The Intelligent Investor (by Benjamin Graham)

You don't need to be super smart, have insider information, or be lucky to do well in investing.

What you need is a good plan for making choices and a way to stay calm under pressure.

Which is what Benjamin Graham’s book, "The Intelligent Investor," gives you — a clear strategy combined with tips on how to stay cool.

This plan has worked really well for over 100 years.

Many people, including Graham and his followers, have done great by using it.

One of his most famous students, Warren Buffett, who is currently the eighth richest person in the world, even says it's "the best book on investing ever written."

Now before we start, this is Ivan here from the Vanilla Investor, a former investment analyst and with over $100k invested in the markets.

My goal is to bring you simple finance at your fingertips.

In this article, I'll share what I believe are the most valuable lessons from The Intelligent Investor by Benjamin Graham, starting with the importance of understanding Mr. Market, who is an imaginary investor mentioned in the book.

2) How to invest as a defensive (or passive) investor

3) How to invest as an enterprising (or active) investor

4) Why you should leave room for error when buying stocks

And finally, why risk and reward aren't always correlated.

So, without further ado, let’s get into:

Lesson #1: Meet Mr. Market

Imagine you own a small part of a company that is worth $1000.

Every day, a person named Mr. Market comes by and tells you how much he thinks your part is worth.

He says you can sell your part to him or buy more from him based on what he thinks.

But the problem is, Mr. Market's ideas about the price can change a lot and don't always make sense.

For example, in March 2024, he might say your part is worth $3200.

But by June 2025, even though the company is doing better and earning more money, he might say it’s only worth $800.

Should you let Mr. Market decide how much your $1000 part is worth?

No way!

Benjamin Graham teaches that owning a stock means you own a piece of a business, not just a ticker symbol with a price tag.

Mr. Market’s daily prices are often different from what the business is really worth because he can be too optimistic or too pessimistic.

Graham says you should only buy a stock if you're okay with keeping it no matter what price Mr. Market gives you.

For people who stay calm and think about the future, Mr. Market’s strange prices can be a chance to make good deals.

You can sell to him when he’s willing to pay a lot and buy from him when he’s selling for cheap.

Back in Graham's time, Mr. Market only came around once a day, maybe with the morning newspaper.

Today, Mr. Market is always around, every time we check our phones, which can be more than 50 times a day.

Even though Mr. Market is here more often now, you don’t have to do business with him any more than people did back in the 1970s.

If his offers aren’t good for you, just ignore him and go on with your day.

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Lesson #2: Investing as a Defensive Investor

Benjamin Graham talks about two kinds of investors: defensive (or passive) and enterprising (or active).

The defensive way is best for most people who don’t want to spend a lot of time thinking about their money.

Here’s a simple plan for defensive investors:

1. Portfolio Balance:

Create a mix of stocks and bonds in your portfolio, such as 50% in each.

The exact split should depend on your personal circumstances and the current returns of stocks versus bonds.

Adjust this balance once or twice a year.

For instance, if stocks increase to 70% of your portfolio while bonds decrease to 30%, sell some stocks and buy more bonds to return to the 50/50 balance.

2. Regular Investment:

Invest a set amount at regular intervals, like right after you get paid.

This method, known as dollar-cost averaging, helps you buy stocks and bonds at various prices over time, leading to an average cost and preventing you from investing too much at the wrong time.

3. Stock Selection:

When choosing stocks, consider these guidelines:

Diversification: Spread your investments across 10 to 30 companies to minimize risk and avoid too much reliance on any single company or industry.
Large Companies: Invest in big companies. Graham’s benchmark for a large company was annual sales of over $100 million, which is roughly $900 million today after adjusting for inflation.
Financial Health: Look for companies with a "current ratio" of at least 200%, meaning their current assets should be at least double their current liabilities.
Dividend History: Pick companies that have consistently paid dividends for at least the past 20 years.
Earnings Stability: Ensure the company hasn’t reported any losses over the last ten years.
Growth: Look for companies with at least 33% growth in earnings over the past decade, which translates to about 2.9% growth per year.
Value for Assets: Don’t pay more than 1.5 times the net asset value of the company, which you can calculate by subtracting liabilities from assets.
Earnings Price: Avoid overpaying for earnings. Make sure the price-to-earnings (P/E) ratio doesn’t exceed 15 based on the last 12 months of earnings.

Another good choice is to put your money in an index fund.

This kind of fund follows the whole market.

So, your money will grow as much as the average market.

If you’re happy with getting average market returns, then you would only need these first 2 lessons.

But, if you want to try for bigger returns and can handle more risk, you might want to think about…

Lesson #3: Investing as an Enterprising Investor

Being a defensive investor means you stick to easy, simple strategies and aim for average market returns.

It might seem like you can beat the market by just spending a bit more time and effort than others.

Right?

