Sunday, October 01, 2006


Benjamin Graham, acknowledged as the Dean of Wall Street authored “Intelligent Investor.’ It was first published in 1949. The fourth revised edition was published in 1973 by Harper Row, Publishers Inc. New York. A recent print of the book contains commentary by Jason Zweig. Interesting ideas (according to me) from the 1973 edition are being posted by me in parts as I am studying the book once again as a preparation to my presentations on value investing principles of Benjamin Graham. While I posted the actual sentences from the book in my posts on Graham and Dodd, I am posting summarized versions along with my comments in these posts.

From Preface

Graham acknowledged the contribution of Warren Buffett in writing this edition and commented that his counsel and practical aid had proved invaluable.

The purpose of the book is to supply, in a form suitable for laymen, guidance in the adoption and execution of an investment (portfolio) policy. The technique of analyzing securities is not the aim. But very useful things about security analysis are given in this book.

The famous warning of Santayana: “Those who do not remember the past are condemned to repeat it,” is truly applicable to Wall Street. Hence in the book historical patterns of financial markets are described by Graham. He says one should be forearmed with an adequate knowledge of how the various types of bonds and stocks have actually behaved under varying conditions-some of which, at least, one is likely to meet again in one’s own experience.

Graham emphasized that this is not a “how to make a million” book. There are no sure and easy paths to riches in Wall Street or anywhere else.

Defensive (Passive) and Enterprising Investors – A Distinction

The defensive (or passive investor) will place his chief emphasis on the avoidance of serious mistakes or losses. His second aim will be freedom from effort, annoyance, and the need for making frequent decisions. According to Graham, majority of the population falls into this category. It is logical also. Most of people in this world are consumers of many products. But a very small minority does business in any product. Securities are similar to the products that we consume. Any body with savings can acquire them. Only few with adequate knowledge, training and flair for the business complexities involved can do business in them.

The determining trait of the enterprising (or active, or aggressive) investor is his willingness to devote time and care to the selection of securities that are both sound and more attractive than the average. Over many decades an enterprising investor of this sort could expect a worthwhile reward for his extra skill and effort, in the form of a better average return than that realized by the passive investor. But the opportunities for this type of investment may not be present on all the days. The investor has to scan the market and the fundamentals periodically to find out suitable investment opportunities and has to acquire such securities in competition with investors/analysts who are also awaiting such opportunities. Hence in theory, enterprising investment is possible, but in practice it is a difficult endeavor. Graham says so very strongly.

Investing based on future physical growth opportunities is not an easy activity.
1. Obvious prospects for physical growth in a business do not translate into obvious profits for investors.
2. The experts do not have dependable ways of selecting and concentrating on the most promising companies in the most promising industries.

Graham says that he did not follow growth-prospects approach in his financial career as fund manager, and cannot offer either specific counsel or much encouragement to those who may wish to try it.

While earnings valuation is the mainstay of Graham’s approach, he suggests as one of the chief requirements that readers limit themselves to issues selling not far above their tangible-asset value. Otherwise, the investment is at the mercy of the speculative elements of the stock market.

The art of investment has one particular characteristic that is not generally appreciated. A creditable, if unspectacular, result can be achieved by the lay investor with a minimum of effort and capability; but to improve upon this easily attainable standard requires much application and more than a trace of wisdom.

Since anyone-by just buying and holding a representative list-can equal the performance of the market averages, it would seem a comparatively simple matter to “beat the averages”; but as a matter of fact the proportion of smart people who try this and fail is surprisingly large. Even a majority of the investment funds, with all their experienced personnel, have not performed so well over the years as has the general market. This is one more warning to persons who want to try enterprising investment approach.

According to Graham, the record of the published stock-market predictions of the brokerage houses is below average, for there is strong evidence that their calculated forecasts have been somewhat less reliable than the simple tossing of a coin. Benjamin Graham wants the broking firms to change their research methods. We have to remember that Graham is the developer of the subject with the title “Security Analysis” and hence he has all the credentials to recommend changes to the practices of broking firms.

A strong-minded (enterprising) approach to investment, firmly based on the margin-of-safety principle, can yield handsome rewards. But a decision to try for these emoluments rather than for the assured fruits of defensive investment should not be made without much self-examination. It is interesting to notice that Graham used the word emoluments to the return in enterprising investment. This actually refers to the excess return over the return available to defensive investors. Hence the enterprising investor is earning his emoluments for the extra labour that he is putting in. But the warning is clear. It is a high-risk activity. Many who tried have not got the anticipated emoluments.
The chapter wise points will be covered in the future posts.

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