Summary: The Intelligent Investor: The Definitive Book on Value Investing by Benjamin Graham

• The book is a classic and influential guide on value investing, which is an investment approach that focuses on buying undervalued stocks that have strong fundamentals and growth potential.
• The book provides strategies and principles on how to successfully use value investing in the stock market, based on the author’s extensive experience and research.
• The book is written in a clear and authoritative style, with many examples and illustrations from the author’s own practice and history. The book is also well-organized and easy to follow, with each chapter ending with a summary and a list of practical suggestions.

Nobody can accurately predict the future of the financial marketplace. But this doesn’t mean that you can’t invest wisely and build a secure future for yourself. In this book review, you’ll learn the keys to intelligent investing in a fast-changing market. You’ll also learn how to remain calm and secure in any financial climate.

Invest rationally in an irrational marketplace.

READ THIS BOOK REVIEW IF YOU:

• Want to build a successful investment portfolio
• Wish you knew when to buy and when to sell
• Are curious about common investing mistakes

Have you ever thought about investing in the stock market? Many of us have given it serious consideration. Yet, most of us have been hesitant to take action due to the financial crises, burst bubbles and economic crashes we’ve witnessed.

However, there is a way to invest in the market that doesn’t leave you at risk of losing everything: intelligent investing. First outlined by Benjamin Graham in 1949, intelligent investing takes a longer-term, more risk-averse approach to the stock market. And it works.

In the decades since The Intelligent Investor was published, many have used Graham’s approach and made fortunes, among them, perhaps the most famous is Warren Buffett.

These book summary, based on Graham’s original advice, as well as comments from journalist Jason Zweig, show how you can become an intelligent investor yourself.

In this summary of The Intelligent Investor by Benjamin Graham and comments by Jason Zweig, you’ll learn

• why you should always ignore Mr. Market;
• why it’s better to start your investment career with virtual money; and
• why the cheapest stocks are sometimes the most valuable.

Recommendation

This classic book on investing belongs on every investor’s bookshelf. The principles that Benjamin Graham outlines are the very precepts that have guided such great investors as Warren Buffett and such mutual fund innovators as John Bogle, the noted Vanguard Group founder, who wrote this edition’s foreword. First published in 1949, Graham’s text shows a few signs of age, most notably in its discussion of interest rates, investment vehicles such as savings bonds and other time-sensitive subjects. However, those are minor issues. Most of Graham’s counsel on fundamental investing is timeless. We highly recommend this seminal book to all investors.

Take-Aways

• Investors fall into two broad categories: the “defensive” and the “enterprising.”
• Speculation is not investing.
• To succeed, enterprising investors must treat investing as they would treat any other business they enter.
• Because most investors do not have the time to work at investing as if it were their business, they should adopt a defensive strategy.
• No evidence suggests that market forecasting and market timing work.
• Value investors should pay more attention to the dividends and operating performance of companies than to the movement of their stock prices.
• As a preliminary to calculating value, estimate the company’s earning ability, multiply appropriately and adjust for the value of assets.
• Stockholders have the rights and responsibilities of ownership, and should exercise them consistently and seriously.
• Shareholders need to test the quality of management objectively.
• Diversification, along with a “margin of safety,” can protect an investment portfolio.

Introduction

This guide is meant to give the average person a roadmap for investing. It will teach you the principles and attitudes necessary for wise investing, which are appropriate regardless of the year or the financial climate.

This is not a “get rich quick” guidebook. Indeed, there is no guaranteed path on Wall Street. But you can use this guide to avoid the biggest errors in investing.

Anyone can be an investor, but that doesn’t mean investing wisely is easy. Learning the ropes requires discipline and curiosity. Apply yourself and stick to the following principles in order to become an intelligent investor with a secure future.

Investment versus Speculation

A common mistake among investors is confusing investments with speculations. An investment is a transaction that, after thorough analysis, you are confident will return your principal plus a decent profit.

Industry jargon labels any transaction in the stock market as an investment and any person actively participating in the market as an investor, but this is simply not true. Attempts to guess the rise and fall of the market are simply speculations.

Never confuse outright speculations with investments. If you want to speculate for fun, set aside a fund to do so, but make sure it’s an amount of money you can stand to lose. Do not mix your investment money with your speculation money.

An intelligent investor understands the risks of speculating and thoroughly analyzes all transactions to ensure that they are true investments.

The Investor and Inflation

Inflation can decrease the purchasing power of any money you earn. Traditionally, stocks can withstand inflation better than bonds, leading many to believe that they should solely invest in stocks.

But nothing in investing is completely sure. Everything fluctuates, and it is impossible to completely predict the future. Thus, diversification is always a better choice than relying on a single type of security.

When protecting yourself from inflation, there are two great options for investment diversification. The first is real estate investment trusts, or REITs. These companies own properties, collect rent, and do a great job of withstanding inflation. The other option is treasury inflation-protected securities, or TIPS. These are government bonds that automatically scale with inflation.

Above all, the intelligent investor diversifies. No single security is always the best option.

A Century of Stock Market History

In the 1990s, investment experts assured the American public that stocks would always be more profitable than bonds based on numbers from previous decades. Many people took this advance wholeheartedly, seeking out stocks at outrageous prices. By 2002, most of those stocks had plummeted.

No one can completely predict the future based on the past. Just because something has happened before — even if it has happened several times — there is no guarantee that it will happen again.

