The Intelligent Investor

The Intelligent Investor Reading Notes (Part 1) Make the world a better place

Graham's significance in investing is as important as Euclid's in geometry and Darwin's in biological evolution.

Interpretation of Buffett's Preface#

Defensive investors should follow four major stock selection principles: appropriately diversify investments in 10 to 30 stocks; choose large, outstanding, conservatively financed companies; ensure dividends have been paid continuously for over 20 years; and maintain a price-to-earnings ratio not exceeding 25 times.
In fact, for most investors, low-cost index funds are the best choice for stock investment.
Three strategies for aggressive investors: buy stocks of large companies that are relatively unpopular in the market; invest in severely undervalued cheap stocks; and special situations or "bankruptcy debt restructuring."
Buffett's investment philosophy: look for large companies with clear and understandable businesses, consistently excellent performance, and management that is extraordinary and considers shareholders.
The function of the margin of safety: with sufficient margin of safety, there is no need to accurately predict a company's future earnings.
The market is a voting machine in the short term but a weighing machine in the long term.
Buffett's simple creed for buying stocks: be fearful when others are greedy and greedy when others are fearful.
Buffett believes that to achieve investment success in a lifetime, one needs a sound knowledge system as a decision-making foundation and the ability to control one's emotions so they do not erode this system.

Introduction: The Purpose of This Book#

Main Text

The obvious growth prospects of a certain industry do not necessarily bring obvious profits to investors.
Even experts have no reliable methods to pick the best companies in promising industries and invest large sums in those stocks.

Comments

A smart investor must have patience, discipline, and a desire to learn; additionally, they must be able to control their emotions and engage in self-reflection.
To become a smart investor, character is more important than intelligence.

Chapter 1: Investment vs. Speculation#

Main Text

Most of the time, investors must recognize that the common stocks they hold often contain some speculative elements. Their task is to keep the speculative components within a small range and prepare financially and psychologically for adverse consequences in the short or long term.
Speculation is often unwise, especially in the following situations: (1) thinking one is investing when in fact speculating; (2) taking speculation seriously without sufficient knowledge and skills, rather than treating it as a pastime; (3) investing too much in speculation beyond one's capacity to bear losses.
Any non-professional engaged in margin trading should recognize that they are actually speculating.
Anyone rushing to buy so-called "hot" stocks or similar behaviors is also speculating, or rather, gambling.
To sustainably and reasonably achieve better-than-average performance, investors must follow two strategies: (1) strategies with inherent robustness and a hope for success; (2) strategies that are not popular on Wall Street.

Comments

According to Graham's definition, investment includes the following three equally important factors:
1. Before buying a stock, thoroughly analyze the company and the stability of its underlying business, studying the facts according to recognized safety and value standards.
2. Protect oneself carefully to avoid significant losses, i.e., prevent losses under normal or reasonable conditions and market changes.
3. Only expect "adequate" performance, do not expect too high, i.e., investors are willing to accept any rate of return or amount of return as long as their actions are rational.
Wall Street, like Las Vegas or a racetrack, has set the odds of winning and losing in favor of the house, thus it can ultimately defeat anyone trying to win in its speculative game.
Investors make money for themselves, while speculators make money for brokers; this is why Wall Street always belittles down-to-earth investing and glorifies flashy speculation.
A smart investor will never sell their stocks merely because the price has fallen; they should first consider whether the company's underlying business has changed.
The January effect: first, many investors sell low-priced poor-quality stocks at the end of the year to lock in losses and reduce taxes owed; second, fund managers are more cautious at year-end to maintain their performance lead (or minimize their lagging position). Although the January effect has not completely disappeared today, it has weakened.
The future performance of stocks is determined solely by the quality of the underlying company’s business—nothing more.
Mechanical methods aimed at achieving excess returns will devolve into "a process of self-destruction, much like the law of diminishing returns." This is mainly due to two reasons:
1. If such methods are purely based on statistical luck, time alone can prove that they are fundamentally meaningless.
2. If such methods were indeed effective in the past, as they become widely known, market elites will always diminish their future effectiveness, often rendering them completely ineffective.
When speculating, one must approach it like an experienced gambler entering a casino:
1. Speculation is speculation; never think of it as investing.
2. Taking speculation too seriously can become very dangerous.
3. One must strictly limit their bets, such as never exceeding 10% of total assets.

Chapter 2: Investors and Inflation#

Main Text

Public utility companies are the biggest victims of inflation:
1. Debt costs rise sharply.
2. Due to price controls, it is difficult to raise service prices.
3. The unit costs of electricity, natural gas, and telecommunications services are growing much slower than the price index, putting these companies in a strong strategic position in the future.
4. PS: This indicates that there is a good investment window for such stocks.
Gold has almost completely failed to prevent the depreciation of the dollar's purchasing power: limit investments in this area to no more than 2% of total financial assets (if over 65, perhaps increase to 5%).
Do not put all your money in one basket.

Comments

REITs: Real Estate Investment Trusts

Chapter 3: A Century of Stock Market History: Early 1972#

Main Text

Simple and useful advice:
1. Advocate for a consistent and controllable investment strategy.
2. Do not encourage "beating the market" and "picking winners."

Comments

A smart investor cannot rely solely on the past to predict the future.
Survivorship bias: stock indices do not include early bankrupt companies, thus these indices severely overestimate investors' actual returns.
The value of any investment is and will always depend on the price at which you buy.
The stock market's trends depend on the following three factors:
1. Actual growth (increase in company profits and dividends).
2. Inflation growth (overall rise in prices).
3. Growth or decline of speculative activity (the public's interest in stocks rising or falling).
Yale University finance professor Robert Shiller, through historical data examination, believes:
1. When the S&P 500's price-to-earnings ratio is above 20, subsequent market returns are usually lower.
2. When it drops below 10 times, subsequent returns can be quite outstanding.
Maintaining humility like Graham can protect one from the pain of overconfidence leading to total loss.

