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The Intelligent Investor Complete Notes - Greg Herman

I enrolled for my freshman year of college at Indiana University in the fall of 2009. I was looking forward to diving directly into finance and investments, but was sad to find out that this would not occur, on a meaningful level, for at least three more years. I was a little distraught. Luckily, as fate would have it, I had the true pleasure of meeting Andrew Schneck, my current stock research partner and best friend. We are both stock junkies and love putting in the hours of research. Andrew convinced me to take a look at a book he was currently reading called the The Intelligent Investor. Though I had never read or heard anything about value investing, I dove into the reading and fell in love with the philosophy. In a three day period, after spending countless hours throughout the night at the main library, I finished reading and compiling notes on this amazing work. The work that I put into this was immense, but I am glad that I made that investment of time. I finished the notes about 15 months ago and have used them as a personal reference frequently. I feel that my notes for the book would be much more beneficial on Seeking Alpha than sitting in my sole possession. I went on to read many more books following the The Intelligent Investor, including works by Monish Pabrai, Joel Greenblatt, and all the books about Buffett. This is the only one I took notes on since it has stood the test of time and is used frequently by many modern authors. Here are my notes and I hope that everyone finds them useful in some manner.

Also, if you enjoy value investing commentary, keep checking out my page in the future, since I just started my page and look to keep writing as many Instablog posts as I can. I also will begin posting in-depth articles once I find some great securities worthy of a spot in my portfolio. Also, check out Andrew Schneck's page and his blog!

The Intelligent Investor

Preface to the Fourth Edition, by Warren E. Buffett

·         Warren Buffet first read The Intelligent Investor when he was 19 years old

·         The Intelligent Investor is by far the best security analysis book EVER

·         Benjamin Graham’s principles have remained sound and are proven during downturns

A Note About Benjamin Graham by Jason Zweig

·         Benjamin Graham believes that “sooner or later, all bull markets must end badly”

·         Graham grew up in a poor family and his mother struggled to make ends meet

·         Benjamin Graham won a scholarship to Columbia University

·         Graham lost a lot of money during the crash from 1929-1932

·         From 1936 to 1956, Benjamin Graham gained at least 14.7 percent annually

·         “The Intelligent Investor is a realist who sells to optimists and buys from pessimists”

·         “The secret to your financial success is inside yourself”

·         “In the end, how your investments behave is much less important than how YOU behave”

Introduction: What this Book Expects to Accomplish

·         “Those who do not remember the past are condemned to repeat it.” –Santayana

·         The Intelligent Investor is NOT meant for speculators, it is meant for Investors

·         There are two types of investors, “defensive” AND “enterprising”

·         “Obvious prospects for physical growth in a business do not translate into obvious profits for investors”

·         “The experts do not have dependable ways of selecting and concentrating on the most promising companies in the most promising industries”

·         “the investor’s chief problem-and even his worst enemy-is likely to be himself”

·         “The habit of relating what is paid to what is being offered is an invaluable trait in investment”

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

·         “A strong-minded approach to investment, firmly based on the margin-of-safety principle, can yield some handsome rewards”

Commentary on the Introduction

·         The Intelligent Investor can teach one how to minimize the odds of suffering irreversible losses, maximize the chances of achieving substantial gains, and control the self-defeating behavior that keeps most investors from reaching their full potential

·         “Once you lose 95% of your money, you have to gain 1,900% just to get back where you started”

·         Benjamin Graham’s reference to intelligence “is a trait more of the character than of the brain”

·         “Intellectually smart” people who failed in markets include Sir Isaac Newton and LTCM

·         United States equities lost over half of their value during the tech bubble of 2000-2002

·         Fraud and bankruptcies fractured the financial industry, along with the threat of terrorism

·         “While enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster”

·         “The pendulum swings from irrational exuberance to unjustifiable pessimism”

·         “The Intelligent Investor dreads a bull market and welcomes a bear market”

Chapter 1 Investment versus Speculation: Results to Be Expected by the Intelligent Investor

·         “An investment operation is one in which, upon thorough analysis promises safety of principle and an adequate return. Operations not meeting these requirements are considered speculative”

·         Wall Street and the media have developed their own definitions of an “investor”, but these are not important to worry about and should be shunned

·         “It is his task to keep this component (speculative factor) within minor limits, and to be prepared financially and psychologically for adverse results that may be of short or long duration”

·         Speculation is unintelligent when one thinks they are investing, without proper and knowledge and skill for it, and risking more money in speculation than you can afford to lose

·         The defensive investor should allocate his holdings 50-50 between equities and high-grade bonds, unless one asset class has a better outlook and/or valuation

·         If proper market conditions exist, this 50-50 ratio can be altered up to 25-75 for either equities or high-grade bonds

·         “The future of security prices is NEVER predictable”

·         We can never allocate all of our holdings to one specific asset class because the future is unpredictable and our predictions could be completely wrong

·         TIPS: Introduced in 1997, are bonds that increase in value if the CPI rises; These can be better than equities for protecting against inflation

·         “The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condition”

·         Aggressive investors can hope to obtain better than average results by trading in the market, using short-term selectivity, and using long-term selectivity

·         Aggressive investors must follow policies that are inherently sound and promising and not popular on Wall Street in order to consistently beat the averages

·         Special situations including intersecurity arbitrages, payouts or workouts in liquidations, and protected hedges of certain kinds

·         Companies selling at less than Net Current Assets (Working Capital) alone are Bargain Issues

·         These companies are selling at a price well below the value of the enterprise as a private business

Commentary on Chapter 1

·         “Note that investing, according to Benjamin Graham, consists equally of three elements: you must thoroughly analyze a company, and the soundness of its underlying business, before you buy its stock; you must deliberately protect yourself against serious losses; and you must aspire to “adequate”, not extraordinary, performance”

·         “An investor calculates what a stock is worth, based on the value of its businesses. A speculator gambles that a stock will go up in price because someone else is willing to pay more for it”

·         “Investing is a unique kind of casino-one where you cannot lose in the end, so long as you play only by the rules that put the odds squarely in your favor”

