Here we have one of the most profound book/guides upon Value investing by Benjamin Graham, The Intelligent Investor.
Rather than analysing chapter by chapter, I will instead summarise the most fundamental lessons all investors should learn from this read.
As always, I strongly advise you take a read for self in order to gain the full insights and gains from Benjamin Grahams utter market brilliance.
1. What we can learn from The Intelligent Investor
- How to locate and buy undervalued businesses
- How interest rates and inflation affect the Investor’s decision-making
- How to maximise our stock market return
- How to find businesses for the long-term
2. Investment Vs. Speculation
It is absolutely crucial that one understands the difference between Investing and Speculating.
Investor – “Promotes the safety of their principal at an adequate return” = Limit the possibility of losing capital, before assessing the likely returns.
Speculator – “The lottery Approach” = Place reward ahead of risk, gamble and do not do their homework.
Inflation affects securities in different ways. For simplicity, we will look at only Bonds and Stocks.
Bonds – Bond yields are directly affected by inflation. For example, a bond yielding 3%, with current inflation of 2% will reduce the bonds actual yield to 1%. (This is excluding tax)
Businesses/Stocks – Businesses are indirectly affected by inflation and to a certain extent are protected against inflation (however not 100% protected). An example will clarify this.
- Revenue = £100
- Costs = £80
- Profit = £20
After inflation (of 2%):
- Revenue = £102
- Costs = £81.60
- Profit = £20.40
What we have witnessed here, is that a business has the ability to adjust its operations to inflation. (When you go shopping and you see the prices of the same goods increase). This is crucial because it means a business/stock can maintain purchasing power.
4. What to Invest In
- Temporarily in decline or out of favour
- More unpopular = More likely to be miss-priced on the market
- Usually Lower P/E companies = unpopular (However this is not always the case)
- Lower P/E companies have lower future earnings potential, however, are much more stable and easier to predict.
- “An issue is not a true bargain unless the indicated value is at least 50% more than the price.” B.Graham
- Over time price and value will converge. This is where the value investor will reap their rewards.
- Walk into a supermarket, find the product that is on the highest sale and purchase that one.
5. Stock Market Psychology
I believe the best way B. Graham’s sentiment upon the stock market has been explained is through Warren Buffett’s stock market psychology analogy.
- You’re sitting at home reading your newspaper
- You get a knock on your door and it’s a gentleman called Mr.Market
- Mr.Market asks your if you want to buy or sell anything today and gives you his price list for the current day
- Every single day Mr.Market is going to come back to your door and ask you the same question, with the price list changing each day
- CRUCIALLY, it’s up to you as a smart, intelligent thinker to determine a value of whatever Mr.Market is offering and then compare it to his price on the day
6. Timing the Stock Market
Short term: “Daily fluctuations in the stock market won’t make the Investor rich.” – So no, in the short term we cannot time the stock market.
Long term: When we include valuations into a long-term approach our answer changes. When prices are attractive (bargains) in comparison to valuations then over time the Investor will reap the benefits as prices and value converge.
7. Margin of Safety
Again similar to the stock market psychology, I believe the best way B. Graham’s sentiment upon Installing a margin of safety has been explained is through Warren Buffett’s Engineering analogy.
- “The concept of margin of safety is the underpinning principle of value investing.”
- Imagine you are driving a truck that weighs 10Tons
- You come across the first bridge that can hold a maximum of 11Tons
- You go further along and find a second bridge that can hold 15Tons
- It is obvious, that one should take the second bridge as this provides the greater margin of safety.
- We cannot be so sure about the first bridge as the weights are too close, therefore if any slight mistakes have been made in the estimated maximum holding there would be a fatal error.
- In this analogy, the Truck = Market Price. Bridge = Indicated Intrinsic Value
* I strongly advise you take a read of the full book, if you have not already.
I hope you enjoyed the review and gained some key insights.
All the best,
Jordonlee W. Smith