tiistai 20. toukokuuta 2014

Benjamin Graham: The Intelligent Investor - The Definitive Book on Value Investing

"I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is. To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. This book precisely and clearly prescribes the proper framework. You must supply the emotional discipline." - Warren Buffet.
There is nothing to add to this Warren Buffet's comment about Benjamin Graham's legendary book The Intelligent Investor - The Definite Book on Value Investing. This book is clearly a must read for any investor - intelligent or not. This book is like the Bible of Investing. It explains all the key principles you need in investing, especially if you prefer value investing. Many people, me included, spend their time on reading all types of investment books without choosing the best, the most fundamental one. Why? Why don't you just take time for these 622 pages once and learn the ideas from their original source? It's highly worth it!
Here below is a relatively short summary about this book. This is a commentary version, due to which I have marked commentaries in italics. These comments are not original Graham's, but still many of them are worth highlighting. Hopefully you can get some basic ideas from here. Anyway, my point is clear: read this book!

Benjamin Graham - The Intelligent Investor
Benjamin Graham - The Intelligent Investor - The Definite Book on Value Investing

Graham developed his core principles, which are:
1) A stock is not just a ticket symbol or an electronic blip; it is an ownership interest in an actual business, with an underlying value that does not depend on its share price.
2) The market is a pendulum that forever swings between unsustainable optimism (which make stocks too expensive) and unjustified pessimism (which makes stocks too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists.
3) The future value of every investment is a function of its present price. The higher the price you pay, the lower your return will be.
4) No matter how careful you are, the one risk no investor can ecer eliminate is the risk of being wrong. Only by investing on what Grahan called the "margin of safety" - never overpaying, no matter how exciting an investment seems to be - can you minimize your odds of error.
5) The secret of your financial success is inside yourself. If you become a critical thinker who takes no Wall Street "fact" on faith, and you invest with patient confidence, you can take steady advantage of even the worst bear markets. By developing your discipline and courage, you can refuse to let other people's mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave.

Those who do not remember the past are condemned to repeat it.

There are no sure and easy paths to riches on Wall Street or anywhere else.

It has long been the prevalent view that the art of successful investment lies first in the choice of those instruments that are most likely to grow in the future and then in identifying the most promising companies in these industries. But this is not as easy as it always looks in retrospect:
1) Obvious prospects for physical growth in a business do not translate into obvious profits for investors.
2) The experts do not have dependable ways of selecting and concentrating on the most promising companies in the most promising industries.
The ultimate results of such a conservative policy is likely to work out better than exciting adventures into the glamorous and dangerous fields of anticipated growth.

The investor's chief problem - and even his worst enemy - is likely to be himself.

An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative. ...Never mingle your speculative and investment operations in the same account nor in any part of your thinking.

We recommend that the investor divide his holdings between high-grade bonds and leading common stocks; that the proportion held in bonds be never less than 25% or more than 75%, with the converse being necessarily true for the common-stock component; that his simplest choice would be to maintain a 50-50 proportion between the two, with adjustments to restore the equality when market developments had disturbed it by as much as, say 5%. As an alternative policy he might choose to reduce his common-stock component to 25% "if he felt the market was dangerously high" and conversely to advance it toward the maximum of 75% "if he felt that a decline in stock prices was making them increasingly attractive".

The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condititon. Aggressive investors may buy other types of common stocks, but they should be on a definitely attractive basis as established by intelligent analysis.

Stock trading is not an operation "which, on thorough analysis, offers safety of principal and a satisfactory return".

To enjoy a reasonable chance for continued better than average results, the investor mus follow policies which are 1) inherently sound and promising, and 2) not popular on Wall Street.

Motley Fool Model: 1) Take the five stocks in Dow Jones Industrial Average with the lowest stock prices and highest dividend yields. 2) Discard the one with the lowest price. 3) Put 40% of your money in the stock with the second-lowest price. 4) Put 20% in each of the three remaining stocks. 5) One year later, sort the Dow the same way and reset the portfolio accordingly to steps 1 through 4. 6) Repeat until wealthy.

Stocks do well or poorly in the future because the businesses behind them do well or poorly - nothing more, nothing less.

Is there a persuasive reason to believe that common stocks are likely to do much better in future years than they have in the last five and one-half decades? Our answer to this crucial question must be a flat no. Common stocks may do better in the future than in the past, but they are far from certain to do so.

