Investment is most intelligent when it is most businesslike.(1)
– Benjamin Graham
Way back in 1934, during the depths of the Great Depression, Benjamin Graham(2) and David Dodd published their monumental Security Analysis, one of the core texts in investment history. Many people believe Security Analysis to be the best book ever written on the investment process.
Fifteen years later, apparently not content to have written one timeless classic, Graham published The Intelligent Investor, which many people believe to be the best book ever published on the investment process. (Warren Buffett, for example.)
Security Analysis grew out of Graham and Dodd’s experience with the lunacy of the Roaring Twenties, when investors (or, rather, “investors”) seemed to have no idea how to evaluate companies or stocks. People bought whatever was going up and they sold whatever was going down. That is, they bought high and they sold low. As Jason Zweig put it, before Graham and Dodd, investors “behaved much like a medieval guild, guided largely by superstition, guesswork, and arcane rituals.”(3) It’s not much of an exaggeration to say that investing in the modern sense began with the publication of Security Analysis.
Security Analysis took on the task of figuring out how to evaluate companies and stocks – how to analyze them – in order to give investors a rational and thoughtful reason to buy Stock A, rather than Stock B, and also when to sell Stock A. This, said Graham and Dodd, was the “businesslike” way to look at investing, the intelligent way, an approach that was grounded in the concept of value, rather than price. Price, as Buffett likes to say, is what you pay, whereas value is what you get. Investors who focused on the value of the stocks and companies they were buying would have a “margin of safety,” that is, they would be buying at a price that allowed some unexpectedly bad things to happen without jeopardizing the investment. Investors who didn’t focus on value weren’t investing at all, but speculating.
Graham and Dodd were so successful in their undertaking that even today, more than eighty years after it was published, nobody can expect to work as a securities analyst without mastering “Graham & Dodd,” as Security Analysis is usually called.
The Intelligent Investor was Graham’s attempt to distill the massive Securities Analysis down into something a lay investor could understand and put to work in the stock market. Graham was so successful that, as noted, many people think The Intelligent Investor is actually the better book, though both are indispensable. (Of course, “distill” is a relative word. My copy of The Intelligent Investor is a solid brick of a book, 5” by 8”, 623 pages, almost a cube.(4))
Most lay investors aren’t likely to read and absorb even the shorter book, 623 pages of investment wisdom. But, as Buffett has pointed out, if you carefully read chapters 8 and 20 of The Intelligent Investor, your investment results are likely to be light-years ahead of most of your peers. Chapter 8 discusses market fluctuations and how to take advantage of them (and how to avoid being taken advantage of by them). Chapter 20 discusses the margin of safety. I would add chapter 1 on the difference between investment and speculation.
One of Graham’s most enduring analogies is his discussion of a fellow named Mr. Market. Mr. Market, says Graham, is this strange fellow who comes around every day and gives you a price for your stock. It’s up to you whether to sell at that price, buy at that price, or do nothing – Mr. Market is indifferent. Most of the time, Mr. Market’s price is pretty close to the true value of your stock and so you likely won’t buy or sell. But sometimes, Mr. Market offers a price that is positively outlandish.
You see, Mr. Market is suffering from what Graham would have called manic-depressive syndrome, but what today we would call bipolar disorder. If the price Mr. Market is offering is really high, it’s probably because Mr. Market is cycling through his manic phase and you should sell. If the price on offer is very low, it’s probably because Mr. Market is cycling through his depressive phase and you should buy.
Graham offers specific ideas on attractive and unattractive price-earnings ratios, but they are hard to adapt to the modern world. This is in part because it’s not 1949 any more (or even 1972, when Graham updated the book). More important, Graham calculates P/E ratios by using multiple years of earnings, more like the Shiller P/E. Zweig’s commentary points out that using next year’s expected earnings to calculate P/Es, as financial analysts do, is like buying a house in the hope that Cinderella will build her castle next door.
Today, some people are “value” investors and some people are “growth” investors, but this sentence wouldn’t make sense to Graham. An investor, according to Graham, is by definition a value investor; the phrase is in fact redundant. But since there are far more “growth” investors than “value” investors, we’ll take a look at the growth stock hairball next Friday.
(1) Warren Buffett called this the wisest sentence ever written about investing.
(2) Nobody seems to know where the name “Graham” came from. Ben’s father’s name was Isaac Grossbaum, and it seems likely that the name was simply “Americanized” when the family moved to the US from England. There may also have been a fear of antisemitism after World War I.
(3) Zweig wrote commentary to the Revised Edition of The Intelligent Investor, which came out in 2003. The Graham text (as opposed to the Zweig commentary) was reproduced from the Fourth Revised Edition, updated by Graham and published in 1973.
(4) Technically, the book is almost a rectangular parallelepiped.
Next up: The Semi-Intelligent Investor, Part 2
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Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.