Sunday, February 22, 2009


"Confusing speculation with investment, Graham warns, is always a
mistake. In the 1990s, that confusion led to mass destruction. Almost
everyone, it seems, ran out of patience at once, and America became
the Speculation Nation, populated with traders who went shooting
from stock to stock like grasshoppers whizzing around in an August
hay field.
People began believing that the test of an investment technique
was simply whether it “worked.” If they beat the market over any
period, no matter how dangerous or dumb their tactics, people
boasted that they were “right.” But the intelligent investor has no interest
in being temporarily right. To reach your long-term financial goals,
you must be sustainably and reliably right. The techniques that
became so trendy in the 1990s—day trading, ignoring diversification,
flipping hot mutual funds, following stock-picking “systems”—seemed
to work. But they had no chance of prevailing in the long run, because
they failed to meet all three of Graham’s criteria for investing.
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.
In 1973, when Graham last revised The Intelligent Investor, the
annual turnover rate on the New York Stock Exchange was 20%,
meaning that the typical shareholder held a stock for five years before
selling it. By 2002, the turnover rate had hit 105%—a holding period of
only 11.4 months. Back in 1973, the average mutual fund held on to a
stock for nearly three years; by 2002, that ownership period had
shrunk to just 10.9 months. It’s as if mutual-fund managers were
studying their stocks just long enough to learn they shouldn’t have
bought them in the first place, then promptly dumping them and starting
all over.
Even the most respected money-management firms got antsy. In
early 1995, Jeffrey Vinik, manager of Fidelity Magellan (then the
world’s largest mutual fund), had 42.5% of its assets in technology
stocks. Vinik proclaimed that most of his shareholders “have invested
in the fund for goals that are years away. . . . I think their objectives are
the same as mine, and that they believe, as I do, that a long-term
approach is best.” But six months after he wrote those high-minded
words, Vinik sold off almost all his technology shares, unloading nearly
$19 billion worth in eight frenzied weeks. So much for the “long term”!
And by 1999, Fidelity’s discount brokerage division was egging on its
clients to trade anywhere, anytime, using a Palm handheld computer—
which was perfectly in tune with the firm’s new slogan, “Every second
And on the NASDAQ exchange, turnover hit warp speed, as Figure
1-1 shows.4
In 1999, shares in Puma Technology, for instance, changed hands
an average of once every 5.7 days. Despite NASDAQ’s grandiose
motto—“The Stock Market for the Next Hundred Years”—many of its
customers could barely hold on to a stock for a hundred hours.
from "The Intelligent Investor" book by Benjamin Graham

Read the book here

Why do you suppose the brokers on the floor of the New York Stock

Why do you suppose the brokers on the floor of the New York Stock
Exchange always cheer at the sound of the closing bell—no matter
what the market did that day? Because whenever you trade, they
make money—whether you did or not. By speculating instead of investing,
you lower your own odds of building wealth and raise someone

Graham’s definition of investing could not be clearer: “An investment
operation is one which, upon thorough analysis, promises safety
of principal and an adequate return.” 1 Note that investing, according to
Graham, consists equally of three elements:
• you must thoroughly analyze a company, and the soundness of its
underlying businesses, before you buy its stock;
• you must deliberately protect yourself against serious losses;
• you must aspire to “adequate,” not extraordinary, performance.

An investor calculates what a stock is worth, based on the value of
its businesses. A speculator gambles that a stock will go up in price
because somebody else will pay even more for it. As Graham once
put it, investors judge “the market price by established standards of
value,” while speculators “base [their] standards of value upon the
market price.” 2 For a speculator, the incessant stream of stock quotes
is like oxygen; cut it off and he dies. For an investor, what Graham
called “quotational” values matter much less. Graham urges you to
invest only if you would be comfortable owning a stock even if you had
no way of knowing its daily share price.3
Like casino gambling or betting on the horses, speculating in the
market can be exciting or even rewarding (if you happen to get lucky).
But it’s the worst imaginable way to build your wealth. That’s because
Wall Street, like Las Vegas or the racetrack, has calibrated the odds
so that the house always prevails, in the end, against everyone who
tries to beat the house at its own speculative game.
On the other hand, investing is a unique kind of casino—one where
you cannot lose in the end, so long as you play only by the rules that
put the odds squarely in your favor. People who invest make money for
themselves; people who speculate make money for their brokers. And
that, in turn, is why Wall Street perennially downplays the durable
virtues of investing and hypes the gaudy appeal of speculation.