The only way that inflation can add to common stock values is by raising the rate of earnings on capital investment. On basis of the past record this has not been the case.

The intelligent investor must never forecast the future exclusively by extrapolating the past. ...Tne only thing you can be confident of while forcasting future stock returns is that you will probably turn out to be wrong. The only indisputable truth that the past teaches us is that the future will always surprise us - always! And the corollary to that law of financial history is that the markets will most brutally surprise the very people who are most certain that their views about the future are right.

The value of any investment is, and always must be, a function of the price you pay for it.

In the financial markets, the worse the future looks, the better it usually turns out to be.

General portfolio theory

It has been and old and sound principle that those who cannot afford to take risks should be content with a relatively low returns on their invested funds. From this there has developed the general notion that the rate of return on which the investor should aim for is more or less proportionate to the degree of risk he is ready to run. Our view is different. The rate of return sought shold be dependent, rather, on the amount of intelligent effort the investor is willing and able to bring to bear 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 intelligent and skill.

There are two ways to be an intelligent investor: 1) by continually researching, selecting and monitoring a dynamic mix of stocks, bonds, or mutual funds. 2) or by creating a permanent portfolio that runs on autopilot and requires no further effort (but generates very little excitement). Graham calls the first approach "active" or "enterprising"; it takes lots of time and loads of energy. The "passive" of "defensive" strategy takes little time or effort but requires an almost ascetic detachment from the alluring hullabaloo of the market. Charles Ellis has explained, the entreprising approach is physically and intellectually taxing, while the defensive approach is emotionally demanding. If you have time to spare, are highly competitive, think like a sports fan, and relish a complicated intellectual challenge, then the active approach is up your alley. If you always feel rushed, crave simplicity, and don't relish thinking about money, then the passive approach is for you. Some people will feel most comfortable combining both methods - creating a portfolio that is mainly and partly passive, or vice versa. Both approaches are equally intelligent, and you can be successful with either - but only if you know yourself well enough to pick the right one, stick with it over the course of your investing lifetime, and keep your costs and emotions under control.

Rules for the Common-Stock Component for Defensive Investor:
1) There should be adequate though not excessive diversification. This might mean a minimum of then different issues and a maximum of about thirty.
2) Each company selected should be large, prominent, and conservatively financed. Indefinite as these adjectives must be, their general sense is clear.
3) Each company should have a long record of continuous dividend payments.
4) The investor should impose some limit on the price he will pay for an issue in relation to its average earnings over, say, the past seven years. We suggest that this limit be set at 25 times such average earnings, and not more than 20 times those of the last twelve-month period. But such a restriction would eliminate nearly all the strongest and most popular companies from the portfolio. In particular, it would ban virtually the entire category of "growth stocks", which have for some years past been the favorites of both speculators and institutional investors.

An industrial company's finances are not conservative unless the common stock (at book value) represent at least half of the total capitalization, including all bank debt.

Insiders (people who work for the company) often possess only the illusion of knowledge, not the real thing. Psychologists led by Baruch Fischhoff of Carnegie Mellon University have documented a disturbing fact: becoming more familiar with a subject does not significantly reduce people's tendency to exaggerate how much they actually know about it. That's why "investing in what you know" can be so dangerous; the more you know going in, the less likely you are to probe a stock for weaknesses. The pernicious form of overconfidence is called "home bias", or the habit of sticking to what is already familiar: 1) individual investors own three times more shares in their local phone company than in all other phone companies combined. 2) The typical mutual fund owns stocks whose HQ are 115 miles closer to the fund's main office than the average U.S. company is. 3) 401(k) investors keep between 25%-30% of their retirement assets in the stock of their own company.

Once you build a permanent autopilot with index funds as its heart and core, you'll be able to answer every market question with the most powerful response a defensive investor could ever have: "I don't know and I don't care".

The knowledge of how little you can know about the future, coupled with the acceptance of your ignorance, is a defensive investor's most powerful weapon.

Buying a bond only for its yield is like getting married only for the sex.

Weighting the evidence objectively, the intelligent investor should conclude that IPO does not stand only for "initial public offering". More accurately, it is also shorthand for: It's Probably Overpriced, Imaginary Profits Only, Insiders' Private Opportunity, or Idiotic, Preposterous and Outrageous.

Operations in Common Stocks for Active Investor

The activities specially characteristics of the enterprising investor in the common-stock field may be classified under four heads:
1) Buying in low markets and selling in high markets
2) Buying carefully chosen "growth stocks".
3) Buying bargain issues of various types
4) Buying into "special situations".