Chapter 4: Investment Portfolio Strategy for Defensive Investors#

Main Text

Graham does not agree with "high risk, high reward":
1. The target return for investors is more determined by the wisdom they are willing and able to invest.
2. Passive investors who prioritize safety should receive the lowest returns.
3. Smart and experienced investors, due to their greatest wisdom and skills, should receive the highest returns.
A basic guiding principle for defensive investors: the funds invested in stocks should never be less than 25% and not more than 75% of their total funds; correspondingly, the proportion of their bond investments should be between 75% and 25%; the two investments of defensive investors should be split evenly.
If one can act like a completely unemotional and calculating gambler, they might reduce their stock investment ratio to 25%, and only increase it to 50% when the Dow Jones Industrial Average's dividends reach two-thirds of bond yields.
With each new wave of optimism or pessimism, we forget history and abandon some time-tested principles, yet stubbornly cling to our biases, believing them firmly.

Comments

To become a smart investor, there are two approaches:
1. Active: continuously researching, selecting, and monitoring a dynamic portfolio of stocks, bonds, and mutual funds.
2. Defensive: creating a permanent investment portfolio in some automatic way, without further effort (though this may seem a bit dull).
Everyone should keep a portion of their assets in cash in a risk-free safe place for emergencies.
Graham advises that funds invested in the stock market should never exceed 75% of total assets.
Determine a final ratio for asset allocation, and unless there is a significant change in life circumstances, do not increase investment ratios due to stock market rises or sell more due to declines:
1. If the stock market rises, sell some stocks to bring your asset ratio back to the set ratio.
2. Adjust asset allocation in a foreseeable and consistent manner, neither too frequently to drive oneself crazy nor too infrequently to keep the predetermined investment ratio long-term unbalanced.
The issuance of preferred stock indicates that the company's financial condition is not healthy, and the market has no appetite for its bonds.

Chapter 5: Defensive Investors and Common Stocks#

Main Text

Regarding the stock market in 1949, it can be summarized in two points:
1. Stocks largely protect investors from inflation losses, while bonds provide no such protection.
2. They can provide investors with higher average returns over the years, not only from their higher average dividend levels than quality bonds but also from the long-term trend of rising market value due to retained earnings reinvestment.
Although these two advantages are significant, if investors buy stocks at too high a price, these advantages will vanish.
For defensive investors, four rules can be followed:
1. Appropriate but not excessive diversification, limiting the number of stocks held to at least 10 and at most 30.
2. Each selected company should be large, well-known, and financially sound.
3. Each company should have a history of paying dividends continuously for a long time, such as 10 years; even 20 years is not too harsh.
4. The purchase price should be limited to a certain price-to-earnings ratio range, with reference to the average earnings per share over the past 7 years: for this average, the price-to-earnings ratio should be controlled within 25 times, and based on the profits of the past 12 months, it should be controlled within 20 times.
Growth stocks: stocks whose past earnings per share growth significantly exceeds the average level of all stocks and is expected to continue to do so in the future; investing in growth stocks has a significant speculative component, making such investment operations difficult to succeed.
For growth stocks, if the stock is chosen correctly, the purchase price is appropriate, and it is sold after a significant rise and before a potential decline, miracles can occur. However, for the average investor, such occurrences are rare.
Lucille Tomlinson conducted a comprehensive study of the dollar-cost averaging method and concluded: regardless of price fluctuations, this investment method can confidently lead to ultimate success; so far, no other investment method has emerged that can compare with dollar-cost averaging.
What constitutes a "large, well-known, and financially sound company":
1. For an industrial company, its common stock's book value must not be less than half of its total assets (including all bank debts); for railroads or public utility companies, this limit is not less than 30%.
2. "Large" and "well-known" imply considerable scale and leading industry position, with its size in the top quarter or third of its industry.
Being overly fixated on such arbitrary standards is foolish; these standards are merely reference points, and investors should set their own standards. Different opinions and choices will not bring adverse effects. In fact, such differences of opinion are beneficial for stock trading, as they will make the distinctions between leading stocks and secondary stocks more nuanced and layered.

Comments

The degree of defensiveness should not depend on the tolerance for risk but on how much time and effort one is willing to invest in their portfolio.
One should not buy stocks of the company they work for:
1. Insiders often have a pile of illusions, and their buying and selling are also subject to time windows.
2. Deepening understanding of something does not significantly reduce people's tendency to exaggerate their actual knowledge; this overconfidence is called "local bias."
3. In short, familiarity can lead to complacency.
Acknowledging one's ignorance about the future and being at peace with this ignorance is the most powerful weapon for a defensive investor.

Chapter 6: Passive Methods of the Aggressive Investor's Portfolio Strategy#

Main Text

Buying high-grade bonds at a significant discount can yield good returns and appreciation opportunities.
Financially secure companies: pre-tax profits are 1.5 times their total interest expenses.
Secondary bonds sold at face value with interest rates of 5.5% or 6% are almost certainly not worth buying; buying such bonds at 70 is more reasonable; with enough patience, it is possible to buy at this price.
Investors should take a prudent attitude toward newly issued securities: carefully assess and rigorously test them before placing orders.
Two finance professors pointed out that companies sell shares to the public when the stock market is near a peak.
During bull markets, many non-listed companies often take the opportunity to go public.
The public's carelessness, along with underwriters willing to sell anything as long as there is money to be made, will only lead to one result: price collapse.
Being able to resist the sweet talk of new stock issuers during a bull market is a fundamental condition for becoming a smart investor.
A smart investor should not take on huge losses to earn short-term profits.

