We look at the best-known work from investment guru Benjamin Graham and the lessons it contains
Thursday 14 Feb 2019 Author: Ian Conway

Books on investing tend to fall into two categories, self-help books and market histories.

Probably the best-known investment book of all and therefore the natural starting point is Benjamin Graham’s The Intelligent Investor.

Warren Buffett, a student of Graham’s at Columbia University’s Business School, has called it ‘by far the most important book on investing ever written’.

Is it still relevant 70 years on? The answer is definitely ‘yes’.

HOW TO GET RICH SLOWLY

One thing this book isn’t is a guide to making millions overnight, nor does it hold with charts, technical analysis or ‘following the market’.

It isn’t an easy read either as the text is quite formal but Graham was a professor of finance and the book is intended to be educational so there is a degree of repetition to reinforce some of the key lessons.

The intelligence referenced in the title doesn’t mean that the book is reserved for super-smart investors like Warren Buffett and it manages to avoid getting bogged down in financial jargon.

It deals with what Graham calls ‘investment principles and attitudes’ and is aimed at investors who take a long-term approach and stick to their principles in the face of a market which more often than not is driven by emotions.

Where it deals with companies it uses comparisons between stocks to show which one is better value or which is better quality.

MR MARKET IS OFTEN WRONG

The book covers stocks and bonds and in both cases the advice is they should be ‘high grade’ and ‘bought at reasonable prices’.

Buying a stock just because it has gone up and selling it because it has gone down is ‘the exact opposite of sound business sense everywhere else’.

Probably the most often-quoted section of the book is the reference to ‘Mr Market’.

In a nutshell, imagine that you have a $1,000 stake in a business and one of your partners, Mr Market, tells you every day what he thinks your stake is worth.

Some days his idea of value appears ‘plausible and justified’ based on what you know about the business.

Other days he’s so depressed that he gives you a ridiculously low price or he’s so excited that he gives you a ridiculously high price.

The point is, as long as you know the real value of the business you can afford to buy when the price is low and sell when the price is high, or you can decide not to trade with Mr Market at all.

Graham cites the biggest danger as being swept along and ‘infected’ with enthusiasm, over-confidence and greed during bull markets.

PEOPLE DON’T CHANGE AND NOR DO MARKETS

The book lists five criteria for bull market tops: historically high prices, high price-to-earnings (PE) ratios, low dividend yields versus bonds, high levels of margin speculation (borrowing money to buy shares) and high levels of low-quality new issues.

While the UK market barely ticks any of these boxes given how low PE ratios are, and how high dividend yields are  for many stocks, we could certainly apply most of these five characteristics to the US stock market.

Prices and PEs are high, dividend yields are low, bond yields are actually rising, and margin speculation is high.

Margin borrowing typically peaks at market tops and troughs at market bottoms as people give up on stocks, which is when the ‘intelligent investor’ finds they are spoilt for choice.

Data from the US regulator FINRA shows that margin borrowing hit an all-time high of $669bn in May last year and has started to fall sharply, removing a key support for the market.

As for new issues, this year we are likely to see Airbnb, Lyft and Uber join the stock market.

While all are supposed to be good businesses, valuations are likely to be rich meaning that inside investors will make vast amounts of money at the expense of outside investors.


KEY LESSONS

The investment world was very different 70 years ago but the book still offers important lessons for today’s investors.

– Decide what kind of investor you are – if you want a quiet life, buy an index fund and drip money into it regularly (known as pound-cost averaging); if you are a more adventurous investor then buy a mix of stocks and bonds but make sure they are high quality and not speculative.

– Buy with a margin of safety – do your homework, satisfy yourself that you know what the business is worth (the intrinsic value) and try to buy it at a price that will give you a ‘cushion’ if prices fall.

– Be prepared for volatility – don’t get spooked by big sell-offs and certainly don’t sell just because prices have fallen, in fact as long as the business case hasn’t changed then buy more as the margin of safety is even greater.

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