This article on The Intelligent Investor review was written by Luis C. Sánchez. Luis is a lawyer and private investor in Bogotá, Colombia who focuses on net net stocks. He is an expert in corporate law and he passed the CFA Level I exam. He manages stocks for his personal account and for clients. Article image (creative commons) by Paul Stevenson, edited by the Broken Leg Investing.
However, some things have changed since Ben Graham published his magnum opus in 1949. That may lead investors to question whether it’s still worthwhile to read The Intelligent Investor and heed its lessons.
Another The Intelligent Investor review seems in order as we hit the 70th anniversary of its release. You’ll soon see that indeed, its principles still hold value for deep value investors today. Why? To answer that question, it may help to think about mountain biking.
The Goal Is to Finish the Ride
At the age of 13, my uncle took me for my first mountain bike ride. I was not into sports by then, but I was young. On the other hand, my uncle and his friends were in their fifties, so it seemed like an easy ride.
We all met at my uncle’s home, put on our gloves and helmets, grabbed our bikes and started pedaling. The first ten or twenty blocks had no cliffs or downhills. On top of that, my companions pedaled slowly and were basically chatting as we rode along the streets, so I thought, “This is boring.”
I asked my uncle where we were heading. He said: “We are turning to the right ten blocks from here, where the small hill begins. The goal is up the hill; we’ll meet there.” I started pedaling faster and left the team behind. I was determined to beat them. Soon enough, the hill began and I had to slow down. It was not a small hill at all, though. It was very steep, and the goal was not visible. Still, I was ahead of the team.
Maybe around one kilometer up the hill, I felt very tired. I was breathing very fast, and my heart was racing. I stopped and jumped off the bike. Now, my uncle and his friends were closer. They were pedaling even slower than before, and they kept chatting.
My uncle passed me as I hopped back on my bike. He asked me if I was ok. I nodded but a hundred meters later, my heart was racing. I had to stop again.
Now, I was behind everyone. My uncle said he’d keep pedaling up the hill and wait for me ahead. I was out of water. My legs hurt. The hill just stretched up endlessly. I felt sick.
A few minutes later, my uncle came down the hill and back to me. He said, “Now, you’ve learned your first lesson about mountain biking: the first goal is to finish the ride, not to finish it first.”
Somehow, between pedaling and resting, I made it to the top. My uncle and his friends had waited for me or around half an hour. It was pretty embarrassing. I learned my lesson.
The Intelligent Investor Review: “To Finish First, You Must First Finish”
As I read The Intelligent Investor for the second time a few months ago, it dawned on me that mountain biking is a lot like investing. As Buffett once said, when investing, “To finish first, you must first finish.”
Every active investor wants to beat the market. They want to finish first — or at least, perform above average. If not, what’s the point of active investment? However, only a few care about actually finishing the ride. That’s why so many investors lose their money in the process. While chasing the upside, many forget to protect their downside. Small private investors are most vulnerable to this trap, typically earning below average returns on their investments.
The Intelligent Investor is a book for the small private investor. That’s why The Intelligent Investor is worth a read even today. It teaches the small private investor how to minimize the downside and, in the process, earn a decent return on their investment. In sum, the book teaches you how to finish the ride.
When reading The Intelligent Investor, review the last chapter with more care. It sums up the volume with three words: margin of safety. This is the secret of sound investing. Always protect your downside. By always investing with a margin of safety, the odds of you finishing the ride are above average. This is how you effectively reduce your risk — defined as the probability of permanent loss.
So, what is the margin of safety? When engineers build a bridge, they make sure that it can resist a couple of times the actual weight it will endure. The difference between the bridge’s weight capacity and the actual weight it can endure is its margin of safety. For investors, the margin of safety is the difference between the intrinsic value of a stock and its price. The intrinsic value is just the appraised value of the stock. Given that the appraisal can be wrong — and thus, the intrinsic value can be actually lower than the investor calculated — if the price paid for the stock is sufficiently low, the investor can be wrong about the intrinsic value and still make a profit — or, at least, not lose as much.
The Intelligent Investor Review: Stock Selection Criteria for the Enterprising Investor
However, you don’t just want to finish — you want to finish first, or at a minimum above average. You want to beat the market. Here’s where Graham explains the different methods of selecting stocks that, along with a margin of safety, have upside potential.
When reading The Intelligent Investor, review carefully the two top stock selection methods Graham mentions. The first is buying the stock of high-quality companies at very low price/earnings ratios (PEs). The margin of safety of any individual stock lies in the fact that the investor is buying the expected earnings of the company for a wide discount (hence the low PE). Buying a diversified portfolio of twenty or thirty stocks of high-quality companies selling at very low PEs increases the probability of favourable results under “fairly normal conditions,” says Graham. However, under abnormal conditions — i.e., when the going rate for bonds is similar or higher than the expected earning power of the stock — there is no margin of safety at all, and even a diversified basket of securities bought at low PEs will probably have average results.
But there is a second method — a “foolproof method,” as Graham calls it — of stock selection that shows extraordinary results over the long term: a basket of twenty or thirty stocks bought at two-thirds or less of the company’s liquidation value — i.e., its net current asset value (NCAV). The NCAV is essentially the company’s current assets less all its liabilities, preferred stock, and off-balance sheet liabilities. An adequately diversified basket of stocks purchased at prices below two-thirds of their liquidation value offers average annual returns of about 20%. Graham himself said that he “used this approach extensively in managing investment funds, an over a 30-odd year period we must have earned an average of some 20 percent per year from this source.” When it comes to net net stocks, Net Net Hunter is the clear authority today.
The Intelligent Investor Review: How The Small Investor Can Beat the Market
This The Intelligent Investor review started with a simple question: Should deep value investors still read The Intelligent Investor?
I believe they should. This book will actually help small value investors in the process of understanding the investing strategy they should follow. Also, luckily for small value investors, the deep value stocks and bargain issues that Graham describes are still alive all around the world and widely overlooked by professional investors. There lies a huge opportunity for the small value investor to reap extraordinary profits.
Of course, applying these methods takes patience and discipline — like the patience and discipline needed to ride a mountain bike up a long and steep hill and actually reach the top. Many will get tired on the way up and resign.
As I said before, when reading The Intelligent Investor, review Graham’s top stock selection methods, and apply them, you’ll probably finish first. This is how the small investor can be the ultimate intelligent investor.
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