This is the twenty-first (and last) in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the twentieth and final chapter, which is on pages 512 to 524, and the Jason Zweig commentary, on pages 525 to 531.

We’ve reached the end of the trail.

This chapter closes out The Intelligent investor by discussing the true message behind the book: companies that provide a great value are quiet, solid, and able to resist competition. They just pay out their dividends and keep doing what works.

Graham sums this up in one concept: the “margin of safety.” Simply put, it’s the idea that a company has established such a stable business that the company can succeed through many environmental changes. The economy goes up or it goes down - either way, the company is safe and stable. Competitors come and competitors go - the company survives. Management changes - the company rolls right through it.

Companies that have established themselves with such steadiness are the real value stocks. Quite often, companies like this are actually seen as boring (particularly if the company’s business is not in an exciting sector) and thus are often ignored in the “hype” talk on CNBC and the like. That means there aren’t a whole lot of buyers, even though the company is very strong, and that results in an undervalued stock. You buy it for cheap, ride the stability, and collect dividends along the way.

Sounds like a great plan to me.

Chapter 20 - “Margin of Safety” as the Central Concept of Investment
A single quote by Graham on page 516 struck me:

Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.

Basically, Graham is saying that most stock investors lose money because they invest in companies that seem good at a particular point in time, but are lacking the fundamentals of a long-lasting stable company.

This seems obvious on the surface, but it’s actually a great argument for thinking more carefully about your individual stock investments. If most of your losses come from buying companies that seem healthy but really aren’t, isn’t that a profound argument for carefully studying any company you might invest in?

Graham takes this point a step further, arguing that diversification is strongly correlated with margin of safety. In effect, Graham states that you introduce some additional margin of safety into your portfolio when you own a widely diverse array of value stocks that each have significant margin of safety.

Graham’s final note is pretty simple: investors get in trouble when they abandon their basic principles in the heat of the moment. One must approach investing with a set of fundamental principles and not abandon them in the heat of the moment.

Commentary on Chapter 20
Zweig closes out this final chapter by arguing that psychology is a major part of investing, one that many people overlook in the rush to find the big bargain. He goes so far as to argue that people are the primary risk in their own investing - poor decision making and abandonment of principles results in far more loss than an investment gone wrong.

Zweig actually ties this to Pascal’s wager, a famous suggestion by the French philosopher Blaise Pascal in which he argues that, since God’s existence cannot be determined through reason, one should behave as though God does exist, since living in that way (as opposed to living as though God does not exist) provides much more gain than loss. Similarly, since one cannot prove what will happen in the future with investments, we’re better off living by our investing principles than playing it by ear.

This is the final entry in the book club reading of The Intelligent investor. I hope you enjoyed it as much as I did.

This is the twentieth in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the nineteenth chapter, which is on pages 487 to 496, and the Jason Zweig commentary, on pages 497 to 511.

There’s an eight hundred pound gorilla in the room when it comes to value investing: the corrupt company.

When you go through a filtered list of companies that might represent great value investments, many of those companies actually are values. They’re simply boring companies - ones that are well established, grow slowly, and dominate a niche that doesn’t get people excited.

At the same time, that list is going to contain at least a few companies that got there because of shady business practices. The company appears to be worth a lot on paper, but in truth it’s all a house of cards. It’s only an illusion of a value, not a real value.

Some of these are easy to detect. Companies like Enron wind up, years after their corruption is exposed, appearing to be a value stock, but a careful evaluation of the history of the company shows it to be a bad investment. Other companies, though, are much more difficult to see - mismanagement isn’t always immediately clear in the hottest companies, let alone the ones that lurk in the quieter parts of the market.

Chapter 19 - Shareholders and Managements: Dividend Policy
Here, Graham seems to indicate that if a stock that otherwise appears to be a value stock isn’t paying out dividends, something is afoot. If there’s not a very clear and concrete reason for no dividends (and the overly simplistic “we’re investing in the company” isn’t satisfactory), then there’s something afoot.

This is not true for companies that would be considered “growth” investments. Quite often, the absence of a dividend (or the presence of only a small dividend) in a growth company is a sign that the company is actually doing what they claim - investing in the company with the intent of maintaining the impressive rate of growth.

The big difference is in why you invest in these different types of stocks. You invest in growth stocks to enjoy the increase in stock price - dividends aren’t really a part of the equation. You intend to ride that wave of growth until it runs out, then sell the stock somewhere near the peak (when the stock is still selling at a premium because of its “growth” status, but the growth is slowing).