Comments

For a smart investor, junk bonds are merely an optional right, not an obligation to buy.
Wise investors typically do not purchase foreign bonds exceeding 10% of their total assets.
Do not buy emerging market funds with annual management fees exceeding 1.25%.
Short-term trading—holding stocks for a few hours—is the best self-destructive weapon ever invented by humans.
High-yield IPO stocks are mostly taken by specialized small groups.
The meaning of IPO not only refers to "Initial Public Offering" but can also be an abbreviation for the following phrases:
1. It’s Probably Overpriced
2. Imaginary Profits Only
3. Insiders’ Private Opportunity
4. Idiotic, Preposterous, and Outrageous

Chapter 7: Active Methods of the Aggressive Investor's Portfolio Strategy#

Main Text

The definition of growth stocks is: not only have past performances exceeded the average level, but they are also expected to continue doing so; they are characterized by generally larger price fluctuations in the market.
Investing in growth stocks faces two unexpectedly complex situations:
1. Common stocks with excellent performance records and promising outlooks also have correspondingly high prices.
2. Judgments about the future may be wrong.
Graham insists on calculating price-to-earnings ratios based on average profits over many years.
To achieve better results than average investments over a long time, operational strategies must have two advantages:
1. They must meet the objective or reasonable standards required for basic robustness.
2. They must differ from the strategies adopted by most investors or speculators.
Choose unpopular large companies; the market tends to underestimate those temporarily out of favor due to unsatisfactory development:
1. They can rely on capital and human resources to weather difficulties and regain satisfactory profits.
2. The market may respond more quickly to any improvements in company performance.
3. Selecting the 10 stocks with the lowest price-to-earnings ratios in the index has advantages in the long run; this method is called the "Dogs of the Dow" investment method.
Choose to buy cheap securities:
1. Definition: based on analysis, the value of the security should be significantly higher than its selling price, i.e., at least 50% higher than its price.
2. Evaluation method for finding: after estimating future profits, multiply by a coefficient corresponding to the specific security.
3. Second method for finding: the value obtained by private owners from the enterprise should focus more on realizable asset value, especially emphasizing net current assets or working capital.
4. The courage shown in the cheap securities market comes not only from past experience but also relies on the application of reasonable value analysis methods.
Investors must conduct prudent investments; merely observing profits and stock prices falling is not enough; they should also require:
1. Profits over the past 10 years or longer should at least have good stability (no years of profit deficits).
2. The company should have sufficient scale and financial strength to cope with potential future difficulties.
3. Therefore, the ideal situation is: the stock price of a well-known large company is significantly lower than its past average price and significantly lower than its past average price-to-earnings ratio.
Long-term neglect or unpopularity is an important reason for low stock prices; another reason for low stock prices is that the market does not understand the company's actual profit situation:
1. The easiest type of security to identify is: priced lower than the company's net working capital (after deducting all preferred debts).
2. "Net working capital" refers to the company's current assets (such as cash, marketable securities, and inventory) minus all liabilities (including preferred stock and long-term debt).
Medium-sized enterprises have enough strength to weather difficulties, and they have genuinely better growth opportunities than existing large enterprises.
The huge profits from buying cheap securities of secondary enterprises come from many aspects:
1. Higher dividend returns.
2. Profits available for reinvestment relative to the price paid are considerable, thus ultimately affecting stock prices.
3. During bull markets, the prices of low-priced securities are generally higher, which will raise the prices of ordinary cheap securities to at least a reasonable level.
4. Even during relatively calm market periods, price adjustment processes will continue to occur, allowing undervalued secondary securities to rise to the price levels they should typically have.
5. Many specific factors that lead to disappointing profit records can be corrected due to the emergence of new situations, the adoption of new policies, and changes in management.
6. Large enterprises acquiring small enterprises.
Do not purchase securities involved in legal disputes; this is a valid survival rule for everyone (except the boldest investors).
Defensive investors should follow three elements: basic safety, simple selection methods, and the hope of obtaining satisfactory structures.
Do not buy three types of securities at "full price": foreign bonds, general preferred stocks, and secondary common stocks (fair business value of enterprises); they should be purchased at two-thirds of the price.

Comments

Hindsight is always completely clear, but predicting in advance is inevitably blind; thus, for most investors, timing trades is practically and psychologically impossible.
If a company's stock price is too high, it is not a very good investment object.
The higher the stock price rises, the more likely it seems to continue rising. But this contradicts the fundamental law of financial physics: the larger the company, the slower the growth rate.
Allocate one-third of stock funds to purchase mutual funds of foreign (including emerging market) stocks to help mitigate risks.

