Summer reading: The Intelligent Investor
Often when I’m about to leave on vacation and am hunting around for some appropriate reading material I’ll pick up an investment classic under the theory that after the first or second read I must know it pretty well and so it’s become a ‘light’ read. I find rereading a classic title can always benefit me in some way, reinforcing a good investment lesson or perhaps even picking up a few insights that I might have missed on previous reads. This year I stuffed a well-worn copy of “The Intelligent Investor” into my carry-on, a book that is especially dear to me as I picked it up at a yard sale for a dollar!
I’ve now made it through again from cover to cover, and much to my delight I did pick up a few tidbits that I had either ignored on my previous reads, forgotten about or simply thought not that important.
The first thing that struck me was that I didn’t remember ‘the dean’ (of value investing) focusing quite so much on market conditions. Yes, the first three chapters of the book are dedicated to a discussion of portfolio allocation for the conservative investor (25%-75% common stocks, the balance in bonds) and WHEN TO PURCHASE (naturally, when the market is low). The interesting thing is that Graham delves into what exactly he means by this, using concrete examples from the time periods corresponding to the various editions of the book. I have the 5th edition which was published in 1972. He expounds on exactly where he thinks the market is in 1971 (not over valued but certainly not undervalued) and then looks back on what he said in previous editions about the market conditions and what happened subsequently. His take on market conditions is always based on the long-term, i.e. 10, 15 even 20 years. What I find fascinating is that he isn’t looking for returns of more than the 6-8% annually (share price appreciation plus dividend yield), about what the overall market has experienced in the past 100 years. Here, it should be remembered that he is considering this from the CONSERVATIVE investor’s perspective. Furthermore, he seems to be using a kind of common sense measure rather than an exact measure and leans toward erring on the conservative side.
So what would the dean say about today’s market? I think he would conclude that shares are generally not underpriced, given that we are now at record highs for almost all US equity market indices. But would he conclude that they are overpriced? I don’t think so. Equity market P/E ratios at the time my edition of the book was published were around 15 and he was advocating a neutral stance (50% common stocks, 50% bonds). Today the S&P 500 P/E is about 18, so we are somewhat higher (20%) but not terribly so. I would extrapolate from this that Graham might suggest a 40% exposure to common stocks today. Defensive, yes, but not completely so.
The second thing that struck me was the meticulous methodology that Graham adhered to. In the book he narrows down the types of investments that the aggressive investor should focus on (and I would put myself in that category given the amount of time I have to dedicate to investing, even if I don’t really dedicate as much time as I might) based on the results he has experienced over the past 10 to 20 years. This means that he tracked the outcome of his investments based on type, and then analyzed this data for use in directing his future investments. How many of us do that? Do you know whether you are better at net-net investing or merger arbitrage? And, can you separate the true skill factor from the luck factor for each investment you have made? I think few of us, me included, are quite so exact about our historic performance. Perhaps we track the overall performance of our portfolio (let’s hope so!), but do we go into detail about how exactly our successes (and failures) occur? For me this is a call to action. More reflection on and analysis of the investment process and less infatuation with what Mr. Market is doing today!
Once again I’ve wrung something more out of a great investor’s writings, and it won’t be the last time I find something to reflect on in “The Intelligent Investor” no matter how many times I read it.