However, the typical reason for owning a value stock is income. You don’t expect that the price of a value stock will jump greatly over time. Instead, you own it for that dividend - it’ll keep putting money in your pocket over the long haul. This isn’t a good enough reason for speculators to own the stock - dividend earnings are a long term thing - so good value stocks tend to be forgotten in the mad rush.

If you see a stock that’s undervalued, it should either be paying out a good dividend, have a stellar reason for not doing so, or it should be avoided.

Commentary on Chapter 19
Zweig offers up one nugget that really caught my attention. From page 506:

Research by money managers Robert Arnott and Clifford Asness found that when current dividends are low, future corporate earnings also turn out to be low. And when current dividends are high, so are future earnings. Over 10-year periods, the average rate of earnings growth was 3.9 points greater when dividends were high than when they were low.

What does that mean? Good, strong companies can afford to pay out dividends. Thus, to an extent, a company paying solid dividends - particularly over a lot of years - is likely a company that’s on very solid footing and sure of their future.

Companies that pay good dividends don’t need to hoard money. They don’t need to invest in themselves. Instead, they’re able to provide direct value to their stockholders.

It’s a pretty good argument for value stocks, I must say.

Next Friday, we’ll take a look at the final chapter, Chapter 20: “Margin of Safety” as the Central Concept of Investment.

This is the nineteenth in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the eighteenth chapter, which is on pages 446 to 472, and the Jason Zweig commentary, on pages 473 to 486.

This is really a “put the principles into practice” chapter, above all else. The premise is really simple: Graham simply picks eight pairs of companies off of a list of stocks available on the stock exchange. He simply chose ones that were adjacent to each other in name on a long list of publicly traded stocks.

The problem with this method is that many of the companies that Graham evaluates are either no longer in business or are completely different entities than they were in 1972. So what’s the value in reading these comparisons?

The value comes in seeing what things Graham looks for when comparing two companies. If you carefully read this chapter, you can tease out a lot of interesting basic concepts that Graham seems to rely on in his analysis. Let’s dig in.

Chapter 18 - A Comparison of Eight Pairs of Companies
So, what “basic concepts” am I talking about? Here are five things that stood out to me in Graham’s comparisons.

Companies that stick to their core businesses are generally better values. Companies that dive into mergers and make big splashes into other businesses get all the attention, but if you’re looking for value, look for companies that focus in one area and do it well.

Investing on what you think will happen in the future is almost always a bad idea. No one can predict the future. If you’re investing for value, don’t bet on a company because of what they’ve done very recently. Look for a long track record.

Overvalued stocks tend to stay overvalued, while undervalued stocks tend to stay undervalued. Why? Conventional wisdom tends to rule the day. If a company is seen as “hot,” it takes a lot for that facade to go away. Similarly, if a company is seen as “boring,” it’s very hard to lose that stigma. That’s why selling short really only works well in certain specific situations where a company is clearly losing something of value, not just merely the fact that it seems overvalued.

A company in a highly competitive market is almost never a value. If a company has a lot of strong competitors, you should never view that stock as a value stock. Most good values sell products in niches where there isn’t much competition - hence the perception that such stocks are boring.

Price volatility is usually a bad sign. If a company is experiencing far greater price fluctuations than the market as a whole is seeing, particularly when it alternates between going up rapidly and going down rapidly, avoid the stock. Such events happen only in companies that are either unstable or are involved in something else going on in the market, both of which are good to avoid.

Commentary on Chapter 18
Zweig attempts to do eight similar comparisons with more modern companies, looking at them as they sat in 2002 and early 2003.

Again, most of these comparisons are really products of their times - they aren’t valid looks at the companies today. However, these comparisons do reinforce most of the principles taught in this book - nice, quiet, steady, stable companies with steady dividends and earnings growth are the ones that make for a great value.

Most importantly, it establishes that Graham’s principles are all about the long term, not the short term. If you’re interested in day trading and selling short, Ben Graham’s philosophy isn’t the right one for you.

Next Friday, we’ll take a look at Chapter 19: Shareholders and Managements: Dividend Policy.

This is the eighteenth in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the seventeenth chapter, which is on pages 422 to 437, and the Jason Zweig commentary, on pages 438 to 445.

The real question in value investing is how do you identify the lemons that are mixed in with the ‘values’?