from "The Intelligent Investor" book by Benjamin Graham

Read the book here

Investment versus Speculation: Results to Be Expected by the Intelligent Investor

What do we mean by “investor”? Throughout this book the
term will be used in contradistinction to “speculator.” As far back
as 1934, in our textbook Security Analysis,1 we attempted a precise
formulation of the difference between the two, as follows: “An
investment operation is one which, upon thorough analysis promises
safety of principal and an adequate return. Operations not
meeting these requirements are speculative.”
While we have clung tenaciously to this definition over the
ensuing 38 years, it is worthwhile noting the radical changes that
have occurred in the use of the term “investor” during this period.
After the great market decline of 1929–1932 all common stocks
were widely regarded as speculative by nature. (A leading authority
stated flatly that only bonds could be bought for investment.2)
Thus we had then to defend our definition against the charge that
it gave too wide scope to the concept of investment.
Now our concern is of the opposite sort. We must prevent our
readers from accepting the common jargon which applies the term
“investor” to anybody and everybody in the stock market. In our
last edition we cited the following headline of a front-page article
of our leading financial journal in June 1962:

In October 1970 the same journal had an editorial critical of what it
called “reckless investors,” who this time were rushing in on the
buying side.
These quotations well illustrate the confusion that has been
dominant for many years in the use of the words investment and
speculation. Think of our suggested definition of investment given
above, and compare it with the sale of a few shares of stock by an
inexperienced member of the public, who does not even own what
he is selling, and has some largely emotional conviction that he
will be able to buy them back at a much lower price. (It is not irrelevant
to point out that when the 1962 article appeared the market
had already experienced a decline of major size, and was now getting
ready for an even greater upswing. It was about as poor a time
as possible for selling short.) In a more general sense, the later-used
phrase “reckless investors” could be regarded as a laughable contradiction
in terms—something like “spendthrift misers”—were
this misuse of language not so mischievous.
The newspaper employed the word “investor” in these
instances because, in the easy language of Wall Street, everyone
who buys or sells a security has become an investor, regardless of
what he buys, or for what purpose, or at what price, or whether for
cash or on margin. Compare this with the attitude of the public
toward common stocks in 1948, when over 90% of those queried
expressed themselves as opposed to the purchase of common
stocks.3 About half gave as their reason “not safe, a gamble,” and
about half, the reason “not familiar with.”* It is indeed ironical

(though not surprising) that common-stock purchases of all kinds
were quite generally regarded as highly speculative or risky at a
time when they were selling on a most attractive basis, and due
soon to begin their greatest advance in history; conversely the very
fact they had advanced to what were undoubtedly dangerous levels
as judged by past experience later transformed them into “investments,”
and the entire stock-buying public into “investors.”
The distinction between investment and speculation in common
stocks has always been a useful one and its disappearance is a
cause for concern. We have often said that Wall Street as an institution
would be well advised to reinstate this distinction and to
emphasize it in all its dealings with the public. Otherwise the stock
exchanges may some day be blamed for heavy speculative losses,
which those who suffered them had not been properly warned
against. Ironically, once more, much of the recent financial embarrassment
of some stock-exchange firms seems to have come from
the inclusion of speculative common stocks in their own capital
funds. We trust that the reader of this book will gain a reasonably
clear idea of the risks that are inherent in common-stock commitments
—risks which are inseparable from the opportunities of
profit that they offer, and both of which must be allowed for in the
investor’s calculations.
What we have just said indicates that there may no longer be
such a thing as a 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 stocks. Outright speculation is
neither illegal, immoral, nor (for most people) fattening to the
pocketbook. More than 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 be 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 skill for it; and (3) risking more money in speculation than you
can afford to lose.
In our conservative view every nonprofessional who operates
on margin† should recognize that he 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 of 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 a 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.
Results to Be Expected by the Defensive Investor
We have already defined the defensive investor as one interested
chiefly in safety plus freedom from bother. In general what
course should he follow and what return can he expect under
“average normal conditions”—if such conditions really exist? To
answer these questions we shall consider first what we wrote on
the subject seven years ago, next what significant changes have
occurred since then in the underlying factors governing the
investor’s expectable return, and finally what he should do and
what he should expect under present-day (early 1972) conditions.
from "The Intelligent Investor" book by Benjamin Graham

