Financial Affluence Podcast
Episode #006 – Mastering Value Investing – The Intelligent Investor by Benjamin Graham
On this episode of the Financial Affluence Podcast, we dive into the timeless wisdom of Benjamin Graham's The Intelligent Investor. We'll explore Graham’s value-driven, margin-of-safety approach to investing, covering key strategies for portfolio construction, stock selection, and financial analysis. This episode also discusses how modern commentary by Jason Zweig keeps Graham's principles relevant in today’s investment landscape.
If you'd like to get your own copy of The Intelligent Investor, click the link here:
The Intelligent Investor: The Definitive Book on Value Investing
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- Broadcast on:
- 21 Sep 2024
- Audio Format:
- other
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Financial Affluence Podcast. Listen your way to riches. Ready to unlock the secrets of smart investing? We're diving into the Intelligent Investor by Benjamin Graham, considered by many to be the Bible of sound financial decisions. And the best part is, this wisdom has stood the test of time. It's helped people navigate market crashes, bubbles, you name it. And speaking of surviving market turmoil, I've heard Graham wasn't just some writer theorizing from afar. This guy was in the trenches, right? He had real skin in the game. Oh, absolutely. He lived and breathed the markets, had his own share of wins and losses, which honestly makes his insights that much more valuable. He knew firsthand what worked and what didn't. Speaking of lessons learned, I hear there's a story about a tire company and a pretty steep learning curve. Something about the roaring 20s. Ah, yes, the Sevelled Tire incident. It's a classic case of speculation gone wrong. Picture this, 1919, the auto industry is booming and this new company, Sevelled Tire, Poxup. Everyone wants a piece of the action. Sounds like a recipe for a speculative frenzy. It absolutely was. And Graham, young and eager at the time, got caught up in the hype. He actually made a 250% profit on the very first day of trading. 150% in a day. Okay. I can see how that would get you hooked. Right. But here's the catch. Sevelled Tire turned out to be built on, well, not much. The company was exposed as a fraud and the stock crashed, becoming practically worthless. Ouch, that's gotta hurt. It reminds me of that saying, "If it sounds too good to be true." It probably is. And that's the lesson Graham took away from that experience. It's not about chasing those quick, exciting wins, but about becoming what he called an intelligent investor. And I'm guessing when Graham talks about intelligence. He's not talking about having a genius IQ rate. You're spot on. He actually says it directly in the book. Being an intelligent investor is a trait more of the character than of the brain. So less about being a mathematical genius and more about temperament. Precisely. Think patience, discipline, a thirst for knowledge, emotional control, and maybe most importantly, the ability to think for yourself. Okay. So not just blindly following the herd. Exactly. That's a critical distinction. Because there's a big difference between being an investor and being a speculator. Because we've all dreamt of outsmarting the market, of becoming the next Warren Buffett. It's tempting for sure. Graham uses a casino analogy to illustrate this. The speculators are like gamblers at the roulette wheel, trying to beat the house, convinced they can time the market perfectly. So they're all about those short-term bets, hoping to get lucky. Exactly. Investors, on the other hand, are playing a different game. They're focused on acquiring ownership in solid businesses, understanding what those businesses are really worth, and letting that value grow over time. So it's less about gambling on stock prices and more about owning a piece of something tangible, something real. And that's a powerful shift in perspective. Because you start thinking like an owner, your whole approach changes. You're not just looking at stock tickers. You're evaluating businesses, their management, their competitive advantages, all the things that contribute to long-term success. But it's easy to get caught up in the excitement of the market, to chase those hot tips and get rich quick schemes. Especially these days, right? Information overload everywhere. Everyone's predict the next big thing. But Graham actually had a lot to say about that. He did. And I think it's something we all need to hear, that trying to predict the market, even with all the fancy algorithm and expert opinions we have today, is essentially a fool's errand. He really doesn't mince words, and he's right, there's this very human desire to try and predict the future, especially when it comes to our money. But Graham argues that market predictions, even from those so-called experts, are often about as reliable as flipping a coin. So all those talking heads on TV making bold predictions about where the market's headed. Don't get too caught up in the noise. He actually predicted the 1969-70 market crash when the Dow Jones took a serious nose dive. He saw the warning signs when everyone else was riding high. He did. And that's why his principles are so timeless. They apply in every market cycle. Okay, so