Introduction: What this book expects to accomplish
No statement is more true and better applicable to Wall Street than the famous warning of Santayana: “Those who do not remember the past are condemned to repeat it.”
Evidently it is not only the tyro who needs to be warned that while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster.
The lesson Graham is driving at is not that you should avoid buying airline stocks, but that you should never succumb to the “certainty” that any industry will outperform all others in the future.
Commentary on The Introduction
this kind of intelligent has nothing to do with IQ or SAT scores. It simply means being patient, disciplined, and eager to learn; you must also be able to harness your emotions and think for yourself. This kind of intelligence, explains Graham, “is a trait more of the character than of the brain.”
In 1998, Long-Term Capital Management L.P., a hedge fund run by a battalion of mathematicians, computer scientists, and two Noble Prize – winning economists, lost more than $2 billion in a matter of weeks on a huge bet that the bond market would return to “normal.” But the bond market kept right on becoming more and more abnormal – and LTCM had borrowed so much money that its collapse nearly capsized the global financial system. (*see Roger Lowenstein, When Genius Failed – Random House, 2000)
And back in the spring of 1720, Sir Isaac Newton owned share in the South Sea Company, the hottest stock in England. Sensing that the market was getting out of hand, the great physicist muttered that he “could calculate the motions of the heavenly bodies, but not the madness of the people.” Newton dumped his South Sea shares, pocketing a 100% profit totaling £ But just months later, swept up in the wild enthusiasm of the market, Newton jumped back in at a much higher price – and lost £20000 (or more than $3 million in today’s money). For the rest of his life, he forbade anyone to speak the words “South Sea” in his presence. (* John Carswell, The South Sea Bubble (Cresset Press, London, 1960); also see www.harvard-magazine.com/issues/mj99/damnd.html)
being an intelligent investor is more a matter of “character” than “brain”.
The worst market crash since the Great Depression, with U.S. stocks losing 50.2% of their value – or $7.4 trillion – between March 2000 and October 2002.
The highest 20-year return in mutual fund history was 25.8% per year, achieved by the legendary Peter Lynch of Fidlity Magellan over the two decades ending December 31, 1994. Lynch’s performance turned $10,000 into more than $982,000 in 20 years.
For now at least, no one has the gall to try claiming that technology will still be the world’s greatest growth industry. But make sure you remember this: The people who now claim that the next “sure thing” will be health case, or energy, or real estate, or gold, are no more likely to be right in the end than the hypesters of high tech turned out to be.
The Pendulum has swung, as Graham knew it always does, from irrational exuberance to unjustifiable pessimism.
Chapter 1 Investment versus Speculation: Results to Be Expected by the Intelligent Investor
An investment operation is one which, upon thorough analysis promises safety or principal and an adequate return. Operations not meeting these requirements are speculative.
what we have just said indicates that there may no longer be such a thing as simon-pure investment policy comprising representative common stocks—in the sense that one can always wait to buy them at a price that involves no risk of a market or “quotational” loss large enough to be disquieting. In most periods the investor must recognize the existence of a speculative factor in his common-stock holdings. It is his task to keep this component within minor limits, and to be prepared financially and psychologically for adverse results that may be of short or long duration.
Two paragraphs should be added about stock speculation per se, as distinguished from the speculative component now inherent in most representative common stock. Outright speculation is neither illegal, immoral, nor (for most people) fattening to the pocketbook. More that that, some speculation is necessary and unavoidable, for in many common-stock situations there are substantial possibilities of both profit and loss, and the risks therein must assumed by someone. There is intelligent speculation as there is intelligent investing. But there are many ways in which speculation may be unintelligent. Of these the foremost are: (1) speculating when you think you are investing; (2) speculating seriously instead of as a pastime, when you lack proper knowledge and sill for it; and (3) risking more money in speculation than you can afford to lose.
In our conservation view every nonprofessional who operates on margin should recognize that his is ipso facto speculating, and it is his broker’s duty so to advise him. And everyone who buys a so-called “hot” common-stock issue, or makes a purchase in any way similar thereto, is either speculating or gambling. Speculation is always fascinating, and it can be a lot fun while you are ahead of the game. If you want to try your luck at it, put aside a portion— the smaller the better—of your capital in separate fund for this purpose. Never add more money to this account just because the market has gone up and profits are rolling in.(That’s the time to think of taking money out of your speculative fund.) Never mingle your speculative and investment operations in the same account, nor in any part of your thinking.
Few people were willing to consider seriously the possibility that the high rate of advance in the past means that stock prices are “now too high,” and hence that “the wonderful results since 1949 would imply not very good but bad results for the future.”