·         The 1990s was full of ridiculous stock valuations and run-ups in stocks that would eventually come crashing back down in the face of the naïve

·         “The January Effect” trading strategy has become less profitable because of the public’s widespread knowledge of its practice

·         “The Foolish Four” investing strategy bases nothing on the value or earnings of the underlying companies and is a perfect example of speculation

·         Benjamin Graham’s rules for speculating are that you must never delude yourself into thinking that you’re investing when you’re speculating, speculating becomes more dangerous the moment you begin to take it seriously, and you must put strict limits on the amount that you are willing to wager

Chapter 2 The Investor and Inflation

·         “Even high-quality stocks cannot be a better purchase than bonds under all conditions”

·         Inflation rises and falls at unsteady rates and can be quite unpredictable in the future

·         Even Benjamin Graham had trouble predicting the change in rates over the next years

·         “There is no close time connection between inflationary (or deflationary) conditions and the movement of common-stock earnings and prices”

·         Benjamin Graham believes that inflation can add little to common stock values

·         From 1950 to 1959, the debt of corporations has expanded nearly fivefold while their profits before taxes a little more than doubled

·         “For then, if another bull market comes along, he will take the big rise not as a danger signal of an inevitable fall, not as a chance to cash in on his handsome profits, but rather as a vindication of the inflation hypothesis and as a reason to keep on buying common stocks no matter how high the market level nor how low the dividend return”

·         Gold has a rocky history of protecting investors against inflation and has at times severely underperformed a simple savings account

·         Other types of investments could include real estate, coins, paintings, and event tickets, but each have their own risks to take into account

·         “There is no certainty that a stock component will insure adequately against such inflation, but it should carry more protection than the bond component”

Commentary on Chapter 2

·         “It’s so important to measure your investing success not just by what you make, but by how much you keep after inflation”

·         Three reasons to believe that inflation is not dead in the United States is because as recently as 1973-1982, the Consumer Price Index more than doubled, a majority of the world’s economies have had inflation in excess of 25% annualized per year, and inflation makes it relatively easier for Uncle Sam to pay off his debts

·         The stock market tends to underperform when inflation is high (>6%) or massive deflation is occurring (contraction of prices)

·         Two new ways to fight inflation are through the purchase of Real Estate Investment Trusts (REITs) and Treasury Inflation-Protected Securities (OTC:TIPS)

·         REITs are companies that own and collect rent from commercial and residential properties

·         “While a REIT fund is unlikely to be a foolproof inflation-fighter, in the long run it should give you some defense against the erosion of purchasing power without hampering your overall returns”

·         TIPS are U.S. government bonds, first issued in 1997, that automatically go up in value when inflation rises

·         “When the value of your TIPS bond rises as inflation heats up, the IRS regards that increase in value as taxable income-even though it is purely a paper gain (unless you sold the bond at its newly higher price)

·         “TIPS are best suited for a tax-deferred retirement account … where they will not jack up your taxable income”

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

·         There are three distinct market patterns for the years 1900-1972

·         “The first runs from 1900-1924, and shows for the most part a series of rather similar market cycles lasting from three to five years. The annual advance in the period averaged about 3%”

·         “We move on to the New Era bull market, culminating in 1929, with its terrible aftermath of collapse, followed by quite irregular fluctuations until 1949 … the annual rate of advance was a mere 1.5%”

·         The third major market trend that took place from 1949-1968 consisted of the greatest bull market run in the stock markets history

·         Following the 1968 high, the market was quite volatile leading up to 1972

·         “Only two of the nine decades after the first show a decrease in earnings and average prices (in 1891-1900 and 1931-1940), and no decade after 1900 shows a decrease in average dividends”

·         The average dividend yield fell steadily for equities from 1949-1970

·         The interest rates on high-grade bonds more than tripled from 1948 to 1971

·          The trailing PE for the S&P went from 6.3 in 1948 to 19.2 during 1971

·         The Stock-earnings yield /bond yield went from 3.96X in 1948 to .72X in 1971

·         The Dividend yield/bond yield went from 2.1X in 1948 to .41X in 1971

·         The Earnings/book value ratio remained in a stable range of 10%-13% for the time period

Commentary on Chapter 3

·         During the 1990’s, many books were written with prophecies of the DOW Jones Industrial Average rising to 36,000, 40,000, and even 100,000

·         “The stock market crushed everyone who had come to believe that the high returns of the late 1990’s were some kind of divine right”

·         “Since the profits that a company can earn are finite, the price that investors should be willing to pay for stocks must also be finite”

·         “Even though investors all know they’re supposed to buy low and sell high, in practice they often end up getting it backwards”

·         “The stock market’s performance depends on three factors: real growth (the rise companies’ earnings and dividends), inflationary growth (the general rise of prices throughout the economy), and speculative growth-or decline (any increase or decrease in the investing public’s appetite for stocks)”

·         “In the long run, you can reasonably expect stocks to average roughly a 6% return (or 4% after inflation)”

·         “The only thing you can be confident of while forecasting future stock returns is that you will probably turn out to be wrong”

·         “In the financial markets, the worse the future looks, the better it turns out to be”

Chapter 4 General Portfolio Policy: The Defensive Investor

·         Depending on one’s risk tolerance and time frame, the ratio of bonds to stocks held can vary greatly or little at all from the golden 50-50 mark

·         Investors must ask themselves two questions when they are buying bonds, should I buy tax-free or taxable bonds, and should I buy long or short term bonds

·         US Savings bonds E and H series are very safe investments, back by the government; E series bonds accumulate interest on the principle, while H series bonds are sold at discount to face value; Can be cashed in at any time upon borrower’ request

·         Other United States are available, with longer term bonds yielding a little more than 6%; Subject to federal income tax, but not state income tax

·         State and Municipal bonds are free from federal tax and free from state income tax in the state which it was issued

·         Corporation bonds are taxed by federal and state governments, but offer higher yields than government bonds; Lower grade bonds yields higher returns than premium grade

·         Call provisions enable a company to recall bonds at a specified time in the future, if conditions are advantageous for the company to do so

·         Preferred stocks offer the owner little legal right in tough times, so large reversals in the market will cause these securities to fall; Best time to buy is at the trough of recession when mispriced