Obviously, when you’re digging into “value” companies, you’re seeking out companies that are currently undervalued by the stock market. This can happen for a lot of reasons: these companies are boring, these companies are not experiencing rapid growth, or, more ominously, something nasty is afoot with this business.

The problem with teasing out companies that are up to shenanigans is that there’s no ready made recipe for identifying them. This is where homework comes into play. You need to study the individual companies you invest in. Careful study of a company will often identify fundamental problems in their business plan - and if you see those things, you can stay away.

In this chapter, Graham discusses four examples of this kind of careful study:
Penn Central (Railroad) Co., which is an example of a corporate giant that’s rotting from the inside
Ling-Temco-Vought, Inc., which is a company that builds an empire on paper, but is actually pretty fragile
NVF Corp., which is an example of corporate acquisitions gone bad
AAA Enterprises, which is an example of a “hot” stock that’s getting elevated beyond all reason

Chapter 17: Four Extremely Instructive Case Histories
Here’s how Graham sniffed out the rat in each company.

Penn Central (Railroad) Co.
A careful reading of the company’s annual reports reveals that the company had been paying virtually no income tax for a decade. That’s a huge warning sign - if they’re not paying income tax, they’re either taking advantage of a ton of tax breaks (which you should be able to discover easily) or they’re not really earning much income at all.

How did they do it? They were reporting earnings without “charges” that were going to be taken several years down the road. These “charges,” however, were merely disguising that the company wasn’t really bringing in any income.

What can you do to avoid this? If you see a company reporting good earnings but also talking about “charges” for mysterious reasons that will be dealt with in future years, be very careful. They could be just extending the life of the company on paper when it’s actually in serious trouble.

Ling-Temco-Vought, Inc.
The warning signs? In 1966, the company stated that their assets were less than 5% of the stock value of the company. This means that if the company went bankrupt, the common stocks would pretty much be worthless - something to avoid like the plague if you’re investing for value.

Another warning sign: large investors started dumping the stock in droves. If you see big investors selling all of their stock in a company, you might want to consider doing the same. Watch out for big changes in institutional investing in the public reports on the company.

In 1969, the company reported a loss far bigger than the total profits in the history of the company. In one year, it lost more money than it ever earned - a sure sign something’s seriously wrong.

The way to avoid this is simple: avoid any stocks that are valued far beyond their asset value. Avoid any stocks that are being sold in droves by institutional investors. Avoid stocks that suddenly report a huge loss seemingly out of nowhere.

NVF Corp.
Here, NVF used a number of accounting gimmicks to hide the fact that they were acquiring companies with a huge amount of debt and unsteady business.

How did they do that? The most flagrant sign was that the company claimed an “asset” called “deferred debt expense” that was actually larger than the entire equity of the company. If you started digging into the annual report and figuring out what the items are, you soon realized that the company was actually claiming some debts as assets - and when you got that all straightened out, it became clear that the company was worthless.

You can avoid this by avoiding any company that has unexplainable items on their annual report. If you can’t get a rational explanation of what an element of a company’s annual report is, avoid that company.

AAA Enterprises
If you can’t determine why exactly people are investing in a company, don’t invest. That’s basically the story here, in which a tiny company played a hype game and wound up being valued at 115 times earnings - a number that’s not realistic no matter what the company.

This was all based on potential - much like the “dot com” stocks of 1999 and 2000. Graham’s point? Avoid companies that are selling nothing more than potential. If you can’t see real assets and real business there, don’t invest.

Commentary on Chapter 17
Zweig spends his commentary making modern analogies for each of these disasters.

Zweig compared Penn Central (Railroad) Co. to Lucent. Both companies were among the largest in America, but once you started digging into the books, it became clear that the large company was rotting from the inside, with apparent earnings that weren’t actually based in reality.

He compared Ling-Temco-Vought, Inc. to Tyco, both of which built a big paper empire that wasn’t really based on real-world assets, but instead based on mergers and shuffling.

He compared NVF Corp. to AOL-Time Warner, the best modern example of a merger that completely made no sense in which the minnow swallowed the whale.

Finally, the easy one: AAA Enterprises could have been compared to a lot of dot-com companies (my favorite disaster was Boo.com), but Zweig analogized it to eToys, another classic dot-com disaster.

What’s the lesson? These same tactics keep getting used and keep fooling investors. Be careful.

Next Friday, we’ll take a look at Chapter 18: A Comparison of Eight Pairs of Companies.

This is the seventeenth in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the sixteenth chapter, which is on pages 403 to 417, and the Jason Zweig commentary, on pages 418 to 421.