Chapter 8: Investors and Market Volatility#

Main Text

The further people are from Wall Street, the more suspicious the boasts about stock market predictions or timing become.
We cannot logically or based on actual experience believe that any ordinary or general investor can predict market trends more successfully than the public (of which they are a part).
Timing trades have no practical value for investors unless they happen to coincide with valuation methods: that is, unless it allows investors to repurchase their stocks at significantly lower prices than their previous selling prices (i.e., rebalancing).
Some methods gain support and become important because they perform well at a certain moment, or sometimes simply because they seem to fit past statistical records; but as they become accepted by more people, their reliability generally declines:
1. Over time, new situations may arise that previous methods cannot adapt to.
2. In stock market trading, a widely popular theory can itself influence market behavior, thereby weakening the long-term profitability of that theory.
Ordinary investors cannot succeed in predicting stock price changes through effort.
Almost all bull markets clearly exhibit some common characteristics:
1. Price levels reach historical highs.
2. Price-to-earnings ratios are very high.
3. Dividend yields are low compared to bond yields.
4. A large amount of margin speculative trading.
5. Many low-quality new common stock issuances.
The longer a bull market lasts, the more severe investors' amnesia becomes.
Any money-making method in the stock market, as long as it is easy to understand and adopted by many, will inevitably fail to last due to its simplicity and ease:
1. Over time, it will revert to natural trends, i.e., "regression to the mean."
2. Many people quickly adopt this stock-picking scheme, destroying the joyful atmosphere enjoyed by early adopters.
Ben Graham's conclusion applies to both philosophy and Wall Street: "All good things are both rare and complex."
Compared to large enterprises, secondary enterprises (now equivalent to thousands of companies outside the S&P 500) exhibit greater price volatility; however, this does not mean that a carefully selected group of small enterprises will perform worse in the long run.
A true investor is unlikely to believe that daily or monthly fluctuations in the stock market will make them richer or poorer.
Significant market rises will immediately bring people appropriate satisfaction and cautious concern, while also creating strong impulses for recklessness.
Even smart investors may need strong willpower to prevent their herd behavior.
As a true investor, one can find satisfaction in the thought that their business operations are exactly the opposite of the general public.
While paying market premiums, investors must bear significant risks, as they must rely on the stocks themselves to prove the rationality of their investments:
1. Net asset value, book value, on-balance-sheet value, and tangible asset value all refer to net worth, i.e., the total value of a company's physical and financial assets minus all liabilities.
2. This value can be calculated based on the balance sheets in the company's annual and quarterly reports: from total shareholders' equity, subtract the value of all "soft" assets such as goodwill, trademarks, and other intangible assets.
The entire stock market quotation system contains an inherent contradiction: the better a company's past record and future prospects, the less connection its stock price has with its book value.
1. However, the greater the premium above book value, the more unstable the basis for determining the company's intrinsic value becomes.
2. This "value" becomes even more dependent on changes in market sentiment and capacity.
3. Thus, we ultimately face a paradox: the more successful a company is, the greater the potential fluctuations in its stock price.
4. The reason is that the higher the assumed future growth rate and the longer the expected time, the greater the margin of error, and even a small calculation error can lead to high costs.
For prudent investors, it is best to focus on purchasing stocks priced close to the company's tangible asset value—e.g., no more than one-third above tangible asset value; in addition, investors must also require: a reasonable price-to-earnings ratio, a sufficiently strong financial position, and profits that will not decline in the coming years.
On Wall Street, one cannot expect anything significant to happen exactly as it did before.
If making valuable predictions about stock price fluctuations is nearly impossible, then doing so for bonds is completely impossible.
The price fluctuations of convertible bonds and preferred stocks result from the combined effects of the following three different factors:
1. Changes in the prices of related common stocks.
2. Changes in the company's credit status.
3. Changes in overall interest rate levels.

Comments

Mr. Market's task is to provide you with prices, while your task is to decide whether these prices are favorable to you.
Smart individual investors can freely choose whether to follow Mr. Market.
Investment activities are not about defeating others in their game but about controlling oneself in one's own game.
The entire meaning of investing is not to earn more money than the average person but to earn enough money to meet one's needs.
Our brains are naturally inclined to perceive trends, even when they do not exist.
The pain of personal losses is twice the pleasure of equivalent gains.
For anyone making long-term investments, continuous declines in stock prices are excellent news.
Investors who frequently obtain the latest news stories receive returns that are only half of those who do not care about stock market news.

Chapter 9: Fund Investment#

Main Text

These professionals can completely determine the direction of the stock market average, and the direction of the stock market average can completely determine the overall results of the funds.
Fund managers are engaging in excessive speculative risks and temporarily obtaining excessive returns.
Smaller size is a necessary factor for consistently achieving excellent results.
Funds that can sustainably outperform the market average over a long time: most businesses focus on specialized areas, self-limit the use of capital, and do not sell large amounts to the public.

Comments

In financial markets, luck is much more important than skill.
Buying funds solely based on past performance is one of the most foolish things investors can do.
Any single most profitable and therefore most popular industry often becomes the worst-performing industry the following year.
After studying mutual funds, financial experts unanimously propose the following points:
1. General funds cannot select good stocks by incurring research and trading costs.
2. The higher the fund's fees, the lower its returns.
3. The more frequently fund shares are traded, the smaller the chances of making money.
4. Highly unstable funds (those with greater fluctuations than the average) may remain unstable over the long term.
5. Funds with high past returns are unlikely to remain winners for long in the future.
A fund that cannot outperform the market can still provide significant value—offering a cheap method of asset diversification.
To succeed, individual investors should either avoid picking the same hot stocks as large institutions or hold these stocks more patiently.
In the long run, index funds will outperform most funds, but they should be selected for low management fees.
Graham and Buffett praise index funds as the best choice for individual investors.
Characteristics of excellent funds:
1. Experiences are from some of the largest shareholders.
2. Low fees.
3. Willingness to be different.
4. Do not accept new investors.
5. Do not advertise.
By type, the annual operating expenses of funds should not exceed the following levels:
1. Taxable municipal bonds (0.75%).
2. U.S. large and mid-cap company stocks (1.0%).
3. High-yield junk bonds (1.0%).
4. U.S. small-cap company stocks (1.25%).
5. Foreign stocks (1.5%).
Yesterday's winners often become tomorrow's losers, but yesterday's losers almost never become tomorrow's winners: do not buy funds that have consistently performed poorly, especially when their annual fees exceed the average.
When to sell a fund:
1. Trading strategies suddenly change drastically.
2. Fees increase.
3. Excessive trading leads to frequent large tax bills.
4. Abnormal returns suddenly occur.
When something can actually be predicted, believing oneself to be able to make predictions is a rational viewpoint. If it is divorced from reality, it is merely blind self-esteem behavior that will ultimately end in self-failure.