Commentary on Chapter 4

·         There are two approaches to investing, “active and enterprising” and “passive and defensive”

·         Benjamin Graham believes that age is not an important determining factor when deciding how much of one’s portfolio should be invested in stocks and bonds

·         “Everyone must keep some assets in the riskless haven of cash”

·         “Instead of buying and holding their stocks, many people end up buying high, selling low, and holding nothing but their own head in their hands

·         Taxable bonds should be bought inside of “sheltered” account like a 401-K

·         Tax-free bonds should be bought outside of “sheltered” accounts

·         Intermediate-term bonds provide the least amount of volatility in interest rates

·         Bond funds are great way to get bond exposure with keeping a diversified approach

·         Treasury Securities are obligations of the United States government and carry no credit risk, because Uncle Sam can simply raise taxes or print more money

·         Savings bonds are not marketable, but are ideal for “set-aside” money

·         Mortgage Securities are bonds issued by Fannie Mae and Ginnie May that are derived from pooling together thousands of mortgages in the United States

·         Annuities are insurance-like investments that enable one to defer current taxes and collect income after one retires; Can be fixed or variable in nature

·         “Preferred shares are a worst-of-both-worlds investment”

·         Common Stocks are actually yielding higher than many bonds at the current time 

Chapter 5 The Defensive Investor and Common Stocks

·         Stocks should be a major part of an investor’s portfolio because they offer better inflation protection than bonds and because the yields can be quite high at certain time periods

·         Benjamin Graham’s four rules for defensive investors are there should be adequate diversification of between ten and thirty stocks, each company selected should be large, prominent, and conservatively financed, each company should have a long record of continuous dividend payment, and the investor should impose some limit on the price he will pay for an issue in relation to its average past earnings

·         “Growth Stocks” should be avoided by defensive investors because of the wild gyrations in their price that could scare the faint of heart away

·         Defensive investors should receive some type of investment advice on their personal portfolio from a trusted , respectable brokerage house at least once a year

·         Dollar-Cost Averaging is at its most basic form when an investor puts adds a set amount of money every month to his/her investments, regardless of price of the securities at the time

·         Time and inclination must be taken into account when deciding whether one can properly do the homework needed for maintaining a successful portfolio

·         Benjamin Graham defines a group of safe stocks as one that makes satisfactory returns over a fair number of years

·         A “large, prominent, and conservatively financed” organization in today’s terms means that a defensive investor should only be looking at companies with a market cap exceeding $10 billion

Commentary on Chapter 5

·         Dollar-cost averaging combined with a disciplined defensive investor can produce good returns with minimal effort

·         Never just “Buy what you know”, unless you have done your homework and understand why it is worth owning this company

·         Online brokerages make it easy for anyone to control their own investments and buy and sell shares at a very small transaction cost

·         Defensive investors can also opt to receive help from index funds and/or professional brokers

·         “Best of all, once you build a permanent autopilot portfolio with index funds as its heart and core, you’ll be able to answer every market question with the most powerful response a defensive investor could ever have: “I don’t know and I don’t care" 

Chapter 6 Portfolio Policy for the Enterprising Investor: Negative Approach

·         Avoid high-grade preferred stocks and inferior types of bonds, unless they can be purchased at least at a 30% discount to par value

·         Also, look to avoid foreign government issues and be wary of new issues in general

·         “The main difference between investing in first- and second-grade bonds is usually found in the number of times the interest charges have been covered by earnings”

·         “Experience clearly shows us that it is unwise to buy a bond or preferred which lacks adequate safety merely because the yield is attractive”

·         “If you are willing to assume some risk you should be certain that you can realize a really substantial gain in principal value if things really go well”

·         “It is mere common sense to abstain from buying securities at around 100 if long experience indicates that they can probably be bought at 70 or less in the next weak market”

·         “Foreign bonds, as a whole, have had a bad investment history since 1914”

·         “Our one recommendation is that all investors should be wary of new issues”

·         “The heedlessness of the public and the willingness of selling organizations to sell whatever may be profitably sold can have only one result-Price Collapse”

·         “Some of [new] issues may prove excellent buys- a few years later, when nobody wants them and they can be had a small fraction of their true worth”

Commentary of Chapter 6

·         “Today, however, more than 130 mutual funds specialize in junk bonds”

·         “Most junk-bond funds charge high fees and do a poor job of preserving the original principal amount of your investment”

·         Junk-bond funds tend to outperform other bond funds when interest rates are rising

·         Many funds today specialize in emerging markets; tend to be more volatile than domestic

·         “When you trade instead of invest, you turn long-term gains into ordinary income”

·         “The more you trade, the less you keep”

·         The people who profit the most from IPO’s are the investment banks and the BIG BOYS

·         “No matter how many other people want to buy a stock, you should buy only if the stock is a cheap way to own a desirable business”

·         “But when we’re in public instead of in private, when valuation suddenly becomes a popularity contest, the price of a stock seems more important than the value of the business it represents”

Chapter 7 Portfolio Policy for the Enterprising Investor: The Positive Side

·         There are four situations that enterprising investors should look for in common stocks are buying in low markets and selling in high markets, buying carefully chosen “growth stocks”, buying bargain issues of various types, and buying into “special situations”

·         Graham’s rules enable the enterprising investor to put up to 75% of portfolio into stocks

·         Growth stocks are dangerous because (1) common stocks with good records and apparently good prospects sell at correspondingly high prices and (2) one’s judgment to the future of the company’s performance may prove wrong

·         “The implication here is that no outstanding rewards came from diversified investment in growth companies as compared with that in common stocks generally”

·         “The investment caliber of such a company may not change over a long span of years, but the risk characteristics of its stock will depend on what happens to it in the stock market”

·         Enterprising investors must (1) must meet objective or rational tests of underlying soundness and (2) must follow strategies different from those followed by most investors or speculators in order to obtain better than average results

·         Buying relatively large companies that are currently unpopular is one way to make large returns

·         Buying bargain issues is another way to make outsized returns; Bargain issues must be at least 50% less than the true value of the underlying enterprise

