hedge fund run by a battalion of mathematicians, computer scientists, and two Nobel Prize–winning economists, lost more than $2 billion in a matter of weeks on a huge bet that the bond market would return to “normal.” But the bond market kept right on becoming more and more abnormal—and LTCM had borrowed so much money that its collapse nearly capsized the global financial system.
...........................................................................................................................................................
That’s the end of the Introduction of the book. Only twenty more chapters to go.