The Intelligent Investor

How to look at bonds???? Research info

Preferred stock- have claim on assets before common shareholders if company goes bankrupt,
pay set dividends at regular intervals must pay preferred shareholders before common
shareholders
Dilution-When a company issues new shares this results in a decreased percentage ownership
for EXISTING shareholders. This usually decreased the EPS. Companies can sometimes buy
these shares back and play with the EPS so it will look HIGHER.
Index funds- look into!!!!
Pro forma- (of a financial statement) showing potential or expected income, costs, assets, or
liabilities, especially in relation to some planned or expected act or situation.
Dow Jones-A list of 30 large publicly owned companies trading in the New York stock change
o The DJIA is calculated through a method of simple mathematical averages.
S&P 500 Index- A list of 500 companies in the U.S
o The S&P 500 is calculated by giving weights to each stock according to their
market value
Bond-essentially a loan
 High grade bond is a bond that has a lower credit rating
Common stock- corporation…multiple people get a piece of a company
Investment portfolio- assets
Yield- refers to earnings generated and realized on an investment using the amount invested and
a percentage based on the invested amount
Convertible issues-issue of corporate bonds that can be converted into shares of the company
Mutual funds-A mutual fund is a type of investment vehicle consisting of a portfolio of stocks,
bonds, or other securities
Dividend yield- annual dividend per share/ stock price per share
o Higher dividends yield could mean that you are getting more dividends back
on returns
o It could also mean that the stock price for the company could be decreasing
P/E Ratio-Price to earnings ratio
o High P/E could potentially mean that a company’s price is high compared to
earnings and possibly overvalued
o Companies that are growing quickly often have high P/Es and this could mean
that investors are expecting growth in the company justifying the high P/E
ratio
o Below 10 is considered low bargain
o Between 10 and 20 is considered moderate
o And greater than 20 is considered expensive
Introduction
The intelligent investor does the following:
 Pendulum of the market endlessly swings due to pessimism and optimism. Sell from
optimists (makes price higher) and buy from pessimists (makes price lower)
  A stock is not a symbol or a ticker, it is a real interest in an ownership with
underlying value that does not depend on share price
 Future values on stocks are all functions of the present value, higher the price less the
profit
 The one risk every investor always will have is the risk of being “wrong. By any
means never overpay, no matter how exciting a stock or investment can be as
you can minimize your odds of error.
 The secret to financial success is inside yourself. Take no Wall street “fact” as faith
and invest in patient confidence. By developing discipline and courage you can refuse
to let other people’s mood swings effect financial destiny. In the end what’s important
is how not how your investments behave but how you behave.

 Obvious prospects for physical growth in a business do not translate into obvious profits
for investors

Chapter 1: Investing vs Speculation

Investment- an operation which upon thorough analysis promises safety of principal and an
adequate return. Operations which do not meet such requirements are considered speculative

A Real investor does:

 Not expect better than average results by buying new offerings or “hot” issues
 Defensive investor must confine himself to shares of important businesses with a long
record of profitable operations and in strong financial condition
 Dollar cost averaging… meaning buying common stocks with the same dollars every
month or quarter
 Diversify investment aka “safety of principal”

Aggressive investor
 Buying stocks that are “behaving” a bit above average market and later selling as the
value decreases
 Having much enthusiasm and excitement when investing
 Buying stocks short term as they are reported to go up in value
 Buying a company who has a history of trending upwards then investing and thinking it’ll
continue or may choose company with not very good results but are expected to have a
upward trend in the future
o An investor calculates what a stock is worth based on the value of its businesses
o A speculator gambles that a stock will go up in price because somebody else will pay
even more for it

Chapter 2: The Investor and Speculation

Effects of Inflation
o People with a fixed income suffer when cost of living increases
o Shareholders have possibility that loss of dollar’s purchasing power may be offset by
advances in dividends and price of shares
Inflation
 Difficult to predict
 No close time connection between common stock and inflation
 Moderate inflation is generally good for stocks on return
 Deflation often times causes loss on returns from stocks
 Extreme inflation causes stocks to act erratically and big losses can occur up to 10%