Chapter 10: Investors and Investment Advisors#

Main Text

Investment advisors: use their superior skills and experience gained through training to prevent clients from making mistakes and ensure they receive the investment income they deserve.
If investors primarily rely on others' advice in using funds, they must strictly limit themselves and their advisors to formulaic, conservative, or somewhat dull investment methods, or they must be very familiar and trust the person guiding their investment channels.
True investment advisors are quite conservative in their commitments and advice; they do not claim to be wiser than others, and their pride lies in being careful, prudent, and competent:
1. The main goal is to retain the principal value over a long period and achieve a relatively steady income growth rate.
2. Any other achievements are seen as additional services.
Financial services companies have been making predictions about the stock market, but no one takes this activity seriously. Of course, their understanding and predictions about business operations are more authoritative and enlightening.

Comments

The best advisors are already full of clients and are therefore unwilling to accept you unless you seem capable of cooperating well with them.

The Intelligent Investor Reading Notes (Part 2) Make the world a better place

Graham's significance in investing is as important as Euclid's in geometry and Darwin's in biological evolution.

Chapter 11: General Methods of Securities Analysis for Ordinary Investors
- Main Text
- [Comments](

Chapter 11: General Methods of Securities Analysis for Ordinary Investors#

Main Text#

Securities analysts should focus on the past, present, and future of a certain security:
1. Introduce the business of the enterprise, summarize its operating results and financial status, point out its shortcomings, and the possible outcomes and risks it may face.
2. Estimate its future profitability based on various assumptions or "best guesses."
3. They may need to adjust the data in the company's annual reports significantly, especially focusing on those aspects that may have been exaggerated or understated.
4. Design and use some safety standards, mainly involving past average earnings, while also considering capital structure, working capital, asset value, and other aspects.
Mathematical valuation methods are very popular in areas where people think they are unreliable:
1. The higher the predicted growth rate and the longer the term, the more sensitive the prediction is to small errors.
2. Investors must be highly vigilant against those who claim to solve basic financial problems using complex calculations.
3. Graham said: In 44 years of experience and research on Wall Street, I have never seen a reliable algorithm regarding the value of common stocks or related investment policies, except for simple arithmetic and recent algebra. Once calculus or higher algebra is used, it should be seen as a warning that the operator is attempting to replace experience with theory, and usually trying to disguise speculation as investment.
The most reliable and therefore most valued aspect of securities analysis is the focus on the safety or quality of bonds and investment-grade preferred stocks:
1. Bonds: how many times past profits cover total interest expenses in certain years.
2. Preferred stocks: how many times profits cover bond interest and preferred stock dividends.
3. Recommendations for the new era: the percentage of profits relative to bond principal, 33% for industrial companies, 20% for utilities, and 25% for railroads.
In addition to profit protection standards, other standards can generally be used:
1. Company size: there is a minimum standard in terms of the company's business scale and the population of the city (the standards for industrial companies, utilities, and railroads vary).
2. Stock-to-equity ratio: the ratio of the market value of common stock to the total face value of debt (or debt plus preferred stock), which roughly reflects the protection or "buffer" provided by common stock investments.
3. Property value: the value reflected in the balance sheet or asset appraisal value; experience shows that in most cases, safety depends on the company's profitability; if this aspect is lacking, most of the presumed asset value will be lost; however, for utilities, real estate companies, and investment companies, asset value is a very important independent standard for many bonds and preferred stocks.
The history of the investment field shows that in the vast majority of cases, if bonds and preferred stocks can meet the strict safety standards determined by past performance, they can successfully cope with future changes in circumstances.
Judging future safety based on past records is more applicable to public utility organizations, which are the main field for bond investments.
When purchasing bonds and preferred stocks of industrial companies, one should limit themselves to those larger companies that have previously been able to withstand severe pressure.
Investors cannot permanently rely on favorable environments, so when selecting industrial or other corporate bonds, they should not relax their standards.
For most investors, the ideal choice is to purchase an overall stock market index fund, which is a cheap way to hold every stock worth buying.
Factors affecting capitalization rates:
1. Overall long-term prospects: sometimes price-to-earnings ratios may be wrong; Wall Street's consensus view of a certain industry's future is usually either too optimistic or too pessimistic. History has shown that Wall Street's "expert" predictions have neither the ability to predict the performance of the entire market nor the ability to predict the performance of a specific industry or stock. As Graham pointed out, individual investors are also unlikely to do better; the excellent performance of smart investors comes from their decisions not being based on the accuracy of anyone's (including their own) predictions.
2. Management: if a method cannot be designed to objectively, quantitatively, and reliably test the management's capabilities, this factor can only be examined vaguely. This factor only becomes important when recent changes have occurred, and the effects of those changes have not yet been reflected in actual data.
3. Financial strength and capital structure: at the same price, companies with the same earnings per share but with large bank loans and preferred securities are less worthy of holding than companies with only common stock and large surplus cash.
4. Dividend record: years of continuous (e.g., over 20 years) dividend payments are an important favorable factor reflecting the quality of a company's stock; defensive investors can only purchase stocks that meet this standard.
5. Current dividend yield: this has changed; U.S. tax laws neither encourage investors to seek dividends nor encourage companies to distribute dividends.
The following concise growth stock valuation formula is very close to the results obtained from some more complex mathematical calculations:
1. Value = Current (normal) profit * (8.5 + twice the expected annual growth rate).
2. The growth rate should be the expected growth rate for the next 7-10 years.
In fact, analysts cannot practically estimate the appropriate multiplier for current profits, nor can they estimate the expected multiplier for future profits.
"Scientific" stock valuations based on future expected results must consider future interest rate conditions.
Researching the economic conditions of an industry and a specific company will yield valuable insights into important factors that will play a role in the future, but the current market does not seem to be aware of this.
However, the actual value of most industry research aimed at investors is not very high, as the materials unearthed are generally very familiar to the public and have already had a significant impact on market prices.
Wall Street's judgments about the distant future are very poor, which inevitably makes the important content of its research (predictions about the profit changes of various industries) also very poor.
If investment conclusions primarily stem from judgments about the future, without obvious value support at present, there is a risk; however, being overly rigid in strictly calculating value ranges based on actual results also carries the risk of missing out on excellent opportunities.
Two-step evaluation process:
1. Use a formula to calculate the weights based on past profitability, stability, growth rates, and current financial conditions.
2. The value based solely on past performance should be adjusted to what extent based on new expected future conditions.
3. Reports should reflect both initial values and adjusted values, along with reasons for adjustments.
Smart analysts will limit their work to the following industry groups:
1. Industries where the future seems reasonably predictable, and these industries should not overly rely on unpredictable factors such as interest rate changes, future price trends of raw materials like oil and metals; industries such as gambling, cosmetics, liquor, nursing homes, and waste recycling are more predictable.
2. The value of past performance relative to current prices should have a large margin of safety.

