The Intelligent Investor is one of the best books out there on the topic of investing. It is quite a dense read and may be a little difficult to follow without a basic understanding of economics but it sheds light on some extremely valuable investing principles, making it well worth the effort. This post aims to briefly go over some of the key points covered in the introduction to set up a foundation for the discussion of later chapters in future posts. Alternatively, this can be read as a stand-alone post that summarizes the key investment principles discussed in the book.
Graham’s Core Investing Principles
The book starts off by outlining Graham’s core investing principles, which are as valid today as they were over the last century. These are what ultimately shape the investing policies explored throughout the rest of the book.
A stock is not just a ticker symbol or an electronic blip — it is an ownership interest in an actual business, with an underlying value that does not depend on its share price.
There is such an important distinction to be made between value and price, and many people make the mistake of confusing the two. A stock may be trading at a discounted price compared to price it has previously been trading at, but it may not be valuable if the business itself is not solid.
Price does play a role in deciding whether and/or when to buy and sell stocks, but I want to reiterate that the underlying value of a business does not change based on some ‘arbitrary’ market price that is put on it. The role of price is explained in the next principle.
The future value of every investment is a function of its present price. The higher you pay, the lower your return will be.
Valuable stocks that are trading at a discounted price provide a certain margin of safety to the investor but stocks trading far above their fair value provide relatively less potential for returns because they can only go so much higher. Returns are finite and so the price you are willing to pay should also be finite.
The market is a pendulum that swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The Intelligent Investor is a realist who sells to optimists and buys from pessimists.
In the end, how your investments behave is much less important than how you behave.
The Two Types of Investors
Graham then makes a distinction between two types of investors or investment philosophies one can adopt:
- Defensive Investor — the defensive (or passive) investor is one who will place his chief emphasis on the avoidance of serious mistakes or losses, aiming to be free from effort and frequent decisions.
- Active Investor — the active investor is one who’s trait is his willingness to devote time and care to the selection of securities that are both sound and more attractive than the average.
The Fallacies of a Common Investing Approach
It has long been the prevalent view that the art of successful investment lies first in the choice of those industries that are most likely to grow in the future, and then in identifying the most promising companies in these industries.
However, there are pitfalls that come with this investment approach.
- Obvious prospects for physical growth in a business do not translate into obvious profits for investors.
- The experts do not have fool-proof ways of selecting the most promising companies in the most promising industries.
While it seems easy to foresee which industry will grow the fastest, that foresight has no real value if most other investors are already expecting the same thing.
Markets are efficient and this means that market prices should reflect all available relevant information. If this foresight has already been priced in, then there should be no way to beat the market. The author himself did not follow this approach to investment and instead aims to warn readers of the areas of possible substantial error, and develop sound investment policies that he or she can follow.
A creditable, if unspectacular, result can be achieved by the lay investor with a minimum of effort and capability, but to improve this easily attainable standard requires much application and more than a trace of wisdom.
If you think that just a little extra knowledge will enable you to realize slightly better than normal returns, you often find that you have performed worse…
Three Powerful Lessons
I am glad that Graham firmly asserts the book will not teach you how to beat the market, because truthfully, nobody can. If you ever find yourself in a situation where someone guarantees they can turn a profit on your funds, run far, far away. Instead, the book focuses on three powerful lessons to guide your investment policy.
- How you can minimize the odds of suffering irreversible losses.
- How you can maximize the chances of achieving sustainable gains.
- How you can control the self-defeating behavior that keeps most investors from reaching their full potential.
The Dangers of Taking a Foolish Risk
Taking a foolish risk can put you so deep in the hole that it is virtually impossible to get out.
When it comes to investing, a lot of individuals become so greedy with trying to maximize their gains that they end up taking risks they can’t afford rather than being satisfied with more reasonable gains. I am not saying that it is wrong to maximize your gains, but often, you need to be able to stomach more risk to achieve significantly higher gains. When undertaking a risky endeavor, you need to set aside the money that you are alright with losing, because if you do lose a significant portion of your money, it is extremely hard to get back to what you had before. To put things in perspective, once you lose 95% of your money, you have to experience gains of 1,900% just to get back to the amount you started with.
What Does It Mean to be an Intelligent Investor?
Finally, the commentary on the Introduction section concludes with a section explaining what it means to be an Intelligent Investor. Intelligence simply means being patient, disciplined, and eager to learn — you must also be able to harness your emotions and think for yourself.
The Intelligent Investor realizes that stocks become more risky, not less, as their prices rise — and less risky, not more, as their prices fall.
You should dread a bull market since it makes stocks more costly to buy, and conversely, you should welcome a bear market as the prices of stocks will become discounted.