no crystal balls or market gurus. What does Graham suggest instead? How do we as intelligent investors navigate this unpredictable world? He offers this great analogy that's become famous in the investing world. Mr. Market. Mr. Market. Okay, I'm intrigued. Tell me more about this Mr. Market. Imagine a character prone to wild mood swings. Some days he's irrationally exuberant, other days he's gripped by fear and pessimism. Every day he shows up at your door, offering to buy or sell you shares of your businesses at wildly fluctuating prices. Sounds exhausting like a roller coaster you can't get off. It can be. But here's the thing. You don't have to play his game. You can choose to ignore his manic depressive behavior and focus on what you know the underlying value of your investments. But you kind of have to let Mr. Market's mood swings work for you, not against you. Exactly. If he's in a bad mood, offering a ridiculously low price, you buy. If he's feeling euphoric and overpaying, you might consider selling. The point is you're not letting his emotions dictate your actions. You're making rational decisions based on your own assessment. Okay, that makes sense. But how do you determine that intrinsic value? How do you know when Mr. Market is offering a steal or grossly overcharging? Yeah, my friend is the million dollar question. And luckily for us, that's what we'll be diving into in our next part. Well, I can't wait to uncover those secrets. We'll be back in a jiffy with more insights from the intelligent investor. So we've established that we don't want to get swept up in Mr. Market's drama. But how do we figure out what a business is actually worth? There's no magic formula, but Graham gives us a framework, a set of tools. We have to think like detectives uncovering hidden gems. Okay, I'm ready to put my detective hat on. What are we looking for? First and foremost, Graham believed in a strong balance sheet, plenty of cash on hand, low debt, assets that can weather any storm. We're talking about companies with solid financial foundations, right? Not those built on smoke and mirrors. Exactly. He actually looked for companies whose stock price was lower than their networking capital. Wow, that's conservative. So even if the company went belly up, you'd still get your money back from the assets. That was the idea. It's rare to find those kinds of deals these days, but the principle remains. You want to cushion a margin of safety for those inevitable downturns. Solid balance sheet check. What's next on our detectives checklist? Earnings, of course. Can this company consistently generate profits? But Graham looked beyond the most recent quarter. He looked at average earnings over five to 10 years. To get a clearer picture of their true earning power, right? Not just a snapshot in time, right? And be wary of those pro forma earnings. They can be manipulated to look better than they are. Like airbrushing the financials, give me the raw, unedited version. Exactly. Graham also placed a lot of emphasis on dividends. Dividends? Ah, yes. That sweet cash flow straight into your pocket. Precisely. Dividends represent a tangible return, regardless of what Mr. Market is doing. Yeah. A sign of financial strength. It shows they're confident in their long-term ability to make money, but don't some companies argue they can reinvest that money for even better growth? They do. And sometimes that's true, especially for high growth companies. But Graham believed the company needs to prove they can reinvest those profits at a higher rate than shareholders could elsewhere. So don't buy the growth argument blindly. Show me the evidence. Right. And this leads to another important point. Graham looked beyond the numbers. He focused on management, their competitive advantages, their long-term prospects, basically their story. So we're not just crunching numbers in a vacuum, we're trying to understand the whole picture, the company's place in the world. Exactly. And that requires effort. Going beyond the headlines, doing your homework, remember, we're playing the long game here. Right. No get-rich-quick schemes. But even with all this research, there's still uncertainty. We can't predict the future, can we? No, we can't. Even the best analysis can't eliminate risk. And that's where Graham's concept of the margin of safety comes in. Margin of safety, like that extra padding you need when you're learning to ride a bike? Tell me more. It means buying a company for significantly less than you think it's worth. It's a buffer against market fluctuations. A cushion for when Mr. Market goes off on one of his tangents. So even if you're a little off with your initial assessment, you've got room for error. Exactly. The wider the margin of safety, the lower the risk. Graham aimed for at least 50%. Meaning he wouldn't pay more than two-thirds of what he believed the company was worth. He really was the ultimate bargain hunter. But with today's valuations, those bargains seem hard to come by. It's definitely more challenging. But remember, that's where being an intelligent investor gives you an edge. Focus on value, not hype, and you can still find those opportunities. Okay, so we've covered a lot, strong balance sheets, earnings, dividends, management, and the margin of safety. I'm feeling a little