The best investing book
The book that every investor should read is a lesson on how life experience shapes an investing philosophy.
Gideons International is an organisation that distributes bibles. A lot of bibles. Since their founding they have distributed 1.3 billion of them. The bible of investing is a book written by Ben Graham in 1949 titled The Intelligent Investor. There is no organisation dedicated to distributing The Intelligent Investor. But there is a pretty good salesman who originally coined the term ‘bible of investing’. Maybe you have heard of him – his name is Warren Buffett.
Millions of copies of The Intelligent Investor have been sold. I am going to go out on a limb and guess that not all of them have been read. The Intelligent Investor is the literary companion for RM Williams in the investing community. Both are signalling mechanisms for working in the industry. Find a list of best investing books and chances are The Intelligent Investor is on it. In the spirit of transparency, I own and have read The Intelligent Investor. I also own RM Williams. And no, they have not seen rougher terrain than Martin Place on a rainy day.
The Intelligent Investor is 640 pages. Funnily enough it is the approachable and concise version of Graham’s first book Security Analysis. It clocks in at 864 pages. I am the last person that should be calling anything dry. Especially if it is written by a remarkable man. But here goes nothing. Most of The Intelligent Investor is dry. And a lot of it is outdated. I am allowed to say that because I’ve been called dry and outdated.
This is not saying that there aren’t pearls among the endless analysis of railroad bonds. In fact, Warren Buffett recommends that investors read two chapters. There is chapter 8 which contains Graham’s famous personification of the market – “Mr. Market”. And there is chapter 20 where Graham introduces us to the margin of safety. And finally, there is the clear distinction that Graham makes between investors and speculators.
All investing roads lead to Ben Graham
Joking aside, The Intelligent Investor is the origin of almost every serious investing concept. Graham was a value investing practitioner but the concepts outlined in the book apply to a wide range of approaches. As previously mentioned, there are three key concepts in The Intelligent Investor. I’ve outlined them below.
Margin of safety
Margin of safety is an investing iceberg. The concept is relatively simple but there is a great deal lurking under the surface. We can start with the high-level concept. According to Graham an investor buying a share should build in a buffer between the price it is purchased and the value of the security. To paraphrase Buffett, if you are driving a 5,000 kilo truck over a bridge you would be happier if it was designed to hold 15,000 kilos instead of 5,001 kilos.
Central to the concept of the margin of safety is a share has an intrinsic value and an investor has bothered to estimate what a share is worth. The point of a margin of safety is to account for a lack of precision in estimating the intrinsic value of a company. But you still need an intrinsic value.
The notion that a share has an intrinsic value was a new concept when Graham first started investing. Before Graham, many Wall Street ‘analysts’ – and I use that term very loosely – simply looked at price momentum and charting to estimate where share prices would go over the short-term. Graham changed all of this and created and professionalised the field of investment analysis.
Calculating an intrinsic value and building in a margin of safety were components of the ownership mentality that was central to Graham’s approach. He wanted an investor to look at a share of stock as a piece of a business and for investors to imagine they were buying the whole business when assessing the price.
If you’ve read the last sentence and think that is a no-brainer you have Graham to thank. Once the ownership mentality becomes internalised the market no longer resembles a casino. It is a marketplace where businesses are offered at different prices at different times – sometimes those prices are attractive and sometimes they aren’t. According to Graham, buying shares with an appropriate margin of safety was the key to investing success.
Graham’s focus was finding investments that were trading at levels well below his estimate of their intrinsic value. In a perfectly rational world this would not happen. Graham recognised early in his career that investors were anything but rational. He saw that most investors did not bother estimating an intrinsic value and instead were driven by emotions. Mr. Market was born.
Mr. Market was Graham’s attempt at explaining what drives the changes in security prices over the short-term. Sometimes Mr. Market was wildly optimistic and shares would trade well above their intrinsic value. Sometimes Mr. Market was utterly despondent and prices were well below their intrinsic value.
And he had a front row seat for one of the wildest rides in stock market history. Graham began his career on Wall Street in the 20s when markets surged. Then he lived through the crash of ’29 and the horrendous conditions during the Great Depression.
And while Graham liked to remove himself from the day-to-day market noise by focusing on the underlying characteristics of a business he was quick to point out that Mr. Market was still an important part of investing success. To quote Graham, “The intelligent investor shouldn’t ignore Mr. Market entirely. Instead, you should do business with him – but only to the extent that it serves your interest.”
Investors vs. speculators
A philosophy is a set of guiding principals for behaviour. And Graham’s philosophy was centred around intrinsic value, the margin of safety and a bi-polar view of markets. A focus on the margin of safety and taking advantage of the disconnect between price and value put someone in Graham’s camp. He called adherents to his approach investors. On the other side of the coin were speculators.
Speculation is treating the market as a casino and a share as simply a piece of paper that fluctuates in value. Speculators seek to make short-term profits from the movement of share prices. He did not believe this was a recipe for success. Afterall, if short-term price movements are driven by emotion than how could anyone consistently figure out which direction they would go?
