The Intelligent Investor: Four Extremely Instructive Case Histories

intelligentThis 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.

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