With over one million copies sold and having been sold and it being described by Buffett as “by far the best book on investing ever written”, it would be a little foolish to have never read “The Intelligent Investor” by British-born American Benjamin Graham before pretending to call yourself an investor.
First published in 1949, the book is remarkable to me for how relevant it remains even more than six decades later.
The text concerns the subject of value investing, an approach to investment Graham began teaching in 1928 and later refined with David Dodd.
After reading The Intelligent Investor at 19, Buffett enrolled at the Columbia Business School in order to study under Graham, and they subsequently became lifelong friends.
Buffett then went on to work for Graham at his company, the Graham-Newman Corporation, for two years until Graham decided to close the business and retire.
Thereafter, many of Graham’s clients asked Buffett to manage their funds and the rest is history.
Buffett went on to develop his own strategy, which differed from Graham’s in that he stressed the importance of an asset’s quality and also the strategy of holding investments indefinitely.
Graham would instead tend to sell an investment when it reached a predetermined value.
Buffett has said, though, that no one ever lost money by following Graham’s methods and advice.
Here are just five of the key lessons I took away from this amazing book:
1. Learn from your mistakes and never give up
Graham lost most of the capital he had built up in the stock market crash of 1929 and the subsequent Great Depression.
He learned a hard lesson about risk, but instead of quitting investment as many would have done, Graham went on to write Security Analysis which detailed his methods of analysing and valuing securities.
He did this by buying the stocks of companies whose shares traded significantly below the companies’ liquidation value.
It is said that even after all of the heartache of the Great Depression, Graham still averaged around a 20% annual return through his many years of managing money.
2. Investing is not gambling or speculating
Graham achieved his great results at a time when buying stocks was considered to be nothing better than an out-and-out gamble, yet he was ultimately able to do so with great returns and a low risk.
Graham felt that investment should involve a certainty of the return of investment capital and a worthwhile return in excess of the inflation rate.
His method was to object to the widely held view that markets are efficient, and instead vow to identify undervalued assets.
This is known as value investing or intrinsic value investing.
Graham introduced a wonderful analogy of a man called Mr Market, an irrational chap who kindly offers you a buy and a sell price for your assets every day.
Unfortunately, Mr Market is rather a manic-depressive chap who some days offers wildly enthusiastic or even ridiculous prices, but on other days can only see doom and gloom and offer hugely depressed prices.
Graham stated that you as an investor are free to take the interest of Mr Market or to ignore him.
The key, he said, is to see Mr Market as your ally and use his kind offer of regular prices to your benefit.
Buy when he is depressed and sell when he is on a high.
4. Minimising downside risk
Graham always stressed how important it was to buy investments using a margin of safety and buying below true or intrinsic value.
This is important because it allows profit on the upside as the market eventually revalues the asset to fair value.
But the margin of safety approach also gives some protection on the downside if things don’t work out as planned and the market turns for the worse.
In shares, Graham would look at the liquidation value of a company.
In property, investors might, for example, consider land value to limit downside risk.
5. The Margin of Safety
The key idea of value investing is to buy assets whose price is lower than their true value and then to hold those assets until their price returns to their true value earning a return on the investment.
Graham stated that his goal was to buy a dollar’s worth of assets for 50 cents – and he managed to achieve exactly that.
There were two ways in which he could do this.
The first method was the use of market psychology.
That is, using the fear and greed of the market to his advantage.
The second was to invest by the numbers to find undervalued assets through investing counter-cyclically when the market was despondent and bargains abounded.
6. See beyond the horizon
“In the short term the market is a voting machine; in the long term it is a weighing machine.”
There are always – always – going to be ‘chicken-littles’ on hand to tell you that the sky is falling and that now is a terrible time to invest.
Over the short term we have no way of knowing what markets will do.
Over the long term, though, the market will revert to the mean and reflect intrinsic value.
Find assets which will be in huge demand over the long term, buy them, and hold on to them.
That, in a nutshell, is intelligent investing.