The book that made Buffett

Prithvi Haldea, managing director of  Prime Database, says that Benjamin Graham’s rules of value investing remain relevant more than half  a century later.

Print Edition: November 2, 2006

“By far the best book on investing ever written, and still is.”
                                                                                                       —Warren Buffett

This can be the best compliment given to a book by none other than the world’s second richest man, whose wealth came from the stockmarkets, and who was mentored by Benjamin Graham, the author. I have revisited this book several years after I had first read it. With the market structures totally changed, information flows redefined and increasing globalisation, I wondered if The Intelligent Investor, first written in 1949, was still relevant. It indeed is.

Reading the book, now in its fourth revised edition, gave me opportunities of validating the several new investment strategies that have become commonplace, but which more often than not have yielded negative results. This book clearly proves that what was valid 50 years ago is still as valid—the fundamentals of value investing do not change.

This is surely not a book for those who are looking at wisecracks or humour. It is also not for those seeking shortcuts. This is a serious book for serious investors. Its 600- odd pages are so very different from what one can find in hundreds of other books that have been written more for the authors to make quick money than for its readers.

This book is not about technicals, it is about fundamentals. It is not for the day-trader and the speculator. It is aimed at the investor. Graham differentiates the two by stating that “an investment operation is one which, upon thorough analysis, promises safety of principal and adequate returns. Operations not meeting these requirements are speculative.”

The first edition of the book was published in 1949. Graham believed that a common investor can learn to analyse a company and arrive at its “real” value. By paying less than the calculated “real” value, he was sure to make a profit. It was an unheard of strategy at that time. Capital market was then considered akin to gambling and reckless speculation, and to profess that they could actually be investments was regarded by most as simply absurd. The Intelligent Investor brought structure and logic to a disorderly and confused activity. Five decades later, it continues to be one of the cornerstones of value investing.

Buffett in his preface aptly says that “to invest successfully over a lifetime does not require a stratospheric IQ, unusualbusiness insights, or inside information. What is needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.” This book precisely and clearly prescribes the proper framework and asks the readers to supply the emotional discipline. A strong minded approach to investment, firmly based on the margin-of-safety principle can yield handsome rewards.

Rules set out by Graham for his preferred “defensive investor” are simple yet strong. One, there should be adequate though not excessive diversification of stocks in one’s portfolio (minimum 10, maximum 30). Two, each company selected should be large, prominent and conservatively financed. Three, each company should have a long record of dividend payments. And four, the investor should impose a limit on P/E ratio. In addition, the portfolio should be periodically inspected.

No book can ever give you a formula of making millions in the market. If that was possible, every one would be a billionaire. Yet what this book does is to give you the insights of building millions over your lifetime. I highly recommend the book to those who want to get a solid foundation in value investing. There are concrete examples to tell the reader what to look for and what not to look for in a stock. The four case studies in the book are a must-read.

The frankness with which Graham explains risk is very refreshing. He is clear about the possibility of losing large sums of money and does not paint a false picture of all profits, all the time. What he does proclaim is that over time, with the right companies, you will come out far ahead. Though an investor may be tempted to look at strategies for the future, he needs to remain firmly anchored in the proven techniques of the past.

The insight Graham offers on IPOs is as valid today, even in India. He says in the middle of the bull market the first common stock floatations appear. These are priced attractively, and large profits are made by the buyers. As the market rise continues, this brand of financing grows more frequent while the quality of the companies becomes steadily poorer.

The prices asked and obtained verge on the exorbitant. One fairly dependable sign of the approaching end of a bull swing is the fact that new common stocks of small and nondescript firms are offered at prices somewhat higher than the current level of many mid-sized companies with a long market history.

Graham makes a fundamental observation on the subject of investment advice. “Most security buyers obtain advice without specifically paying for it. It stands to reason therefore that in most cases, they are not entitled to and should not expect better earnings.” The book also debunks the forecasts of brokerages. “There is strong evidence that their calculated forecasts have been less reliable than the simple tossing of coin.”

This book is not for the beginner, though it has a chapter on “Security analysis for the lay investors”. The book requires a basic understanding of investing as the book assumes you have at least a working knowledge of the capital market and are now seeking to build upon it. There is probably a need for an abridged version for the small investors who get overawed by such serious- looking publications.

Losing money in the market is very painful, especially if it is hardearned. Yet we see millions of investors losing money after every boom cycle. What most do is to forget the principle of value investing. They chase price instead of value and worse, many are sucked in by penny stocks. If you follow Graham, you will profit from the follies of the market, rather than participate in them. Graham died in 1976, but his philosophy will remain alive for ever. I am sure I shall revisit The Intelligent Investor again, sooner than later.

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