But being an enterprising (or active) investor and beating the market is much harder.

You need a lot of patience, discipline, a strong desire to learn, and you have to spend a lot of time on it.

Many people, even professionals, find this difficult and can be easily swayed by changing stock prices.

Think about what happened during the dot-com bubble in the early 2000s.

Experts said things like, "It's a new world order...." and "The stock market isn't riskier today just because prices are higher."

These ideas turned out to be wrong and hurt investors who believed them.

Remember, since companies can only make so much profit, you shouldn’t pay too much for their stocks.

If you want to be an enterprising (or active) investor, be careful not to overpay for stocks.

The market often makes popular, fast-growing companies too expensive.

On the other hand, it undervalues companies that aren’t growing as quickly.

Graham advises to avoid buying "growth stocks" that depend on future earnings, which are uncertain.

Instead, look for companies worth less than their net working capital.

This means their market value is less than their current assets minus their total liabilities, so their fixed assets like buildings and machinery are basically free.

These opportunities are rare, especially when the market isn't doing very poorly, but they were very profitable for Graham.

Graham also offers another approach for enterprising investors, similar to the defensive strategy but with more flexibility.

This includes looser criteria on the number of stocks held for diversification, the company size, and the option to decide how high of a P/E ratio is too high, tailored to the investor’s preference.

Other criteria are as follows:

Financial Health: Look for companies with a "current ratio" of at least 150%, down from 200%.
Dividend History: Pick companies that have consistently paid dividends for this year only.
Earnings Stability: Ensure the company hasn’t reported any losses over the last five years, down from 10 years.
Growth: Look for companies that’s at least growing and not staying stagnant for the past 5 years.
Value for Assets: Don’t pay more than 1.2 times the net tangible asset value of the company, which you can calculate by subtracting liabilities from tangible assets.

For those taking the enterprising route, analyzing a company’s financial health through its annual reports is crucial.

Graham wrote extensively on this in his book, "The Interpretation of Financial Statements," providing detailed guidance on evaluating a company's financial position.

So if you want me to do a book summary on this, let me know :)

Lesson #4: Always Be Safe When Buying Stocks

When you invest your money, you always want to be careful because you might be wrong about how much a stock is worth.

To be safe, you should only buy a stock if it's priced much lower than what you think it’s worth.

This is called having a "margin of safety."

It’s like having extra room for mistakes.

Ideally, you shouldn't pay more than two-thirds of what you think a stock is worth.

Think of it like building a bridge.

If the bridge can hold 100 cars, you don’t want it to fall down if 101 cars drive on it.

In the same way, if you think a stock is worth $51, don’t buy it if it costs $50 because your guess might be wrong.

If you’re wrong about the bridge, it could be very dangerous.

If you’re wrong about the stock, you could lose money and take longer to reach your financial goals.

To avoid problems, always have a good margin of safety.

To figure out if a stock has a margin of safety, you can use this formula from the book:

Value = (current normal earnings) x 8.5 + 2 x (expected yearly growth).

The "growth rate" is how much you think the company will grow every year for the next 7 to 10 years.

Let's use this to look at the 3 biggest companies in the S&P 500 in June 2024.

We’ll see how much their stocks are worth based on how much money they make now and how much they might grow.

This way, we can tell if they are good to buy.

We can also use the formula backward to see how much these companies need to grow in the next 7 to 10 years to be worth their current price.

For example, Microsoft needs to grow by 11% every year, and NVIDIA needs to grow by 23% every year.

Do you think these companies can grow that much?

Lesson #5: Risk and Reward Don’t Always Match

Many people think you have to take big risks to get big rewards in investing.

They believe if a stock's price goes up and down a lot, it's riskier and should give you more money back.

But Benjamin Graham thinks differently.

He says the price you pay for something doesn't always match its true worth.

So, you can get good returns if you find stocks that are worth more than their price.

People who don't look for good deals (defensive investors) get lower returns.

People who do a lot of research and find bargains (enterprising investors) get higher returns.

Imagine you and your friends are at a carnival.

There are two games.

In the first game, you have to hit a tiny bullseye with a dart to win a big stuffed bear.

The prize is awesome, but it's really hard to win.

The second game is a ring toss.

The rings are big and the targets are close.

The prize is smaller, but it's much easier to win.

Seems logical, right?

The more risk you take on, the better the reward you get.

But the stock market doesn’t have to be this way.

If you can buy a stock worth $1 for only 70 cents, then that’s a good deal for you to make money with little risk.

But if you find another stock worth $1 for only 50 cents, that’s even better.

You get higher reward and lower risk combined.

If you like this summary here, then you need to get the actual book and read it.

It’s quoted as the best book on investing by Warren Buffett!

Otherwise, do let me know what other books you would like me to summarize.

Thank you for reading, cheers!

- Ivan