Chapter 3: Level of Stocks prices in Early 1972

 Why should future returns on stocks always be the same their past returns?
o DUE TO THE FACT THAT COMPANIES RETURNS ARE FINITE, THE
PRICE INVESTORS SHOULD BE WILLING TO PAY MUST BE FINITE
 The stock market was booming in the late 1990s inflation was low,
corporate profits were appearing to be high, however that does not
mean you can pay ANY price for a stock
 i.e. Michael Jordan was the greatest basketball player of all time the
Bulls got a bargain for him to play for $34 million a year. But that
does not justify the Bulls paying $100 million a year for him
 When every investor believes that stocks are guaranteed to make money in the long
run won’t the market end up being wildly overpriced? How can returns possibly be
high in the future?
 The stock market’s performance essentially depends on three factors
o Real growth (rise of companies’ earnings and dividends)
o Inflationary growth (general rise of prices throughout the economy)
o Speculative growth or decline (any increase or decrease in the investing
public’s appetite for stocks)

Chapter 4: General Portfolio Policy the Defensive Investor

Bond-stock allocation
 Investments should be made between high-grade common stocks and high-grade bonds
o The defensive investor should never have less than 25% or more than 75% of his
funds in common stocks with bonds within the range of 75% and 25%
How aggressive should your portfolio be? There are two ways to be an intelligent investor
o By continuously researching, selecting monitoring a dynamic mix of stocks
o By creating a permanent portfolio that runs on autopilot and requires no further effort
(but generates very little excitement)
These are essentially the two paths that one can take when becoming an intelligent investor
however both have pros and cons and depending on one’s personality each path would hinder or
benefit them. (There are people that can do a combination of both of these)

Money allocation
 How you allocate your money depends on one’s circumstances, will they change?, will
the door kick in?, how much do you earn?, what are your expenses?
 Single or married?
  Children?
 Will you inherit money, or will you end up financially responsible for aging parents?
 What factors might hurt your career?
 Do you need investments to supplement your cash income? (in general bonds will; stocks
won’t)
 Given salary how much money can you afford to lose on investments?
IF YOU FEEL AFTER THESE FACTORS YOU CAN TAKE THE HIGHER RISKS IN
GREATER OWNERSHIP OF STOCKS ONLY THEN you can belong around 25% of Graham’s
in bonds or cash. IF NOT then steer towards the 75% in bonds or cash. (once these percentages
have been made change them as your life circumstances change).
Rebalancing allocation
 These allocations made can also change for instance if you have 70% in stocks and 30%
in bonds and the stock market goes up by 25% and your bonds stay steady you now
approximately have 75% in stocks and 25% in bonds
o To make sure that your allocation is in order it is recommended that every 6
months rebalance the allocation on easy to remember dates like new year or 4th of
July (use the 401(k))
Taxable or tax free?
 Unless your in lowest tax bracket you should only buy tax-free (municipal) bonds outside
of your retirement
 Only taxable income should be within your 401(k)

Short term or long term

 Bonds and interest rates teeter if interest rates rise, bond prices fall
 Short term bonds fall far less than long term bonds
 If interest rates fall and bond prices rise, then long term bonds outperform shorter ones
 By buying intermediate bonds maturing from 5 to 10 years which do not soar when their
side of the seesaw rises but don’t slam into the ground either
Bonds vs bond funds
 You must buy at least 10 bonds to diversify away the risk if one of them fail
 Bond funds offer cheap and easy diversification while individual bonds don’t make sense
for a regular person unless you have $100,000 to put into bonds
 Major firms like Vanguard, Fidelity, Schwab and T. Rowe Price all offer low bond funds
at a low price

