Second, let’s review a few nuggets of wisdom from The Intelligent Investor. My book is full of highlights, and I wanted to limit the length of this post so I limited myself to nine quotes.
“Several years ago Ben Graham, then almost eighty, expressed to a friend the thought that he hoped every day to do “something foolish, something creative and something generous.”
This is a fun quote from the start of the book... when is the last time you did “something foolish, something creative and something generous” in a day? I think of Mr. Graham as an analytical type so it really strikes me that he recommends being foolish and creative on a daily basis.
“The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condition.”
Graham consistently discusses the value of the long-term track record. In my experience, it's difficult to find companies that have a ten year history free of share dilution, dividend cuts, excess debt, etc. Companies with strong historical metrics tend to offer downside protection.
“The third is the device of “dollar-cost averaging,” which means simply that the practitioner invests in common stocks the same number of dollars each month or each quarter. In this way he buys more shares when the market is low than when it is high, and he is likely to end up with a satisfactory overall price for all his holdings.”
Graham (and basically all intelligent investors) recommend dollar-cost averaging.
"The rate of return sought should be dependent, rather, on the amount of intelligent effort the investor is willing and able to bring to bear on his task. The minimum return goes to our passive investor, who wants both safety and freedom from concern. The maximum return would be realized by the alert and enterprising investor who exercises maximum intelligence and skill.”
A greater return is available to those who are willing to "work" for it. However, if you don't have the right temperament, skills and patience you are best severed as a passive investor.
"The Basic Problem of Bond-Stock Allocation We have already outlined in briefest form the portfolio policy of the defensive investor.* He should divide his funds between high-grade bonds and high-grade common stocks. We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequent inverse range of between 75% and 25% in bonds. There is an implication here that the standard division should be an equal one, or 50–50, between the two major investment mediums. According to tradition the sound reason for increasing the percentage in common stocks would be the appearance of the “bargain price” levels created in a protracted bear market. Conversely, sound procedure would call for reducing the common-stock component below 50% when in the judgment of the investor the market level has become dangerously high."
Graham emphasized owning high-grade bonds and holding between 25% - 75% of your portfolio in bonds.
“Nonetheless we are convinced that our 50–50 version of this approach makes good sense for the defensive investor. It is extremely simple; it aims unquestionably in the right direction; it gives the follower the feeling that he is at least making some moves in response to market developments; most important of all, it will restrain him from being drawn more and more heavily into common stocks as the market rises to more and more dangerous heights.”
Graham recommends a 50/50 mix of stock and bonds for the defensive investor.
"A caution is needed here. A stock does not become a sound investment merely because it can be bought at close to its asset value. The investor should demand, in addition, a satisfactory ratio of earnings to price, a sufficiently strong financial position, and the prospect that its earnings will at least be maintained over the years. This may appear like demanding a lot from a modestly priced stock, but the prescription is not hard to fill under all but dangerously high market conditions.”
Throughout the book, Graham frequently emphasizes caution and defensiveness. It's clear to me that Graham's experiences during the great depression shaped his thinking. Every time I review The Intelligent Investor this stands out to me, it's almost always a good time to wonder: is my current investment strategy too aggressive?
"Let us close this section with something in the nature of a parable. Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly. If you are a prudent investor or a sensible businessman, will you let Mr. Market’s daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position."
Mr. Graham created "Mr. Market" to explain how irrational the crowds that drive market prices can be. Understanding that prices don't always reflect true value is key to understanding how one can create a strategy to outperform the market.
"The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices."
Graham makes a clear distinction between the "speculator" and the "investor." I'd argue that the majority of individuals that own stock act as market speculators and not true investors.