We have two major sources of undervaluation: 1) currenlty disappointing results and 2) protacted neglet or unpopularity.

The ideal combination is a large and prominent company selling both well below its past average price and its past average price/earnings multiplier.

There is a world of difference between "hindsight profits" and "real-money profits".

As an investor you cannot soundly become "half a businessman", expecting thereby to achieve half the normal rate of business profits on your funds. It follows from this reasoning that the majority of security owners should elect the defensive classification. They do not have the time, or the determination, or the mental equipment to embark upon investing as a quasi-business. They should therefore be satisfied with the excellent return now obtainable from a defensive portfolio (and even with less), and they should stoutly resist the recurrent temptation to increase this return by deviating into other paths.

"It requires a great deal of boldness and a great deal od caution to make a great fortune; and when you have got it, it requires ten times as much with to keep it". -Nathan Mayer Rothschild

A great company is not a great investment if you pay too much for the stock.

"Put all your eggs into one basket and then watch that basket" proclaimed Andrew Carnegie a century ago. "Do not scatter your shot. ...The great successes of life are made by concentration." As Graham points out, "the really big fortunes from common stock" have been made by people whp packed all their money into one investment they knew supremely well. Nearly all the richest people in America trace their wealth to a concentrated investment in a single industry or even a single company (Bill Gates, Sam Walton, Rockefellers...). The Forbes 400 list has been dominated by undiversified fortunes since it was first compiled in 1982. However, almost no small fortunes have been made this way - and not many big fortunes have been kept this way. What Carnegie neglected to mention is that concentration also makes of the great failures of life.

It is absurd to think that the general public can ever make money out of market forecasts. For who will you buy when the general public, at a given signal, rushes to sell out at a profit? If you, the reader, expect to get rich over the years by following some system or leadership in market forecasting, you must be expecting to try to do what countless others are aiming at, and to be able to do it better than your numerous competitors in the market. There is no basis either in logic or in experience for assuming that any typical or average investor can anticipate market movements more successfully than the general public, of which he is himself a part.

Nearly all the bull markets had a number of well-defined characteristics in common, such as 1) a historically high price level, 2) high price/earnings ratios, 3) low dividend yields as against bond yields, (4) much speculation on margin, and (5) many offerings of new common-stock issues of poor quality. (193)

The better a company's record and prospects, the less relationship the price of its shares will have to their book value. But the greater the premium above the book value, the less certain the basis of determining its intrinsic value, i.e., the more this "value" will depend on the changing moods and measurements of the stock market. Thus we reach the final paradox, that the more successful the company, the greater are likely to be the fluctuations in the price of its shares. (198)

Net asset value, book value, balance-sheet value, and tangible-asset value are all synonyms for net worth, or the total value of a company's physical and financial assets minus all its liabilities. It can be calculated using the balance sheet in a company's annual and quarterly reports; from total shareholder's equity, subtract all "soft" assets such as goodwill, trademarks, and other intangibles. Divide by the fully diluted number of shares outstanding to arrive at book value per share. (198)

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 sufficient strong financial position, and the prospect that its earnings will at least be maintained over the years. (200)

Investing intelligently is about controlling the controllable. (219)

Investing isn't about beating others at their game. It's about controlling yourself at your own game. (219)

If your investment horizon is long - at least 25 or 30 years - there is only one sensible approach: Buy every month, automatically, and whenever else you can spare some money. The single best choice for this lifelong holding is a total stock-market index fund. Sell only when you need the cash. (219)

After all, the whole point of investing is not to earn more money than average, but to earn enough money to meet your own needs. The best way to measure your investing success is not by whether you're beating the market but by whether you've put in place a financial plan and a behavioral discipline that are likely to get you where you want to go. (220)

Late in his life, Graham praised index funds as the best choice for individual investor, as does Warren Buffet. (249)

As the investmen consultant Charles Ellis puts it, "If you are not prepared to stay married, you shouldn't get married." Fund investing is no different. If you're not prepared to stick with a fund through at least three lean years, you shouldn't buy it in the first place. Patience is the fund invetor's single most powerful ally. (256)

Formula for valuation of growth stocks: Value = Current (Normal) Earnings X (8.5 plus twice the expected annual growth rate). (295)