·         One must make a clear choice on whether to be a defensive or enterprising investor

Commentary on Chapter 7

·         It’s easy to look back and see what would have worked, but timing the market in real-time is nearly impossible for all but the most informed investors

·         “A great company is not a great investment if you pay too much for the stock”

·         “Growth stocks are worth buying when their prices are reasonable”

·         No one ever kept their wealth by keeping all their eggs in one basket

·         “But on the very rare occasions when Mr. Market generates that many true bargains, you’re all but certain to make money”

·         “To be prudent, you should some of your investment portfolio elsewhere-simply because no one, anywhere, can ever know what the future will bring at home or abroad”

Chapter 8 The Investor and Market Fluctuations

·         The only certainty in the markets are that there will be large and volatile swings in pricing

·         Two ways to take advantage of the price swings are through timing and pricing

·         “What this means is that timing is of no real value to the investor unless it coincides with pricing- that is, unless it enables him to repurchase his shares at substantially under his previous selling price”

·         Finding the tops and bottoms of markets is no longer clear-cut like it was in the past

·         “All things excellent are as difficult as they are rare” –Spinoza

·         Serious investors are not worried in the day-to-day or month-to-month fluctuations

·         The ideal strategy for dealing with varying market valuations is “rebalancing”

·         “The better the quality of a common stock, the more speculative it is likely to be- at least as compared with the unspectacular middle-grade issues”

·         Focus on companies that are trading at or close to tangible-asset value

·         Additionally, desirable stocks must also have a satisfactory P/E ratio, strong financial position, and the prospect that its earnings will be maintained over the years

·         Portfolios of strong companies trading around book value can neglect the day-to-day changes in market pricing and may even put let the manager take advantage of pricing irregularities

·         “The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage”

·         Having a quoted market for securities gives an investor more options, but does not require him to appraise the value of the stock based on the market’s going price

·         True investors use price fluctuations to either purchases or sell shares of a company

·         “At other times he [investor] will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies”

·         Stock quotations are there for convenience and can either be taken advantage of or ignored

·         “Good managements produce good average market price, and bad managements produce bad market prices”

·         Predicting the movements of stocks and bonds is a waste of time and nearly impossible

·         Be wary of buying nonconvertible common stocks

Commentary on Chapter 8

·         Mr. Market’s wild pricing inconsistencies can wildly undervalue or overvalue equities

·         “You do not have to trade with him [Mr. Market] just because he constantly begs you to”

·         “In the short run, our returns will always be hostage to Mr. Market and his whims”

·         You can control your brokerage costs, ownership costs, expectations, risk, tax bills, and your OWN Behavior

·         “But investing isn’t about beating others at their game. It’s about controlling yourself at your own game”

·         “In the end, what matters isn’t crossing the finish line before anybody else but just making sure that you do cross it”

·         As Graham puts it, the typical investor “would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment”

·         For the Intelligent Investor, falling stock prices are a great for the long-term

·         “Selling into a bear market can make sense if it creates a tax windfall”

·         The Investment Owner’s Contract outlines all the key teachings of Benjamin Graham

Chapter 9 Investing in Investment Funds

·         Investment funds can either be open-end or close-end; Also, either front, back, or no load

·         “Most of the companies operate under special provisions of the income-tax law, designed to relieve the shareholders from double taxation on their earnings”

·         Investment funds have done a good job at keeping many people from making large mistakes

·         The decisions of the mutual fund managers determines the movement of the market itself

·         Performance funds can beat the averages for a few years, but rarely ever keep-up in the long-run with the overall market averages

·         Large-cap, well managed performance funds can at best gain a slightly better than average return than the market as a whole

·         In Graham’s day, the close-end funds offered much better returns than open-end funds solely based on the fact of how much less one had to pay to enter the funds

·         Graham states that in 1970 U.S. Savings bonds were a much better investment than bond funds 

Commentary on Chapter 9

·         Mutual funds are a great advancement because it brought so many new people into investing

·         Past Performance is a poor indicator for predicting future performance of mutual funds

·         Very, very few funds can keep beating the averages over an extended amount of time

·         Winning mutual funds face many problems going forward that include migrating managers, enlarged investable assets, inability to use tricks to increase fund’s performance, rising expenses, and sheepish behavior of funds managers

·         “An index fund… will beat most funds over the long run”

·         “As the years pass, the cost advantage of indexing will keep accruing relentlessly”

·         “Later in his life, Graham praised index funds as the best choice for individual investors, as does Warren Buffet”

·         Funds that consistently beat the averages have managers who are large shareholders, have low fees, dare to be different (Peter Lynch, Fidelity Magellan), eventually close their funds, and do not advertise

·         When finding the right fund, first evaluate its expenses, then evaluate its risk using a prospectus, and then look at the manager’s reputation and past performance of the fund

·         Close-end stock funds have dwindled in recent years; some bond funds are worth looking at

·         Low-cost ETF’s are worth looking at for investors looking to gain exposure to specific areas

·         Sell a fund if there is a sharp and unexpected change in strategy, an increase in expenses, large and frequent tax bills, and/or suddenly erratic returns in either direction

·         “If you’re not prepared to stick with a fund through at least three lean years, you shouldn’t buy it in the first place. Patience is the fund investor’s single most powerful ally”

Chapter 10 The Investor and His Advisors

·         Investment advice can be gained from a variety of sources

·         Graham believes that people who turn over their money to other people to handle for them must set modest goals, be conservative, and not worry about beating the market

·         Financial services companies provide analysis and outlooks for thousands of stocks; These analysis only reflect whether a company is worth buying or selling in the short-term

·         Graham points out that this analysis overlooks whether a stock is undervalued or overvalued at the current price given the company’s long-term earning power

·         “The Intelligent Investor will not do his buying and selling solely on the basis of recommendations received from a financial service”

·          Advice from brokerage houses will be of little help unless the broker understands that the client is an “Intelligent Investor”

·         “Once the analyst is convinced that he is dealing with a man who is value-minded rather than quotation-minded, there is an excellent chance that his recommendations will prove of real overall benefit”

·         The title CFA is given to senior practitioners who pass exams and understand the industry