The intelligent investor buys when the market is low and sells when it is high. The best strategy is to go against the flow: Assume the worst when everyone else is rejoicing, but stay positive when others are fearing the worst.

The only sure thing about the market is that it will surprise you.

General Portfolio Policy

There are two kinds of intelligent investors: enterprising and defensive.

An enterprising investor has the time and energy to build their own portfolio from scratch and constantly update it, while a defensive investor creates a stable and steady portfolio that performs automatically.

Either approach can be done well, but you must understand yourself and know which category best fits your personality and emotions.

If you are a defensive investor, you must make the decision about where to allocate your money up front.

If you can responsibly take risks, allocate up to 75% of your investment into stocks, leaving the remaining 25% in bonds. If you don’t want that much risk, then do the reverse, or go somewhere in the middle.

Once you have decided the percentages that you will allocate to stocks and bonds, the key is to leave your portfolio alone unless something major changes in your life, increasing or reducing your ability to take risks.

To maintain your current allocations, you will need to rebalance your portfolio periodically. For example, if you have 70% of your assets in stocks and 30% in bonds but the stock market rises, you will then sell some of your stocks to keep your number at 70%. This also ensures that you are selling high and buying low — one of the major keys to intelligent investing.

The Defensive Investor and Common Stocks

Even the most defensive investor should buy stocks. The key is doing your homework to find the right stocks.

Don’t take a company’s success for granted just because you are familiar with it — Study the financials and estimate the value of stocks before you buy them.

Once you’ve done your homework, you can rest easy with an automated portfolio that allocates a bit of your investment into predetermined stocks each month. There are plenty of online brokerages that do just that. Mutual funds and index funds are the defensive investor’s best friend because they provide diversification without the maintenance.

As a defensive investor, your most powerful weapon is your inaction. Put a fixed dollar amount into your portfolio regularly and forget about trying to guess what the market is doing.

Portfolio Policy for the Enterprising Investor: Negative Approach

If you want to take a more enterprising approach to investing — one that doesn’t rely on an automated portfolio — you must be wary of some major pitfalls common among aggressive investors.

The biggest mistake aggressive investors make is buying and selling quickly. In fact, this isn’t investing at all: It’s speculating. This method generally leads to overexcited investors buying overvalued stock or fearful investors selling stock that has dropped — the exact opposite of what you should do.

Additionally, stock that isn’t held for a decent amount of time is taxed as income rather than capital-gains. That higher tax rate, plus the constant transaction fees, mean you need to gain a big chunk back just to recoup your initial investment.

Steer clear of initial public offerings and junk bonds, both of which can offer high yields but also pose higher risks. They both tend to underperform.

There is a lot to be gained from being an enterprising investor, as long as you take care to avoid the most common mistakes of investing.

Portfolio Policy for the Enterprising Investor: The Positive Side

You cannot accurately predict the financial market, and anyone who claims to do so is lying, pure and simple. Instead of trying to guess what the market will do next, follow a few tried and true strategies for investing.

When it comes to growth stocks — stocks from companies whose earnings are expected to increase rapidly — remember that the bigger a company gets, the slower it grows. Infinite, massive growth is impossible.

Buy growth stocks only when their prices are reasonable, and remember to take advantage when things go downhill. Temporary unpopularity can be a great opportunity to buy in at dirt-cheap prices.

When it comes to common stocks, remember that diversity is key. You never want all your eggs in one basket. While some of America’s richest investors have made their fortune by concentrating on a single industry, this is also a common way to lose everything.

Buying foreign stock is a great way to diversify your portfolio because their markets won’t necessarily follow the same patterns as the market in the United States. If the DOW tanks, your foreign funds may be your saving grace.

The Investor and Market Fluctuations

While most people would never make their life choices based on the mood swings of an unstable individual, investors tend to do just that with their financial choices. They buy high and sell low because they are following the market instead of thinking critically.

The intelligent investor must realize that the market is simply deciding the prices of securities, and it is up to the investor himself to choose whether or not to buy.

You can’t control the market, but you can control the fees you pay, the risks you take, your tax bills, and your own choices. The best strategy for the intelligent investor is to automatically contribute to an index fund each month. This is known as dollar-cost averaging.

If you are investing in the future, the temporary highs and lows of the market don’t matter in the long run. Your commitment to steadfast investing and controlling your emotions will make all the difference.

Investing in Investment Funds

Mutual funds are popular because they are cheap, convenient, diversified, and professionally managed. But these funds are far from perfect.

Many mutual fund managers try to predict the market, which already know is unwise. Additionally, many mutual funds come with excessive trading fees and higher tax costs because the managers trade frequently.

A better alternative for the intelligent investor is an index fund. While regular mutual funds own certain securities based on the manager’s decisions, index funds hold all of the securities in a certain market. For example, the S&P 500 is an index of the 500 largest publicly traded companies in America, and an index fund in the S&P 500 would hold a security from each of these companies, regardless of the ups and downs of their individual performances.

Index funds have extremely low fees and attempt to stay on track with the market instead of beating it.

Index funds work when the intelligent investor holds them for a long period of time. There will be ups and downs — which the investor should ignore — but over the long haul these funds outperform regular mutual funds.

The Investor and His Advisers

Individual investors are perfectly capable of doing the work of researching and investing on their own, but some people feel better having a professional take the reins. This is fine, as long as you do your due diligence when hiring a financial adviser. Not all advisers are created equal.

