Benjamin Graham’s The Intelligent Investor (Book review)


“I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.”

These words in a preface to a revised edition of The Intelligent Investor by Benjamin Graham, the father of value investing, came from none other than Warren Buffett, the legendary  investor who is chairman and chief executive officer of Berkshire Hathaway.

Known to many as the Wizard of Omaha or the Oracle of Omaha or the Sage of Omaha, Warren Buffett is a strong believer of value investing, a belief which the legendary value investor steadfastly puts into practice at Berkshire Hathaway. Reflecting the great success of his  investment approach, Berkshire Hathaway’s 2013 Annual Report shows that “over the last 49 years (that is, since present management took over), book value has grown from US$19 to US$134,973, a rate of 19.7% compounded annually”. These are per-share book values.

“To me, Ben Graham was far more than an author or a teacher. More than any other man except my father, he influenced my life,” Warren Buffett said in the same book preface.

In a section of his letter to Berkshire Hathaway shareholders on February 28, 2014 (for FY 2013), Warren Buffett said: “Ben’s ideas were explained logically in elegant, easy-to-understand prose (without Greek letters or complicated formulas). For me, the key points were laid out in what later editions labeled Chapters 8 and 20. (The original 1949 edition numbered its chapters differently.) These points guide my investing decisions today.”

Sharing “some thoughts about Investing”, Warren Buffett said:  “I  learned most of the thoughts in this investment discussion from Ben’s book The Intelligent Investor, which I bought in 1949. My financial life changed with that purchase. Before reading Ben’s book, I had wandered around the investing landscape, devouring everything written on the subject. Much of what I read fascinated me: I tried my hand at charting and at using market indicia to predict stock movements. I sat in brokerage offices watching the tape roll by, and I listened to commentators. All of this was fun, but I couldn’t shake the feeling that I wasn’t getting anywhere.”

There are 20 chapters in the revised edition of Benjamin Graham’s The Intelligent Investor. For Warren Buffett, the most known disciple of Benjamin Graham,  the key points were laid out in Chapters 8 and 20. The best takeaway from Chapter 8 is Benjamin Graham’s parable about Mr Market, a character he used to personify the behavior of the stock market. Warren Buffett once described this Mr Market as a character with uncurable emotional problems. For the intelligent investor, the question is how to turned the behavior of Mr Market to your investment advantage.  Chapter 20 is on “Margin of Safety” as the Central Concept of Investment.

The best part about intelligent investing is that one doesn’t need a high IQ to achieve success. Warren Buffett said it best: “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information.”

The Intelligent Investor can be heavy going for the beginner investor but the beauty of the revised edition is that the chapters, and the introduction, are each accompanied by a commentary from veteran investment writer Jason Zweig.

For those who love Benjamin Graham’s value investing philosophy, The Intelligent Investor is seen as a book shielding investors from substantial error and teaching them to develop long-term strategies. This investment philosophy has made the book  the stock market bible for value investors.

 

Recommended reading:

The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition) (Collins Business Essentials)

 

Berkshire Hathaway’s fifteen common stock investments that at FY2013 yearend had the largest market value

 

12/31/13
Shares** Company Percentage owned Cost* Market
(in millions)
151,610,700 American Express Company 14.2 $1,287 $13,756
400,000,000 The Coca-Cola Company 9.1 1,299 16,524
22,238,900  DIRECTV 4.2 1,017 1,536
41,129,643 Exxon Mobil Corp 0.9 3,737 4,162
13,062,594 The Goldman Sachs Group, Inc 2.8 750 2,315
68,121,984 IBM Corp 6.3 11,681 12,778
24,669,778  Moody’s Corporation 11.5 248 1,936
20,060,390 Munich Re 11.2 2,990 4,415
20,668,118  Phillips 66 3.4 660 1,594
52,477,678 The Procter & Gamble Co 1.9 336 4,272
22,169,930  Sanofi 1.7 1,747 2,354
301,046,076   Tesco plc 3.7 1,699 1,666
96,117,069 U.S. Bancorp 5.3 3,002 3,883
56,805,984  Wal-Mart Stores, Inc 1.8 2,976 4,470
483,470,853 Wells Fargo & Company 9.2 11,871 21,950
Others 11,281 19,894
Total Common Stocks Carried at Market $56,581 $117,505
*This is our actual purchase price and also our tax basis; GAAP “cost” differs in a few cases
because of write-ups or write-downs that have been required under its rules.
**Excludes shares held by Berkshire subsidiary pension funds.

