The fifth and last edition, in 1973, of Graham's book remains a popular and valuable book on investing.  In it Graham outlines the principles of investing that he developed over 50 years of practicing the art.  It is a tribute to the timelessness of Graham's principles, and perhaps, the unchanging fundamental nature of Wall Street, that the book remains quite relevant to 2003.  In fact, the current market, having lost the value that it gained in the fin de siecle bull market, is quite similar to the market in the early 1970s, which had seen a series of speculative bubbles in the previous decade.  Graham's comments about the behavior of the market, the general public, and analysts are as poignant and timely as they were when he wrote the book.

Fundamental to understanding the book is realizing Graham's characterization of people who buy and sell securities, which differs from the common definition.  The first type is the speculator, who buys a security on the hopes that it will go up.  Graham identifies this as the largest and most prevalent category of market participant.  There are, of course, the professional speculators ("day-traders" in our parlance), but the brokerage houses selling securities to the general public largely sell based on rumors, opinions, and "favorable market action" (i.e. the stock has been going up for a while).  The investor, by contrast, buys only those securities for which he has determined that their current price is favorable in relation to their fundamental value.  "Market action", which is likely to be adverse in this situation, opinions, and rumor have no place in the decision process of the investor.  The investor does not seek to gamble but seeks to purchase only that which he knows will go up;  hope is not a factor.

The fundamental question, then, is determining the fundamental value of a security.  However, Graham does not seem to have developed a method for reliably computing the fundamental value of a security and he limits himself largely to equating fundamental value with book value, or the value of the company if it were liquidated.  Even so, he notes that the realizable value of an asset is largely unknown until the actual sale.  So to account for this impossibility of quantitatively determining the fundametal value, he promulgates his key thesis, namely the concept of the margin of safety.  Graham realizes that his valuation can be wrong or that the market may not come to his valuation, even if it is correct, and therefore the margin of safety provides a buffer.  Furthermore he advises diversification as his methods are somewhat probabilistic in nature;  a particular security may not realize its proper value in a reasonable time frame, but securities on average will.  Diversification provides the average.

Graham advises several rules to guide the investor.  The first is portfolio management:  between 25% and 75% of a portfolio should be bonds, depending on the number of available bargain securities.  Keeping some bonds guarantees a portion of the principle while providing some growth, while the riskier security portion increases the rate of increase.  The second relate to the companies themselves:  buy only large companies that are leaders in their field (first, second, or maybe third place), that have a history of uninterrupted and increasing dividends, and whose price offers a large (25%) margin of safety.  This enhances the odds that the companies will be strong enough to continue their past performance.  Graham believes that additional knowledge decreases risk, so for the rare investors who have more time to devote to their analysis, he suggests that secondary companies can be considered.

After explaining the philosophy and principles of his investment theory, Graham spends a large portion of the book in case studies.  Many of the case studies are comparisons of companies, sometimes similar companies with different business prospects, sometimes completely different companies.  Each of the comparisons examines the corporate balance sheet and is accompanied by an explanation of the balance sheet and the principles to draw from it.  Particularly hard-hit are companies that exemplify trends that, sadly are recurring, such as over acquisition.

Not to be overlooked, however, are the comments about the nature of the market and the players in it.  Analyists in particular are lambasted because "as a matter of business practice, or perhaps of thoroughgoing conviction, the stock brokers and investment services seem wedded to the principle that both investors and speculators in common stocks should devote careful attention to market forecasts".  Other comments note the effect of human nature on investors and other observations about market behavior garnered from years in the industry.  While not the main thesis of the book, these comments are witty but instructive and further a sub-thesis that the market does not value value, yet value is of paramount importance to the investor.

The Intelligent Investor is ultimately a fairly scholarly book written for a non-academic audience which explains Graham's theory of value investing.  Of primary importance is the concept of letting the intrinsic value of the company determine the fair purchase price and then to apply a margin of safety to account for misevaluations by either the investor or the market over the long-term.  The book is complete with examples and provides the neophyte with the information necessary to understand the value investment philosophy but yet containing enough information to satisfy the finer points raised by the more experienced investor.

Rating:    10

    (Clearly presents theses and methods of application.  Provides concise and cogent explanation of concepts.  Witty.)

Specific advice

• Portfolios should contain 25% - 75% bonds, the rest in stock.
• Investments in stock should be limited to companies that are

1. Large (~$200 million)
2. Conservatively financed (debt is less than 50% of assets)
3. Prominent (leader in the industry)
4. Long record of continuous dividend payments (preferably 20 years)
5. Current price is no more than 25 times the seven year average of earnings and not more than 20 times the previous year's earnings (i.e. P/E <= 20) (pg. 54).  pg. 185 suggests that the "current price should not be more than 15 times average earnings of the past three years."
   
6. No earnings deficit (i.e. earnings were positive)
7. "A minimum increase of at least one-third in per-share earnings in the past ten years using three-year averages at the beginning and end." (pg. 184)
8. Price should not be more than 1.5 times the book value.
   

• Growth stocks are very volatile and tend to lose a lot of value in downturns.  This gives them a large speculative component because while large amounts of money can be made by buying and selling at the right time, this is hard to do.  Holding on too long will result in poor returns. (pp. 55-56)
• A stockholder has two options:  consider himself the part-owner of the company (and therefore owning the appropriate percent of assets and profits) or he can consider the value of his ownership to be that of the market, whichever is most convenient.  Obviously, the more one pays for a stock over book value, the less attractive the part-ownership becomes.
• Bonds should only be bought from issuers who have enough income to cover the bond (at least 2x - 4x, depending on the industry).
  
• Bonds can be bought at a discount, but only bonds from well rated companies (AAA for the defensive investor and B for the enterprising investor) should be purchased.
• Closed mutual funds have empirically performed better than open mutual funds (open funds sell at a ~9% premium to cover sales expenses but closed funds do not have these costs and can often be had at a discount).  Small funds usually perform better than large funds.
• Earnings should be computed using fully diluted values of the outstanding stock (i.e. assume that all options and preferred conversion rights have been exercised).
• In general, avoid IPOs.  New issues are generally floated at the height of a bull market (to maximize capital obtained) and the goals of the issuer (to raise as much money as possible) are at odds with the value investor (to buy at a discount).
  
• A stock with a dividend is generally priced higher than an equivalent stock without a dividend.
• Trying to make money by timing the market or with the "buy low, sell high" approach does not lead to good returns.  Most people in the market have about the same skills (self-assessments notwithstanding) and there is no reason to expect better than average returns without better than average skills.  Even then it is pure speculation.
• "However, the risk of paying too high a price for good-quality stocks--while a real one--is not the chief hazard confronting the average buyer of securities.  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.  The purchasers view the current good earnings as equivalent to 'earning power' and assume that prosperity is synonymous with safety. ... These securities do not offer an adequate margin of safety in any admissible sense of the term." (pg. 280)

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