·         Benjamin Graham notes that it is inexcusable that certain brokerage houses became insolvent in the late 60’s, as too much speculation and unwarranted risks were being taken by them

·         Investment bankers are the people that bring new companies to market, perform mergers, spinoffs, and other corporate underwriting

·         “Investment banking is perhaps the most respectable department of the Wall Street Community, because it is here that finance plays its constructive role of supplying new capital for the expansion of industry”

·         Graham advises the Intelligent Investor to pay attention to the advice of Investment Banks 

Commentary on Chapter 10

·         The public should turn over investments to professionals if they had big losses exceeding those of the major indexes during the last bear markets, have poor or non-existent budgets, have undiversified, volatile portfolios, and/or have recently made major life changes

·         Make sure you trust the person that you want to handle your money

·         The financial manager and client should both ask tough questions to test one another

·         The financial advisor should have a comprehensive financial plan, investment policy statement, and asset-allocation plan made specifically for his client

Chapter 11 Security Analysis for the Lay Investor: General Approach

·         Security analysts look at the past performance of a company, take a look at the current state of the company, and then form an opinion for the company’s performance over the next year

·         Properly valuing growth stocks is the most difficult activity for security analysts

·         “Whenever calculus is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience , and usually also to give to speculation the deceptive guise of investment”

·         The most dependable and respectable branch of security analysis deals with the safety and quality of bond issuances and investment-grade preferred stocks

·         “The chief criterion used for corporate bonds is the number of times that total interest charges have been covered by available earnings for some years in the past”

·         Other tests that are employed for bonds and preferred issues include the size of enterprise, stock to equity ratio, and the property value ratio

·         Though Graham shuns upon using past performance as a major decision-making tool for the Intelligent Investor, looking at the prospective entity’s ability to whether past storms is vital to choosing sound bond investments for a diversified portfolio

·         At the time, Graham stated that the “now-standard” procedure for estimating future earning power starts with average past data for physical volume, prices received, and operating margin; Future sales in dollars are then projected on the basis of assumptions as to the amount of change in volume and price level over the previous base

·         Factors that can affect the valuation of stocks include the general long-term prospects, management, financial strength and capital structure, dividend record, and current dividend

·         “There is really no way of valuing a high-growth company in which the analyst can make realistic assumptions of both the proper multiplier for the current earnings and the expectable multiplier for the future earnings”

·         Industry analysis provides few major convictions towards opinions on various industries

·         Graham advocates that analysts should first work out the “past-performance value”

·         The second step in Graham’s process is to see how much the past performance should be modified based on what is expected in the future

Commentary on Chapter 11

·         Two questions to ask when looking for investable companies that meet the demands of the Intelligent Investor are what makes this company grow and where do and where will its profits come from

·         Watch out for companies that are “serial acquirers”, companies raising boatloads of Other People’s Money (OPM), and companies that rely on one customer

·         Look for companies with large competitive advantages, companies that consistently grow earnings at a steady pace (10% pre-tax long-term), and that spend on R&D

·         In past company filings, make sure that management has lived up to their outlooks and that they take responsibility for any shortcomings that may have occurred

·         “If a company reprices its stock options for insiders, stay away”

·         “Form 4” shows whether senior executives have bought or sold shares

·         “Executives should spend most of their time managing their company in private, not promoting it to the investing public”

·         “The most basic possible definition of a good business is this: It generates more cash than it consumes. Good managers keep finding ways of putting that cash to productive use”

·         “Warren Buffet has popularized the concept of owner earnings, or net income plus amortization and depreciation, minus normal capital expenditures; If you owned 100% of this business, how much cash would you have in your pocket at the end of the year”

·         Additionally, subtract costs of granting stock options, any unusual, nonrecurring, or extraordinary charges, and any income from the company’s pension fund

·         “If owner earnings per share have grown at a steady average of at least 6%  or 7% over the past 10 years, the company is a stable generator of cash, and its prospects for growth are good”

·         Make sure the company has a prudent amount of debt and can cover its fixed charges

·         Evaluate the company’s dividend policy, split policy, and buy-back policies

·         “In investing, as with life in general, ultimate victory usually goes to the doers, not the talkers”

Chapter 12 Things to Consider About Per-Share Earnings

·         EPS reports can be misleading after looking at special charges and dilution

·         Valuing a company in the future is difficult because one may not know whether to look at primary earnings or net income after special charges in different situations

·         Companies that continually have reoccurring “extraordinary” or “nonrecurring” items in statements should be avoided or highly scrutinized before becoming a position

·         Factors that can skew earnings reported by companies are special charges, reduction in normal income-tax deduction by reason of past losses, dilution, and the method of treating depreciation, method of charging R&D costs, and choice between LIFO and FIFO

·         “Corporate accounting is often tricky, security analysis can be complicated; stock valuations are really dependable only in exceptional cases”

·         Graham advocates using the average earnings from the past seven to ten years, which include the special charges, in order to get a better picture of the company’s performance

·         Companies with higher short-term growth rates can be looked at over a shorter three year horizon, instead of the longer 7 to 10 years for more stable growers

·         Over long periods of time, certain stocks may trade at wildly varying P/E ratios

Commentary on Chapter 12

·         Though “pro forma” earnings were enacted to provide a better look at the long-term growth of earnings, Wall Street took advantage of this and skewed it to paint an unrealistic picture

·         “The only thing you should do with pro forma earnings is ignore them”

·         “Aggressive revenue recognition is often a sign of dangers that run deep and loom large”

·         In the 1990s, Global Crossing Ltd. was able to inflate reported profits by transforming normal operating expenses into capital assets

·         “The Intelligent Investor should be sure to understand what, and why, a company capitalizes”

·         “The Intelligent Investor must always be on guard for “nonrecurring” costs that, like the Energizer bunny, just keep on going”

·         A portion of a company’s income may be coming from pension plans that could go away

·         Three tips to avoid investing in “accounting time bombs” are to read the company’s report backwards, read the footnotes in entirety, and read other books about financial reporting

Chapter 13 A Comparison of Four Listed Companies

·         The four companies that Graham chose to compare in this chapter are ELTRA, Emerson Electric, Emery Air Freight, and Emhart Corp.