Almost all bonds have fluctuated much less than stock prices, and investors generally could buy good bonds of any maturity without having to worry about changes in their market value. There were a few exceptions to this rule, and the period after 1964 proved to be one of them.
But it should be remembered that between 1949 and 1969 the price of the DJIA had advanced more than fivefold while its earnings and dividends had about doubled. Hence the greater part of the impressive market record for the period was based on a change in investors’ and speculators’ attitudes rather than in underlying corporate values. To that extent it might well be called a “bootstrap operation.”
To enjoy a reasonable chance for continued better than average results, the investor must follow policies which are (1) inherently sound and promising, and (2) not popular on Wall Street.
Thus it seems that any intelligent person, with a good head for figures, should have a veritable picnic on Wall Street, battening off other people’s foolishness. So it seems, but somehow it doesn’t work out that simply. Buying a neglected and therefore undervalued issue for profit generally proves a protracted and patience-trying experience. And selling short a too popular and therefore overvalued issue is apt to be a test not only of one’s courage and stamina but also of the depth of one’s pocketbook. The principle is sound, the successful application is not impossible, but it is distinctly not an easy art to master.
Commentary on Chapter 1
All of human unhappiness comes from one single thing: not knowing how to remain at rest in a room. – Blaise Pascal
To see why temporarily high returns don’t prove anything, imagine that two places are 130 miles apart. If I observe the 65-mph speed limit, I can drive that distance in two hours. But if I drive 130 mph, I can get there in one hour. If I try this and survive, am I “right”? Should you be tempted to try it, too, because you hear me bragging that it “worked”? Flashy gimmicks for beating the market are much the same: In short streaks, so long as your luck holds out, they work. Over time, they will get you killed.
For better or worse, the gambling instinct is part of human nature- so it’s futile for most people even to try suppressing it.
Chapter 2 The Investor and Inflation
In the economic cycles of the past, good business was accompanied by a rising price level and poor business by falling prices.
In the memorable words of the elder J. P. Morgan, “They will fluctuate.” This means, first, that the common-stock buyer at today’s priced- or tomorrow’s- will be running a real risk of having unsatisfactory results therefrom over a period of years. It took 25 years for General Electric (and the DJIA itself) to recover the ground lost in the 1929-1932 debacle. Besides that, if the investor concentrates his portfolio on common stocks he is very likely to be led astray either by exhilarating advances or by distressing declines. This is particularly true if his reasoning is geared closely to expectations of further inflation. For then, if another bull market comes along, he will take the big rise not as a danger signal of an inevitable fall, not as a chance to cash in on his handsome profits, but rather as a vindication of the inflation hypothesis and as a reason to keep on buying common stocks no matter how high the market level nor how low the dividend return. That way lies sorrow.
Real estate … This too is not our field. All we should say to the investor is, “be sure it’s yours before you go into it.”
Commentary on Chapter 2
For more insights into this behavioral pitfall, see Eldar Shafir, Peter Diamond, and Amos Tversky, “Money Illusion,” in Daniel Kahneman and Amos Twersky, eds., Choices, Vales, and Frames (Cambridge University Press, 2000), pp. 335-355.
As recently as 1973 – 1982, the United States went through one of the most painful bursts of inflation in our history….. In 1979 alone, inflation raged at 13.3%, paralyzing the economy in what became known as “stagflation”- and leading many commentators to question whether America could compete in the global market place. Goods and services priced at $100 in the beginning of 1973 cost $230 by the end of 1982, shriveling the value of a dollar to less than 45 cents. No one who lived through it would scoff at such destruction of wealth; no one who is prudent can fail to protect against the risk that it might recur.
Rising prices allow Uncle Sam to pay off his debts with dollars that have been cheapened by inflation. Completely eradicating inflation runs against the economic self-interest of any government that regularly borrows money.
While mild inflation allows companies to pass the increased costs of their own raw materials on to customers, high inflation wreaks havoc – forcing customers to slash their purchases and depressing activity throughout the economy.
REITs – Real Estate Investment Trusts
TIPS – Treasury Inflation-Protected Securities
The one question never ask a bureaucrat is ‘why?’ – Mark Schweber, financial analyst.
Chapter 3 A Century of Stock-Market History: The Level of Stock Prices in Early 1972
We suggest, however, that if the investor is in doubt as to which course to pursue he should choose the path of caution.
(my comment: Overall it is hard or not reliable to predict the following course of the stock market. The market price level can be approximately judged by Price/earning ratio.)
Commentary on Chapter 3
You’ve got to be careful if you don’t know where you are going, ’cause you might not get there. – Yogi Berra