Chapter 5: The Defensive investor and Common Stock

4 Rules of common-stock component
1. Must be diversification between investments in common stock but not too much. Min 10
issues with a max of 30
2. Each common stock must be large, prominent and conservatively financed.
3. Every company should have a long record of continuous payments.
4. Investor must impose limit on price he will pay for an issue in relation to its average
earnings over
Advantages of common stock
 Better protection from inflation than bonds
  Higher yield than bonds

Dollar cost averaging

 Lower cost of shares
 Reduces risk of investing a lump sum when prices are higher
 Limitation is when investing in a market upswing (could constantly pay higher prices)

When people are sometimes familiar with a company, they get lazy and feel as if they already
know everything about the company and do not do any research

Chapter 6: Portfolio Policy for the Enterprising Investor: Negative

Approach
Read pg146 on just being blinded by yield when looking at bonds
 Purchasing foreign bonds are as risky as junk bonds but they do offer something which is
that they are not affected by the DOW so if the Dow happens to be down, they won’t be
affected
 When you trade instead of investing you turn long term gains into REGULAR INCOME,
so you are taxed more at max 38.6% while long term gains are max at 20%

IPO- initial public offering which is initial start of stock to public for that company
 Sounds like a great idea to begin with as so many investors want to buy the “next
Microsoft” however most companies DO NOT reach that and are a risk for many
investors
 IPOs also go against one of Graham’s fundamental teachings which is “no matter how
many people want to buy a stock, you should buy only if the stock is a cheap way to own
a desirable business”
Chapter 7: Portfolio Policy for The Enterprising Investor: The
Positive Side
Growth Stocks
 When a company is going up rapidly at some point it will slow down as it gets
increasingly difficult to maintain that level of growth
Buying an unpopular large company
 When a company’s price is increasing the company’s, growth slows down many think
it’ll keep growing and growing when seeing this
 The intelligent investor often gets interested in a large company that is a growth stock
when things “go wrong”
o For instance, in 2002 Johnson and Johnson announced that federal regulators had
a case with them for false keeping at drug factories at this point in time stocks
crashed for Johnson and Johnson and were considered a growth stock at this point
in time go to pg. 184 for another example
Do not keep your eggs in one basket pg. 185
Go to pg186 for link to help analyze stocks

Chapter 8: The Investor and Market Fluctuations

The two most important aspects of purchasing are
 Timing
 Price
Reasons why theories and formulas don’t work for long
 Passage of time brings new conditions so that formula or theory doesn’t work after
 Popularity of trading theories makes a difference as the profit-making possibilities
detracts as everyone does the same thing

Investors tend to put money into stocks when they are increasing, and this gives money to
managers to invest into more stocks causing the company to go into higher prices
o Refer to pg 218 for how “pros become a slave to the market”
 Brokerage costs- trade rarely, patiently, and cheaply
 Ownership costs- by refusing to buy mutual funds with excessive annual expenses
 Your expectations-use realism, not fantasy, to forecast your returns
 Tax bills-by by holding stocks for at least one-year end and whenever possible, for at
least five years, to lower your capital gains liability
The expectation for investing should not be to make more money than the average but to
make enough money for YOUR NEEDS!!

o Our brains are designed to constantly want to perceive trends in all aspects of life the new
technology, game, sports player and stocks are no different and that’s why many get tied
up in wall street
o Checking your phone to see your stocks is unhealthy as
o If you bought a property and asked your real estate agent to give an estimate of
price and value would your call them the next day and asked if it had changed

Bull market indicators

1. A historically high price level

2. High price/earnings ratio

3. Low dividend yields as against bond yields

4. Much speculation on margin

5. Many offerings of new common stocks of pour quality

Chapter 9: Investing in Investment Funds

 Average funds do not pick stocks well enough to overcome its costs of researching and
trading them
 Higher the expenses usually lower the returns
 The more frequent the fund trades stocks the less it tends to earn
 Highly volatile funds which can bounce up and down are likely to stay volatile
 Funds with high past returns are unlikely to remain winners for long (pg246 for more
reasons)
Migrating managers- When an advisor seems to have the Midas touch when picking stocks
they usually are switched in about a year and go to another firm potentially even start their own
business