·         First, Benjamin Graham compares the companies of their chief elements of performance which include profitability, stability, growth, financial position, dividends, and price history

·         Emerson Electric and Emery Air Freight both traded at extremely high multiples compared to Emhart Corp. and ELTRA

·         Graham desires to look at Emhart Corp. and ELTRA because of their attractively priced stocks relative to P/E and book value and because both have stable earnings

·         The seven statistical requirements for inclusion in the defensive investor’s portfolio are (1) adequate size, (2) sufficiently strong financial condition, (3) continued dividend for at least the past 20 years, (4) no earnings deficit in the past ten years, (5) Ten-year growth of at least one-third in per-share earnings, (6) price of stock no more than 1.5X net asset value, and (7) price no more than 15X average earnings of the past 3 years

Commentary on Chapter 13

·         Jason Zweig does a modern-day four stock comparison with the companies Emerson Electric, EMC Corp., Expeditors International of Washington, Inc., and Exodus Communications

·         Emerson Electric made it through the bear market of 2000-2002 relatively unscathed, while Expeditors actually closed 51% from the start to finish of the recession

·         On the other hand, however, EMC Corp. and Exodus Communications both experienced colossal stock losses during 2001 and 2002, negating any gains made during the roaring 1990s

·         This should serve as a reminder that many companies trade at valuations that are not justified, even when outstanding growth and performance are present                                                                           

Chapter 14 Stock Selection for the Defensive Investor

·         Graham outlines two ways for the defensive investor to gain exposure to stocks: (1) purchase all 30 issues of the DJIA (or an index fund today) or (2) find companies that meet minimum quality of past performance and financial position, along with minimum quantity in earnings and assets per dollar of price

·         The seven quality and quantity criteria that Graham for picking individual equities are (1) adequate size, (2) strong financial condition, (3) earnings stability, (4) consistent dividend record, (5) continued earnings growth, (6) moderate P/E, and (7) moderate price/assets ratio

·         Graham points out that at the end of 1970, five of the DJIA components met all of his criteria for being part of the defensive investors’ portfolio

·         Benjamin Graham advocates using many public utilities because of their prices that tend to trade around book value, steady earnings, and high dividend rate

·         With financial companies, Graham advises to picking attractively priced companies

·         At time of publication, Graham advocated “There is no compelling reason for the investor to own railroad shares; before he buys any he should make sure that he is getting so much value for his money that it would be unreasonable to look for something else instead”

·         “The future itself can be approached in two different ways, which may be called the way of prediction (or projection) and the way of protection”

·         “Investing on the basis of projection is a fool’s errand; Investing on the basis of protection is the best solution”

·         The Intelligent Investor must make sure that the company first passes the quantitative threshold (good value and solid growth prospects) and then worry about the qualitative measures (future prospects and management effectiveness)

Commentary on Chapter 14

·         Jason Zweig advocates that the defensive investor should keep at least 90% of his money in an index fund and pick other defensive names with the remaining amount, if desired

·         Referring to Index Funds: “By owning the entire haystack you can be sure to find every needle, thus capturing returns of all the superstocks. Especially if you are a defensive investor, why look for the needles when you can own the whole haystack”

·         Jason Zweig states that defensive investors should stick to stocks worth +$2 billion market cap

·         “Graham’s criterion of financial strength still works: If you build a diversified basket of stocks whose current assets are at least double their current liabilities, and whose long-term debt does exceed working capital, you should end up with a group of conservatively financed companies with plenty of staying power”

·         “Graham’s insistence on some earnings for the common stock in each of the past ten years remains a valid test”

·         Many companies have consistent and strong dividend records for the past 25 years

·         More than half of the companies in the S&P 500 were able to meet Graham’s ten-year earnings growth requirement; The growth requirement could actually be raised a little today

·         Almost 40% of the companies met Graham’s goal of trading at or below 15X average earnings over the past 3 years

·         123 of the S&P 500 companies traded at or below 1.5X book value; Can be raised a little

·         Be cautious toward companies which have too much institutional ownership

Chapter 15 Stock Selection for the Enterprising Investor

·         In the long-run, all common-stock have failed to keep pace with the S&P 500 or DJIA

·         Two reasons that it is extremely difficult for any investors, amateur or professional, to beat the market indexes is that there are so many smart people working on Wall Street who cancel out each others’ relative advantages and effectiveness and that many analysts are more worried about growth and current prospects rather than true value and stable, long-term growth

·         “Extremely few companies have been able to show a high rate of uninterrupted growth for long periods of time. Remarkably few, also, of the larger companies suffer ultimate extinction”

·         In order to beat the market, one “must follow specific methods that are not generally accepted on Wall Street, since those that are so accepted do not seem to produce the results everyone would like to achieve”

·         At Graham-Newton Corporation, the men classified their trading strategies into the following categories: Arbitrages, Liquidations, Related Hedges, Net-Current-Asset (or “Bargain”) Issues

·         “The professional techniques that we followed are not suitable for the defensive investor”

·         The enterprising investor should look to take full advantage of high-quality, stable stocks that have overly-pessimistic sentiment at the current time, but have positive long-term prospects

·         Benjamin Graham highly recommended Standard and Poor’s Stock Guide as a research tool to help with looking at the majority of information that the Intelligent Investor needs to know

·         Rules that the enterprising investor must follow when picking individual stocks are (1) a strong financial condition, with current ratio of +1.5 and debt no more than 110% of net current assets, (2) earnings stability, having no losses in the last 5 years, (3) a current dividend, (4) earnings more than in the same period 5 years prior, and (5) a price less than 120% net tangible assets

·         Another factor that may be taken into account is the S&P Ranking attached to the company

·         “The two methods of this sort that we found to give quite consistently good results in the longer past have been (a) the purchase of low-multiplier stocks of important companies (such as the DJIA list), and (b) the choice of a diversified group of stocks selling under their net-current-asset value (or working-capital value)”

·         “Low-multiplier issues had a smaller decline in this period than high-multiplier issues, and long-term dividend payers lost less than those that were not paying dividends”