Comments#

Graham believes five factors are decisive:
1. The company's "overall long-term prospects."
2. The level of the company's management.
3. The company's financial strength and capital structure.
4. The company's dividend record.
5. The company's current dividend payout rate.
Long-term prospects: obtain five years of annual financial reports and at least one year's quarterly financial statements, organize and collect evidence to answer two decisive questions: What are the reasons for the company's growth? Where do the company's current (and future) profits come from? Issues to note include:
1. If a company is a "serial acquirer," averaging more than 2-3 acquisitions per year may indicate potential trouble; after all, if a company believes it should buy shares in other companies rather than invest in its own, verify its past acquisition records. Overly greedy companies may ultimately spit out large companies they swallowed, suffering heavy losses. If the acquisition price is too high, it may lead to long-term asset write-offs or accounting impairments, which is an ominous sign for future business.
2. OPM (Other People’s Money) addicts, who inflate the total amount of "other people's funds" through borrowing or selling shares. In the cash flow statement, these funds are referred to as "cash from financing activities," making a troubled company seem to be growing even if its core business does not generate enough cash, i.e., operating cash flow is consistently negative while financing cash flow is consistently positive.
3. Companies that are not very flexible, with most of their income coming from one (or a few) customers.
4. Companies should have broad "defensive works" or competitive advantages, such as strong brand images, monopolies or near-monopolies in the market, economies of scale, unique intangible assets, and irreplaceability.
5. Companies are long-distance runners, not sprinters; check whether the company's revenue and net profit have steadily grown over the past 10 years, with a 10% pre-tax profit growth being sustainable; higher growth rates (or sudden rapid growth within 1-2 years) will inevitably slow down.
6. Companies that diligently sow and reap; those without any R&D spending are at least as vulnerable as those that overspend.

Comments#

The more defensive one is, the less it depends on the tolerance for risk, but rather on how much time and energy one is willing to invest in their investment portfolio.
One should not buy stocks of the company they work for:
1. Insiders often have a pile of illusions, and their buying and selling are also subject to time windows.
2. Deepening understanding of something does not significantly reduce people's tendency to exaggerate their actual knowledge; this overconfidence is called "local bias."
3. In short, familiarity can lead to complacency.
Acknowledging one's ignorance about the future and being at peace with this ignorance is the most powerful weapon for a defensive investor.

Chapter 6: Passive Methods of the Aggressive Investor's Portfolio Strategy#

Main Text

Buying high-grade bonds at a significant discount can yield good returns and appreciation opportunities.
Financially secure companies: pre-tax profits are 1.5 times their total interest expenses.
Secondary bonds sold at face value with interest rates of 5.5% or 6% are almost certainly not worth buying; buying such bonds at 70 is more reasonable; with enough patience, it is possible to buy at this price.
Investors should take a prudent attitude toward newly issued securities: carefully assess and rigorously test them before placing orders.
Two finance professors pointed out that companies sell shares to the public when the stock market is near a peak.
During bull markets, many non-listed companies often take the opportunity to go public.
The public's carelessness, along with underwriters willing to sell anything as long as there is money to be made, will only lead to one result: price collapse.
Being able to resist the sweet talk of new stock issuers during a bull market is a fundamental condition for becoming a smart investor.
A smart investor should not take on huge losses to earn short-term profits.

Comments

For a smart investor, junk bonds are merely an optional right, not an obligation to buy.
Wise investors typically do not purchase foreign bonds exceeding 10% of their total assets.
Do not buy emerging market funds with annual management fees exceeding 1.25%.
Short-term trading—holding stocks for a few hours—is the best self-destructive weapon ever invented by humans.
High-yield IPO stocks are mostly taken by specialized small groups.
The meaning of IPO not only refers to "Initial Public Offering" but can also be an abbreviation for the following phrases:
1. It’s Probably Overpriced
2. Imaginary Profits Only
3. Insiders’ Private Opportunity
4. Idiotic, Preposterous, and Outrageous

