In this article I am going to make a review of The Intelligent Investor, written by Benjamin Graham and with preface by Warren Buffet. It is a work that is often quoted and looked up to within finance. Sometime ago I therefore chose to take on the task to go read through this roughly 600 page book in order to see if all the hype was true.
In this review of The Intelligent investor I will go through the, in my opinion, main takeaways so that you can make a judgement whether this book is something for you.
Investment versus speculation
The main aspect to keep in mind is the difference between investment and speculation. The investor sees the stock as an actual part of a business and not just a fluctuating value. The speculator tries to anticipate such fluctuations in the market. But the goal of the investor is instead to hold securities at suitable prices.
The investor looks for stable companies with a long record of profitable operations and good balance sheets. He is also aware of that the future long term performance is decided by the actual business behind the stock.
An investor can choose to allocate some of his capital into speculative equities. This part should never go above 10% of the total assets.
A stock should furthermore not be bought just because it is close to its asset value. It is important to look at the p/e-ratio and to make sure that the financial position is strong.
There should be a projection that the company’s earnings will be maintained over the years. It should not be something only maintained in the short run.
Emotional control versus business insight
This difference between the two types of traders brings us to the second point. Emotional control or emotional intelligence is of the essence. For the investor such emotional intelligence is more important for earnings than IQ or business insight.
Such factors are of course important. However, other things that are of greater importance are:
- Discipline
- Patience when observing the market
- A willingness to continuously learn and
- Keeping one’s emotions in check when the market has its mood swings of its own
Graham’s main point is therefore that a lack of emotional discipline is more to blame than some kind of stupidity (perceived or otherwise) if you have been unsuccessful at investing. He also points out that enthusiasm is valuable elsewhere, but when it comes to investing it is the main cause of defeat.
The market is an ever swinging pendulum and an investor can never eliminate the risk of being wrong. The important thing is how you handle your fears. Therefore you need to develop emotional discipline. You should be able to take advantage of other peoples’ mood swings in order to gain an advantage. This is what Graham calls the defensive investor.
Review of the intelligent investor and the death of the bull market
The classic rule within trading is to buy low and sell high. But due to the aforementioned reasons of a lack of emotional intelligence, this is not always the case. The defensive investor is, according to Graham, seldom forced to sell his stocks.
The only reason for him to act upon price changes is when it goes in accordance with his strategy. The death of the bull market is hence not seen as bad news for a defensive investor. It is instead seen as the perfect time to start building wealth.
This point connects back to our first discourse regarding emotional intelligence. Emotional discipline is needed in order to not become a victim of the bipolar swings of the market.
Neuroscience and the bull market
Graham goes on to say that all the more investors will be affected by amnesia. That is a tendency that will go on as long as the bull market lasts. After around five years of a bull market, people will no longer think that a bear markets is even possible. All the people who forget are doomed to be painfully reminded later.
The reason that traders fall victim for such an illusion is twofold:
- Advances within the field of neuroscience has shown that the brain is designed to perceive trends. That holds true even where they might not exist.
- The book also points to works by the psychologists Daniel Kahneman and Amos Tversky, who have demonstrated that the pain associated with a financial loss is more than double as intense as the pleasure sensation associated with an equivalent gain.
It is not about beating the market at all
Within financial discussions a common cliche is to talk about if a trading strategy is beating the market. Personally I have often found this to be quite frustrating, since I think it makes no sense. Luckily for me Graham also contradicts such a cliche by stating that:
“Investing isn’t about beating others at their game.
It is about controlling yourself at your own game.”
The entire point of an investment strategy is not to beat the market compared to the average person. The point is to make enough in order to achieve your goals and to follow your strategy.
Graham brings up that he once interviewed some retirees at Boca Raton, which is one of Florida’s wealthiest communities for retirees. He asked several of them whether they had beaten the market during the years. Most of them weren’t sure and few of them even seemed to care. What mattered to them was that they had achieved their financial goals.
