- Choose a strategy: defensive or enterprising and stick with it
- Most people should choose defensive and use diversification (index funds, ETFs)
- Most speculators and market timers lose money
Benjamin Graham refer so the “intelligent investor” as the one who follows the rules of value investing.
The Intelligent Investor VS Speculator
A recurring theme in The Intelligent Investor is that of the value investor, also called “Intelligent Investor” VS the speculative investor. Graham defines investment as:
The result of a thorough fundamental analysis in the company in which you invest, which results in the promises safety of principal and an adequate return
Any investment not meeting those requirement is a speculative by nature. Also notice the word “adequate” return. Value investing indeed is not looking for outsized returns.
Graham is very skeptical of the speculative methods and says it’s likely to lose money.
The defensive, or passive investor, wants freedom and safety. He doesn’t know the intricacies of markets and investment very well, so he buys 10-20 high grade stocks with a long positive history of dividends and keeps them for the long haul (note: there were no ETFs at that time).
A good option for the defensive investor is not to look much at prices but simply buy the same amount of stocks on a recurring basis, a technique which is called Dollar Cost Averaging.
The enterprising investor has the time, the willingness, and the market knowledge to try to beat the average market returns.
The enterprising investor looks at company which are undervalued through a financial quantitative analysis and a qualitative analysis on growth prospects.
Once he picks a good stock chances are it will grow quicker than the overall market as other investors realize these companies are underpriced.
Usually he will start his research first by looking at companies with a low price earning ratio and a low price book ratio (P/B).
Few Speculative Bets
The enterprising investor looks mostly at high quality companies, but might sometimes look at more speculative investments and lower quality securities.
He only does though when he has a firm grasp and knowledge of the market, the security is very lowly priced, and he has hedged his investment.
Fewer Growth Stocks
Growth stocks are stocks which are overpriced compared to the overall market because they have ambitious growth plan or because the market expects them to keep delivering outstanding and uncommon results.
The enterprise investor will rarely invest in growth stocks.
The enterprise investor is focused on “price” and not on “time”. Timing is the attempt to buy and sell based on the idea that one can predict whether the market will go up and down. That’s a speculative effort which rarely pays off.
The enterprise investor instead focuses on price as he looks for undervalued stocks.
Graham’s tips on enterprising investor are:
- Don’t trade daily
- IPOs are often over-hyped (and overpriced)
- Junk bonds are risky
- Only look into foreign bonds if the expenses are lower than 1.25%
- Great companies don’t necessarily make great investments
- Temporary setbacks and unpopularity can be great buying opportunities
Defensive or Enterprising?
A frequently asked question is if you should be a defensive or enterprising investor.
Graham is clear that few people should follow the enterprising investor path. Unless you’re very knowledgeable and spend lots of time, you should expect to achieve lower returns with an enterprising investor strategy.
Whatever you pick, make sure you’re serious about it.
If you decide to be an enterprising investor, you must invest time and effort in your portfolio. If you’re a defensive investor don’t over-trade. Don’t let the flurry of news and speed of the Internet dupe you into becoming a speculator.
Art or Science?
Graham admits that value investing is not exacts science but entails a margin of art, experience, guesswork and risk. However the risk is not so high when investing in high grade companies because, even if you got it wrong, the company might not grow but it will rarely sink either.
He advises to buy a stock when, based on your analysis, it’s at more than 50% discount.
Past Does Not Equal Future
Graham says a common mistake is that of extrapolating from the past to guess the future. It’s another human bias to see a trend and believe it will keep going… Indefinitely.
The Mind is The Enemy
Graham says that the human psychologies and out tendencies of overreacting and going with the crowd as the worst enemies of an investor. Also read Thinking Fast and Slow and Fooled by Randomness.
As a matter of fact, he should do the opposite of what the crowd does. As Warren Buffet also said:
Mutual Funds: Watch Out
Graham says most investment funds are overpriced compared to their expenses. This is a common refrain in many investment books, including the valid and more recent Money Master the Game and Unshakable.
Here’s what you should look into before investing in any of them:
- Risk level
- Reputation of decision makers
- Past performance
Later on in his life Graham recommended passive index funds, especially good for defensive investors. These days you can buy them easily through ETFs.
Listen to Warren Buffet talk about Benjamin Graham:
Real Life Applications
This is typical of guys starting out. I know it was for me.
Don’t Time the Market
Don’t try to time the market.
Tune Out Noise
The market is irrational and often random. Don’t overreact to the daily price swings.
If you have been around markets and investment for a while you know the main principles of The Intelligent Investor. But that’s only because The Intelligent Investor made those tenets popular and because time proved them (so far) right.
If you’re just approaching markets and investment, it might make sense to start with what is Warren Buffet’s favorite book: The Intelligent Investor.
And even if you’ve been around for a while, you should still probably read the classics.
Stay on top of the best books out there (I write once a month with a recap of the best books out there):