Chapter 7: Active Methods of the Aggressive Investor's Portfolio Strategy#

Main Text

The definition of growth stocks is: not only have past performances exceeded the average level, but they are also expected to continue doing so; they are characterized by generally larger price fluctuations in the market.
Investing in growth stocks faces two unexpectedly complex situations:
1. Common stocks with excellent performance records and promising outlooks also have correspondingly high prices.
2. Judgments about the future may be wrong.
Graham insists on calculating price-to-earnings ratios based on average profits over many years.
To achieve better results than average investments over a long time, operational strategies must have two advantages:
1. They must meet the objective or reasonable standards required for basic robustness.
2. They must differ from the strategies adopted by most investors or speculators.
Choose unpopular large companies; the market tends to underestimate those temporarily out of favor due to unsatisfactory development:
1. They can rely on capital and human resources to weather difficulties and regain satisfactory profits.
2. The market may respond more quickly to any improvements in company performance.
3. Selecting the 10 stocks with the lowest price-to-earnings ratios in the index has advantages in the long run; this method is called the "Dogs of the Dow" investment method.
Choose to buy cheap securities:
1. Definition: based on analysis, the value of the security should be significantly higher than its selling price, i.e., at least 50% higher than its price.
2. Evaluation method for finding: after estimating future profits, multiply by a coefficient corresponding to the specific security.
3. Second method for finding: the value obtained by private owners from the enterprise should focus more on realizable asset value, especially emphasizing net current assets or working capital.
4. The courage shown in the cheap securities market comes not only from past experience but also relies on the application of reasonable value analysis methods.
Investors must conduct prudent investments; merely observing profits and stock prices falling is not enough; they should also require:
1. Profits over the past 10 years or longer should at least have good stability (no years of profit deficits).
2. The company should have sufficient scale and financial strength to cope with potential future difficulties.
3. Therefore, the ideal situation is: the stock price of a well-known large company is significantly lower than its past average price and significantly lower than its past average price-to-earnings ratio.
Long-term neglect or unpopularity is an important reason for low stock prices; another reason for low stock prices is that the market does not understand the company's actual profit situation:
1. The easiest type of security to identify is: priced lower than the company's net working capital (after deducting all preferred debts).
2. "Net working capital" refers to the company's current assets (such as cash, marketable securities, and inventory) minus all liabilities (including preferred stock and long-term debt).
Medium-sized enterprises have enough strength to weather difficulties, and they have genuinely better growth opportunities than existing large enterprises.
The huge profits from buying cheap securities of secondary enterprises come from many aspects:
1. Higher dividend returns.
2. Profits available for reinvestment relative to the price paid are considerable, thus ultimately affecting stock prices.
3. During bull markets, the prices of low-priced securities are generally higher, which will raise the prices of ordinary cheap securities to at least a reasonable level.
4. Even during relatively calm market periods, price adjustment processes will continue to occur, allowing undervalued secondary securities to rise to the price levels they should typically have.
5. Many specific factors that lead to disappointing profit records can be corrected due to the emergence of new situations, the adoption of new policies, and changes in management.
6. Large enterprises acquiring small enterprises.
Do not purchase securities involved in legal disputes; this is a valid survival rule for everyone (except the boldest investors).
Defensive investors should follow three elements: basic safety, simple selection methods, and the hope of obtaining satisfactory structures.
Do not buy three types of securities at "full price": foreign bonds, general preferred stocks, and secondary common stocks (fair business value of enterprises); they should be purchased at two-thirds of the price.

Comments

Hindsight is always completely clear, but predicting in advance is inevitably blind; thus, for most investors, timing trades is practically and psychologically impossible.
If a company's stock price is too high, it is not a very good investment object.
The higher the stock price rises, the more likely it seems to continue rising. But this contradicts the fundamental law of financial physics: the larger the company, the slower the growth rate.
Allocate one-third of stock funds to purchase mutual funds of foreign (including emerging market) stocks to help mitigate risks.

Chapter 8: Investors and Market Volatility#

Main Text

The further people are from Wall Street, the more suspicious the boasts about stock market predictions or timing become.
We cannot logically or based on actual experience believe that any ordinary or general investor can predict market trends more successfully than the public (of which they are a part).
Timing trades have no practical value for investors unless they happen to coincide with valuation methods: that is, unless it allows investors to repurchase their stocks at significantly lower prices than their previous selling prices (i.e., rebalancing).
Some methods gain support and become important because they perform well at a certain moment, or sometimes simply because they seem to fit past statistical records; but as they become accepted by more people, their reliability generally declines:
1. Over time, new situations may arise that previous methods cannot adapt to.
2. In stock market trading, a widely popular theory can itself influence market behavior, thereby weakening the long-term profitability of that theory.
Ordinary investors cannot succeed in predicting stock price changes through effort.
Almost all bull markets clearly exhibit some common characteristics:
1. Price levels reach historical highs.
2. Price-to-earnings ratios are very high.
3. Dividend yields are low compared to bond yields.
4. A large amount of margin speculative trading.
5. Many low-quality new common stock issuances.
The longer a bull market lasts, the more severe investors' amnesia becomes.
Any money-making method in the stock market, as long as it is easy to understand and adopted by many, will inevitably fail to last due to its simplicity and ease:
1. Over time, it will revert to natural trends, i.e., "regression to the mean."
2. Many people quickly adopt this stock-picking scheme, destroying the joyful atmosphere enjoyed by early adopters.
Ben Graham's conclusion applies to both philosophy and Wall Street: "All good things are both rare and complex."
Compared to large enterprises, secondary enterprises (now equivalent to thousands of companies outside the S&P 500) exhibit greater price volatility; however, this does not mean that a carefully selected group of small enterprises will perform worse in the long run.
A true investor is unlikely to believe that daily or monthly fluctuations in the stock market will make them richer or poorer.
Significant market rises will immediately bring people appropriate satisfaction and cautious concern, while also creating strong impulses for recklessness.
Even smart investors may need strong willpower to prevent their herd behavior.
As a true investor, one can find satisfaction in the thought that their business operations are exactly the opposite of the general public.
While paying market premiums, investors must bear significant risks, as they must rely on the stocks themselves to prove the rationality of their investments:
1. Net asset value, book value, on-balance-sheet value, and tangible asset value all refer to net worth, i.e., the total value of a company's physical and financial assets minus all liabilities.
2. This value can be calculated based on the balance sheets in the company's annual and quarterly reports: from total shareholders' equity, subtract the value of all "soft" assets such as goodwill, trademarks, and other intangible assets.
The entire stock market quotation system contains an inherent contradiction: the better a company's past record and future prospects, the less connection its stock price has with its book value.
1. However, the greater the premium above book value, the more unstable the basis for determining the company's intrinsic value becomes.
2. This "value" becomes even more dependent on changes in market sentiment and capacity.
3. Thus, we ultimately face a paradox: the more successful a company is, the greater the potential fluctuations in its stock price.
4. The reason is that the higher the assumed future growth rate and the longer the expected time, the greater the margin of error, and even a small calculation error can lead to high costs.
For prudent investors, it is best to focus on purchasing stocks priced close to the company's tangible asset value—e.g., no more than one-third above tangible asset value; in addition, investors must also require: a reasonable price-to-earnings ratio, a sufficiently strong financial position, and profits that will not decline in the coming years.
On Wall Street, one cannot expect anything significant to happen exactly as it did before.
If making valuable predictions about stock price fluctuations is nearly impossible, then doing so for bonds is completely impossible.
The price fluctuations of convertible bonds and preferred stocks result from the combined effects of the following three different factors:
1. Changes in the prices of related common stocks.
2. Changes in the company's credit status.
3. Changes in overall interest rate levels.

