My Key Takeaways From Chapter 3 and Commentary 3 of the Intelligent Investor. Part 4/16. To Be Continued.

Chapter 3 A Century of Stock-Market History: The Level of Stock Prices in Early 1972

In this chapter, we shall present the figures, in highly condensed form, with two objects in view. The first is to show the general manner in which stocks have made their underlying advance through the many cycles of the past century. The 2nd is to view the picture in terms of successive ten-year averages, not only of stock prices but of earnings and dividends as well, to bring out the varying relationship between the 3 important factors. We will determine whether the market is attractive or unattractive for the given time frame.

*Table 3-1 Major Stock-Market Swings Between 1871 and 1971

*Table 3-2 A Picture of Stock-Market Performance, 1871-1970

*Table 3-3 Data Relating to Standard & Poor’s Composite Index in Various Years

Commentary on Chapter 3

“You got to be careful if you don’t know where you’re going, because you might not get there.” – Yogi Berra

The heart of Graham’s argument is that the intelligent investor must never forecast the future exclusively by extrapolating the past.

The indexes used to represent the U.S. stock market’s earliest returns contain as few as 7 (yes, 7!) stocks. By 1800, however, there were some 300 companies in America (many in the Jeffersonian equivalents of the internet: wooden turnpikes and canals).

Graham urges the intelligent investor to ask some simple, skeptical questions. Why should the future returns of stocks always be the same as their past returns? When every investor comes to believe that stocks are guaranteed to make money in the long run, won’t the market end up being wildly overpriced? And once that happens, how can future returns possibly be high? Graham’s answers, as always, are rooted in logic and common sense.

Graham’s warning in this chapter is simple:” By the rule of opposites,” the more enthusiastic investors become about the stock market in the long run, the more certain they are to be proved wrong.

The stock market’s performance depends on 3 factors:

• Real growth (the rise of companies’ earnings and dividends)
• Inflationary growth (the general rise of prices throughout the economy)
• Speculative growth or decline (any increase or decrease in the investing public’s appetite for stocks

Robert Shiller, a finance professor at Yale University, says Graham inspired his valuation approach: Shiller compares the current price of the Standard & Poor’s 500-stock index against average corporate profits over the past 10 years (after inflation). By scanning the historical record, Shiller has shown that when his ratio goes well above 20, the market usually delivers poor returns afterward; when it drops well below 10, stocks typically produce handsome gains down the road. – Figure 3-1