The final five chapters of The Intelligent Investor (of which this is the first) really serve as a “wind-down” for the entire book. Graham spends the chapters looking at examples, special cases, and special topics that really almost serve as a supplement to the real meat of the book - the earlier chapters.

This chapter is a particularly interesting one, as it focuses on an area of investing that very few people in mainstream life are even aware of - convertible issues and warrants.

What are they? Convertible issues refer to financial instruments (usually bonds) issued by companies that can be converted into other financial instruments. The most common example of this is a convertible bond issued by a company in order to raise money. A convertible bond is just like any other bond - you buy it for a certain price, it pays a certain amount every so often, and when it’s finished, the bond has a face value. You might, for example, pay $9,800 for a bond that pays $400 a year for five years, then can be redeemed for $10,000. A convertible bond adds another option - you can, at any time, convert it into stock of the company that issued the bond at whatever rate was specified when the bond was issued. So, let’s say you have that $10,000 face value bond and it can be “converted” into 500 shares of stock in the company. If the stock’s value goes much above $20, it might be worthwhile to convert it.

A warrant is a long-term option to buy shares of stock at a certain price. For example, you might have a warrant for company A that lasts ten years that allows you to buy 1,000 shares of their stock at $10 a pop. If the company’s stock goes up to $20, that warrant itself has some significant value to it.

While I doubt I’ll ever find direct use for knowing how to find value when buying warrants or convertible issues, one can still garner useful principles from reading this information. So let’s dig in.

Chapter 16: Convertible Issues and Warrants
In short, Graham seems pretty wary of both of these types of investments. For the most part, throughout The Intelligent Investor, Graham seems to totally eschew the complex in favor of the simple.

For convertible issues, Graham points out that convertible issues that are issued late in a bull market are almost always an awful investment. Why? The bonds themselves usually aren’t a very good investment - your hope is usually that you’ll be able to convert the bond (or sell the bond when the conversion is good). At the end of a bull market, prices are usually inflated and are about to sink. Thus, convertible issues bought late in a bull market are usually not able to be converted at a profit, making them a terrible investment.

Here’s the kicker: the latter stages of a bull market are when most convertible issues are created and sold. Companies are usually seeking to fund expansion and big spending projects when the economy seems to be roaring and that’s when they issue things like convertible bonds.

So, in a nutshell, Graham is very wary of all convertible issues - he all but encourages individual investors to simply leave them out of their investing plans.

What about warrants? He’s pretty clear about them on page 413: “We consider the recent development of stock-option warrants as a near fraud, an existing menace, and a potential disaster.” That’s about as clear as one can be - stay away from these as well.

Commentary on Chapter 16
Zweig’s commentary here is very short, and he focuses exclusively on convertible bonds. His primary point about such investments is that, if you choose to invest in convertible bonds, don’t think of them as bonds. Instead, think of them as rather stable stocks, since the performance of convertible bonds mirrors the stock market, not the bond market.

Next Friday, we’ll take a look at Chapter 17: Four Extremely Instructive Case Histories.

This is the sixteenth in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the fifteenth chapter, which is on pages 376 to 395, and the Jason Zweig commentary, on pages 396 to 401.

As I mentioned last week, this chapter (and the one preceding it) form what I consider to be the heart of The Intelligent Investor.

What I found most interesting about the previous chapter - Stock Selection for the Defensive Investor - is that Graham basically advocates for index funds if you’re a defensive investor. The interesting part is that Graham wrote that chapter in 1972 - years before index funds appeared for people to invest in. They simply didn’t exist in 1972 - the only mutual funds around at that time were heavily managed by active investors.

This chapter, though, sees Graham talking about individuals who aren’t simply defensive in their investing. How does one seek out and find value stocks, not just ones listed in the S&P 500? Graham really answers that question here.

Chapter 15 - Stock Selection for the Enterprising Investor
So, how do you find a value stock? That’s really the question Graham strives to answer in this chapter.

The first factor to look for is a low price to earnings ratio - information you can easily get from a good stock tracking software like the Yahoo Stock Screener (that’s the tool I use). Graham suggests looking for stocks that have a price-to-earnings ratio of 9 or lower.

Graham immediately points out that simply screening based on a P/E ratio of less than 9 will get you a lot of stocks - and he’s right. I found 909 stocks that had a P/E ratio of 9 or less - a mix of big companies and little ones, ones I’d heard of and ones that I hadn’t.

