Food for Thought 2 – Book of the Month
#2 The Intelligent Investor
The Intelligent Investor is one of those 20th century business classics that you assume will be worthy but outdated.
Given that it was first published in 1949, it’s an understandable reaction if you presuppose that much of it will be irrelevant.
On the other hand, any book Warren Buffet has described it as “by far the best book ever written on investing”, really can’t be ignored.
Well, hold on to your hats – the 2006 version I recently read was entertaining, stimulating and full of good advice.
I expected an arid, technical read, but found the majority of it entertaining and quickly breezed through it.
Although it’s an investment book, the author Ben Graham focuses on psychology and temperament.
No matter how brilliant the investment strategy is, it won’t succeed in practice unless the investor has the right temperament.
Graham distinguishes between Defensive Investors—investors who are hands-off and satisfied with the average market return—and Enterprising Investors—who like to put in the extra work and research to try to beat the market.
Graham believed most people are not emotionally suited to be Enterprising Investors and recommended the vast majority of us be Defensive.
There is a great deal of wisdom here on both styles of investing.
General Wisdom
Base decisions on the value of the underlying business.
Would you be willing to buy the whole company for the valuation implied by the share price? Analyse businesses not securities and don’t try to time the market.
Don’t let market prices drive your decisions. The market just allows you to buy more of a great investment or exit of an underperforming one.
Buy stocks that are clearly underpriced. Look for “no brainers”, so even if your analysis doesn’t quite pan out, you’re still likely to earn a profit. These opportunities are tough to spot, but worth waiting for.
The higher the price, the riskier the investment. When prices are high, your margin of safety contracts. Some of the worst losses arise from buying bad stocks in a bull market.
Don’t ignore the performance of your investments. It’s important to be an intelligent investorand an intelligent shareholder. Make sure the company is performing.
Industry growth does not necessarily translate to advantageous investment returns. Take the airline industry, for example. It was obvious in the early days that the sector would grow dramatically. Yet it’s generally been an absolute bloodbath for investors.
Defensive Investor advice
Invest in a mix of stocks and bonds. A 50/50 mix of cheap shares and bond index funds is a good place to start.
Invest up to 2% of your portfolio in a low fee (<1%) unit trust specialising in precious metals.
Invest up to 10% of retirement assets in inflation-linked bonds to provide inflation protection.
Invest up to 33% of stock portfolio in low-cost index funds concentrated on foreign stocks.
So, one thing is obvious. Being a defensive investor is easy, particularly with the vast array of low cost index funds on offer.
If you want to be a little more proactive the book offers the suggestion of actively managing up to 10% of your portfolio.
Wisdom for Enterprising Investors
Novice Enterprising Investors should test the waters with a portfolio tracker for one year before putting any money at risk. If it makes you uneasy or you lose money you can go back to being Defensive.
The first big step is to pinpoint financially-sound businesses. This is all about identifying undervalued-but solid – companies. Graham’s suggested criteria (updated in 2006) are as follows:
- Market cap of at least $10bn
- Revenues of at least $1bn 20-year dividend history
- 2-to-1 current assets to current liabilities
Graham bought stocks with a method that provided both low risk and a high return, and reportedly averaged a 20% annual return over his investing career.
Now that is a very impressive statistic.
Paul Connolly
Paul Connolly has been a journalist for more than 20 years, as a reporter and editor for Argus Media, Reuters, The Times, Associated Newspapers and The Guardian. He has covered Islamic Finance for Reuters in the 1990s. Paul has since helped launch three newspapers, as well as reported from Tokyo, Los Angeles and Stockholm.