Read the book here


Now let’s take a moment to look at some of the major financial developments of the past few years:

1. 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.
2. Far deeper drops in the share prices of the hottest companies of the 1990s, including AOL, Cisco, JDS Uniphase, Lucent, and Qualcomm—plus the utter destruction of hundreds of Internet stocks.
3. Accusations of massive financial fraud at some of the largest and most respected corporations in America, including Enron, Tyco, and Xerox.
4. The bankruptcies of such once-glistening companies as Conseco, Global Crossing, and WorldCom.
5. Allegations that accounting firms cooked the books, and even destroyed records, to help their clients mislead the investing public.
6. Charges that top executives at leading companies siphoned off hundreds of millions of dollars for their own personal gain.
7. Proof that security analysts on Wall Street praised stocks publicly but admitted privately that they were garbage.
8. A stock market that, even after its bloodcurdling decline, seems overvalued by historical measures, suggesting to many experts that stocks have further yet to fall.
9. A relentless decline in interest rates that has left investors with no attractive alternative to stocks.
10. An investing environment bristling with the unpredictable menace of global terrorism and war in the Middle East.

Much of this damage could have been (and was!) avoided by investors who learned and lived by Graham’s principles. As Graham puts it, “while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster.”
By letting themselves get carried away—on Internet stocks, on big “growth” stocks, on stocks as a whole—many people made the same stupid mistakes as Sir Isaac Newton. They let other investors’ judgments determine their own. They ignored Graham’s warning that “the really dreadful losses” always occur after “the buyer forgot to ask ‘How much?’ ” Most painfully of all, by losing their self-control just when they needed it the most, these people proved Graham’s assertion that “the investor’s chief problem—and even his worst enemy—is likely to be himself.”
from The Intelligent Investor book by Benjamin Graham


Now let’s answer a vitally important question. What exactly does Graham
mean by an “intelligent” investor? Back in the first edition of this
book, Graham defines the term—and he makes it clear that this kind of
intelligence 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.” 2
There’s proof that high IQ and higher education are not enough to
make an investor intelligent. In 1998, Long-Term Capital Management
L.P., a hedge fund run by a battalion of mathematicians, computer
scientists, and two Nobel 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.3
And back in the spring of 1720, Sir Isaac Newton owned shares 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 £7,000. But just months later, swept up in
the wild enthusiasm of the market, Newton jumped back in at a much
higher price—and lost £20,000 (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.
Sir Isaac Newton was one of the most intelligent people who ever
lived, as most of us would define intelligence. But, in Graham’s terms,
Newton was far from an intelligent investor. By letting the roar of the
crowd override his own judgment, the world’s greatest scientist acted
like a fool.
In short, if you’ve failed at investing so far, it’s not because you’re
stupid. It’s because, like Sir Isaac Newton, you haven’t developed the
emotional discipline that successful investing requires. In Chapter 8,
Graham describes how to enhance your intelligence by harnessing
your emotions and refusing to stoop to the market’s level of irrationality.
There you can master his lesson that being an intelligent investor is
more a matter of “character” than “brain.”
from The Intelligent Investor book by Benjamin Graham

A Note About Benjamin Graham by Jason Zweig

"Who was Benjamin Graham, and why should you listen to him?
Graham was not only one of the best investors who ever lived; he was
also the greatest practical investment thinker of all time. Before Graham,
money managers behaved much like a medieval guild, guided largely by
superstition, guesswork, and arcane rituals. Graham’s Security Analysis
was the textbook that transformed this musty circle into a modern profession.

