The Intelligent Investor

by Benjamin Graham

With every new wave of optimism or pessimism, we are ready to abandon history and time-tested principles, but we cling tenaciously and unquestioningly to our prejudices.

For most investors, bond funds beat individual bonds hands down (the main exceptions are Treasury securities and some municipal bonds).

4. The investor should impose some limit on the price he will pay for an issue in relation to its average earnings over, say, the past seven years. We suggest that this limit be set at 25 times such average earnings, and not more than 20 times those of the last twelve-month period.

But such a restriction would eliminate nearly all the strongest and most popular companies from the portfolio. In particular, it would ban virtually the entire category of “growth stocks,” which have for some years past been the favorites of both speculators and institutional investors. We must give our reasons for proposing so drastic an exclusion.

The problem lies there, of course, since growth stocks have long sold at high prices in relation to current earnings and at much higher multiples of their average profits over a past period. This has introduced a speculative element of considerable weight in the growth-stock picture and has made successful operations in this field a far from simple matter.

In contrast we think that the group of large companies that are relatively unpopular, and therefore obtainable at reasonable earnings multipliers,* offers a sound if unspectacular area of choice by the general public.

and with notable effects in the sale of new common stock issues during periods of active speculation.”

Chaotic portfolios. All too many investors thought they were diversified in the late 1990s because they owned 39 “different” Internet stocks, or seven “different” U.S. growth-stock funds.

by fairly definite projections of expected earnings running fairly far into the future.

Experience has shown that in most cases safety resides in the earning power, and if this is deficient the assets lose most of their reputed value.

14 cents.

It will fall for any company identified with “franchising,” computers, electronics, science, technology, or what have you, when the particular fashion is raging.

pooling-of-interests

grab bag

thorough-going

The very low book value of Home illustrates a basic ambiguity or contradiction in common-stock analysis. On the one hand, it means that the company is earning a high return on its capital—which in general is a sign of strength and prosperity.

rub shoulders

The price of 55 at the close of 1969 was more than 100 times the last reported 12-months’ earnings—which of course were the largest to date. The aggregate market value of $300 million for the stock issue was nearly 30 times the tangible assets behind the shares.*

mirabile dictu,

These include virtually all the cases where there has been great market activity in companies of questionable underlying soundness. Such stocks not only were speculative—which

It will be noted that in each of the last 13 years the price either advanced or declined over a range of at least three to two from one year to the next.

But, if the picture is viewed as a whole, there is a reasonably close connection between the growth of corporate surpluses through reinvested earnings and the growth of corporate values.

Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.

The purchasers view the current good earnings as equivalent to “earning power” and assume that prosperity is synonymous with safety. It is in those years that bonds and preferred stocks of inferior grade can be sold to the public at a price around par, because they carry a little higher income return or a deceptively attractive conversion privilege.

It is then, also, that common stocks of obscure companies can be floated at prices far above the tangible investment, on the strength of ...

deal in.

“Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it—even though others may hesitate or differ.”

Similarly, in the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand.

bear upon

achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.

annually. Unfortunately, you are so enthusiastic that you pay too high a price, and the stock loses 50% of its value the first year. Even if the stock then generates double the market’s return, it will take you more than 16 years to overtake the market—simply because you paid too much, and lost too much, at the outset.

Risk exists in another dimension: inside you. If you overestimate how well you really understand an investment, or overstate your ability to ride out a temporary plunge in prices, it doesn’t matter what you own or how the market does.

If I am buying, someone else is selling. How likely is it that I know something that this other person (or company) does not know?

If I am selling, someone else is buying. How likely is it that I know something that this other person (or company) does not know?

toss-up,

“In making decisions under conditions of uncertainty, the consequences must dominate the probabilities.

an online survey of 1,338 Americans by Money Magazine in 1999 found that nearly one-tenth of them had at least 85% of their money in Internet stocks.

Ironically enough, the aggregate of profits accruing from this single investment decision far exceeded the sum of all the others realized through 20 years of wide-ranging operations in the partners’ specialized fields, involving much investigation, endless pondering, and countless individual decisions.

But behind the luck, or the crucial decision, there must usually exist a background of preparation and disciplined capacity. One needs to be sufficiently established and recognized so that these opportunities will knock at his particular door. One must have the means, the judgment, and

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.

coin-flipping call

identified with

The point I want to make here is that there is a special paradox in the relationship between mathematics and investment attitudes on common stocks, which is this: Mathematics is ordinarily considered as producing precise and dependable results; but in the stock market the more elaborate and abstruse the mathematics the more uncertain and speculative are the conclusions we draw therefrom.

In effect this meant that the investor did not have to pay anything substantial for superior long-term prospects. He got these, virtually without extra cost, as a reward for his own superior intelligence and judgment in picking the best rather than the merely good companies. For common stocks with the same financial strength, past earnings record, and dividend stability all sold at about the same dividend yield.

Some years later, when the public woke up to the historical merits of common stocks as long-term investments, they soon ceased to have any such merit, because the public’s enthusiasm created price levels which deprived them of their builtin margin of safety,

and thus drove them out of the investment class.

It seems a truism to say that the old-time common-stock investor was not much interested in capital gains.

He bought almost entirely for safety and income, and let the speculator concern himself with price appreciation.

his interest centers on long-term appreciation. Yet one might argue, perversely, that precisely because the old-time investor did not concentrate on future capital appreciation he was virtually guaranteeing to himself that he would have it, at least in the field of industrial stocks.

And, conversely, today’s investor is so concerned with anticipating the future that he is already paying handsomely for it in advance.