Do some research to make sure any potential adviser doesn’t have any complaints or disciplinary actions on their record. Consult the US Securities and Exchange Commission as well as your state’s securities commissioner.

Don’t feel pressured to settle for the first adviser you meet with. The one you choose should care about helping clients, have a thorough understanding of investment principles, and have adequate training and experience.

The best advisers should ask you questions regarding your goals and budget. If they don’t seem interested in getting to know your particular situation, they are likely just in it for the money.

Security Analysis for the Lay Investor: General Approach

Not all stocks are created equal. Which factors should an intelligent investor consider when deciding how much a particular stock should cost?

First, download several years of annual reports for each company. These are available on the EDGAR database of the SEC website. The companies that are worth a lot should show steady, not erratic, growth over the last decade.

Judge a company based on their management. Did the leaders follow through with forecasts from previous annual reports? Did they acknowledge mistakes and improve? Leadership decisions should be consistent and accounting practices transparent.

The biggest sign that a company’s stock is worth your money is simply this: They earn more than they spend. When reading annual reports, pay close attention to statements of cash flow. A company’s debt shouldn’t exceed 50% of their total capital.

Doing your research ensures that you, as an intelligent investor, don’t overpay for stocks.

Things to Consider About Per-Share Earnings

One of the best pieces of advice any intelligent investor should follow is to disregard the short-term earnings of any company and focus on long-term stability and growth.

If you do choose to consider the short-term earnings, then at least be on guard for some tricky strategies that can easily mislead the uninformed investor. Countless companies have manipulated accounting principles in order to make their forecasts more favorable than they had any right to be.

Pro forma earnings are one such manipulation. Originally, this practice was meant to give a better picture of long-term growth by eliminating certain costs from consideration. The idea was that eliminating one-off, nonrecurring costs would give a better overall picture of the company’s growth. But, companies soon took advantage of this practice and gave projections without considering very impactful costs. The intelligent investor should simply ignore pro forma earnings.

Other companies also use aggressive revenue recognition: reporting earnings that haven’t actually occurred yet and may never actually happen. Still others treat regular operational expenses as capital expenditures, which are actually the costs of buying fixed assets that generate future business such as land or equipment. Interchanging these types of expenses inflates the profit margin by hiding the fact that a company is spending lots of money.

There are other tricks hidden in financial reports, and it is up to the intelligent investor to dig deep before buying stock. Enterprising investors who plan to build their own portfolios from scratch must become familiar with financial reporting in order to make the wisest decisions.

Stock Selection

Choosing individual stocks isn’t necessary, nor is it usually very effective. Generally, you could do better by simply buying a low-cost index fund, contributing regularly, and leaving it alone. This is a low-maintenance strategy that awards healthy returns.

If you are committed to doing it yourself, it’s wise to practice first by tracking stocks without actually buying any and measuring your progress. Would you have done better had your money simply been in an index fund like the S&P 500? If so, you have your answer.

If, after practicing, if you’ve discovered that you enjoy the process and actually did well, then begin assembling your portfolio. It is still highly suggested that you keep the majority of your money in an index fund, however.

When choosing those extra stocks, use some specific criteria. Only buy stock from companies whose assets are at least double their liabilities. Companies should show at steady, continual growth and have clear financial statements. Avoid companies that have a plethora of nonrecurring or unusual costs.

Whether you are a defensive or enterprising investor, you must still do your due diligence. Consult the EDGAR database from the SEC and read financial reports from at least the past five years before buying stock from any company.

Convertible Issues and Warrants

Convertible bonds are bonds that behave more like stocks. Those who own convertible bonds have the option of exchanging them for stock in the issuing company.

These bonds can give investors stock-like returns without as much risk, but they are more risky and less profitable than regular bonds.

Convertible bonds are protected from immense losses, but they also put a cap on potential gains. They can only do so well before the issuing company forces you to exchange them for regular stock.

It’s better, and simpler, just to diversify your investments across regular bonds and stocks.

Shareholders and Managements: Dividend Policy

It’s important to remember that buying stock in a company makes you one of the owners. But, most stockholders are far more concerned with buying or selling stock than actually acting as a conscientious owner.

Being an intelligent investor means being an intelligent owner. It is up to you to do the research and decide if company leadership is doing the work to ensure that outside shareholders are getting what they deserve.

Publicly traded companies are required to supply their shareholders with proxy materials, which give vital information regarding company processes, dividend payouts, executive compensation, and outstanding shares. Responsible investors should read the proxy materials carefully and vote conscientiously at shareholder meetings.

If you ignore proxy materials and neglect your shareholder vote, you have no right to be angry if the company does poorly. It is up to you to monitor the behavior of corporate managers whose decisions affect your wallet.

‘Margin of Safety’ as the Central Concept of Investment

The idea of investing goes hand in hand with risk. Those who take the biggest risks may experience big wins, but they almost always experience huge losses, too.

One major loss can take years and years to recoup. Is it worth it?

Some loss is inevitable in investing, but the intelligent investor takes care not to lose the majority of their money. The best margin of safety is to refuse to pay too much for any investment.

Even the best investor is still human. Your analysis will be incorrect at some point in your life. Don’t take a risk if you can’t afford to deal with the consequences of an incorrect analysis.

Once again, the most intelligent way to invest is to keep your assets diversified, regularly contribute, and ignore the mood swings of the market. Buy low and sell high. With this strategy, you will be able to withstand mistakes. Your investments will be safe from both yourself and the market.

