Intelligent Investing
Cover Story, by Mark Robertson, Managing Partner October 1st, 2009
The Intelligent Investor is a book for true investors ... inherently for the longer term and requires a commitment of effort.
Among the library of investment books promising no-fail strategies for riches, Benjamin Graham’s classic, The Intelligent Investor, offers no guarantees or gimmicks but overflows with the wisdom at the core of all good portfolio management.
“If you read just one book on investing during your lifetime, make it this one.” — Fortune magazine.
I’ve read it at least two, maybe three, times. Maybe it has something to do with falling leaves and spending a few quiet moments during autumn beside the pond in my back yard. As we embark on a series of case studies and research into what George Nicholson called, “Broadening Your Investment Management Program,” I found myself spending time with Benjamin Graham’s “The Intelligent Investor” again. Warren Buffett knew Graham well (Ben taught Warren how to invest as his professor at Columbia and as a professional colleague) and says, “I read this book as a 19-year-old. I thought then that it was by far the best book about investing ever written. I still think it is.” If you’re serious about learning to invest intelligently, how can you avoid it?
The Intelligent Investor is a book for true investors … inherently for the longer term and requires a commitment of effort. The true investor uses discipline, research, and his analytical ability to make unpopular but sound investments in bargains … Graham coaches the investor to develop a rational plan for buying stocks and bonds, and he argues that this plan must be a bulwark against emotional behavior that will always be tempting during abrupt bull and bear markets.
MANIFEST contributor Ken Kavula often speaks of discipline as the greatest gift bestowed by George Nicholson, Jr. upon the modern investment club movement. Graham and Buffett mention patience and discipline frequently and routinely. On the next few pages, we’ll share some of the highlights from the book. My copy is dog-eared, highlighted and yes, I’ve even written notes in it. Relax, Sister Rita Claire taught me that it was OK to write in books and bend pages so long as it didn’t say “Property of St. John’s” inside the front cover.
In the most recent edition, Jason Zweig makes a solid contribution with editorial remarks and commentary as a continuous “side bar” throughout the book. In his introduction, Zweig listed his interpretation of Graham’s common sense and core principles. Here is how I’d play them back:
1. A stock is not a ticker. Think ownership in an actual business.
2. The market is a pendulum. Momentum creates opportunity during both bear and bull markets.
3. The value of any investment is merely a function of its current price. That value is established by the projected return which is based on the current price and a reasonable expectation for a future price.
4. Insist on suitably high projected returns (but not too high) to build a margin of safety into the decisions you make.
5. Invest with patient confidence.
“If you have built castles in the air, your work need not be lost, that is where they should be. Now put the foundations under them.” — Henry David Thoreau, Walden
Hmmm. If memory serves, Thoreau used to spend quite a bit of time by the pond, also. Interesting that Zweig chose that for the first comment. We’ll now dig in to some of the highlights from my dog-eared pages …
The Myth of 15% Growth
Graham spends time defining investing vs. speculating and investing defensively vs. what he referred to as “enterprising investing.” Our community of investors would easily qualify for the enterprising label.
Many of our colleagues still believe that the magic 15% number cited by NAIC/Better Investing refers to growth characteristics. It doesn’t.
“… only 8-of-150 largest companies on the Fortune 500 managed to increase their EPS at least 15% for two decades during 1960-1999.”
“… only 10% of large U.S. companies increased EPS by 20% for at least five consecutive years, only 3% achieved this for 10 years straight; and not a single one had done it for 15 years in a row.”
The 15% refers to long-term annualized returns for total portfolios.
Market Fluctuations
Common stocks, even of investment grade (relatively high-quality), are subject to recurrent and wide fluctuations in their prices. The intelligent investor should be interested in the possibilities of profiting from those pendulum swings. Every investor who owns common stocks must expect to see them fluctuate in value over the years. 195
The investor with a portfolio of sound stocks should expect prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances. Remember that market quotations are there for convenience, either to be taken advantage of or to be ignored. Never buy a stock because it has gone up or sell one because it has gone down. 206
Patient Focus — Things That Matter
“… investors who receive frequent news updates on their stocks earned half the returns of investors who got no news at all. 223
Consider this another important attribute of investment club practices, the notion of meeting monthly. In some cases, reactive decisions to events that were not made have turned out to be some of the best decisions overall.
Researchers Brad Barber and Terrance Odean divided thousands of traders into five tiers based on their turnover. Those with less frequent transactions (at the left) kept most of their gains. Impatient and hyperactive traders make yacht payments for somebody else. (Source: Barber and Odean, University of California at Davis, and Berkeley, respectively.)
The Math — Keep It Simple
… 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 … of substituting theory for experience … or to give speculation the deceptive guise of investment. 282
Occam was right about his razor.
This is the prevailing thinking behind our emphasis on (1) top-line growth, (2) profitability and (3) reasonable and considered forecasts for P/E ratios … and the math behind it all is relatively simple.
Aggregate Forecasts
…individual forecasts can be wide of the mark. Our general view is that composite or group estimates are likely to be a good deal more dependable than those for individual companies. 288 Think dashboard averages. Think MIPAR.
Smartly Own
When you buy a stock, you become an owner of the company. … there is just as much reason to exercise care and judgment in being an owner as in becoming a stockholder.” 499
The prudent homework and diligence shouldn’t end when the purchase decision is made. Proportion your time and attention appropriately between candidates for purchase and your holdings.
Trapping Bulls & Quality
George Nicholson warned of swapping high-quality for lower quality stocks as bull markets rage as one of the most dangerous things that an inexperienced investor could do.
Here we find Graham’s own warning on the same behavior: The risk of paying too high a price for good-quality stocks — while a real one — is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that chief losses to investors come from the purchase of low-quality companies at times of favorable business conditions. 516
Translation: Avoid lower quality companies when MIPAR is in single digits.
Investing is most intelligent when it is most businesslike … disciplined … and superior results are possible. Thanks, Ben (and Jason Z.)
Mark Robertson
Mark Robertson is founder and managing partner of Manifest Investing, a source for research and portfolio management focusing on strategic long term investors.