The intelligent investor by Benjamin Graham is a classic book on the principles of value investing. It's definitely a book that every investor should try to read at least once in their lifetime.
Warren Buffett first read the intelligent investor when he was just 19 and later when he went on to Columbia business school, the author of the book, Benjamin Graham, actually became Warren Buffett's professor. Warren Buffett has referred to the book as by far the best investing book ever written, and they had that all over the place.
It isn't the easiest book in the world to read, but a way around this is to get the version that has the commentary chapters, and what you can do is to read through these commentary chapters first, so that you have a better understanding of what that chapter is actually going to be talking about.
9 Important Lessons From The Intelligent Investor
Benjamin Graham starts the book by talking about the difference between investing and speculation.
1) Investing vs Speculation
Benjamin comments that there are three goals when you are actually investing and not speculating:
- Using thorough fundamental analysis
- Seeking safe and steady but still adequate returns
- Protecting against loss
We will break these down further and some of the following sections.
2) Type of investor
The next key lesson from the intelligent investor is that you need to determine what type of investor you are.
This book categorizes the types of investors in two ways:
- The active/enterprising investor
- The Passive/defensive investor
Passive/defensive investors usually have a long-term portfolio that they want to put on autopilot. A lot of the time, they may include ETFs, or different types of funds in their portfolios, since that makes it a little easier to manage and they don't have to research in analyze those individual stocks.
Investing passively takes up less of your time, but the book does point out that no matter which way you go, you are going to have to take your emotions out of your investing decisions. Knowing that stock prices will fluctuate, even if you are a passive investor, you'll still need to be able to get through all of the highs and the lows of the market.
3) Protection Against Inflation
The third lesson from the intelligent investor is to invest in order to protect yourself against inflation.
Inflation happens when the dollar loses value or purchasing power. To put this into perspective, if you had one dollar in the year 1900, you could have bought 70 pounds of potatoes. But today, if you had one dollar, you would be lucky to find a piece of candy that costs less than a dollar.
When talking about inflation, Benjamin Graham also talks about the psychological effect that he calls "money illusion". He gives an example where the inflation rate is going up, meaning the dollar is losing value, but you get a raise and that raise doesn't actually make up for the rate of inflation, so in the end, you're losing money. This is overlooked because of the feel-good effect of getting that initial raise.
The point that he's getting at here is that if you had two dollars and you put one in a bank account and you invested the other, that dollar that you invested has a lot more potential to grow over time than that dollar that you kept in your bank account that is just sitting there and losing value.
4) Importance of Fundamental Analysis
The fourth lesson from the intelligent investor is the importance of fundamental analysis. According to the author, our investments must be based on numbers and performance and not on our emotions.
These are a few of the factors that Benjamin Graham looked at When selecting stocks:
- Earnings Per Share (EPS)
- Price to Earnings ratio (P/E)
- Long-term growth rate
Throughout the book, Benjamin Graham speaks more on this idea and also talks about investing in stocks that are performing well versus the stocks that you know.
What he meant by that is that even if you know and you like and you use a company, those feelings towards that company do not necessarily override how that company is actually performing. So to him, he believed that even if you like a company, if the numbers didn't line up, then it didn't necessarily make sense to invest in it.
5) Value Investing
The fifth key lesson from the intelligent investor is the whole idea of value investing. The whole goal of using fundamental analysis, as discussed in part 4, is to find the intrinsic value of a company. In other words, how much a company is actually worth? Once you find the intrinsic value of a company, the whole idea of value investing is to find companies that are trading under that intrinsic value. Benjamin Graham's investing strategy was to always buy stocks that were undervalued.
As you've probably heard many times, diversification is key, and the intelligent investor definitely reinforces this as Benjamin Graham specifically talks about having a mix of stocks and bonds, and he also touches on adding REITs or different funds to your portfolio in order to diversify.
The way in which you choose to diversify is personal, and it does depend on if you are an active or a passive investor, but the bottom line for all of this is to not put all of your eggs in one basket.
6) Dollar-Cost Averaging
Another lesson from the intelligent investor is to use dollar-cost averaging as a way to stay consistent and avoid trying to time the market. Dollar-cost averaging simply means investing consistently over time. This is usually taking a fixed amount of money and investing that every week, or every month, and to always invest regardless of what the share price is doing.
Let's say that you invest $1000 every month into your portfolio. Some months when the market is up, that $1000 is going to buy fewer shares of the companies that you want. But when the market is down, that $1000 is going to buy more shares. So over time, your average share prices will become lower.
If you use dollar-cost averaging in your investing strategy in today's world, it's helpful to use a platform that offers fractional shares. That wasn't a thing when Benjamin Graham wrote this book, but there are lots of platforms that offer that now which makes dollar-cost averaging easier.
7) Mr. Market
One of the best-known ideas from the intelligent investor is the imaginary character "Mr. Market". Mr. Market shows up every day with price quotes for what he will buy or sell things for, but this all is dependent on Mr. Market's mood, and that mood swings from extreme optimism to extreme pessimism.
8) Price Matters
The 8th lesson is that price does matter and not to overpay. We touched on dollar-cost averaging or investing consistently without worrying too much about small changes in price, but Benjamin Graham gives his opinion that even if a stock is a good stock, it is still possible to overpay for it, and if you're buying a good stock at a bad price, then that isn't a good investment.
Of course, an investor is never going to be 100% right on the price that they think a stock should be, but this is why Benjamin Graham always encourages people to go back to fundamental analysis, to really get the best idea of what a stock is worth.
9) Margin of Safety
Last but not least, one of the biggest concepts that is repeated throughout the book is to have a margin of safety.
A margin of safety is partially based on the intrinsic value of the stock and the price that you ideally buy it undervalued for, and buying it at that undervalued price does give you room space if that price moves.
Another part of that margin of safety does go back to diversification by having a mix of where you're putting your money. That way, you're making sure that everything in your portfolio isn't necessarily dependent on one area doing well.
Conclusion
So, how do you become an intelligent investor? Benjamin Graham believes that fundamental analysis, seeking safe and steady returns in minimizing your loss and your risk is the best way to go. If you're interested in learning more about becoming a passive investor and how you can start automating your finances, check out Payout Factor.
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