Benjamin Graham: The Intelligent Investor – Key Lessons For Investing
First Published date: 27. October, 2022Last Updated: 23. November, 2022Fact-checked by Adrian Müller
Benjamin Graham is one of the most famous and influential investors. He mentored investing legends, including Warren Buffet. He has written books that became the fundamentals of value investing.
This guide will look deeply into one of his books, The Intelligent Investors. It’s one of the essential books for new investors and seasoned ones.
Table of Content
About The Author – Benjamin Graham
Benjamin Graham is one of the most influential investors. His work laid the essential groundwork for fundamental valuation. It’s used in stock market analysis today all the time.
So, yes, not only did Benjamin Graham write one of the most important investment books of all time, but his work outside of being an author is pretty substantial. He was born in 1894 in London, UK.
But his family moved to the US when Benjamin was still very young. Unfortunately, his parents lost all of their savings due to the 1907 Bank Panic. You’ll discover that losing money isn’t something Benjamin Graham was unfamiliar with. But despite this, he always pulled himself up.
Benjamin accepted a scholarship offer from Columbia University and got a job offer immediately after graduation, where he started working on Wall Street. He was a pretty good money-making machine.
By 25, he had earned $500,000 – a substantial amount. Unfortunately, as fate would have it, he lost it all. The stock market crashed heavily in 1929, leading him to lose most of his money.
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But this devastating loss taught him important skills and lessons about investing and money. He wrote a book after this crash with David Dodd. Irving Kahn, a famous investor, also contributed to the book. It was called Security Analysis.
His book mentioned the crucial fundamentals of value investing. A common one is buying undervalued stock early on. This will likely lead to huge profits, later on, providing there’s growth potential.
Benjamin Graham was mainly known for his value investing. He was a renowned value investor. Apart from that, he was a researcher, a university lecturer, and a mentor to investing guru Warren Buffet.
He also wrote the book, The Intelligent Investor. This book is considered an essential book for any value investor. A short synopsis of the book is included below.
Synopsis Of The Intelligent Investor
Benjamin Graham wrote The Intelligent Investor in 1949. Since then, it has become one of the most important books for every value investor. It’s the default piece of text that anyone a little bit serious about value investing picks up.
This book teaches the reader to evaluate companies with complete precision. Benjamin Graham’s key skill was making money in the stock market. But the kicker was he did it without taking much risk. That’s like having your cake and eating it too!
Although this section is a synopsis, we’ll still dive deep into the most important things the book talks about. So, let’s get started.
The book mainly teaches investors three main things. First is how to minimize any chances of suffering substantial and damaging losses. Secondly, it teaches you how to maximize your chances of winning while achieving sustainable wins.
Thirdly, how you can overcome your worst enemy – your doubting self, by overcoming self-defeating modes, an investor can reach their full potential regardless of age.
Inflation
Interest rates traditionally increase over time. They oscillate, but the overall trend is usually an increase. The interest rate is difficult to forecast, and it’s risky to forecast what it’ll look like in the future.
Although the interest rate can be difficult to judge, it doesn’t mean everyone should just take their money and invest in bonds. When an investor starts to rely on the income from their portfolio, the tendency to protect that portfolio begins to creep in.
Active Vs. Defensive Investors
In the book, author Benjamin Graham states two main ways anyone can be a smart investor. One way is by being an active investor. You can research and observe the market for a mix of bonds, stocks, and mutual funds.
This is you being an active investor. But it takes a lot of time and energy. It is also called the enterprising approach.
The other way is to have a portfolio that runs on autopilot. This autopilot approach is for passive or defensive investors. Using this approach, you’ll create a permanent portfolio that requires little effort. These portfolios don’t generate that much excitement, though.
There’s no right or wrong approach here. The main decision factor is which one works for you. Or, instead, which one works better for your personality and your investment style? The style or approach you choose will most likely stick with you for the rest of your career.
This implies that you must enjoy what you’re doing. Suppose you’re naturally competitive, like a challenge, and enjoy getting your hands dirty. In that case, an active approach might be the right one.
But if you prefer to take things slowly, the passive or defensive approach might be more suitable for you.
Security Analysis
The author makes it relatively easy to assess which stock options are most desirable. For the average or lay investor, picking the most important factors for deciding which stock to buy can be challenging.
But Benjamin Graham gives you 5 clear measures to assess which stocks are the most attractive. Let’s take a look.
Management Quality
If the company doesn’t have a high-quality upper management team, then it’s bound to doom. A good company’s management team is honest; they do what they say. They should also be able to take responsibility for their failures and successes.- Long-term Projects
Investors shouldn’t just look at the present. You should also have a more future-focused approach. There are two important questions to ask here. Where’s the profit coming from now, and what’s making the company grow?
You need to look at least five years ahead. According to Benjamin Graham, just reading a company’s annual report isn’t enough.
