My Key Takeaways From the Introduction of the Intelligent Investor. Part 1/16. To Be Continued.

Preface to the Fourth Edition by Warren E. Buffett

To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What is needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.

If you follow the behavioral and business principles that Graham advocates – and if you pay special attention to the invaluable advice in Chapters 8 and 20 – you will not get a poor result from your investments.

A Note About Benjamin Graham by Jason Zweig

Sooner or later, all bull markets must end badly.

Combining his extraordinary intellectual powers with profound common sense and vast experience, Graham developed his core principles, which are at least as valid today as they were during his lifetime:

• 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
• The market is a pendulum that forever 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.
• The future value of every investment is a function of its present price. The higher the price you pay, the lower your return will be.
• No matter how careful you are, the one risk no investor can ever eliminate is the risk of being wrong. Only by insisting on what Graham called the “margin of safety” – never overpaying, no matter how exciting an investment seems to be – can you minimize your odds of error.
• The secret to your financial success is inside yourself. If you become a critical thinker who takes no Wall Street “facts” on faith, and you invest with patient confidence you can take steady advantage of even the worst bear markets. By developing your discipline and courage, you can refuse to let other people’s mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave.

Introduction: What This Book Expects to Accomplish

Chief focus is on investment principals and investor attitudes, not on techniques on analyzing securities.

No statement is more true and better applicable to Wall Street than the famous warning of Santayana: “Those who do not remember the past are condemned to repeat it.”

This is not a “how to make a million” book.

In the climatic year 1929 John J. Raskob, a most important figure nationally as well as on Wall Street, extolled the blessings of capitalism in an article in the Ladies Home Journal, entitled “Everybody Ought to Be Rich.” His thesis was that savings of only $15 per month invested in good common stocks – with dividends reinvested – would produce an estate of $80,000 in twenty years against total contributions of only $3,600. Based on the 30 stocks making up the DJIA indicates that if Raskob’s prescription has been followed during 1926-1948, the investor’s holdings at the beginning of 1949 would have been $8,500, not $80,000.

The one principle that applies to nearly all these so-called “technical approaches” is that one should buy because a stock or market has gone up and one should sell because it has declined. In our own stock-market experience, extending over 50 years, we have not known a single person who has consistently or lastingly made money by thus “following the market.”

In updating the current version we shall have to deal with quite a number of new developments since the 1965 edition was written. These include:

• An unprecedented advance in the interest rate on high-grade bonds.
• A fall of about 35% in the price level of leading common stocks, ending in May 1970. This was the highest percentage decline in some 30 years. (Countless issues of lower quality had a much larger shrinkage.)
• A persistent inflation of wholesale and consumer’s prices, which gained momentum even in the face of a decline of general business in 1970.
• The rapid development of “conglomerate” companies, franchise operations, and other relative novelties in business and finance. (These include a number of tricky devices such as “letter stock,” proliferation of stock-option warrants, misleading names, use of foreign banks, and others.)
• Bankruptcy of our largest railroad, excessive short and long term debt of many formerly strongly entrenched companies, and even a disturbing problem of solvency among Wall Street houses.
• The advent of the “performance” vogue in the management of investment funds, including some bank-operated trust funds, with disquieting results.

The underlying principles of sound investment should not alter form decade to decade, but the application of these principles must be adapted to significant changes in the financial mechanisms and climate.

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.

2 morals for our readers;
1. Obvious prospects for physical growth in a business do not translate into obvious profits for investors.
2. The experts do not have dependable ways of selecting, and concentrating on the most promising companies in the most promising industries.

“The fault, dear investor, is not in our stars – and not in our stocks – but in ourselves…”

In an article in a women’s magazine many years ago we advised the readers to buy their stocks as they bought their groceries, not as they bought their perfume. The really dreadful losses of the past few years were realized in those common-stock issues where the buyer forgot to ask “How Much?”

In June 1970 the question “How Much?” could be answered by the magic figure 9.40% - the yield obtainable on new offerings of high-grade public utility bonds. This has now dropped to about 7.3%, but even that return tempts us to ask, “Why give any other answer?”

We shall suggest as one of chief requirements here that our readers limit themselves to issues selling not far above their tangible-asset value.

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.

*The reader should bear in mind that when he finds the word “now,” or the equivalent, in the text, it refers to the late 1971 or 1972. *

Commentary on the Introduction

“If you have built castles in the air, your work need not be lost; that is where they should be. Now put the foundations under them.” – Henry David Thoreau, Walden

Notice that Graham announces from the start that this book will not tell you how to beat the market. No truthful book can. Instead, this book will teach you 3 powerful lessons:

• 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

Back in the boom years of the late 1990s, when technology stocks seemed to be doubling in value every day, the notion that you could lose almost all your money seemed absurd. But, by the end of 2002, many of the dot-com and telecom stocks had lost 95% of their value or more. Once you lose 95% of your money, you have to gain 1,900% just to get back to where you started.

You must harness your emotions and think for yourself. This kind of intelligence, explains Graham, “is a trait more of the character than of the brain.”

A Chronicle of Calamity
Now let’s take a moment to look at some of the major financial developments of the past few years:

  1. The worst market crash since the Great Depression, with U.S. stocks losing 50.2% of their value-or $7.4 trillion-between March 2000 and October 2002.
  2. Far deeper drops in the share prices of the hottest companies of the 1990s, including AOL, Cisco, JDS Uniphase, Lucent, and Qualcomm-plus the utter destruction of hundreds of Internet stocks.
  3. Accusations of massive financial fraud at some of the largest and most respected corporations in America, including Enron, Tyco, and Xerox.
  4. The bankruptcies of such once-glistening companies as Conseco, Global Crossing, and WorldCom.
  5. Allegations that accounting firms cooked the books, and even destroyed records, to help their clients mislead the investing public.
  6. Charges that top executives at leading companies siphoned of hundreds of millions of dollars for their own personal gain.
  7. Proof that security analysts on Wall Street praised stocks publicly but admitted privately that they were garbage.
  8. A stock market that, even after its bloodcurdling decline, seems overvalued by historical measures, suggesting to many experts that stocks have further yet to fall.
  9. A relentless decline in interest rates that has left investors with no attractive alternative to stocks.
  10. An investing environment bristling with the unpredictable menace of global terrorism and war in the Middle East.

“Obvious prospects for physical growth in a business do not translate into obvious profits for investors.” 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. By the time everyone decides that a given industry is “obviously” the best one to invest in, the prices of its stocks have been bid up so high that its future returns have nowhere to go but down.

If no price seemed too high for stocks in the 1990s, in 2003 we’ve reached the point at which no price appears to be low enough. The pendulum has swung, as Graham knew it always does, from irrational exuberance to unjustifiable pessimism. The intelligent investor realizes that stocks become riskier, not less, as their prices rise-and less risky, not more, as their prices fall.

More to come. Chp 1-12, 14-15, 19

> My Key Takeaways From Chapter 1 and Commentary 1 of the Intelligent Investor

 

To all beginning investors I would recommend Security Analysis instead of The Intelligent Investor.

Security Analysis contains the same messages and is pragmatic. I.e. after reading it you'll actually know how to analyze a 10K.

 

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