I started 2018 with almost no investment knowledge.
Most of what I knew, I’d gleaned from an old Simpsons cartoon – “buy low, sell high. That’s my motto!”
After realizing that I couldn’t just rely on my pension, I read a few books and started an RRSP.
I learned about ETFs and index funds.
Then a friend mentioned The Intelligent Investor by Benjamin Graham. It’s a book written by a man who survived The Great Depression and still made a profit investing through the 30s and 40s.
It's a dense book which requires some prior knowledge. Don’t worry though.
I will take the tough bits and break them down into some simple steps and ideas.
I won't be able to cover everything.
If you like what you see here, then you should go buy the book for yourself.
It's packed with more knowledge, history, and insight than I could manage to distill into this review.
What I'm attempting to do is break down some of the bigger ideas – just give you an introduction.
If you read this review, you should have the basics.
You should also have enough knowledge to be able to do some follow-up research on your own.
So let’s jump in.
Intelligent investing – not speculating
Maybe you’ve had a little extra money at the end of the month and decided to try and buy stock in a company.
With the recent legalization of marijuana in Canada, for example, many people have tried to ride the wave of popular pot stocks.
Some have made money, and some have lost. It all depends on when you bought it.
The point is simple. Those people were speculators, not intelligent investors.
- A speculator takes a look at a stock and sees that it's rising. The false assumption is that it'll continue to rise.It may not! Five days of success does not mean that a sixth is guaranteed.
- An intelligent investor looks at the value of a company, not the price of a stock. They look at the assets the company controls, its past performance, its management strategy, and then assess the value of the stock, compared with the value of the company.
What kind of investments to look for
What you're looking for is undervalued stocks. Basically, you're bargain hunting and looking for the best deals. The idea is that the public opinion or attitude towards the company may have made the stock price drop. It may be priced low for a variety of reasons.
The important thing is this:
When buying a stock, the value must be lower than the price. The company must have the ability to realize its value and grow in the future.
If you're following the trends and hoping for growth, then you're just speculating. To be an intelligent investor, making good value investments, you need to know:
- the company,
- its value,
- and if they will be managed well in the future.
If a company is managed well, then there's a reasonable chance that it will grow and improve its value.
There needs to be a difference between what you invest and what you'll earn as the company grows. Call this difference the margin of safety.
Your goal is to invest safely, so that your money will grow
It might feel fun to find a new and exciting stock and buy some shares.You'll sit anxiously waiting and hoping to see those shares climb in value.
Maybe they will.
But there's a flip side to that coin...Maybe they won’t.
In 1929, the stock market crashed. Credit was a relatively new concept and people were investing in the stock market without much knowledge.
Many people were using money they didn’t have.
People do this today with RRSPs during tax season.
They borrow money and get an RRSP to get the tax deduction, and then pay back the majority of the loan with their refund.
Today, that seems like a great idea, and it can be.
The problem is that when you buy a stock and then see its value drop, your knee-jerk reaction is to sell and get your money back before you lose more.
What that does is lower the value. If everyone has that reaction, then the stock price drops further. Then people start losing serious money.
The speculators and plummeting stocks
There are many examples of this, but I’ll use Facebook. This is from Market Watch’s Max A. Cherney:
On Thursday, Facebook FB, -6.33% lost about $120 billion in market capitalization, after its earnings report after the market close on Wednesday missed expectations on revenue and showed slowing user growth. Weak guidance also rattled investors (Cherney).
At the sign of slowed growth, people started a selling frenzy and that meant a quick plummet in the price of shares.
But the opposite can happen. Take the example of Turtle Beach.
It’s a company that makes headphones for video gaming.
When Fortnite came out and gained popularity, so did the need for good headphones.
Turtle Beach was perfectly positioned. They had a good product and they were in the right place.
And if you were in the right place, at the right time, you could have made a lot of money on this stock.
But that's why this is so tricky – and that's why this book is so important.
If you read Benjamin Graham’s iconic investment bible, The Intelligent Investor, you'll be able to spot quality companies.
They'll be worthwhile, long-term investments, and you'll be able to minimize losses and develop sustainable growth.
The lesson is simple: Only buy a stock if its price is below its intrinsic value.
The 3 principles of choosing your investments: Research, diversity, modesty
The rules are fairly simple:
Do your research
Look at companies, not just at the stock price.
A lot of people see a stock start to move up and want to jump on the bandwagon.
They want to ride the wave and make some money, hoping to hop off and sell prior to any drop in stock price.
But this is your financial future, not surfing.
I’ll say it again: Look at the company, not just the stock price. So what do you look at?
You can ask yourself a few important questions when it comes to the financial structure of a company:
- How much money does the company have?
- How much does it owe? You need to look at debt-equity ratio, short-term debt, creditors, and cash-flow.
- Is the company in a strong financial position?
There are several factors to consider here.
- First, how much does the CEO make? Compare the CEO’s compensation package to how well the company is doing. They should align.
- Does the management team have a clear vision for where the company is going? There should be a short and clear mission statement.
- How long has the management team had the job? If they have a long track record with the company, then they're likely doing something right.
- Is there insider buying? If people inside the company are buying its stock, then they likely have confidence in the company.