The most basic possible definition of a good business is this: It generates more cash than it consumes. Good managers keep finding ways of putting that cash to productive use. In the long run, companies that meet this definition are virtually certain to grow in value, no matter what the stock market does. (308)

If owners earnings per share have grown at a steady average of at least 6% or 7% over the past 10 years, the company is a stable generator of cash, and its prospects for growth are good. (308)

Don't take a single year's earnings seriously. (310)

In short, pro forma earnings enable companies to show how well they might have done if they hadn't done as badly as they did. As an intelligent investor, the only thing you should do with pro forma earnings is to ignore them. (323)

Stock Selection for the Defensive Investor: 1) Adequate Size of the Enterprise, 2) A Sufficient Strong Financial Condition (Current assets should be at least twiec current liabilities), 3) Earnings Stability (for the past 10 years), 4) Dividend Record (uninterrupted payments for at least the past 20 years), 5) Earnings Growth (a minimum increase of at least one-third in per-share earnings in the past ten years using three-years averages at the beginning and end), 6) Moderate Price/Earnings Ratio (current price should not be more than 15 times average earnings of the past three years). (349)

As a rule of thumb we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5. This figure corresponds to 15 times earnings and 1.5 times book value. It would admit an issue selling at only 9 times earnings and 2.5 times asset value etc. (349)

We invest in the present, but we invest for the future. (364)

In the short run the market is a voting machine, but in the long run it is a weighnig machine. (477)

Graham begins his original (1949) discussion "The Investor as Business Owner" by pointing out that, in theory, "the stockholders as a class are king. Acting as a majority they can hire and fire management and bend them completely to their will". But, in practice, says Graham, the shareholders are a complete washout. As a class they show neither intelligence nor alertness. They vote in sheeplike fashion for whatever the management recommends and no matter how poor the management's record of accomplishment may be... The only way to inspire the average American shareholder to take any independently intelligent action would be by exloiding out the paradoxical fact that Jesus seems to have been a more practical businessman than are American shareholders. (498)

Today's investors have forgotten Graham's message. They put most of their effort into buying a stock, a little into selling it - but none into owning it. "Certainly", Graham reminds us, "there is just as much reason to exercise care and judgement in being as in becoming a stockholder". Then, how to be an intelligent owner? There are just two basic questions to which stockholders should turn their attention: 1) Is the management reasonably efficient? 2) Are the interest of the average outside shareholder receiving proper recognition? (499)

Graham succests that every company's independet board member should have to report to the shareholders in writing on whether the business is properly managed on behalf of its true owners. (511)

The function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future. If the margin will not fall far below those of the past in order for an investor to feel sufficiently protected against the vicissitudes of time. The margin of safety for bonds can be calculated, alternatively, by comparing the total value of the enterprise with the amount of debt. If the business owes 10 million and is fairly worth 30 million, there is room for a shrinkage of two-thirds in value - at least theoretically - before the bondholders will suffer loss. (513)

The risk of paying too high price for a good-quality stocks - while a real one - is not the chief hazard confronting the average buyer of securities. Observations over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions. (516)

There is no such thing as a good or a bad stock; there are only cheap stocks and expensive stocks. Even the best company becomes a "sell" when its stock price goes too high, while the worst company is worth buing if its stock goes low enough. (521)

Investment is most intelligent when it is most businesslike. (523)

Every corporate security may best be viewed, in the first instance, as an ownership interest in, or a claim against, a specific business enterprise. (523)

"Know what you are doing - know your business." Do not try to make "business profits" out of securities - that is, returns in excess of normal interest and dividend income - unless you know as much about security values as you would need to know about the value of merchandise that you proposed to manufacture or deal in. (523)

"Do not let anyone else run your business, unless (1) you can supervise his performance with adequate care and comprehension or (2) you ahve unusually strong reasons for placing implicit confidence in his integrity and ability." (523)

"Do not enter upon an operation - that is, manufacturing or trading in an item - unless a reliable calculations shows that it has a fair chance to yield a reasonable profit. In particular, keep away from ventures in which you have little to gain and much to lose". (523)

"Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it - even though others may hesitate of differ." (523)

To achieve satisfactory investment results is easier that most people realize; to achieve superior results is harder than it looks. (523)

Successful investing is about managing risks, not avoiding it. (535)

Without a saving faith in the future, no onw would ever invest at all. To be an investor, you must be a believer in a better tomorrow. (535)

To keep investing from decaying into cambling, you must diversify. (535)

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