Graham then suggests five additional factors to screen for:
1. Good financial conditions - assets that are at least 1 1/2 times current liabilities
2. Earnings stability - no losses in the last five years
3. Dividends - some current dividend is being paid
4. Earnings growth - last year’s earnings are more than those of five years ago
5. Price - a stock price less than 120% of the company’s assets

I entered some of these criteria into the tool and found that these factors quickly eliminated hundreds of stocks, leaving me with a much tighter list with companies like Exxon and Chevron to investigate.

Much of the rest of this chapter deals with special situations, most of which Graham encourages people to avoid (”special” issues) or has a lot of caveats about (buying stocks with a stock price lower than the company’s assets - probably meaning the company is in fairly serious trouble).

Commentary on Chapter 15
Zweig actually extracted different lessons from this chapter than I did, which speaks to the density of information in Graham’s writing - and probably indicates why many people have a hard time trudging through the book.

Zweig argues that the biggest lesson here is the value of practice. Graham’s pointers seem straightforward at first glance, but they really only help you find a group of stocks which you’ll have to dig through on your own. The process of digging through those stocks, picking a few, seeing how they do, and learning some of the patterns is something that can’t really be taught in a book - it requires a lot of experience.

How can you get that experience? Zweig strongly encourages people to spend some serious time (he suggests at least a year of practice) using an online portfolio tracker like the one at Yahoo. Study stocks, add some to your virtual portfolio, and watch them. See what works and what doesn’t. If you enjoyed this process and earned a decent return, start investing with real money - but if you just wind up confused and bored, stick with index funds.

Next Friday, we’ll take a look at Chapter 16: Convertible Issues and Warrants.

This is the fifteenth in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the fourteenth chapter, which is on pages 347 to 366, and the Jason Zweig commentary, on pages 367 to 375.

I’ve been writing these chapter-by-chapter discussions of The Intelligent Investor on my second read-through of the book.

The first time I read the book was roughly a year ago. To me, it came across quite like most good books - it built to a climax that contained the key portion of the book, which occurred about two-thirds of the way through. Prior to that climax was a ton of “setup” material - putting all the pieces in place so that the climax could be understood, processed, and enjoyed. The material after the climax was largely clarification and continuation - a bit more detail.

From my perspective, this chapter and the next (Stock Selection for the Enterprising Investor) serve as the climax of The Intelligent Investor. These chapters really outline what exactly Graham’s stock selection philosophy is in great detail.

This first chapter in the pair focuses on a more conservative philosophy for picking individual stocks, which personally appeals to me more than aggressive strategies. My personal philosophy for stock investing tends to stick pretty strongly to broad-based index funds - I have very little confidence that I can regularly pick stocks that will do substantially better than comparable index funds.

Chapter 14 - Stock Selection for the Defensive Investor
Graham’s strategy for defensive investors is actually pretty straightforward. He recommends that you start off with a broad index of funds - he uses the Dow Jones Industrial Average for his example, but the philosophy would work just as well with the S&P 500 or the Wilshire if you so wanted (and you could easily do that with computer-based tools).

Once you have this list, Graham suggests applying seven criteria to each stock on that list, in this order:

1. Adequate size of the enterprise Don’t invest in small companies, in other words. A defensive investor avoids stocks that would be considered small-cap.

2. A sufficiently strong financial condition The assets of any good defensive company should be at least twice the debts of that company.

3. Earnings stability The company must have had positive earnings each of the last ten years.

4. Dividend record The company must have made uninterrupted dividend payments each year for the past twenty years.

5. Earnings growth The company must have seen an increase of at least 33% in per-share earnings as compared to ten years ago.

6. Moderate price/earnings ratio The stock’s price must be nome more than 15 times the company’s earnings over the past three years.

7. Moderate ratio of price to assets The company shouldn’t have a stock value 50% greater than the total value of the company’s assets.

If you apply all of these criteria, even to every stock available, you’ll find the list of acceptable stocks at the end to be very, very small - if you find any at all. If you do find a stock that matches these criteria, it’s almost assuredly going to be a very steady value.

If you want to play around with these criteria using all publicly available stocks, it’s pretty easy to set up Yahoo’s Stock Screener. I used all of these criteria and didn’t find a single matching stock, but when I experimented a bit and loosened some of the criteria just a touch, I did find quite a few matches. This would be a great place to start for a defensive investor looking to jump into individual stocks.

