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Intelligent Investor

August 19, 2013

Intelligent Investor by Benjamin Graham (2003 revised edition)

The book starts with saying that successful investing is more about a person’s character and discipline than intelligence. An example to illustrate this assertion was how Sir Isaac Newton was caught up in a market frenzy in lost a great deal of money on the South Sea Company. The book focuses on investing for value rather than market hype and goes to great lengths to define “investing” versus “speculating”. One clear definition of a speculator is: “a non-professional using margin”. If you trade more than twice a year you are probably a speculator.

Investing for the long term should be about making average or above average returns over a long period of time. Investing in financially sound and promising businesses is key rather than investing in whatever is currently HOT in the market. A good tip for deciding if you should but a stock: “Invest only if you’d be comfortable never knowing the daily share price”.

No government that borrows wants to eliminate inflation because it makes paying down debts easier because it’s cheaper.

Inflation is the enemy of any investor. It robs you of your principal’s purchasing power. Some example investments that fare well against inflation are: Real Estate Investment Trusts (REITs) and Treasury Inflation-Protected Securities (TIPS).

Enterprising or Defensive Investor

TIP: 50-75% of your funds should be allocated to stocks. Investing in mutual funds is an effective way to get diversification of stocks.

Some seek out professional investment advice which is a great resource to prevent costly mistakes, but they can not be expected to earn more than average returns. Learning to do your own analysis of a company is extremely important. A good book to read on the subject is Interpretation of Financial Statements by Benjamin GrahamSome good things to focus on when analyzing a company are: long-term prospects, management, equity/debt ratio, capital structure, dividend record, and current dividend rate. It’s also important not to focus too much on an analysis of the industry and instead focus on the particular company.

Value = Normal Earnings x (8.5 + 2x annual growth)

An enterprising investor that wishes to manage his investments more closely should be cautioned. Managing your investments yourself might not do better than the market. Whatever analysis techniques you choose should be “test driven” before putting large sums of money in them. You probably can’t beat the professionals, so be careful with the idea that you believe you can.

Dividends are not as popular as they once were and there is good reason for that. Businesses have convinced investors that re-investing all profits into the business for growth is the best use of profits. However, not all companies grow when they do this. Companies that do pay dividends to shareholders usually pay a majority of profits in dividends. So why else would companies not want to pay dividends? For a very self serving reason: Dividends reduce stock price volatility which therefore reduce stock option valueAnd since most company senior management have stock options as part of their compensation packages, they have a vested interest in not reducing the value of their stock options.

Tips

  • Read financial statements backwards. The back is where they hide the bad news.
  • Download and analyze the last 5 years of Form 10-K to understand the company over time.
  • A company that acquires many companies (a serial acquirer) is a sign of trouble.
  • Defensive investor: should have high grade bonds and leading common stocks. Also a Total Market Index Fund is a good choice.
  • If during quarterly reports they talk more about stock price rather than business, that’s a sign of a problem.
  • 2 important figures to study: EPS (earnings per share) and ROIC (return on investment capital).
  • Companies get tax breaks from compensation expenses when employees exercise options.
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