Data source: Warren Buffett’s letter dated February 28, 2014 for FY2013 to Berkshire Hathaway shareholders

Recommended reading:

(1) The Essays of Warren Buffett: Lessons for Corporate America, Third Edition

(2) Berkshire Hathaway Letters to Shareholders, 1965-2013

Benjamin Graham’s The Intellingent Investor Chapter 20 (Margin of Safety As The Central Concept Of Investment)

Benjamin Graham's teacher and friend. Mr Graham used Mr. Market as the character to personify the behavior of the stock   market. Photo: Wikipedia.
Benjamin Graham: “Investment is most intelligent when it is most businesslike.” Photo: Wikipedia.

In a section of his  letter to Berkshire Hathaway shareholders on February 28, 2014 for FY2013, Warren Buffett shared “Some Thoughts About Investing”  (Post: Investment is most intelligent when it is most businesslike) .

He also shared more about Benjamin Graham, his teacher and friend, and about Benjamin Graham’s book, The Intelligent Investor .

“Ben’s ideas were explained logically in elegant, easy-to-understand prose (without Greek letters or complicated formulas). For me, the key points were laid out in what later editions labeled Chapters 8 and 20. (The original 1949 edition numbered its chapters differently.) These points guide my investing decisions today.”

So what is   Chapter 20  in the later editions of The Intelligent Investor all about?

As Chapter 20’s title, “Margin of Safety” as the Central Concept of Investment, suggests,  “margin of safety” is the motto governing  Benjamin Graham’s investment policy. It is the thread that runs through all the investment policy discussion in preceding chapters.

The chapter started off with the margin-of-safety concept as applied to “fixed value investments”.

“All experienced investors recognize that the margin-of-safety concept is essential to the choice of sound bonds and preferred stocks. For example, a railroad should have earned its total fixed asset charges better than five times (before income tax), taking a period of years, for its bonds to qualify as investment-grade issues. This past ability to earn in excess of interest requirements constitutes the margin of safety that is counted on to protect the investor against loss or discomfiture in the event of some future decline in net income. (The margin above charges may be stated in other ways – for example, in the percentage by which revenues or profits may decline before the balance after interest disappears – but the underlying idea remains the same.)

The margin-of-safety concept as applied to “fixed value investments” can be carried over to the field of common stocks, says Chapter 20, but with some necessary modifications.

“There are instances where a common stock may be considered sound because it enjoys a margin of safety as large as that of a good bond. This will occur, for example, when a company has outstanding only common stock that under depressed conditions is selling for less than the amount of bonds that could safely be issued against its property and earning power. That was the position of a host of strongly financed industrial companies at the low price levels of 1932-33. In such instances, the investor can obtain the margin of safety associated with a bond, plus all the chances of larger income and principal appreciation inherent in a common stock. (The only thing he lacks is the legal power to insist on dividend payments “or else – but this is a small drawback as compared with his advantages.”

Elsewhere in Chapter 20, it says “the risk of paying too high a price for good-quality stocks – while a real one – is not the chief hazard confronting the average buyer of securities”. “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.”

As for growth stocks, the danger lies in the market’s “tendency to set prices that will not be adequately protected by a conservative projection of future earnings”.

The margin of safety is much more evident in the field of undervalued  or bargain securities.  By definition, it means there is a favorable difference between price on the one hand and indicated or appraised value on the other. “That difference is the margin of safety”.

The gem of Chapter 20 comes in this famous Benjamin Graham quote: “Investment is most intelligent when it is most businesslike.”

“It is amazing to see how many capable businessmen try to operate in Wall Street with complete disregard of all the sound principles through which they gained success in their own undertakings.”

Related posts: (1) The Intelligent Investor Chapter 8

(2) Warren Buffett on intelligent investing

Recommended reading:

The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition) (Collins Business Essentials)

 

Benjamin Graham’s The Intelligent Investor Chapter 8 (The Investor and Market Fluctuations)

Benjamin Graham's teacher and friend. Mr Graham used Mr. Market as the character to personify the behavior of the stock   market. Photo: Wikipedia.
Benjamin Graham, author of The Intelligent Investor Photo: Wikipedia

In a section of his  letter to Berkshire Hathaway shareholders on February 28, 2014 for FY2013, Warren Buffett shared “Some Thoughts About Investing”  (Post: Investment is most intelligent when it is most businesslike) .

He also shared more about Benjamin Graham, his teacher and friend, and about Benjamin Graham’s book, The Intelligent Investor .

“Ben’s ideas were explained logically in elegant, easy-to-understand prose (without Greek letters or complicated formulas). For me, the key points were laid out in what later editions labeled Chapters 8 and 20. (The original 1949 edition numbered its chapters differently.) These points guide my investing decisions today.”

So what is   Chapter 8  in the later editions of The Intelligent Investor all about?

The takeaway  lesson from Chapter 8 of The Intelligent Investor is Benjamin Graham’s parable about Mr Market, a character that Benjamin Graham used to demonstrate the behavior of the stock market.