This notion of Mr. Market and putting people who buy shares into an investor or speculator camp put Graham way ahead of his time and provided the foundation for behavioural economics. It challenged the notion of an efficient market where prices and values were always perfectly synced. To be an investor is not letting Mr. Market dictate your view of a share. Graham’s most famous quote separated a short-term orientation from a long-term one when he said “in the short-run, the market is a voting machine but in the long-run, it is a weighing machine.”
We know Graham's approach but where did it come from
We are often focused on the ideas and philosophy that emanate from history’s great thinkers. And rightful so. The fastest way to get better at something is to learn and apply the lessons from great practitioners of that activity. But being good at something also involves persistence and consistency. To maintain excellence involves internalising these lessons. That means approaching an activity with a philosophy that is our own – even if it wasn’t originally our idea.
Beyond just the ideas it is worth exploring how their originator came to them. Before something is recorded for posterity in a book the central idea was developed over time and often shaped and influenced by life experiences. To understand his investment approach it is worthwhile understanding Ben Graham’s story.
Ben Graham was born in England and moved with his family to the US when he was 1 years old. His father took the family to New York to set up a new branch of a successful family business. This was far from the prototypical immigrant experience. His family was wealthy and moved to 5th Avenue in a house staffed by domestic servants. This lifestyle would not last.
Graham’s father died in 1903 when Graham was just 10 years old. The family business soon went under and his mother sold off their possessions to keep the family afloat. In a last gasp to try and salvage a future for her family his mother took their little remaining money and bought US Steel shares on margin. She was wiped out in the 1907 banking crisis.
Graham and his brothers were put to work and divided up the household chores. Graham was responsible for buying all the food for the family and stretching every dollar to ensure they had enough to eat.
Graham’s formative experiences with money would shape his investment philosophy. He knew what it was like to lose everything. He saw firsthand the results of his mother’s uninformed foray into speculation when she purchased shares in the hope they would go up in price. He learned how to stretch a dollar and find bargains because that was the only way his family would get enough to eat.
It is no wonder that his life’s work in the investment industry was to bring structure to the process of picking out investments and professionalism to a field that was anything but in the early 1900s. That is the genesis of his exploration of the emotions of investing as personified by “Mr Market” and his desire to remove them from his investment process. He had a profound concern with risk and minimising the chance of losing money. Hence his constant promotion of the margin of safety.
Graham was a loner who never felt like he fit in. He didn’t feel fully part of his family and couldn’t relate to his classmates as he skipped so many grades he graduated high school at 15. He also felt separated from American society due to the antisemitism he faced which caused him to change his name from Grossbaum to Graham in 1914.
His real or imagined isolation made it easier for him to go against the herd as an investor. This contrarian streak served him well. His investment philosophy may have emphasised rationality, but he did not arrive there through a single-minded pursuit of wealth like his most famous student Warren Buffett.
Ben Graham’s investment approach was a byproduct of his life experiences. It is doubtful he would have been able to pivot as Buffett did in the early 70s when he embraced components of growth investing, Graham wanted as much certainty as possible through hard numbers in financial statements. He didn’t spend time talking to the management of a company he invested in. He wasn’t looking for intangible assets that couldn’t be captured in a financial statement. He wanted safety and believed this was only possible by buying a $1 of assets for 50 cents.
Pages and pages of The Intelligent Investor are filled with an analysis of bonds and discussions about buying companies for less than their book value. This is often dismissed as an approach for a different era. But it is also reflective of the author.
And before dismissing Graham as a quantitative automatron it is worth considering the whole man. He was an intellectual and renaissance man who was offered professorships at Columbia University in Greek & Latin philosophy, English and mathematics at 20 years old after ranking second in his Columbia graduating class. He held multiple U.S patents for inventions, authored an original Broadway Play, translated a Uruguayan novel into English, Homer into Latin and Virgil into Greek.
Why does the connection between Graham’s life and investing approach matter
While undeniably interesting this foray into Graham the person and the origin of his investing philosophy has a point. We are all shaped by our experiences and that informs how each of us invest and deal with money. To be a successful investor requires an intellectual connection with the approach we choose to take.
Growth, value, or any other approach is not about holding a finger in the air and assessing which way the wind is blowing. It is finding an approach that resonates with each of us and more importantly, is within us.
Fostering a connection and establishing an intellectual framework facilitates the consistency and patience needed to be successful. Becoming a contrarian investor is portrayed as a conscious decision to do the opposite of what everyone else is doing. In reality, contrarians believe in one way of doing things so completely that even when everyone is doing something different it seems like madness to join them.
Praising the Intelligent Investor has become a litmus test of sorts for investors. A signalling mechanism that you take investing seriously. If you read the book and can’t understand what all the fuss is about that is perfectly fine. Keep searching for an investing philosophy that resonates with you and that you can consistently follow. Maybe it is doing discounted cash flow analysis on companies. Maybe it is focusing on income and the safety and growth of dividends. Maybe it is buying index funds. There are many ways to be a successful investor. Find the one that works for you.
Did the Intelligent Investor influence your investment approach? Did something else? Let me know at email@example.com.