Does the stock pay dividends, and are the percentages reasonable?
There are instances where companies will pay higher dividends to investors than their cash-flow warrants. Look at the company’s history.
Diversify your portfolio
Let’s keep this short and sweet. If you've read any other book on investing, you know this already.
Diversify your portfolio. Do not put all of your money in one stock.
You should be sure to have investments across sectors and across the globe.
The market fluctuates and when one sector falls, another will likely rise, and you'll protect yourself from the highs and lows by having money in a variety of companies, in a variety of types of companies, and in a variety of regions of the world.
Don’t buy all Canadian or American. Look at global markets.
Don’t buy all tech stocks or energy stocks. Look to invest in a variety.
You get the idea.
Some people manage this with ETFs, index funds, or mutual funds.
This is a good method for beginner investors who don’t have the time to do all of the research mentioned above.
It's the method proposed in books like Money: Master the Game and The Wealthy Barber Returns.
Aim for a modest return
If you try to ride the wave to huge returns, you may just faceplant.
Look to meet your personal needs, and grow a portfolio that will sustain you.
Some financial advisors will promise you 10% - 20% returns.
They'll show you charts of their funds outperforming everyone else.
They'll tell you that they can make you rich, quick.
Take your time. Even though the promise of a big return will get you emotionally charged, you should always look at the history of the company.
Follow the rules above. Aim for small and safe gains.
Be the tortoise, not the hare.
“The investors chief problem - and even his worst enemy - is likely to be himself” - Benjamin Graham
The history lesson extended
The history of the company is one thing. What about the market itself?
The market is like an elevator. It goes up and down, and it will take you with it.
Be sure you can ride the ups and downs. Psychologically, you need to be prepared.
It's possible to not sell at the first sign of trouble.
You need to be able to take a loss, so don’t invest what you can’t lose. Crises happen.
1929! 2009! 2020!
Everyone knows those dates, even if you know nothing about investing. You learn about them in high school.
So look at the market, do some research and decide if the market is stable.
Graham presents the concept of Mr. Market as the personification of the stock market itself.
He has mood swings, he’s irritable, and he caves easily to peer-pressure.
Think about iPhone crazes and the excitement over a new Tesla.
This is the nature of Mr. Market. People get excited. Prices go up. People pay more.
None of this is related to the actual value of a company.
Don’t follow Mr. Market. For that matter, you should avoid checking the market as much as possible.
A warning to the daily checker
If you're one of those people who needs to see how their stocks are doing every day, then maybe you need to rethink your habits and investment strategy.
People who check the market every day are likely to sell frequently, and usually at the first sign of a loss.
Crazes can be optimistic or pessimistic. Sometimes stocks get over-valued. People pay too much, and that drives the price further.
Sometimes people grow pessimistic and look to sell.
The market mirrors this pessimism and that might warn you to sell in the wrong circumstances.
Remember that a company has value. It's a real entity, not just a symbol on a stock ticker.
There are people, products, and assets involved that don't change with the whim of speculators.
While stocks are going through their daily tidal movement – up and down, in and out of portfolios – you should do nothing unless you can see a clear change in the actual value of the company.
Don’t watch the market. Don’t follow the whim of Mr. Market. Ignore him.
How to be the smart, defensive investor
The defensive investor hates risk. Be this person.
They invest in bonds, securities, and common stocks – but mostly bonds.
Remember to look for a modest return.
If you're defensive, you should have a 50-50 split between bonds and stocks. If you're more defensive? 75-25. And remember to diversify in each category.
The easiest way to do this could be to buy index funds.
Once you've chosen your investments, you'll have to commit to regular contributions to those investments.
Graham called this method formula investing. We call it dollar-cost averaging.
Essentially, it works a little like this: You buy stocks in The Random Company. Over the course of 10 weeks, the price fluctuates.
When it's high, you feel good. When it's low, you feel bad.
But because you researched the company, you're confident in it. You can ignore Mr. Market.
10 weeks investing in The Random Company
Let's say this is how those 10 weeks look:
Expressed as a chart, it looks like this:
Despite the highs and lows, you regress to the mean.
The prices average out, and the growth you'll see in your investments follow.
You need to pick an undervalued company with good leadership. Invest regularly and don’t pay attention to Mr. Market.
As long as you set your investment to continue regularly, at a set amount, you'll need to do little to monitor your investments.
Check them once a month, or once every few months, and rebalance them to be sure that you're still diversified and your allocations still balance.
Are you still at a 50-50 split, money-wise? OR has one set of investments done better? If so, there'll be more money there.
You'll need to redistribute funds to balance your investment portfolio.
If you're a savvy investor who's ready to discuss a more aggressive approach, then I recommend you read The Intelligent Investor. It's well worth it.
There's much more to the book than I could possibly outline in this article.
For that reason, I gave you the important points to get you started.
If you want more, then you should go to the source. The book is timeless. Warren Buffett read it, and recommends it to everyone.
After reading it, he enrolled in Columbia University to study under Benjamin Graham himself.
Is it the book you should start with? No.
Start with something simple, like The Wealthy Barber.
But Graham’s work is central to good investing.
It's dense, and boring at times, but it's worth it.
So give it a shot.
There's so much more to learn!