Commentary on Chapter 14
Zweig’s message is simple: the easiest method for a defensive investor to invest in stocks today is by buying a broad-based index fund and simply sitting on it. This broad-based fund will match the stock market, have very little cost, and require very little effort from the buyer.

He does walk through each of Graham’s seven criteria for good defensive stocks and uses them to analyze the S&P 500 as it sat in early 2003 (when prices were pretty low). Zweig actually found that a sizable percentage of the S&P 500 passed each individual criteria, but he doesn’t mention how many companies pass all of the criteria - I’m willing to bet that it’s a very low number, if any at all.

Next Friday, we’ll take a look at Chapter 15: Stock Selection for the Enterprising Investor.

This is the fourteenth in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the thirteenth chapter, which is on pages 330 to 338, and the Jason Zweig commentary, on pages 339 to 346.

Over the past few chapters, Graham finally began to lay out some of the specifics of how to implement his concept of value investing.

It only took him ten chapters to reach the supposed “meat” of the book. I wouldn’t hesitate a bit to speculate that Graham’s “slow start” to the book is the reason many people have a hard time picking it up and going with it - it’s simply a slow starter, especially if you just want to know specifically how Graham values stocks.

But that’s not the point of the book.

What does it say on the front? The Intelligent Investor. That doesn’t mean “The Guy Who Can Price Value Stocks Really Well” - and the fact that many people believe that the two are the one and the same is actually a real problem.

Investing isn’t just about knowing how to evaluate a company properly or how to seek out huge values on Wall Street - that’s only one small part of the bigger picture. Investing is about knowing yourself (how much risk you can tolerate, for one), knowing the people around you, setting goals, defining a broader portfolio than just stocks, and so on.

Here’s the problem - those topics are boring to a lot of people. Yet Graham devoted the first nine or ten chapters of The Intelligent Investor to just these issues.

Graham views these elements as the bedrock of what it means to be an intelligent investor, and that’s why he devoted the first third of his book to it. Those who would skip it or not “waste their time” paying attention to it are missing a key part of Graham’s message.

Chapter 13 - A Comparison of Four Listed Companies
This chapter, however, does focus on evaluating companies in terms of finding ones that offer significant value to the investor. Graham does this by actually running through how he would evaluate four different companies given their situation in early 1972 - ELTRA, Emerson Electric, Emery Air Freight, and Emhart Corp.

What companies? If you looked at those names and shrugged your shoulders, there’s good reason - only Emerson still actually exists as a distinct company and brand. The other three were subject to mergers and buyouts from other firms - ELTRA merged with Bunker Ramo and that operation was eventually purchased by Honeywell, Emery Air Freight is now a part of CNF, and Emhart was bought by Black and Decker. Remember, though, the point here isn’t to point out good stock buys. Graham’s discussion here is about how he would evaluate these companies from his position in early 1972.

Graham walks through all four companies, considering their profitability (he looks at the past decade of results), stability (he looks at their worst year over the past decade), growth (compared over multiple time frames, not just the last year), financial position (they must have $2 in assets for every $1 in debt), dividends (years of dividends paid without interruption), and price history (evaluated over the companies’ entire histories).

Graham concludes a few things here: Emerson and Emery are both overpriced - or at least aren’t value stocks at the moment. He thinks Emerson has better long term potential, but seems fairly gold on buying Emery as a value stock. The other two companies, though, are undervalued, and he believes they would be good buys for a defensive investor.

What exactly constitutes a “good buy”? Graham just begins to touch on that, indicating “seven statistical tests,” but then holds off on delving into those tests until the next chapter.

Commentary on Chapter 13
Zweig basically does the same analysis as Graham, except Zweig focuses on four modern companies - Emerson (again), EMC, Expeditor’s International, and Exodus Communications.

Why those four? Together, they actually provide a very nice history of the stock market during the 1980s, 1990s, and early 2000s, highlighting all of the ups and downs along the way.

What did Zweig conclude from his evaluation? Companies that aren’t stable on paper aren’t stable investments. Exodus Communication was his “dot-com” stock and it went belly-up before 2003 was out. On the other hand, Emerson was Zweig’s stable old horse - and it weathered the dot-com bust just fine.

There’s a lesson here - value investors don’t buy the flashy stocks. The flashy stocks are almost always overvalued compared to what the company is really worth on paper. Instead, value investors tend to look for the boring - Emerson’s shop-vacs aren’t glamorous, but the company does provide a good value for the shareholders.

Next Friday, we’ll take a look at Chapter 14: Stock Selection for the Defensive Investor.