Intelligent investors don’t rush in; they take time to rationally examine a company’s long-term value.

There is a lot of money to be made through investing. But also a lot to lose. Finance history is full of stories of investors like Warren Buffett, who, by investing in the right companies, earned vast amounts of money in return. There are just as many — if not more — stories of misfortune, in which people place the wrong bets and end up losing it all.

So, we have to ask ourselves: is investment really worth the risk? The answer is yes, it can be, so long as you follow the strategy of intelligent investing.

Intelligent investors use thorough analyses in order to secure safe and steady returns. This is very different from speculating, in which investors focus on short-term gains made possible by market fluctuations. Speculations are thus very risky, simply because nobody can predict the future.

For example, a speculator might hear a rumor that Apple will soon release a new hit product, and would then be motivated to buy lots of Apple stocks. If she’s lucky, then this knowledge will pay off and she’ll make money. If she’s unlucky and the rumor proves wrong, then she stands to lose a lot.

In contrast, intelligent investors focus on pricing. These investors buy stock only when its price is below its intrinsic value, i.e., its value as it relates to a company’s propensity for growth.

As an intelligent investor, you’ll buy a stock only if you believe there is a probable margin between what you pay and what you will earn as the company grows. Think of this margin of safety the same way you would if you were out shopping. An expensive dress, for example, is only worth it if you end up keeping it for a while. If the quality is insufficient, then you might as well buy a cheaper one that lasts for the same amount of time.

The life of an intelligent investor isn’t very exciting, but that’s not the point. The point is the profit.

Intelligent investing is broken down into three principles.

There are three principles that apply to all intelligent investors:

First, intelligent investors analyze the long-term development and business principles of the companies in which they’re considering investing before buying any stock.

A stock’s long-term value is not arbitrary. Rather, it depends directly on how well the company behind it performs. So, be sure to examine the company’s financial structure, the quality of its management and whether it pays steady dividends, i.e., the distribution of profits to investors.

Don’t fall into the trap of only looking at short-term earnings. Look instead at the big picture by examining the company’s financial history.

These steps will give you a better idea of how well a company performs independent of its value on the market. For instance, a company that isn’t currently popular (and therefore has low share price) but shows promising records, i.e., has earned consistent profits, is likely undervalued, and would thus make a prudent investment.

Second, intelligent investors protect themselves against serious losses by diversifying their investments. Never put all your money on one stock, no matter how promising it appears!

Just imagine the horror you would feel if the promising company that you poured all your investments into shows up in the news for a tax fraud scandal. Your investment will lose its value immediately, and all that time and money will be lost forever. By diversifying, you ensure that you won’t lose everything at once.

Finally, intelligent investors understand that they won’t pull in extraordinary profits, but safe and steady revenues.

The target for the intelligent investor is to meet her personal needs, not to outperform the professional stockbrokers on Wall Street. We can’t do better than those who trade for a living, and we shouldn’t be aiming for fast money anyway; chasing dollar signs only makes us greedy and careless.

Intelligent investors understand the importance of stock-market history.

The first thing you should do before you invest isn’t to look at a stock’s history. That’s important, sure, but what’s more important is looking at the history of the stock market itself.

Looking back through history reveals that the stock market has always been defined by regular ups and downs. Often, these fluctuations can’t be foreseen. The unpredictability of the market means that investors need to be prepared – financially and psychologically.

Economic crises, like the Wall Street crash in 1929, are a fact of life, and happen from time to time.

Thus you need to ensure that you can take a big hit and survive. This means that you should have a diverse stock portfolio, so your investments don’t all get hit at once.

What’s more, you should be mentally and psychologically prepared for crisis. Don’t sell everything at the first sign of danger. Remember instead that, even after the most devastating crashes, the market will always recover.

And while you can’t predict every crisis, looking at the history of the market will give you a better idea of its stability.

Once you’ve determined that the market is stable, focus on the history of the company in which you’d like to invest.

Look, for example, at the correlation between stock price and the company’s earnings and dividends over the past ten years. Then consider the inflation rate, i.e., the rise in prices generally, in order to see how much you’d really earn, all things considered.

For example, you calculate a 7-percent return on investment within one year, but if inflation is at a 4-percent rate, then you’ll earn a return of only three percent. Think carefully about whether it’s worth the effort for only a three-percent return!

When it comes to shrewd trading, a knowledge of history is a fine weapon, so be sure to keep it sharp.

Don’t trust the crowd or the market.

To understand the whims of the market, it’s sometimes easier to imagine the entire stock market as being a person, let’s call him Mr. Market. As far as people go, Mr. Market is unpredictable, very moody and not very clever.

Mr. Market is easily influenced, and this causes him to have major mood swings. You can see this in practice in the way the market always swings back and forth between unsustainable optimism to unjustified pessimism.

When a new iPhone is released, for instance, people lose themselves in their excitement. Mr. Market is no different, and we see this reflected in the stock market when something exciting is about to happen: prices go up and people are more willing to overpay.

As result, when the market is too optimistic about future growth, stocks become too expensive. On the other hand, sometimes the market is too pessimistic, warning you to sell in unwarranted circumstances.

The intelligent investor needs to be a realist and stop herself from following the crowd. She should likewise ignore the mood swings of Mr. Market.

Moreover, when Mr. Market is happy, he makes you see future profits that aren’t really there.