Here is the Benjamin Graham parable: “Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr Market, is very obliging indeed. Everyday he tells you what your interest is worth and further offers to buy you out or sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr Market lets his enthusiasm or his fears run away with him, and the value he proposes to you seems to you a little short of silly.

“If you are a prudent investor or a sensible businessman will you let Mr Market’s daily communications determine your view of the value of $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out  to him when he quotes you a ridiculously high price, and equally happy to sell to him when his price is low. But the rest of the time you will be wiser to form your own idea of the value of your holdings, based on full reports from the company about its operations and financial position.

“The true investor is in that very position when he owns a listed common stock. He can take advantage of the daily market price or leave it alone, as dictated by his own judgment and inclination. He must take cognizance of important price movements, for otherwise his judgment will have nothing to work on. Conceivably they may give him a warning signal which he will do well to heed – this in plain English means he is to sell his shares because the price has gone down, foreboding worse things to come. In our view such signals are misleading at least as often as they are helpful. Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he would be better off if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”

Related posts: (1) The Intelligent Investor Chapter 20

(2) Mr Market’s Incurable Emotional Problems.

Recommended reading:

The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition) (Collins Business Essentials)

Understanding financial statements (cash flow statement)

Cash flow statement

Company ABCXYZ Ltd

Year Ended Dec 31, 2013

all figures in US$

Cash flow from operations

Net earnings 4,000,000
Additions to cash
Depreciation 20,000
Decrease in accounts receivable 30,000
Increase in accounts payable 30,000
Increase in taxes payable 4,000
Subtractions from cash
Increase in inventory -60,000

Net cash from operations

4,024,000

Cash flow from investing

Equipment -1,000,000

Cash flow from financing

Notes payable 20,000

Cash flow for Year Ended Dec 31, 2013

3,044,000

The above table is a simple example of a Cash Flow Statement, which is  one of three key financial statements of a company, the other two being Profit & Loss Statement and Cash Balance.

The cash flow statement shows how much cash a company is generating in a given financial period, such as for one financial year. It is divided into three parts:  (1) cash flows from operating activities; (2) cash flows from investing activities; and (3) cash flows from financing activities.

(1) Cash flows from operating activities

Cash flows from operating activities form the first part of the cash flow statement. It shows how much cash a company generated for its business during a financial period, say for a year. This will show how the company’s cash flow changes from year to year. How the company performed in this area is of  interest to stakeholders because it shows the cash-generating power of the company. As the table above shows, the first cash item in operating activities is net earnings or net income. This figure can be obtained from the Profit & Loss statement – in this case, we are assuming that the net earnings figure in the Profit & Loss statement was 4,000,000. We have next to make some additions to cash (including for non-cash items) and some subtractions from cash.  These cash additions or subtractions need some explanation.

The part on  cash additions and subtractions in the given table shows four items as cash additions (inflows) and one item as  cash subtraction:

(a) Depreciation: 20,000

(b) Decrease in accounts receivable: 30,000

(c) Increase in  accounts payable: 30,000

(d) Increase in taxes payable: 4,000

(e) Inventory: -60,000.

Why are the four items from (a) to (d) considered as cash inflows into the company while (e) is considered a cash outflow?  Let’s examine them one by one.

For the depreciation item, assume the company bought an equipment costing 100,000. To simplify matter, assume that the equipment was paid for in cash when it was acquired. If the equipment has a useful life of five years, it means that it will lose 20,000 in value each year under a “straight line” method of depreciation. So the depreciation cost is 20,000 a year. In the profit & loss statement, this 20,000 would have already been deducted as an operating expense in Year 2013  when computing earnings. In reality, the 20,000 depreciation expense did not leave the company as it was a non-cash item. Why was it  so? Remember the company had already paid 100,000 upfront for the equipment? So while depreciation was a cost in Year 2013 and was deducted as an expense, there was no actual outflow. The 20,000 was  therefore treated in the cash flow statement as an addition.

Next, we look at why a decrease in accounts receivable of 30,000 in the Balance Sheet became a cash inflow of 30,000 in the cash flow statement. Accounts receivable are what others owe the company for products sold to them on credit, meaning the buyers were given a grace period to pay later. For Year 2013, accounts receivable payable fell 30,000, so there was a net flow of  30,000 into the company. This item was therefore a plus item in the cash flow statement. If this situation was in reverse, that is there was instead an increase in accounts receivable, there would then be a cash outlfow and the amount of increase will  be a minus item in the cash flow statement.

An increase in accounts payable means the company is owing others more, say for goods supplied to the company. In the example in the table, the increase in accounts payable was 30,000. That meant the company owed 30,000 more to suppliers at the end of Year 2013 than at the end of Year 2012, resulting in a cash inflow for the company and hence was a plus item in the cash flow statement. If it was the reverse, meaning there was instead  a drop in accounts payable, it would have meant money had gone out of the company and had  to be treated as a cash outflow.

