‘The Intelligent Investor’ is one of the best books ever written on investing, as said by the famous investor Warren Buffett. Benjamin Graham authored the book while focusing on the value investing strategy. If you are new to the investment field, this book can build a strong foundation regarding the stock market perception.
Here are the five major ideas that you can gain from the book ‘The Intelligent Investor’
1. Investment Vs Speculation
Graham has highlighted the major line between Investment and Speculation. According to Graham ” Investment is an operation which, upon thorough analysis promises safety of principal and an adequate return. Operation not meeting these requirement is speculation.”
Graham insists that one should not mix the investing and speculative activities. However, he is not against the speculation. He simply suggest one to separate from other. The investor should have a clear idea about which of his operation are investments and which ones are speculative activities. While entering into speculation, one should be aware that there is a chance for permanent loss of capital. Investment, on the other hand should always ensure safety of capital.
2. Defensive Vs Enterprising Investor
Benjamin Graham states that there are two different types of investors depending upon the time, skill, and effort they put into their operations. One is defensive or passive investor. The other is enterprising or active investor. Graham doesn’t differentiate whether one is better than the other. He states that both differ in strategy that they should implement in their investment operation.
A defensive investor should focus more on the preservation of capital. Hence, he accepts relatively less return provided that the risk is minimized. So, he must choose a diversified portfolio of high-grade bonds and common stocks with bonds outweighing the stocks. Stocks in his portfolio have low risk and provide high dividend yield. Through this strategy, the defensive investor will receive freedom from spending large amount of time in his investment operation along with the safety of principal.
On the other hand, the enterprising investor focuses on the growth of capital. His portfolio is inclined largely to stocks with some bonds mixed in. The enterprising investor will actively exercise his skill and effort and hunt for stocks which are at bargain level than his present holdings. If he is successful in his endeavor, he/she will generate maximum return.
3. Price Vs Value
Price and Value are not the same. Price of the stock is the market price at which the stock is currently trading. Value, on the other hand is the worth of the business based on its assets and earnings. Simply, Price is what you pay, Value is what you get.
If a stock is currently trading at the stock market at Rs. 1000 per share, then this is its price. However, Value of same stock may differ from the price. The value may be Rs. 500 per share based on its assets and the earnings capability. Even if it is trading at a price of Rs. 1,000 it is merely worth Rs. 500.
The investor should have a clear concept of price and value. He/she should always purchase those stocks whose value is substantially higher than its price. Stocks with the current price higher than its value should be avoided at all cost.
With the volatility of the stock market, the price of stocks may fluctuate far from its actual value. Even if the price declines below the purchase price, the investor should not sell his/her holdings if the value of the business is intact i.e. there is no fall in the intrinsic value of the business.
4. Mr. Market
Graham urges investor to view the stock market as a person named Mr. Market. He is your partner in the business and quotes you daily value of your business. You can either take action to his daily quotes by buying or selling your shares or you can remain indifferent.
In Graham’s own words:
“Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis.
Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.
If you are a prudent investor or a sensible businessman, will you let Mr. Market’s daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low.”
5. Margin of Safety
The principle of Margin of Safety is the most important in the book. Margin of Safety indicates that one should purchase a stock with price far below its actual value such that even if the unexpected occurs and the value of your business declines, your investment will remain safe.
Suppose, you calculated the actual value of a business to be worth Rs. 600 per share. And it is trading at Rs. 300 per share in the stock market. If you purchase the stock, you will have a huge margin of safety. Even if you were slightly incorrect in the evaluation of the business value or the value of business declines due to unforeseen future developments, you have enough safety margin in your investment. The value of the business will have to plunge by more than 50 percent before the erosion of your principal investment.
On the other hand, If you purchase a stock at Rs. 475 per share and you estimated its actual value to be Rs. 500 per share, then there is less margin of safety. You may be slight wrong in your estimation and you will suddenly find that there is no safety in you stock purchase. Any negative development will erode your principal investment.
Thus, Graham highly focuses on Margin of Safety in every investment operation.