Review of the Intelligent investor and caution with advise
According to Graham the investment made in securities, such as stocks and bonds, is unique. That is because is almost always, to a varying degree, based on advice given by others such as:
- Financial advisor firms
- Media within the financial sphere
- Friends and family
Most people who choose to invest are amateurs. And due to their fear of failing they often choose to rely on advice from people who they deem to be experts. This can however be a mistake since the person giving the advice can have ulterior motives or be under pressure:
- The person giving the advice might have holdings in the company and is therefore trying to give advice that raises the share price. There are rules to prevent misleading financial information in such cases, where the person needs to disclose if he has holdings in the company he is discussing. Such rules can however sometimes be circumvented depending on who he gives the result AS (for example as a representative of a company or as the opinion of a private citizen).
- The financial analyst can be under pressure from his employers to give advice that gives “extraordinary” results in order to for example contribute to great headlines and/or reputation of the consultancy firm he is working at.
- Financial newspapers can have an incentive to gather a lot of readers with clickbaity headlines in order to get more ad revenue. Such headlines can often be quite misleading.
Due to such reasons it is therefore necessary that the investor does his own analysis instead of relying on great headlines in tabloid-like financial newspapers and financial analysts with an incentive. I am not saying that this might be entirely out of the question, but you should consider the person’s possible motives.
Study the managers of the company
One of the most important points that Graham talks about, which is often overlooked, is whether the people running the company are actually acting in the interest of the shareholders. A company that pays their CEO a substantially higher salary than other firms in the same industry needs to have a good reason to why this is being done, which of course might or not be the case. If there isn’t any such case present however, then this suggests a company that is run by the managers, for the managers.
In my personal experience I can think of two instances where the quality of the CEO has had an impact:
- Within the salmon industry Mowi’s CEO Alf-Helge Aarskog has had a substantially higher compensation than other CEOs within this industry. At the same time Mowi (Ticker: MOWI.OL) seems to have benefited from his leadership. In such a case it can be argued that the compensation has been just.
- Anthony Marino, who was the CEO of Vermilion Energy (Ticker: VET.TO), a Canadian oil and gas company argued during both 2019 and 2020 that their continuous (and somewhat high in my opinion) monthly dividend payment was economically justified. In the months to come Vermilion had to cut their monthly dividend payments completely and Anthony Marino stepped down as CEO in May 2020. The question that then comes to mind is whether there was prestige or pressure involved in order to keep the image of being a large oil company that pays monthly stable dividends, since they had done it for about 17 years already?
What to do?
It is important as a defensive investor to check whether that which the manager says stays consistent in the future. This can be done either by watching interviews with the management, reading the exact statements made in print in various media sources or, as Graham says, read the forecasts made by the management to see whether these forecasts were fulfilled or if they fell short.
The book The Intelligent investor denotes that if you are willing to put time and energy into improving your portfolio, then it is a necessity to learn about financial reporting in order to diminish the risk of being mislead. Three books are given as examples of possible resources:
- Martin Fridson and Fernando Alvarez’s Financial Statement Analysis
- Charles Mulford and Eugene Comiskey’s The Financial Numbers Game
- Howard Schilit’s Financial Shenanigans
Final words regarding this review of The Intelligent Investor…
In this review of The Intelligent Investor by Benjamin Graham, I have focused on the takeaways which I found to be most important:
- Investment versus speculation
- The death of the bull market
- Neuroscience and the bull market
- A word about beating the market
- Caution when taking advice from experts
- The company management
The book brings up quite a few other topics, some of which are contemporary for the time the book was written, and some which are still relevant today. There are upsides and downsides to it. The positive side is that it emphasizes and gives a great explanation of the psychology of investors and that which makes them fail and succeed in the long term.
The downside could perhaps be that it at times has a too large discussion about the most adequate division between bonds and stocks during different historical periods. Such historical information is of course necessary to understand, but in my view it ought to be somewhat lighter in comparison with the other topics brought up in the book.
All in all, it is a must read for anyone who is serious about investing long term and not fall victim to the psychological effects from volatility on the market.
Images by Gino Crescoli, Colin Behrens and Gerd Altmann from Pixabay
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