Just because a stock generates profit in a given moment doesn’t necessarily mean that it will remain profitable forever. Quite the contrary: stocks that have been performing well are more likely to lose value in the near future because demand often inflates the price to the breaking point.

Even knowing this, it’s exceedingly easy to become enticed by short-term gains; we have evolved to easily recognize patterns, especially those that promise good things to come. In fact, people are so good at recognizing patterns that, when psychologists show them random sequences and even tell them that there is no pattern, they will still try to search for one.

Likewise, when we see profits rising and rising, we trick ourselves into seeing a pattern that we believe will continue.

By this point, you should understand the basic principles of intelligent investing. Our following book summary will offer you practical investment tips based on your unique investment style.

The defensive investor’s portfolio should be well balanced, safe and very easy to manage.

When you start on the path of investing, it’s important that you pick a strategy that best matches you as an individual. You’ll need to decide whether you’re a defensive investor or an enterprising investor. Right now, we’ll focus on the defensive investor:

The defensive investor hates risks. Thus, safety is her main focus. This safety can only be achieved if she diversifies her investments.

First, you should invest in both high-grade bonds, things like AAA government debt securities, as well as common stocks, by which your share of the company translates to voting power for major business decisions. Ideally, you should make around a 50-50 split between the two; or, for the extremely risk-averse investor, splits of 75 percent for bonds and 25 percent for stocks are acceptable.

Stocks and bonds have different degrees of safety and profitability: bonds are more secure but produce less profit, while stocks are less secure but can lead to greater rewards. This kind of diversification accounts for both tendencies.

Second, your common stock portfolio should be likewise diversified. Invest in big, well-known companies with long histories of success, and try investing in at least 10 different companies to reduce the risk.

This diversification might sound to you like more work than we initially promised, but don’t worry. To make things simpler, you’ll make use of the simplicity of choice:

When deciding on common stocks, it’s best not to reinvent the wheel. Look at the portfolios of well-established investment funds and simply align your portfolio with theirs. This doesn’t mean you should follow the bandwagon and buy the stocks that are fashionable. Rather, look for investment funds with a long history of success, and copy them.

Finally, always make sure to employ the services of an expert. They know the game better than you, and can guide you to making the best investment decisions.

If you follow these simple principles, then your prudence will be rewarded sooner or later with good results.

Investing is easy when you follow the formula.

Once you’ve chosen the companies you want to invest in, then it’s time to congratulate yourself. Most of your work is now complete! Now all you have to do is determine how much money you want to regularly invest and check your stocks from time to time.

During this time, you will use a process called formula investing, in which you act strictly according to a predefined formula that determines how much money you will invest and how often. This approach is also called dollar-cost averaging, whereby you invest in a common stock every month or quarter and always with the same amount of money.

Once you’ve found a stock that you’ve determined to be safe and sound, you’ll want to set your investments on autopilot. Start by committing yourself to a certain amount of money, e.g., $50, which you will invest every few months. Then buy as many stocks as possible for your $50.

The advantage here is that you now have to exert no further effort. You won’t ever invest too much, and you certainly won’t gamble.

The disadvantage, however, lies in the emotional demands of formula investing. Even if the price for your target stock is a real bargain and you want to buy more, you’ve already limited yourself to spending only your limit.

Nevertheless, defensive investors should check from time to time to ensure that their investment portfolios are still running well.

A good rule for this is to readjust your portfolio’s division of common stocks and bonds every six months. Ask yourself: are my stocks still profitable? Is the ratio about the same as when I had initially invested (e.g., 50-50)?

Finally, you should seek out a professional once a year to consult about adjusting your funds.

You now know all you need to start your career as a defensive investor. Our following book summary will lay out the strategies you need to become a successful enterprising investor.

Enterprising investors start similarly to defensive investors.

To become a successful enterprising investor, you’ll want to employ many of the same strategies as defensive investors.

Just like a defensive investor, you will divide your funds between bonds and common stocks.

Whereas the defensive investor will most often opt for a 50-50 split between stocks and bonds, the enterprising investor will invest more in common stocks, as they are more profitable (yet riskier). And just like the defensive investor, enterprising investors should also consult a financial planner.

However, the enterprising investor sees her financial planner not as a teacher, but rather as a partner in managing her money. That is, she is not led by her financial planner; they make decisions together.

In addition to using bonds and common stocks as the base for their portfolios, enterprising investors will also experiment with other kinds of stocks that have higher risk and higher reward.

For instance, you might have read about an up-and-coming start-up, and you suspect that it might be the next Google. In other words: it represents an amazing opportunity. As an enterprising investor, you have an opportunity to take a risk on this company, but only with a limited amount of money.

No matter how exciting or promising an investment opportunity seems, enterprising investors should limit these stocks to a maximum of 10 percent of her overall portfolio.

Remember: intelligent investors are not without fault, and sometimes Mr. Market is too wild for any rational person to predict. So, we have to place limits to protect our money in case of economic downturn or poor investment.

And like defensive investors, enterprising investors don’t forget that continual research and monitoring of their portfolios is essential to maintain an incoming profit flow.

The enterprising investor doesn’t follow the market’s ups and downs.

If you own stocks and their price falls, do you sell them immediately or keep them? If another stock is rising, is it a good idea to get in on the action before it’s too late?

This approach, known as trading in the market, is typical of investors, because they fear that going against the flow will result in financial losses. An intelligent investor, however, knows better!