Index funds pose a huge advantage over mutual funds they have a far smaller operating expense
and it can really accrue over a long period of time compared to mutual funds

Index funds
 Managers own most so they treat your money like its theirs
 The operating expenses are cheap
 They try to be different compare the fund’s holdings with the S&P 500 index if they are
the same then choose another fund
 When the fund close to new investors only their existing shareholders to buy more this
stops the pains of asset elephantiasis this should be done before the fund blows up in size
 The best funds are the one’s that don’t advertise and act like they don’t need your money

Evaluate the fund’s prospectus

 Check a funds Morningstar rating a rating from 1 to 5 bases how much risk they took to
earn their returns (1 is the worst 5 is the best). 5-star funds have a habit of
underperforming compared to 1-star funds. Remember these ratings are based on THE
PAST they don’t always predict the future
o Find a fund who has low cost, managers who are major shareholders, dare to be
different, don’t hype their returns, and have shown a willingness to shut down
before they got too big for their britches then find their Morningstar rating
o Be careful looking at the previous success yesterday’s winners are often
tomorrows losers, but another thing is yesterday’s losers almost never become
tomorrow’s winners
 If you’re not willing to get married, then don’t a fund is no different at least three lean
years must be spent if you’re looking at investing in a fund

Chapter 10: The Investor and his Advisors

Sometimes when people seek help they don’t want the pressure of buying stocks and they
sometimes want help for guidance or even they want someone to blame if it all goes wrong

You need a hand if you have the following

 If you have big losses in your investments
 If you fail to budget your money
o Find it hard to save on a regular schedule
 Chaotic portfolio
o Many people think they are “diversifying” when they buy say seven different
internet stock or seven different U.S growth stocks
 Major changes
 o If you have tough circumstances with aging parents for say or college for you
children or other types of hardships
Trust then verify
 Make sure to not be gullable when speaking to advisors
 Make sure to be comfortable with the other person and analyze if they are truly honest or
not
o Asking someone you know and have a close connection with and asking them
who their advisor is and if they give them good advice can be a good place to start
 Once you have found the person you must see their specialty stockbroker, financial
planner, accountant, insurance agent???
o Google their name to see if they have any lawsuit or cases against them
o If the person is a stockbroker or insurance agent contact the office of your state’s
securities commissioner and ask if they have any customer complaints or
disciplinary actions filed
o Financial planners in the U.S must register to the U.S securities and Exchange
commission or regulators
o For more info go to pg275 and see words of warning
 See whether the advisor cares aobut helping clients or just goes through the motions
 Make sure he or she understands the fundamental principles in this book about investing
 Make sure they are sufficiently educated, trained and experienced to help you
 Some prominent questions to ask your advisor would be
o Why are you in this business?
o What is the mission statement of your firm?
o What is your investing policy?
o Do you use stocks or mutual funds?
o Do you use technical analysis?
o Do you use market timing?
 IF THEY ANSWER YES TO THE LAST TWO QUESTIONS THIS IS A
NO AND A SIGNAL TO YOU, THEY CAN SPECULATE
o For more questions go to pg 277 for all questions IMPORTANT

