Wednesday, March 01, 2006

The Intelligent Investor by Benjamin Graham

This is one of two classics of value investing by the inventor of the field that has brought the likes of Warren Buffett and others great wealth in our financial markets. The other book he wrote is actually the textbook used for value investing courses at places like Columbia, UPenn, etc. titled Security Analysis written in the 1930's.

Turns out, things haven't really changed all that much. Sure, the actors have changed, from railroad tycoons to internet tycoons, but the story has remained the same. Benjamin Graham continued to update the earliest version of this book through the early 70's modifying it with information relevant for the stocks and bonds of the era. Jason Zweig, a value investing guru and Money magazine columnist, has added invaluable commentary to each chapter of the last version of Benjamin Graham's classic text as it relates to the markets in the late 90's through 2003. His writing reinforces the viewpoint of Benjamin Graham.

I started reading this thinking that I was going to learn how to be a value investor and how to do analysis myself. I ended thinking "Woah, if it takes this much work I'll stick to value investing funds and index funds and use the time I would have spent doing the recommended analysis on other things." I am fairly serious about that based on the current capital I have to commit to the markets. I love the field of finance and love exploring the mathematical aspects, algorithms, predictions, securities analysis for fun, but with a full time job I really don't have the time to invest the significant amount of time it would take to get it right and seems I'm better off letting somebody else with a track record and the resources assist.

Highly recommended reading, 4.5 out of 5, very illuminating, but mostly in a pessimistic way. Time spent reading this will save you lots of money and hassle in life. Attain financial enlightenment through Benjamin Graham! A long read, takes quite some time to get through, but you can skip around a bit and get the point. I'm a bit thick skulled sometimes so I had to read the entire thing and enjoyed every minute.

I'll add here a few of my favorite enlightenments from the book:

The Foolish Four from the Motley Fool
First, around page 45, Jason Zweig takes a swipe at the Foolish Four. While the Motley Fool is a great place to start one's investing career, its hardly a place to put too much faith. Basically, the Foolish Four algorithm is as follows:

  1. Take lowest price/highest divident yield stocks from the DJIA.
  2. Discard one with lowest price.
  3. Put 40% of your money in the one with second lowest price
  4. Put 20% in each of the remaining.
  5. One year later, do it again.
  6. Repeat until wealthy.

Guess what?!? Money magazine found that a portfolio made up of stocks whose names contained no repeating letters has performed nearly as well as The Foolish Four--and for the same reason: luck alone. (See the article, False Profits, Money Magazine, August, 1999, page 55-57.) The author's main point using this example is that it was not based on any kind of thorough analysis, putting 40% of your money is not minimal risk, and 4 stocks are not diversified enough to provide safety of principal capital.

What you can expect as a return in the stock market
Another interesting discussion is stock valuation and the fact that it is based on 3 factors (page 85): real growth (the rise in teh companies' earnings and dividends), inflationary growth (the general rise of prices throughout the economy), and speculative growth (any increase or decrease in investing public's appetite for stocks).

In the long run, yearly growth in corporate EPS is around 1.5 to 2%, inflation in 2003 was 2.4%, and the dividend yield was 1.9% for stocks. Therfore, 5.8% to 6.3% is what you can reasonably expect stocks to average. Not 20%, not even 10%, but 6%.

Something that has been lost on my generation is bond investing. I need to learn more about bonds as this is critical to a well diversified portfolio.

Growth Stocks
Benjamin Graham discussed growth stocks. On page 158, he says: "The authoritative manual entitled Investment Companies, published annually ... , computes the annual performance of some 120 such "growth funds" over a period of years. Of these, 45 have recoreds covering 10 years or more. The average overall gain for these companies--unweighted for size of fund--works out at 108% for the decade 1961-1970, compared with 105% for the S and P composite and 83% for the DJIA. .... Similar results were found in our earlier studies. The implication here is that no outstanding rewards came from diversified invesetment in growth companies compared with that in common stocks in general."

No comments: