The Intelligent Investor by Benjamin Graham
Graham is known as the father of value investing which is a strategy which involves buying undervalued stocks. The hallmark of Graham's philosophy is not profit maximization but loss minimization. These are 10 key lessons from The Intelligent Investor.
Process, process, process: Having a sound intellectual decision-making framework is essential but only useful if one is able to prevent emotions from corroding that framework.
Market behaviour: The more irrational the market behaves, the greater the opportunity for the disciplined investor.
Value and price: The future value of every investment is a function of its present price. The higher the price you pay, the lower your return will be.
Margin of safety: No matter how disciplined your process is, the one risk no investor can eliminate is the risk of being wrong. Only by having a satisfactory "margin of safety" (i.e. difference between the intrinsic value of a stock and its market price) can you minimise your chances of making a mistake. It allows you to never overpay for an investment, no matter how exciting it may appear to be.
Your worst enemy: As an investor, your principal problem and worst enemy is likely to be you yourself. That is because our capability for rational decision-making are clouded by emotions (fear and greed) and biases (overconfidence, selective memory, and predictive fallacy to name a few).
Future projections: Mathematical valuations that are dependant on anticipating the future are vulnerable to miscalculation and serious error because nobody can predict the future. Unfortunately, a significant part of the value of a ‘high-multiplier’ stock is derived from future projections which differ significantly from past performance.
Bargain issues: Graham argues that we can profit from "bargain issues" (i.e. stocks worth considerably more than they are selling for) without taking a serious risk. Indeed, we can find enough of them to make a diversified group if we are patient.
Contrarian thinking: The intelligent investor understands that a stock becomes more risky as its price rises, and less risky as its price falls. Since a bull market makes stocks more costly to buy, you should dread it. Conversely, you should welcome a bear market as it puts stocks back ‘on sale’, as long as you keep enough cash to hand to meet your spending needs.
Look beyond yield: The performance of stocks depend on the performance of the underlying businesses, and for no other reason. As such, no matter how desperate they might be for income, no intelligent investor would ever buy a stock on the basis of its dividend yield alone. The underlying business must be solid and its share price must be reasonable.
Sources of undervaluation: The two principal reasons why the wider market will undervalue a stock are currently disappointing results, and protracted neglect or unpopularity. As such, Graham argues that an investor should require an indication of at least reasonable stability of earnings over the past decade or more plus sufficient size and financial strength to meet possible setbacks in the future.