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- Dividend Records
A steady increase in dividends is always a good sign. Benjamin always asks to research the company’s past dividend track record. You should look into at least the past 10 years of dividends. A minimal increase of 6 to 7% is a good sign. - Financial Strength And Capital Structure
You should also consider whether the company consumes more cash than it produces. Additionally, whether or not the higher-ups are investing the money back into the business or not. These are all key signs. - Current Dividend Rate
Of course, there’s the current dividend rate. You need to see whether or not the current dividend rate is satisfactory.
The book dives into the right stock selection for aggressive or active investors and passive investors, plus many more things. You can read more about the synopsis here. As mentioned, The Intelligent Investor by Benjamin Graham is a must-read for any investor.
Portfolio Policies
In the book, Benjamin Graham also outlines portfolio policies. He dives deep into the positive and negative sides too. The portfolio policies are a great way to understand how your portfolio should look. But keep in mind that these are general guidelines.
That’s exactly how it should be treated. You should create your portfolios but use the framework to help you.
Avoid High-yield Preferred Stock
The first thing the author talks about is avoiding the high-yield preferred stock. This is because there’s no cheap and available method you can use to reduce the risks involved. Some risks are always involved when getting active with these kinds of stocks.
Getting Conned By Attractive IPOs
Hype can be either a good thing or a bad thing. But you should always exercise caution when approaching IPOs. Don’t get swayed by a company’s IPO with a lot of hype. In other words, don’t get conned by high-profile and attractive IPOs.
It is argued that the more hype around a stock, the more overpriced it is. You should make a call based on your judgment here. Do not get pulled into the hype train.
Not Dying A Trader’s Death
This section sounds a bit grim. But what does it mean? Benjamin Graham is talking about traders getting stuck in a cycle. Many traders will cycle between buying and selling depending on fluctuations. This is an exaggerated form of aggressive investing.
Many traders have fallen for it. You’re bound to fail if you can’t hold onto a stock for more than 2 months.
Ways An Aggressive Investor Makes Money
When it comes to making money for an aggressive investor, there are four main ways. They are:
- Buying bargain stocks
- Buying in low markets and selling in high markets
- Taking advantage of unique situations
- Buying growth stocks after carefully considering them
You buying stocks should be based on solid reasoning and nothing else. This is also where having ample knowledge and the right judgment come in. Usually, it shouldn’t be popular with other speculators or investors.
Below are his two ideals. He also mentioned three investment approaches for these two ideals. Let’s take a closer look at them.
1. Invest In Relatively Large And Unpopular Companies
Assume that the market frequently over-values common stocks of companies growing rapidly. This means you can also assume that it undervalues companies that do not show signs of tremendous growth.
You can get these stocks for a meager price when you identify them. You should become interested in these growth stocks when something is going wrong. Not when everything is fine, and it’s the most popular.
There’s a classic Johnson & Johnson story from 2002. The company announced that the government is investing in it for allegedly false record-keeping. This caused the stock price to fall.
In this situation, a smart investor will buy the stocks for a low price. That’s exactly what happened. The investors later got a significant return.
2. Bargain Issues
Bargain issue stocks are worth at least 50% more than what they’re selling for. So, how do you tell whether a stock is a bargaining issue? The first step is to look at the future earnings potential.
Do its future earnings outweigh the cost of the issue, causing it to be undervalued currently? The second one evaluates the value of the company or business to a private owner. This is revealed by looking into the future earning potential.
3. Any Special Situations
A common ‘special situation’ is when a more prominent firm buys or acquires a smaller one. How does that help the investor? The smaller company will often offer stocks at almost double the price.
This helps make the acquisition possible and gets the shareholders on board. An intelligent investor should, therefore, look for companies almost nearing bankruptcy. This means that they’ll be selling stocks cheaply.
But that isn’t the full picture. You must make sure you choose a company with a high chance of being bought out, as this will increase the stock price.
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Benjamin Graham’s Philosophy Of Value Investing
To truly understand Benjamin Graham’s investing philosophy, you must understand the Benjamin method. This method is the original value investing philosophy created by the author.
Benjamin proposes two types of investors – the short-term investor and the long-term investor. Short-term investors are those that bet on fluctuations. Long-term investors invest as if they were the companies’ owners. This is a significant difference.
Here’s another way of explaining it. If you’re the owner of a particular company, you wouldn’t necessarily put too much thought into what the market itself thinks. You would understand the value your company has. This is true, given that you have solid evidence to believe in that value and act accordingly to those beliefs.
Benjamin Graham has a formula for calculating the intrinsic value of a stock. It’s:
V = EPS * (8.5 + 2g)
Let’s break this down in more detail. Here, V refers to the intrinsic value. EPS is pretty self-explanatory. It’s the company’s EPS (the trailing 12-month EPS, to be more specific). 8.5 refers to the P/E ratio of a zero-growth stock. Finally, g is the long-term growth rate. In 1974 the formula was revised. The more recent formula looks like this:
V = (EPS * (8.5 + 2g) * 4.4)/Y
You can learn more about it from this Investopedia article.
Apart from the Benjamin method, there are some timeless lessons or principles you can rely on. Let’s check them out below.
1. Invest With A Margin Of Safety
You should buy a stock with a discount on its intrinsic value. This will decrease your risk and give you a substantial return on your investment.