Trusting Mr. Market is dangerous. If a stock’s prices are climbing fast, then chances are that it’s either already more expensive than its inherent value or it will make a risky investment.

Do you remember the US housing bubble only a few years back? Everyone kept investing in housing, and as prices continued to climb, nobody realized that prices were already totally unrepresentative of their intrinsic value. Once this became too obvious to ignore, however, the entire market crashed.

To avoid this exact scenario, enterprising investors buy in low markets and sell in high markets.

Check your portfolio regularly and examine the companies you invest in. Ask yourself questions like: Is the management still doing a good job? How is the financial situation?

As soon as you realize that one of the companies in your portfolio is overrated and its stock prices are growing without any relation to its true value, then it’s better to sell before it crashes.

On the other hand, you’ll want to buy in low markets.

That’s exactly what Yahoo! Inc. did in 2002 when it bought Inktomi Corp. for only $1.65 per share. It was a sensational bargain. Mr. Market had become depressed after Inktomi’s shares fell from the seriously overrated $231.625 per share, at a time when the company wasn’t profitable.

The enterprising investor has the chance to find real bargains.

By this point, the idea of becoming an enterprising investor should sound like a fun challenge. But is it really worth it to go through all this trouble of constantly checking your portfolio?

As a matter of fact, it is, since that’s where the best bargains lie — but only if you start smart.

The best way to start your life as an enterprising investor is to virtually track and pick stocks. Invest virtually for one year in order to hone your ability to pick out a bargain and track your stocks’ progress.

Today, there are many websites that allow you to make virtual investments. All you have to do is register in order to see if you can really achieve better-than-average results. This one-year practice period serves a number of purposes: not only does it help you learn the ins and outs of investment, but it will also free you from your fantastic expectations.

Once you’ve had your year’s virtual experience, then you’re ready for bargain hunting. The best place to find a bargain is in undervalued companies’ stocks.

The market normally undervalues the stocks of companies which are either temporarily unpopular or are suffering economic losses.

To illustrate this, imagine that Enterprise B is the second-strongest competitor in the refrigerator market. The company is large, and has shown sound — but not spectacular — profits over the past seven years. However, due to a production error, the company hasn’t been as profitable over the past two months, causing its share price to plummet as skittish investors get scared.

Once that production error is resolved, the company will be right back where it was, and an intelligent investor would see these falling prices as an opportunity to get a great bargain.

But finding bargains is hard. That’s why it’s so important to get your year’s worth of practice in first. If you can make it in the virtual world, then you can make it in real life!

Summary

Foreword by John Bogle

Financial markets are far different today than they were in 1949, when Benjamin Graham wrote The Intelligent Investor. Stock valuations are much higher, and the savings bonds that Graham praised are no longer attractive investments. Graham described the markets by using a character he called “Mr. Market,” a mythical fellow who offered investors a daily price at which he would buy their stock or sell them more. Generally speaking, Graham advised investors to ignore Mr. Market. However, today’s investors are doing “1,500 times as much business with him as they did a near-half-century ago,” so many investors have ignored this good advice.

“The genuine investor in common stocks does not need a great equipment of brains and knowledge, but he does need some unusual qualities of character.”

Graham would probably have cocked a skeptical eye at today’s volume of speculative trading. He certainly would have criticized the shift from owning stocks to renting them, because short-term stock ownership gives investors little incentive to exercise responsible oversight. However, Graham’s words about “defensive” and “enterprising” investors are still true. He was also prescient about the inability of fund managers to earn a return superior to the market average.

“Investment is most intelligent when it is most businesslike.”

His emphasis on long-term ownership suggests that he would have endorsed the idea of an index mutual fund. In an interview shortly before he died, he said investors should insist on earning at least the average market return from a fund. Graham conceded that his ideas might not pass the test of time, however, some of his principles remain valid, including his view that speculation usually leads to losses. Modern-day investors would also benefit from his exhortations to buy when others are eager to sell and to sell when others are eager to buy, and to do the necessary homework before investing.

“Nothing in finance is more fatuous and harmful…than the firmly established attitude of common stock investors and their Wall Street advisers regarding questions of corporate management.”

“The Intelligent Investor”

Investors – as opposed to speculators – come in two broad categories:

• Defensive – This investor intends to preserve capital, make as few mistakes as possible, enjoy a good return and hedge against inflation. Defensive investors want safety and freedom, so they are well-advised to put up to 40% of their money in savings bonds and a good portion in common stocks, both as an inflation hedge and as an opportunity to earn dividend income and profit from the stocks’ appreciation.
• Enterprising (or aggressive) – This investor wants to buy securities at less than their intrinsic value. Enterprising investors may try to profit by trading on market averages, picking market-beating stocks, selecting growth stocks, purchasing bargains, and, overall, buying when the market is pessimistic and selling when it is optimistic. Attempts to beat the market average and pick winning stocks are more akin to speculation than investing, but the other techniques are genuine investment strategies. Purchasing undervalued securities that offer a “margin of safety” may be the most certain route to riches, if you devote time and effort to becoming an investment expert.

“That attitude is summed up in the phrase: ‘If you don’t like the management, sell your stocks’.”

Investing is a business, and investors should treat it as such. Many businesspeople who are quite prudent in their own work seem to lose this discipline when they encounter Mr. Market. Intelligent investors are not uncommonly smart, shrewd or insightful, but they understand the market as a business. Investing success is more a matter of character than brains. An investor must have the personal strength to resist urges to speculate, make quick money and follow the crowd.