The table shows an increase in taxes payable of 4,000 in Year 2013 and this was treated as a cash inflow. This came about because taxes, while accounted as an expense in the profit & loss statement of a financial year , that amount of money did not leave the company immediately.  Let’s assume that in Year 2012 the tax payable was 20,000 and in Year 2013 it was 24,000.   In Year 2013, there was a cash outflow of 20,000 being taxes for Year 2012.  But Year 2013 saw a cash inflow of 24,000 because this amount, while having been deducted in Year 2013 as an expense in the profit & loss statement, would be  be due for settlement the following year in Year 2014.

There was also an increase of 60,000 in inventory in Year 2013 and this was treated as a cash outflow for obvious reasons. When a company buys more stocks, it means more money flows out. It will still be a cash outflow if the goods are on credit term as this mean an increase in accounts payable.

(2) Cash flow from investing activities

These activities involve acquiring or dispensing of property, plant and equipment (PP&E), corporate acquisitions and any sales or purchases of investments. In the table given, the company spent 1,000,000 on equipment in Year 2013, so 1,000,000 was treated as a cash outflow.

(3) Cash flow from financing activities

Financing activities include transactions with the company’s owners or creditors. In the example in the table, the company issued 20,000 notes to raise funds. The 20,000 notes payable are considered a cash inflow. Some other examples of items that fall under this part of the cash flow statement are:

(a) dividends;

(b) issuance/purchase of common stocks;  and

(c) issuance/repayment of debt.

Recommended reading:

(1) The Five Rules for Successful Stock Investing: Morningstar’s Guide to Building Wealth and Winning in the Market

(2) Analysis for Financial Management, 10th Edition

(3) Financial Statements: A Step-by-Step Guide to Understanding and Creating Financial Reports

Who is Barton Biggs?


(https://www.youtube.com/watch?v=w_1dGYDwmU4)
According to Wikipedia, Barton Michael Biggs (November 26, 1932 – July 14, 2012) was a money manager whose attention to emerging markets marked him as one of the world’s first and foremost global investment strategists, a position he held—after inventing it in 1985—at Morgan Stanley, where he worked as a partner for over 30 years. Following his retirement in 2003, he founded Traxis Partners,  a multi-billion dollar hedge fund, based in Greenwich, Connecticut.  He is best known for accurately predicting the dot.com bubble in the late 1990s.

At age 18, Barton Biggs was given a portfolio of 15 stocks worth about $150,000, but he showed little interest in finance and investing in his youth. He ended up choosing that career path after feeling left out from conversations between his father and younger brother, Jeremy, who worked at a pension fund. He took his father’s advice and read Security Analysis by Benjamin Graham and David Dodd, first published in 1934. He graduated from NYU Stern School of Business with distinction.

He “sealed his fame” as an investor when he correctly identified the dot-com bubble at a time the Dow Jones Industrial Average was posting annual gains that had averaged 25 percent from 1995 to 1999. In a July 1999 interview in Bloomberg Television, Barton Biggs called the U.S. stock market “the biggest bubble in the history of the world”, a view that was dismissed by the industry until March 2000, when the Nasdaq Composite Index dropped 78 percent.

Barton Biggs was the author of Hedgehogging, which came from a journal kept by the former creative writing major at Yale and chronicles some of the indignities of being in the hedge fund business as well as its “very brilliant and often eccentric and obsessive people”. He wrote about quirks of hedge fund culture; he noted that golf was very popular, perhaps due to its “measurable” nature similar to investing. “Or”, he wrote, “maybe it’s because hedge-fund guys are so competitive and have such massive egos”.

Barton Biggs was also author of the 2008 book Wealth, War and Wisdom.  He had a gloomy outlook for the economic future, and suggests that investors take survivalist measures, such as looking into “polar cities” as safe refuges for future survivors of global warming. Biggs recommended that his readers should “assume the possibility of a breakdown of the civilized infrastructure”. He went so far as to recommend planning adaptation strategies now and setting up survival retreats: “Your safe haven must be self-sufficient and capable of growing some kind of food”, Mr. Biggs wrote. “It should be well-stocked with seed, fertilizer, canned food, wine, medicine, clothes, etc. Think Swiss Family Robinson. Even in America and Europe there could be moments of riot and rebellion when law and order temporarily completely breaks down.”

In 2010, Barton Biggs published a novel about the stock market, A Hedge-Fund Tale.  In 2012, a final book, “Diary of a Hedgehog” was published posthumously on November 6.

One notable quote which superstar investor Warren Buffett attributed to the late  Barton Biggs is: “A bull market is like sex. It feels best just before it ends.” Warren Buffett was making the  point about the danger of a timid or beginning investor  entering  the market at a time of extreme exuberance and then becoming  disillusioned when paper losses occur (When Warren Buffett and Charlie Munger buy stocks…).