The Intelligent Investor Summary and Key Takeaways
Casino or Investing
The distinction between investing and speculation. It is a simple concept, yet a lot of “investors” or what Graham and Buffett would call speculators does not know the difference. This is in spite of the catastrophic effect this ignorance could have on their bank account.
Speculation is celebrated by Wall Street, wrapped in story telling and vivid pictures of success. It’s brilliantly marketed by Wall Street and anyone who makes a profit on your trades.
What is the main difference between a gambling speculator and an intelligent investor?
- The investor calculates what the stock is worth based on underlying businesses and the speculator gambles that a stock will go up in price because somebody else will pay even more for it.
- The investor judge the market price by established standards of value like the underlying assets and business value. The speculator base their standard of value upon the market price.
Treat speculation like you would treat a visit to the Casino. Don’t take it too serious. The odds given to you by Wall Street are calibrated so you can’t win in the long run. “Investors make money for themselves, speculators makes money for their brokers.”
On the other hand, Graham will tell you that investing is a game you can win, If you play by the rules putting the odds in your favor.
As an investor, first keep your principal safe, then seek a satisfying return on your money. Intelligent investing has three elements:
- Analysis of the stock and soundness of the underlying businesses.
- Deliberately protect yourself against serious losses.
- Aspire to adequate not extraordinary performance.
If you want to be an intelligent investor, you have two choices.
You can be a passive/defensive investor and you can be an enterprising/active investor.
When choosing your category, you have to remember that there is no middle ground. Enterprising investors must have a lot of knowledge about security value. Enough to call his activities a real business. If you can’t, you should be a passive investor. Trying to be a bit of both is like trying to be half a businessman, expecting half the profits.
There is a good chance that you will have to choose the strategies of a defensive investor. How should you invest in stocks then?
It should be simple, and there are four rules to be followed:
- You must diversify and you should hold from 10 to 30 different stocks.
- You should only buy large, prominent and conservatively financed firms.
- The firms you buy should have a long record of continuous dividend payments.
- You should set a limit on the price t0 be paid for the stock in relation to the average earnings over the past 7 years. This limit should be max 25 times earnings.
The enterprising investor activities consist of:
- Buying low and selling high.
- Buying carefully chosen growth stocks.
- Buying bargain issues of various types.
- Buying into special situations.
“Chapters 8 and 20 (of this book) have been the bedrock of my investing activities for more than 60 years”.
Market Fluctuations – Buy Low, Sell High
“The market is a pendulum forever swinging between unsustainable optimism (expensive stocks) and unjustified pessimism (cheap stocks). The intelligent investor is a realist who buys from pessimists and sells to optimists.”
The approach of the intelligent investor, is that called pricing. Here you will buy and hold stocks when the price is fair.
Buy stocks when they’re below fair value and sell when they rise above such value.
For the defensive investor this means: just make sure you don’t overpay when you buy the stock. Market movements is only important in a practical way, because they create low price levels where you should buy and high levels where you might want to sell your stocks.
What Shouldn’t You Do?
You should never sell your stocks after a big drop in price, nor buy after a big rise. We should remember that prices are only there for our convenience and don’t necessarily reflect the underlying value of the stock.
A valuable metaphor is that you should buy stocks as you would buy groceries, not as you buy perfume. You need to look for fair or discounted prices.
Margin of Safety
“The thread that runs through all value investing policies.”
Imagine you’re at a casino and you bet 1 dollar on a given number on the roulette. You are paid 35 dollars if you win but you will only win 1 out 37 times. You have a negative margin of safety of two dollars. Here diversification is foolish as the more numbers you bet on, the greater is the chance that you end up loosing. If you regularly bet 1 dollar on every number you will end up losing 2 dollars every turn of the roulette wheel. If you would receive 39 instead of 35 dollars, then you will have a small but very important margin of safety. You could then be certain to win two dollars on every spin by betting on all the numbers.
This shows why Graham’s emphasis on diversification is important. Diversification only makes sense if you have a positive margin of safety that ensures you will win “the roulette game” in the long run.
Part the Waters
The margin of safety should be used as a way to distinguish real investing from gambling and speculation. Because as Graham writes in the book, the speculator might think he has a margin of safety, but it is often based on his own subjective judgement unsupported by any real evidence. On the other hand, the intelligent investor’s concept of margin of safety rest on simple arithmetic reasoning from statistical data. Also supported by practical investment experience.
“A true investment must have a true margin of safety and a true margin of safety can be demonstrated by figures, by persuasive reasoning and by reference to a body of experience.”