·         “If one can acquire a diversified group of common stocks at a price less than the applicable net current assets alone- after deducting all prior claims, and counting as zero the fixed and other assets- the results should be quite satisfactory”

·         Graham talks briefly about arbitrage opportunities, but individuals should not take part

Commentary on Chapter 15

·         “A small percentage of investors can excel at picking their own stocks. Everyone else would be better off getting help, ideally through an index fund”

·         Graham advised to practice with fake money for one year and then decide whether to continue

·         Return on Invested Capital (NASDAQ:ROIC)shows what the company the company earns from its operating businesses- and how efficiently it has used the shareholders’ money to generate that return; This formula can help find great bargains and help provide a margin of safety

·         Make sure there are not too many “extraordinary” expenses, management who are stakeholders and actively engaged, and companies that perform in-line with past expectations

·         Successful investing professionals are disciplined and consistent and they think a great deal about what they do and how they do it

Chapter 16 Convertible Issues and Warrants

·         “Convertible issues are claimed to be especially advantageous to both the investor and the issuing corporation”

·         “The safest conclusion that can be reached is that convertible issues are like any other form of security, in that their form itself guarantees neither attractiveness nor unattractiveness. The question will depend on all the facts surrounding the individual issue”

·         During the tail of bull markets, convertible issues perform the worst

·         “Even when a profit appears it brings a dilemma with it. Should the holder sell on a small rise; should he hold for a much bigger advance; if the issue is called-as often happens when the common has gone up considerably- should he sell out then or convert into and retain the common stock”

·         Convertibles should only be bought when there are exceptional upside opportunities that justify the amount of risk being taken

·         When companies are merging or being bought out, watch out for the possible dilution that could occur down the road if all convertible shares or bonds were converted to common

·         Because preferred now yield more than common, there are instances where the preferred stock is much more desirable of an investment because of its flexibility and higher income stream

·         “We consider the recent development of stock-option warrants as a near fraud”

·         A footnote points out that warrants are no longer used in practice at large exchanges

·         The common stock is diluted and is worth less if there are warrants outstanding

·         “Once more we assert that large issues of stock-option warrants serve no purpose, except to fabricate imaginary market values”

Commentary on Chapter 16

·         Convertibles bonds are “stocks for chickens”; More correlated to stocks than bonds

·         “Most converts are now medium-term, in the seven-to-10-year range; roughly half are investment-grade; and many issues now carry some call protection (an assurance against early redemption). All of these factors make them less risky than they used to be”

·         You can buy a convertible fund, but there is no real need for the Intelligent Investor to do this

·         Jason Zweig states that covered calls cap your upside too much to justify their use 

Chapter 17 Four Extremely Instructive Case Histories

·         Four cases of terrible and outright dangerous stocks that Graham discusses are Penn Central (Railroad) Co., Ling-Temco-Vought Inc., NVF Corp., and AAA Enterprises

·         Penn Central was a massive company that was forced into bankruptcy in 1970 because it was unable to cover all the interest charges that came due

·         The company had an inefficient “transportation ratio”, overstated its earnings, similar to pro forma style today, and took too much debt on to be able to survive

·         Ling-Temco-Vought (LTV) had similar debt problems just like Penn Central, but also had a very overstated equity per share because all of the preferred stock that was not taken into account

·         Additionally, banks continued to pour money into LTV, which only worsened the problem

·         NVF Corp. took over Sharon Steel, which was 7X larger than the company itself

·         This proved disastrous and NVF attempted to use nifty accounting to skew true valuations

·         AAA Enterprises started as a mobile home business that became grossly overvalued when it went public, eventually hitting a P/E ratio of 115

·         The company was forced into bankruptcy, while shareholders had been completely burned

·         “It will be difficult to impose worthwhile changes in the field of new offerings, because the abuses are so largely the result of the public’s own heedlessness and greed”

Commentary on Chapter 17

·         Jason Zweig exposes four modern-day examples of hyped-up stocks gone bad

·         Lucent Technologies Inc. went from an operating income of $763 million to a net loss of $301 million from June 30, 1999 to June 30, 2000

·         Lucent’s $4.8 billion acquisition of Chromatis netted the company no future profits and the company eventually would have to write-down the value of this purchase

·         Lucent went on to lose almost $30 billion dollars in 2001 and 2002

·         The company lost market value of $190 billion in a matter of two years

·         Tyco International Ltd. did not have any organic growth and was a serial acquirer

·         Tyco would continually try to hide many of its expenses as “nonrecurring” year after year

·         Tyco lost $9.4 billion in 2002 and lost 71% of its market value

·         The AOL Online, Inc./Time Warner Inc. merger proved a costly move for the latter as AOL had such a high stock valuation and a market cap similar to that of TW, but only had 1/5 the sales

·         AOL was trading at 164X earnings, which meant that TW grossly overpaid for the enterprise

·         AOL Time Warner Inc. ended up losing $98.7 billion in 2002 alone

·         eToys went public with their IPO and attained a market value of $7.8 billion

·         eToys had a higher market value than Toys “R” Us, even though the retail giant had over $2 billion in sales, compared to $30 million for eToys, and it reported a net income, while eToys reported a net loss of $29 million, nearly as much as its entire revenue

·         eToys filed for bankruptcy in 2001, after reaching a high of $86 per share only 2 years before

Chapter 18 A Comparison of Eight Pairs of Companies

·         Graham first compares Real Estate Investment Trust and Realty Equities Corp. of New York

·         Real Estate Investment Trust was a prudently managed company that paid a dividend dating back to 1889

·         Real Estate Investment Trust was a fast-growing venture that came into the limelight in the past decade, exploding its revenue and liabilities simultaneously

·         The debt that Real Estate Investment Trust carried brought it down quite fast by 1973

·         The second pair compared is Air Products and Chemicals and Air Reduction Co.

·         Air Reduction only traded at 9.1X earnings while Air Products and Chemicals traded 16.5X

·         Additionally, Air Reduction only traded at 75% of book value, compared to 165%

·         Both companies performed similar, with Air Reduction posting slightly better results

·         The third example compares two massive health-care companies; American Home Products Co. and American Hospital Supply Co.

