The Intelligent Investor

Chapter 1: Investment versus Speculation: Results to Be Expected by the Intelligent

Investor
• “Investor” will be used in contradistinction with “speculator” throughout the book
• From the 1934 edition of Security Analysis “An investment operation is one, which upon
thorough analysis promises safety of principal and an adequate return. Operations not
meeting these requirements are speculative.”
• On Wall Street the word investor is often used to describe anyone who buys or sells a
security regardless of what they buy, or for what purpose, or at what price, or whether for
cash or on margin
• Understanding the distinction between investor and speculator is critical
• Risks are inherent in the purchase of commons stocks and are inseparable from the
opportunity to profit
• Both risk and profit opportunity must be included in the investor’s calculation
• There is always a speculative factor involved in common stocks in the sense that there can
be a decline and the investor could suffer a paper loss
• An investor has to be financially and psychologically prepared for these adverse results
• Outright speculation is not immoral or illegal
• There are many types of unintelligent speculation that the investor should avoid:
• Speculating when you think you are investing
• Speculating seriously instead of as a pastime
• Risking more money in speculation than you can afford to lose
• Every nonprofessional operating on margin is speculating
• Buying a “hot” stock is also a form of speculation
• If an investor needs to speculate he should put aside a small portion of his portfolio for this
purpose
• He should never add more to this speculative portfolio just because prices have been rising
• Speculative and investment operations should not be comingled in the same account
• Results to be Expected by the Defensive Investor
• The defensive investor is primarily concerned with safety of principle and freedom
from bother
• The defensive investor should divide his holdings between high-grade bonds and
common stocks
• The percentage of stocks or bonds within the defensive investor’s portfolio should
never be higher than 75% in either direction
• The allocation between stocks and bonds can be altered based on the expected
outlook for each asset class going forward
• The expected return on high-grade bonds are calculated by their coupon rate
• Expected returns on stocks are their dividend yield plus an estimate of annual
appreciation (when this book was published in 1972 Graham used 4% annually as
an estimate)
• Future security prices are never predictable and investors should always proceed
with caution
• Interest and principal on high quality bonds are much better protected than
dividends and price appreciation of stocks
• The defensive investor should limit himself to high quality issues with a record of
profitable operations and strong financial conditions
• New offerings and “hot” issues should be avoided
• Results to be Expected by the Aggressive Investor
• The enterprising investor expects to attain better results than the defensive investor
• His first concern should be to make sure that he does not do worse
• Many intelligent people have tried and failed miserably to beat the market
 • It is therefore extremely important that the enterprising investor begin his journey
with a clear understanding of which methods offer the best chance of success
• The following methods offer a limited chance of success for enterprising investors
§ Trading in the market
• Buying stocks when the market advances and selling after a decline
§ Short-term selectivity
• Buying stocks of companies that are expected to produce increased
earnings or have some other favorable short-term event occur
§ Long-term selectivity
• Buying companies with a track record of growth in anticipation
that the growth rate will continue into the future or buying
companies that do not yet have earnings in anticipation that they
will produce large amounts of future earnings
• Trading is not an operation that relies on thorough analysis or offers safety of
principal
• Picking the most promising stocks in the short and long term is difficult for two
reasons
§ Estimating the future is always difficult
§ Current year and next fiscal year earnings to the extent that they are
predictable are generally already incorporated into a security’s current
price
• In order to achieve success an enterprising investor must follow policies that are
inherently sound and not popular on Wall Street
• The best opportunity to achieve success as an enterprising investor is to take
advantage of speculative stock movements that have been carried too far in either
direction
• Buying undervalued securities and selling overvalued securities is simpler in theory
than in practice
• There are also special situations like arbitrages, protected hedges and liquidation
scenarios that can produce above market returns for enterprising investors
• Bargain issues selling below their net current assets, or net working capital, are
especially attractive
§ Working capital are all current assets excluding plant and other assets after
deducting all liabilities ahead of the stock owner
• A 5% annual return above the market is required to make enterprise investing a
worthwhile activity
• Commentary on Chapter 1
• “All of human unhappiness comes from one thing: not knowing how to remain at rest
in a room.” – Blaise Pascal
• Investing consists of three equal elements
§ You must thoroughly analyze a company, and the soundness of its
underlying business, before you buy the stock
§ You must deliberately protect yourself against serious losses
§ You must aspire to “adequate,” not extraordinary performance
• Investors calculate what the stock is worth based on the value of its businesses
• Speculators gamble that a stock will increase in price because someone will pay
more for it than they will
• Investors determine market price by established standards of value, while
speculators base their standards of value upon market price
• Quoted values matter much less to the investor because they should be comfortable
owning the business even if they couldn’t get a daily quote
• People who invest make money for themselves; people who speculate make money
for their brokers
• Speculators will use any method they think will work
• The investor has no interest in being temporarily right and aspires to be sustainably
and reliably right
• Gimmicks may beat the market in short spurts, but over time they will get an
investor killed
• In 1973 mutual funds held a stock for 3 years on average
• In 2002 the average hold period for a mutual fund was 10.9 months
• Most investors know the price of everything, and the value of nothing
• Stocks do well or poorly based on the future of the business behind them
• Gambling instinct is a part of human nature and suppressing it is difficult, but the
investor must confine and restrain it