overwhelmed. It's a lot to take in, I know. But it becomes more intuitive over time. Like learning a new language. At first it's intimidating, but then it just clicks. Exactly. So now let's talk about some practical steps you can take to build a more intelligent portfolio using what we've learned from Graham. Now we're talking. Give me the good stuff. One of the most crucial things is diversification. Don't put all your eggs in one basket no matter how promising it seems. Spread the risk. Don't fall in love with a single stock. Exactly. Diversify across different industries, geographies, even asset classes. Stocks, bonds, real estate, maybe even some gold. Precisely. Another powerful tool is dollar cost averaging. I've heard of it, but refresh my memory. How does that work again? Simple but effective. You invest a fixed amount at regular intervals, regardless of what the market's doing. So you buy more when prices are low, fewer when high. Makes sense, but hard to do when emotions run high. It is. Time to get swept up in the excitement, buying high, but dollar cost averaging removes emotion. You stick to your plan. Which with Mr. Market's mood swings is probably for the best. Definitely. And finally, the intelligent investor is patient. They're building wealth over the long term, not chasing quick wins. Patience. A virtue and short supply these days. We all want everything instantly. It's true. But in investing, it really is key. Remember, Graham said, "The investors should know about these possibilities and should be prepared for them both financially and psychologically." Wise words, and incredibly relevant even today in our fast-paced world. We've talked about the mindset of an intelligent investor, but how about we see these principles in action? Did Graham have any examples, any stories that really bring this to life? Absolutely. One of my favorites is the story of Northern Pipeline Co. It shows how research and spotting value can lead to amazing opportunities. I love a good treasure hunt. Tell me more. It's 1925. No internet. No fancy databases. Graham's pouring over these dry technical reports filed with the U.S. Interstate Commerce Commission. Talk about dedication. He wasn't just skimming headlines, he was going deep. Exactly. And it paid off. Buried in these reports, he uncovers this company, Northern Pipeline Co. Trading at $65 a share, but his analysis showed they held at least $80 per share in bonds alone. Hold on, the market was basically saying the entire company was worthless. That's wild. That's how inefficient things could be, especially with those less exciting companies. Graham saw this discrepancy, bought as much stock as he could, and then he started pushing the management to increase the dividend. He wasn't messing around, I like it. He wasn't. And it worked. Three years later, he sells his shares for $110 each. A 69% return in three years from a company everyone else seemed to write off. That's incredible. So what's the takeaway? Should we be hunting through old government reports? Maybe not those reports specifically, but the point is opportunities are still out there for those who do the work, who think differently, and who look where others aren't looking. Hidden in plain sight, as they say. Sometimes the best investments are the ones everyone else has overlooked. Exactly. Now let's fast forward a few decades to the late 1960s. Markets on fire, valuations are sky high, everyone's feeling good. That's a bit like the dot-com bubble we talked about, that irrational exuberance. Very similar. And yet, in the midst of all this, Graham's spots trouble brewing. He actually predicts the 1969-70 market crash when the market takes a serious hit. He kept a cool head when everyone else was getting swept up. He did. And that's a hallmark of the intelligent investor. They understand those swings are inevitable, and use that to their advantage. They don't panic and sell when the market dips. They have that long-term view. They know true value will prevail. Exactly. Goes back to that margin of safety. It's your protection, your buffer, against those moments when the market loses its mind. So we've got Northern Pipeline, deep research on covering hidden value, and the 1969 crash reminding us to stay grounded. What's the common thread here? What's the big takeaway for our listeners? Intelligent investing isn't about outsmarting the market, predicting the future or chasing hot tips. It's about building a sound philosophy based on timeless principles, sticking with it with discipline and patience, especially when things get crazy. Turning out the noise, doing your homework, making rational decisions based on real value, becoming a student of the market, always learning, always growing. That's it. And as we wrap up this deep dive into the intelligent investor, I'll leave you with a final thought. I'm listening. In a world obsessed with instant gratification and short-term wins, are you willing to embrace the long-term perspective? Are you willing to cultivate the patience and discipline to become a truly intelligent investor? That's a question we all need to ask ourselves. Thanks for joining us on this deep dive into the world of intelligent investing. Until next time, keep learning, keep growing, and keep diving deep. 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