2. Knowing Yourself
This is a critical one. Every investor is different, and you need to know what kind of investor you are. If you’ve been paying attention, you would know that you’re either a passive investor or an aggressive investor.
Again, there’s no right or wrong answer here. You need to research stocks and understand the market with an aggressive approach. In comparison, a passive investor is more relaxed about money.
Graham says that a passive investor can get by with modest returns just from buying into an index. For example, Dow Jones Industrial Average.
Here’s what most people get wrong. Many believe that if it’s possible to get an average return with little work, you might get even more return by doing slightly more work. But in reality, that’s not how it works.
3. Profiting From Volatility
You should always expect volatility. But prepare to profit from it. A great investor doesn’t automatically run for the exit when the market seems less favorable.
Instead, they use this as a chance to find great investments. This article talks in more depth about these three principles.
Mr. Market
Mr. Market is Benjamin Graham’s finest creation. It’s an allegory, an imaginary investor, a character that Benjamin Graham created and introduced to the world in the book The Intelligent Investor.
Mr. Market’s character is very pessimistic. Someone prone to erratic mood swings, sometimes pessimistic, sometimes optimistic. Since the stock market is filled with investors just like Mr. Market, the character takes on all of these characteristics.
He uses this character to teach how investors shouldn’t act on whims and desires. The market might be overly excited about something or be very pessimistic. An intelligent investor doesn’t get caught up in these movements and doesn’t act on whims and emotions.
In the book, Mr. Market seems to be buying and selling stocks without basing any decisions on investing principles. Graham believes that investors are much better at assessing value through fundamental analysis.
Mr. Market is very emotional; as such, he will offer favorable stocks at a lower price. In comparison, he’ll offer an opportunity to sell the overvalued stocks when he’s too optimistic.
Determining Value and Fundamental Analysis
Benjamin Graham always believed that determining the value of a stock through fundamental analysis was the better approach. Fundamental analysis is used to determine the intrinsic value – the value of a security based on future earning potential.
It can be another company’s attribute but not related to the security’s market price at that time. It uses both macro and macro perspectives. Doing this helps investors identify securities that aren’t priced correctly.
Three main things are taken into consideration:
- The economy
- Industry strength
- Company financial performance
Investopedia has a fantastic article on fundamental analysis. You can read it and develop a more in-depth understanding of it.
Benjamin Graham’s Investments And Returns
Benjamin Graham’s investment performance was much higher than average. From 1936 to 1956, his annualized return was approximately 20%. However, the market’s performance was a little over 12%.
It’s, therefore, pretty clear he was an excellent investor. However, his most famous student, Warren Buffet, thinks that following Benjamin Graham’s methods is a bit outdated. Charlie Munger, Vice Chairman of Berkshire Hathaway, believes the same.
Benjamin Graham’s most profitable gain was from the company GEICO. GEICO contributed more to his portfolio than all of his other investments combined.
He invested $712,000 with his Graham-Newman partnership in 1948. This investment got him 50% of the company, valued at $400 million by 1972. Berkshire Hathaway then acquired GEICO.
Long-term Stock Market Strategies
As we’ve already mentioned, Graham says a long-term investor treats his investments like he’s the company’s owner. As an investor (and owner), you shouldn’t always get influenced by the market.
He understands the true and intrinsic value of the companies. Here’s where the Mr. Market allegory comes into play perfectly. According to Benjamin Graham, it’s recommended to distribute your portfolio evenly between stocks and bonds and not commit your portfolio to one or the other completely.
His approach was to preserve capital and then try to make it grow. Knowing oneself is also very important if you want to be in the investing game long-term.
Benjamin Graham’s Legacy
Benjamin Graham is a legendary investor. That much is clear. He contributed to numerous fields, including value investing and fundamental value investing.
He has well-known disciples such as Warren Buffet, Walter J. Schloss, Charles Brandes, Irving Kahn, William J. Ruane, and more. Benjamin Graham made notable contributions to economic theory.
One of his most notable contributions was developing a new alternative to the gold standard for the US and international currencies.
Key Lessons From Graham For My Investment Portfolio
What are the key lessons you should take away from Benjamin Graham? The best thing would be to read his books.
That’s first-hand invaluable knowledge that cannot be replicated anywhere. These principles and lessons will stick with you even after reading his books. Here are some of the key lessons for your portfolio:
- Invest with a margin of safety
- Know yourself as an investor
- Know whether you’re an intelligent investor or an intelligent speculator
- Aim for long-term investing
- Prepare for Mr. Market
- Learn from mistakes
Wrapping Up
Benjamin Graham has inspired many hyper-successful investors. You, too, could be one of them! If you’re interested in more inspiring stories like these and investing tips and tricks, check out Trading for Beginners! We have tons of priceless information all about investing.
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About the author – D. Schmidt
I’m a German stock trader who has lived around the world. I travel extensively and believe that my experiences give me a unique perspective on global markets. I love trading! It’s always exciting to see what happens next. My goal is to help people understand the game so they too can enjoy it to the fullest. In this blog, I will share some tips and tricks that helped me along the way.
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