Comments

Mr. Market's task is to provide you with prices, while your task is to decide whether these prices are favorable to you.
Smart individual investors can freely choose whether to follow Mr. Market.
Investment activities are not about defeating others in their game but about controlling oneself in one's own game.
The entire meaning of investing is not to earn more money than the average person but to earn enough money to meet one's needs.
Our brains are naturally inclined to perceive trends, even when they do not exist.
The pain of personal losses is twice the pleasure of equivalent gains.
For anyone making long-term investments, continuous declines in stock prices are excellent news.
Investors who frequently obtain the latest news stories receive returns that are only half of those who do not care about stock market news.

Chapter 9: Fund Investment#

Main Text

These professionals can completely determine the direction of the stock market average, and the direction of the stock market average can completely determine the overall results of the funds.
Fund managers are engaging in excessive speculative risks and temporarily obtaining excessive returns.
Smaller size is a necessary factor for consistently achieving excellent results.
Funds that can sustainably outperform the market average over a long time: most businesses focus on specialized areas, self-limit the use of capital, and do not sell large amounts to the public.

Comments

In financial markets, luck is much more important than skill.
Buying funds solely based on past performance is one of the most foolish things investors can do.
Any single most profitable and therefore most popular industry often becomes the worst-performing industry the following year.
After studying mutual funds, financial experts unanimously propose the following points:
1. General funds cannot select good stocks by incurring research and trading costs.
2. The higher the fund's fees, the lower its returns.
3. The more frequently fund shares are traded, the smaller the chances of making money.
4. Highly unstable funds (those with greater fluctuations than the average) may remain unstable over the long term.
5. Funds with high past returns are unlikely to remain winners for long in the future.
A fund that cannot outperform the market can still provide significant value—offering a cheap method of asset diversification.
To succeed, individual investors should either avoid picking the same hot stocks as large institutions or hold these stocks more patiently.
In the long run, index funds will outperform most funds, but they should be selected for low management fees.
Graham and Buffett praise index funds as the best choice for individual investors.
Characteristics of excellent funds:
1. Experiences are from some of the largest shareholders.
2. Low fees.
3. Willingness to be different.
4. Do not accept new investors.
5. Do not advertise.
By type, the annual operating expenses of funds should not exceed the following levels:
1. Taxable municipal bonds (0.75%).
2. U.S. large and mid-cap company stocks (1.0%).
3. High-yield junk bonds (1.0%).
4. U.S. small-cap company stocks (1.25%).
5. Foreign stocks (1.5%).
Yesterday's winners often become tomorrow's losers, but yesterday's losers almost never become tomorrow's winners: do not buy funds that have consistently performed poorly, especially when their annual fees exceed the average.
When to sell a fund:
1. Trading strategies suddenly change drastically.
2. Fees increase.
3. Excessive trading leads to frequent large tax bills.
4. Abnormal returns suddenly occur.
When something can actually be predicted, believing oneself to be able to make predictions is a rational viewpoint. If it is divorced from reality, it is merely blind self-esteem behavior that will ultimately end in self-failure.

Chapter 10: Investors and Investment Advisors#

Main Text

Investment advisors: use their superior skills and experience gained through training to prevent clients from making mistakes and ensure they receive the investment income they deserve.
If investors primarily rely on others' advice in using funds, they must strictly limit themselves and their advisors to formulaic, conservative, or somewhat dull investment methods, or they must be very familiar and trust the person guiding their investment channels.
True investment advisors are quite conservative in their commitments and advice; they do not claim to be wiser than others, and their pride lies in being careful, prudent, and competent:
1. The main goal is to retain the principal value over a long period and achieve a relatively steady income growth rate.
2. Any other achievements are seen as additional services.
Financial services companies have been making predictions about the stock market, but no one takes this activity seriously. Of course, their understanding and predictions about business operations are more authoritative and enlightening.

Comments

The best advisors are already full of clients and are therefore unwilling to accept you unless you seem capable of cooperating well with them.