“Good managements produce a good average market price, and bad managements produce bad market prices.”

Market Movements

Speculators aim to make money on market movements. Investors, by contrast, intend to buy good stocks at good prices and hold them. Market movements matter only because they offer prices at which it becomes prudent for the investor to buy or sell. The average investor should not wait for the market to drop before buying stocks. As long as prices are not unreasonably high, you should work to build a portfolio of stocks through prudent purchasing patterns, such as averaging.

“Only in the exceptional case, where the integrity and competence of the advisors have been thoroughly demonstrated, should the investor act upon the advice of others without understanding and approving the decision made.”

Many investors attempt to identify stocks that will outperform the market in the short term. This is too close to speculation to be worth recommending. The stock price includes information about forecasts of higher or lower prices (both are always present in the market, for any stock) and reflects the net effect of these opinions. The value investor can ignore daily price fluctuations.

“The intelligent investor (needs) an ability to resist the blandishments of salesmen offering new common-stock issues during bull markets.”

Portfolio Policies: Defensive, Aggressive and Enterprising

Investment advisers can be useful, but do not rely on them for advice on how to profit. Professionals can help you achieve a low level of risk and a conservative income, and financial services firms can provide economic and market information – but do not put much store in their market forecasts. Brokerages are more like businesses than like professional firms, such as law firms. Investment bankers are salespeople who see customers as potential buyers for the securities they underwrite.

“Some of these issues may prove excellent buys – a few years later, when nobody wants them and they can be had at a small fraction of their true worth.”

The way to use advice and advisers depends on whether you are a defensive or enterprising investor. Defensive investors should limit their securities purchases to relatively low risk, high-quality bonds and stocks. They need only relatively simple, straightforward advice about which stocks meet their requirements and whether prices are reasonably in line with past averages.

“A prime test of the competent analyst is his power to distinguish between important and unimportant facts and figures in a given situation.”

Aggressive investors, however, work with advisers and demand detailed explanations and recommendations. A well-constructed portfolio of stocks is not too risky for a defensive investor. Although share prices fluctuate, the investor does not lose money merely because the market price declines. The investor only really loses value when selling at a price lower than the purchase price.

“This matter of choosing the ‘best’ stocks is at bottom a highly controversial one. Our advice to the defensive investor is that he let it alone.”

Aggressive investors should rely on their own judgment and look to advisers not for direction but for knowledge to supplement their own expertise. Two portfolio management principles apply to the aggressive investor: First, avoid buying corporate bonds since US savings bonds offer almost equal returns and much lower risk. Second, avoid high-quality preferred stocks. Lower-quality preferred stocks and corporate bonds may be good investments when prices are at least one-third below par. Foreign bonds are best left alone, as are convertibles and common stocks with superior recent earnings performance. New issues are attractive investments only when they are out of favor and selling at less than intrinsic value. The enterprising investor may seek to profit by:

• Market timing – Trying to buy when the market is down and sell when it is up is both attractive and dangerous. Future market fluctuations may not resemble past shifts. The one advantage of market timing formulas is that they may encourage investors to behave as contrarians, selling and buying against the crowd. This is a sound approach – but the rest of market timing has little merit.
• Growth stocks – Identifying stocks that have outperformed in the past is relatively easy, but forecasting future performance is difficult. Do not overpay for growth.
• Buying bargains – Bonds and preferred stocks may be good buys when their prices are below par. Common stocks may be bargains if their intrinsic value is higher than the market price. At times, some stocks may sell for less than the value of their working capital. An industry’s secondary stocks may also be bargains, as the market tends to exaggerate the risk of equities that are not industry leaders. Those who buy bargain-priced stocks can profit from the high dividend returns, earnings reinvestment and price escalation that come in the course of time or as the result of a bull market.
• “Special situations” – Bankruptcies, reorganizations, mergers and the like can offer profit opportunities. The market often discounts stocks excessively in the face of such concerns as in, for example, a firm’s potential involvement in lawsuits.

“Insiders never suffer loss from an unduly low market price which it is in their power to correct. If by any chance they should want to sell, they can and will always correct the situation first.”

Aggressive investors require a great deal of knowledge to conduct what is, in fact, an investing business. No middle ground exists between passive and active. Because relatively few investors have the expertise or the character necessary to act aggressively, most investors should adopt a defensive strategy.

“It is amazing to see how many capable businessmen try to operate in Wall Street with complete disregard of all the sound principles through which they have gained success in their own undertakings.”

Rules for Appraising Stocks

The following 11 rules can guide investors and analysts:

1. As a preliminary to calculating value, estimate the company’s earning ability, multiply appropriately and adjust for the value of assets.
2. Earning power is an estimate of the company’s earnings over a five-year horizon.
3. Estimate a company’s average earnings over this five-year horizon by averaging good and bad prior years, then projecting revenues and margins into the future.
4. Adjust prior years’ figures to reflect any capitalization changes in the company.
5. Use a minimum multiplier of eight and a maximum of 20. The multiplier allows for earnings changes over the long term.
6. If the value calculated on the basis of earning power is greater than the value of tangible assets, deduct from the earnings value appraisal. “Our suggested factor is as follows: Deduct one-quarter of the amount by which the earning-power value exceeds twice the asset value. (This permits a 100% premium over tangible assets without penalty.)”
7. If the valuation based on earning power is less than the value of net current assets, add 50% of the difference to the value calculated on earning power.
8. In unusual circumstances, such as those related to war, rentals or short-lived royalties, adjust the appraised value accordingly.
9. Allocate value among stockholders and bondholders or preferred stockholders. Before taking this step, calculate the enterprise value as if its capital structure consisted only of common stock.
10. The more aggressive the capital structure (that is, the more debt and preferred stock in proportion to common stock), the less you can rely on the appraised value when making a decision.
11. A stock’s appraisal that is one-third higher or lower than its current market value can be the basis for a decision to buy or sell. When the differential is less, the appraisal is merely another fact to consider in the analysis.