 Keep in mind good advisors do not grow on trees and often the best ones already have
enough clients he or she may ask you questions and may only take you if you seem a
good match
o Why do you feel you need a financial advisor?
o What are your long-term goals?
o What has been your greatest frustration in dealing with other advisors? (including
yourself)
o Do you have a budget?
o Do you live within your means?
o What percentage of your assets do you spend each year?
o When we look back a year from now what will I need to have accomplished in
order for you to be happy with your progress?
o How do you handle conflict?
 o What are your financial fears? Your greatest financial hopes?
 An advisor is not hired to manage your money they are hired to manage YOU
 If your advisor is the defence between your money and your bad tendencies, then they
should have the following
o A comprehensive financial plan that outlines how you will earn, save, spend,
borrow, and invest your money
o An investment policy statement that spells out your fundamental approach to
investing
o An asset-allocation plan that details how much you will keep in different
investment categories
Chapter 11: Security Analysis for the Lay Investor
There are 5 major determinants Graham lists as to judge a company’s value
 The company’s “general long- term prospects
o Get 5 years’ worth of report off of sites from company of www.sec.gov.
o Find what makes this company grow? Where do its profits come from?
 Is the company making 2 or 3 acquisitions a year? Take a hint if they are
investing in other companies but not their own
 See how many sources of revenue the company has? Make sure they
aren’t Johnny one note just getting revenue from a single place
 Make sure the company is not growing “too fast” as fast revenues are not
sustainable long term
 Quality of its management
o Look at if “nonrecurring” charges keep recurring
o See if EBITDA take priority over net income or “pro forma” earnings
o Are they managers or promoters?
 Financial strength and capital structure
o Dividend record
 Make sure the money is being put to good use
 The company must prove to you that they can sell you the company even
without the dividend
o Current dividend rate
 Intrinsic value formula
o Value = Current (Normal) Earnings x (8.5 plus twice the expected annual growth
rate)
 Updated intrinsic value formula
o V = {EPS x (8.5 + 2g) x 4.4} / Y

Chapter 12: Per- Share Earnings

Pro forma
 Historically companies have tampered with their “as if” statements as an intelligent
investor try to ignore these for the most part
Reading financial reports
 In company reports anything they do not want you to see will likely be at the back which
is a great reason why to start there
  Read the footnotes usually labelled “summary of significant accounting policies”
 GET BOOK FOR READING FINANCIAL REPORTS
Dilution
 When a company issues new shares this results in a decreased percentage ownership for
EXISTING shareholders. This usually decreased the EPS. Companies can sometimes buy
these shares back and play with the EPS so it will look HIGHER
Special charges
 If a company incurs a loss, they may label this as a “special charge”
o Thus, making the “primary earnings” higher and increasing the EP
Chapter 13: A Comparison of Four Listed Companies
Stability
 Can be measured by max decline in per share earnings any of the past 10 years as against
the average of the three preceding years
High to low price ratio formula in between years
High/low= ratio

The 7 statistical requirements for inclusion in a defensive investor’s portfolio

 Adequate size
o
 Sufficiently strong financial condition
o The 2-1 ratio of assets to liabilities bare minimum
o Long term debt should not exceed current net assets
 Continued dividends for at least the past 20 years
 No earnings deficit in the past ten years
 Ten-year growth of at least one third in per share earnings
 Price of stock no more than 1 ½ times net asset value
 Price no more than 15 times average earnings of the past three years

Chapter 14: Stock Selection for The Defensive Investor

7 requirements for common stocks
 Adequate size
o Market value of at least 2 billion in today’s market
 Sufficiently strong financial condition
o The 2-1 ratio of assets to liabilities is a bare minimum requirement
o Long term debt should not exceed current net assets
 These both allow the company to STAY so the chances of it gradually
going up in the future is higher
 Earnings stability
o Some earnings for the common stock in each of the past ten years
 Dividend record
o Uninterrupted payments for last 20 years
 Earnings growth
 o Min increase of at least one third in per share earnings in the past ten years using
three-year averages at beginning and end
 Moderate price/ Earnings ratio
o Current price should not be more than 15 times average earnings of the past three
years
 Analysts nowadays use a “forward P/E Ratio” which is derived by
dividing the current price by something called “next year’s earnings” but
its nonsense to make an assumption by using a made-up number from next
year’s earnings often calculations have been far off
o Current price divided by average of earnings over past three years
 Moderate ratio of price to assets
o √¿ ¿
o Graham recommends a ratio of no more than 1.5 in ratio of price to book value
 Recent years have seen companies have increasing value from intangible
things like patents, trademarks and franchises
 Due to this companies are priced higher compared to Graham’s
day
 Selectivity for the defensive investor
o Every investor has different views on stocks if you were to ask the top financial
personnel to choose the best 5 stocks to buy, they would likely all have different
lists
 This is down to each person’s personal partialities and expectations
 If everyone was to buy the same stock, then that stock would advance to a
high price and would offset all previous advantages
o When investing you are investing in the present for the future and the future is
ALWAYS uncertain there could be economic recessions, upheaval of war,
terrorist attacks and commodity shortages all come at random and could have a
large effect on the market