And The Intelligent Investor is the first book ever to describe, for
individual investors, the emotional framework and analytical tools that
are essential to financial success. It remains the single best book on
investing ever written for the general public. The Intelligent Investor
was the first book I read when I joined Forbes Magazine as a cub
reporter in 1987, and I was struck by Graham’s certainty that, sooner
or later, all bull markets must end badly. That October, U.S. stocks suffered
their worst one-day crash in history, and I was hooked. (Today,
after the wild bull market of the late 1990s and the brutal bear market
that began in early 2000, The Intelligent Investor reads more prophetically
than ever.)
Graham came by his insights the hard way: by feeling firsthand the
anguish of financial loss and by studying for decades the history and
psychology of the markets. He was born Benjamin Grossbaum on
May 9, 1894, in London; his father was a dealer in china dishes and
figurines.2 The family moved to New York when Ben was a year old. At
first they lived the good life—with a maid, a cook, and a French gov-erness—on upper Fifth Avenue. But Ben’s father died in 1903, the
porcelain business faltered, and the family slid haltingly into poverty.
Ben’s mother turned their home into a boardinghouse; then, borrowing
money to trade stocks “on margin,” she was wiped out in the crash
of 1907. For the rest of his life, Ben would recall the humiliation of
cashing a check for his mother and hearing the bank teller ask, “Is
Dorothy Grossbaum good for five dollars?”
Fortunately, Graham won a scholarship at Columbia, where his
brilliance burst into full flower. He graduated in 1914, second in his
class. Before the end of Graham’s final semester, three departments—
English, philosophy, and mathematics—asked him to join the faculty.
He was all of 20 years old.
Instead of academia, Graham decided to give Wall Street a shot.
He started as a clerk at a bond-trading firm, soon became an analyst,
then a partner, and before long was running his own investment partnership.
The Internet boom and bust would not have surprised Graham. In
April 1919, he earned a 250% return on the first day of trading for
Savold Tire, a new offering in the booming automotive business; by
October, the company had been exposed as a fraud and the stock
was worthless.
Graham became a master at researching stocks in microscopic,
almost molecular, detail. In 1925, plowing through the obscure
reports filed by oil pipelines with the U.S. Interstate Commerce Commission,
he learned that Northern Pipe Line Co.—then trading at $65
per share—held at least $80 per share in high-quality bonds. (He
bought the stock, pestered its managers into raising the dividend, and
came away with $110 per share three years later.)
Despite a harrowing loss of nearly 70% during the Great Crash of
1929–1932, Graham survived and thrived in its aftermath, harvesting
bargains from the wreckage of the bull market. There is no exact
record of Graham’s earliest returns, but from 1936 until he retired in
1956, his Graham-Newman Corp. gained at least 14.7% annually,
versus 12.2% for the stock market as a whole—one of the best longterm
track records on Wall Street history.
How did Graham do it? Combining his extraordinary intellectual
powers with profound common sense and vast experience, Graham
developed his core principles, which are at least as valid today as they
were during his lifetime:
• A stock is not just a ticker symbol or an electronic blip; it is an
ownership interest in an actual business, with an underlying value
that does not depend on its share price.
• The market is a pendulum that forever swings between unsustainable
optimism (which makes stocks too expensive) and unjustified
pessimism (which makes them too cheap). The intelligent investor
is a realist who sells to optimists and buys from pessimists.
• 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.
• No matter how careful you are, the one risk no investor can ever
eliminate is the risk of being wrong. Only by insisting on what
Graham called the “margin of safety”—never overpaying, no matter
how exciting an investment seems to be—can you minimize
your odds of error.
• The secret to your financial success is inside yourself. If you
become a critical thinker who takes no Wall Street “fact” on faith,
and you invest with patient confidence, you can take steady
advantage of even the worst bear markets. By developing your
discipline and courage, you can refuse to let other people’s mood
swings govern your financial destiny. In the end, how your investments
behave is much less important than how you behave.
The goal of this revised edition of The Intelligent Investor is to apply
Graham’s ideas to today’s financial markets while leaving his text
entirely intact (with the exception of footnotes for clarification).4 After
each of Graham’s chapters you’ll find a new commentary. In these
reader’s guides, I’ve added recent examples that should show you just
how relevant—and how liberating—Graham’s principles remain today.
I envy you the excitement and enlightenment of reading Graham’s
masterpiece for the first time—or even the third or fourth time. Like all
classics, it alters how we view the world and renews itself by educating
us. And the more you read it, the better it gets. With Graham as
your guide, you are guaranteed to become a vastly more intelligent

by Jason Zweig