·         Graham correctly points out that both are too expensive for the Intelligent Investor because both trade way over their book value

·         Though both had great growth prospects, both stocks did not produce positive returns

·         The fourth pair of stocks compared is H & R Block and Blue Bell

·         Blue Bell traded at only 1.42X book value, while Block sold at nearly 30X

·         Both stocks performed very well during the recovery, even with Block’s ridiculous valuation

·         In the fifth comparison, International Flavors & Fragrances, a high-growth stock, is compared to International Harvester Co., a large DJIA component

·         Though Harvester was only 59% of book value, it grew too little to justify stock ownership

·         On the other hand, Flavors traded at an excessively high P/E ratio, as well as 10.5X book

·         There are three more examples that point out arbitrary and obvious differences

·         These comparisons show that there is over-valued and under-valued companies all the time

Commentary on Chapter 18

·         “Although there are good and bad companies, there is no such thing as a good stock; there are only good stock prices, which come and go”

·         In all of Jason Zweig’s examples, the growth companies may win in the short-run, but get utterly destroyed once they come crashing back down to earth

·         “The market scoffs at Graham’s principles in the short run, but they are always revalidated in the end. If you buy a stock purely because its price has been going up- instead of asking whether the underlying company’s value is increasing- then sooner or later you will be extremely sorry. That’s not likelihood. It’s a certainty” 

Chapter 19 Shareholder and Managements: Dividend Policy

·         Graham is crying out in this last edition for shareholders to stand-up to bad management

·         The amount that companies are giving out in dividends has greatly decreased from the publication of the book to the modern day

·         Interestingly, higher quality companies are not paying-out the largest dividends, while instead re-investing money, while the less profitable companies are expected to have large yields

·         Graham believes that a company should definitely pay a dividend if it has the means to

·         All stock splits today are carried out by a change of value

·         Special dividends are rare toady, but were much more popular when Graham worked

·         Dividend policy is also greatly affected by the current rate at which they are taxed

·         Graham really pushed the idea of rewarding shareholders through dividend payments

Commentary on Chapter 19

·         In light of recent corporate scandals, shareholders need to be more vigilant than ever

·         Graham wanted to invigorate shareholders to exercise their authority as owners

·         However, Graham noted that shareholders in practice just followed the path of management

·         Graham believes that shareholders should think of two questions about management; Is the management reasonably efficient and are the interests of the average outside shareholder receiving proper recognition

·         Graham believes that it is the shareholders duty to vote on proxy material

·         1/3 of all individual investors do not even vote on their proxy statements

·         Always read the proxy statements before and after you buy a stock

·         The current trend is for companies to pay less and less in dividends

·         Research reports have shown that companies that pay out higher dividends actually have higher future corporate earnings

·         Stock buybacks are great in theory, but are often difficult to time for a good price and are sometimes motivated by tax breaks that management is looking to garner

·         Stock buybacks are also used to make-up for the dilution of shares after stock options are issued

·         Stock buybacks are a lot more dangerous to companies than paying out dividends

·         Stockholders must watch out for compensation plans that can quickly be cashed in

·         Stockholders should look for plans that reward management on meeting stringent benchmarks

·         Jason Zweig closes this section with the idea of if the independent board members having to report why they believe management was not overpaid for the particular year

Chapter 20 “Margin of Safety” as the Central Concept of Investment

·         The Margin of Safety ensures that the Intelligent Investor will not overpay for securities

·         The Margin of Safety is instituted to make sure that the Intelligent Investor becomes an owner of securities that are priced so that ample returns can be made, while limiting relative risk

·         Though future earnings forecasts are necessary for growth stocks, people must err on the side of caution when valuing issues in the future

·         “If these are bought on a bargain basis, even a moderate decline in the earning power need not prevent the investment from showing satisfactory results. The margin of safety will then have served its proper purpose”

·         “Diversification is an established tenet of conservative investment”

·         Maximizing investors total number of invested companies offers a better chance for profit than for loss

·         “We suggest that the margin-of-safety concept may be used to advantage as the touchstone to distinguish an investment operation from a speculative one”

·         The defensive investor will stick to U.S. government issues and high-grade dividend paying stocks, as well as first-quality bonds when the yield is justifiable

·         The enterprising investor will take advantage of severe depreciation in lower-grade issues, including stocks, bonds, and convertibles

·         “Investment is most intelligent when it is most businesslike”

·         First Principle: “Know what you are doing- know you business”

·         Second Principle: “Do not let anyone else run your business, unless you can supervise his performance with adequate care and comprehension or you have unusually strong reasons for placing implicit confidence in his integrity and ability”

·         Third Principle: “Do not enter upon an operation unless a reliable calculation shows that it has a fair chance to yield a reasonable profit”

·         Fourth Principle: “Have the courage of your knowledge and experience”

·         “You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right”

·         “To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks”

Commentary on Chapter 20

·         “No wonder, when he was asked to sum up everything he had learned in his long career about how to get rich, the legendary financier J.K. Klingenstein of Wertheim & Co. answered simply: DON’T LOSE”

·         “Ultimately, financial risk resides not in what kinds of investments you have, but in what kind of investor you are”

·         “Before you invest, you must ensure that you have realistically assessed your probability to being right and how you will react to the consequences of being wrong”

·         “Simply by keeping your holdings permanently diversified, and refusing to fling money at Mr. Market’s latest, craziest fashions, you can ensure that the consequences of your mistakes will never be catastrophic. No matter what Mr. Market throws at you, you will always be able to say, with a quiet confidence, This, too, shall pass away”


·         Graham averaged a return of close to 20% per year, an amazing feat for anyone during anytime

·         Graham actually made a ton of money off his stake in GEICO

·         Graham points out that behind his successful enterprise was a background of preparation and disciplined capacity, along with his courage and judgment to seize the moment

Commentary on Postscript

·         “Without a saving faith in the future, no one would ever invest at all. To be an investor, you must be a believer in a better tomorrow”

·         “Investing, too, is an adventure; the financial future is always an uncharted world. With Graham as your guide, you lifelong investing voyage should be as safe and confident as it is adventuruous”

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.