Chapter 15: Stock Selection for The Enterprising Investor

 Arbitrage
o Purchase of a security and simultaneous sale of one or more securities into which
it was to be exchanged under a plan
 ROIC=Owner Earnings/ invested capital refer to pg 398
o Way of measuring how efficiently company uses shareholders money and how
efficiently it uses from its operating businesses
 Finding out who the owner is important
o Do “they think like owners and not just managers”
 Are the financial statements easily understandable, or are they full of
obfuscation
 Are there “unusual”, “extraordinary” costs taking place regularly or a one
off
 Finding honesty in statements of leaders is important if the company is not
doing well that the leader is honest and takes ownership of that in the
financial reports and meetings
  Warren buffet method
o Franchise companies with strong consumer brands, easily understandable and
near monopolies in their market like H&R Block, Gillette and Washington Post
o Get these kinds of stock when a scandal or a new loss occurs
o See managers who build realistic expectations and build the company from within
and not with acquisition

Chapter 16: Convertible Issues and Warrants

 Graham states that when using convertible bonds that the investor must give up
something usually either in quality or yield or both
 In the past main fund managers have converted their convertible bonds into stocks and
when doing so they became all hypnotised by the company’s prospects and no longer
were investors but became speculators in that instance
 Graham generally mistrusts convertible issues as that is his overall view of them
 Warrants are a derivative that give the right, but not the obligation, to buy or sell a
security most commonly an equity at a certain price before expiration. The price at which
the underlying security can be bought or sold is referred to as the exercise price or strike
price
o Warrants overall are very useless and investors should stay away from them as
they are complete nonsense due to speculating about a price during the course of
the warrant

Chapter 19: Shareholders and Managements: Dividend Policy

 The attitude towards dividends has changed from previous years before shareholders
wanted more liberal dividends as opposed to small ones
o Now companies want smaller dividends to retain funds and expand business
 Proper stock dividend is described as one that is paid to shareholders to give them a
tangible evidence or representation of specific earnings which have been reinvested in the
business for their account over some relatively short period in the recent past
 Many shareholders nowadays are very sheep like and do not know exactly what it means
to be a shareholder
o As a shareholder the company works for you
o Hold them accountable and pay attention in the meetings and make sure
management is doing their best
 Is management efficient?
 Are the interests of the average outside shareholder receiving proper
recognition?
o Compare management’s profitability, size and competitiveness against similar
firms
o If management is deemed unsuccessful
 A few of the substantial stockholders should be convinced that a change is
needed
 The rank and file of the stockholders should be open minded enough to
read material and hear arguments on both sides and know when
management has been unsuccessful and demand more
  Numbers should be clear to show progress

Chapter 20: Margin of Safety as the Central Concept of Investment

 The margin of safety is the difference between the percentage rate of the earnings at the
price you pay for a stock with the interest rate on a bond. So, if the rate of earnings on a
stock is 9% and a bond is 4% then the margin of safety is more than 100%
o This can also be sometimes done with value and price the difference is the
cushion you have
 Diversification goes hand in hand with the margin of safety for example
o If you are playing roulette and there are 37 numbers and you bet 1$ on a number
and if you win you get 35$ your odds are 37 to 1. Diversification would not make
sense in this situation because if you pay more you end up lessening your chances
of maximizing profit. However, if the winner got 39$ then you could bet on every
number and at least make 2$ on every spin