Stockholders and Managers

Stockholders have the rights and responsibilities of ownership, and should exercise them consistently and seriously, but for practical purposes, stockholders are impotent. They tend to follow management, regardless of its performance record. Although management is typically decent, there are enough cases of incompetent or dishonest managers that stockholders should hold them accountable.

In particular, shareholders should consider management’s efficiency. Although managers are critically important in the performance of any stock investment, investors seem to have little interest in examining their quality and less in removing or improving bad managers.

Shareholders need to test the quality of management objectively. If returns falter even when the industry prospers, if margins lag the sector or if the company does not sustain its market share, then stockholders should demand explanations. Stockholders may believe that elected directors will diligently protect their interests, but managers choose the directors. Many ties, including ties of friendship, bias directors in favor of management.

The Margin of Safety

The margin of safety, an essential investment principle, is the difference between the intrinsic value of a business and the price at which its stock is selling. Investors should make sure that an adequate margin of safety exists to defend against future falls in value. For example, before buying a railroad bond, an investor should determine whether the company has consistently earned enough to cover its interest payments by two or more times over a period of years. Diversification, along with the margin of safety, can protect an investment portfolio.

Conclusion

To succeed as an intelligent investor, your goal should be to manage risk rather than avoid it. The truth is, risk and uncertainty are simply part of the package with investing.

But if you follow the roadmap for intelligent investing, the gamble is exciting instead of terrifying. Take only the risks you can afford, diversify your investments, and forget about trying to predict the market.

These tools will make you an intelligent investor who is confident and excited for the future.

The key message in this book:

Whether you want to play it defensively or go the route of the entrepreneur, when it comes to stocks, you always want to walk the path of the intelligent investor. All you have to do is follow the guidelines laid out here, and you too can turn your investments into modest — but steady — profits.

About the author

Benjamin Graham (1884-1976) began his career as investor in 1914, after which he had to deal with substantial losses during the economic crash in the 1920s. His book The Intelligent Investor is a compilations of the lessons he learned as a young investor.

Benjamin Graham (1894-1976), the father of value investing, was also the author of Security Analysis and The Interpretation of Financial Statements.

Benjamin Graham was a British-American investor, professor, and author who became known as the father of value investing. After losing nearly everything in the stock market crash of 1929, Graham developed new investment techniques centered around mitigating risks and wrote Security Analysis, a book that is still highly regarded in the field of value investing.

Jason Zweig is an author, editor, and financial commentator. His works include Your Money and Your Brain and The Devil’s Financial Dictionary. Zweig’s writing has appeared in The Wall Street Journal, Money, and Time.

Genres

Personal finance, Personal Investing, Securities, Business, Economics, Money, Self Help, Personal Development, Investments

Review

The book is a classic and influential guide on value investing, which is an investment approach that focuses on buying undervalued stocks that have strong fundamentals and growth potential. The book provides strategies and principles on how to successfully use value investing in the stock market, based on the author’s extensive experience and research. The book covers the following topics:

• The difference between investment and speculation, and why investors should avoid being influenced by market fluctuations and emotions.
• The concept of “margin of safety”, which is the difference between the intrinsic value of a stock and its market price, and why it is the key to successful investing.
• The criteria and methods for selecting and analyzing stocks, bonds, and mutual funds, based on their quality, performance, dividends, earnings, assets, and growth prospects.
• The importance of diversification, portfolio management, and risk control, and how to balance between defensive and enterprising investing styles.
• The challenges and opportunities of investing in different market conditions, such as inflation, deflation, recessions, booms, bubbles, and crashes.
• The updated commentary by Jason Zweig, a financial journalist who adds his perspective on the current market situation, draws parallels between Graham’s examples and today’s financial headlines, and gives readers a more thorough understanding of how to apply Graham’s principles.

The book is a valuable and timeless resource for anyone who wants to learn how to invest wisely and profitably. The book is written in a clear and authoritative style, with many examples and illustrations from the author’s own practice and history. The book is also well-organized and easy to follow, with each chapter ending with a summary and a list of practical suggestions.

The book is not meant to be a comprehensive or technical manual on value investing, but rather a philosophical and educational guide that offers useful advice and insights for investors of all levels. The book is based on the author’s own perspective and experience, which may not always agree with other experts or sources. However, the book does not claim to be the final or ultimate word on value investing, but rather an invitation for investors to think for themselves and develop their own judgment.

The book is a must-read for anyone who wants to understand the fundamentals of value investing, and how to apply them in today’s market. The book is also suitable for anyone who wants to learn more about the history and evolution of the stock market, and the lessons that can be learned from its successes and failures. The book is highly recommended for anyone who wants to learn more about the intelligent investor.

Summary: The Intelligent Investor: The Definitive Book on Value Investing by Benjamin Graham