The Intelligent Investor

Preface to the Fourth Edition, by Warren E. Buff et t

Warren Buffett first read The Intelligent Investor when he was 19 years old
The Intelligent Investor is by far the best security analysis book EVER
Benjamin Grahams principles have remained sound and are proven during downturns

A note about Benjamin Graham by Jason Zweig

Benjamin Graham believes that sooner or later, all bull markets must end badly.
Graham grew up in a poor family and his mother struggled to make ends meet
Benjamin Graham won a scholarship to Columbia University
Graham lost a lot of money during the crash from 1929-1932
From 1936 to 1956, Benjamin Graham gained at least 14.7% percent annually
The Intelligent Investor is a realist who sells to optimists and buys from pessimists
The secret to your financial success is inside yourself
In the end, how your investments behave is much less important than how YOU
behave

Introduction: What this book expects to accomplish

Those who do not remember the past are condemned to repeat it. Santayana
The Intelligent Investor is NOT meant for speculators, it is meant for investors
There are two types of investors, defensive AND enterprising
Obvious prospects for physical growth in a business do not translate into obvious profits
for investors
The experts do not have dependable ways of selecting and concentrating on the most
promising companies in the most promising industries
The investors chief problem and even his worst enemy is likely to be himself
The habit of relating what is paid to what is being offered is an invaluable trait in
investment
We shall suggest as one of our chief requirements here that our readers limit
themselves to issues selling not far above their tangible-asset value
A strong-minded approach to investment, firmly based on the margin-of-safety principle,
can yield some handsome rewards

Commentary on the introduction

The Intelligent Investor can teach one how to minimize the odds of suffering irreversible
losses, maximize the chances of achieving substantial gains, and control the selfdefeating behavior that keeps most investors from reaching their full potential
Once you lost 95% of your money, you have to gain 1900% just to get back where you
started
Benjamin Grahams reference to intelligence is a trait more of the character than of the
brain

Intellectually smart people who failed in markets include Sir Isaac Newton and LTCM
US equities lost over half of their value during the tech bubble of 2000-2002
Fraud and bankruptcies fractured the financial industry, along with the threat of terrorism
While enthusiasm may be necessary for great accomplishments elsewhere, on Wall
Street it almost invariably leads to disaster
The pendulum swings from irrational exuberance to unjustifiable pessimism
The Intelligent Investor dreads a bull market and welcomes a bear market

Chapter 1 Investment versus Speculation: Results to be expected

by the Intelligent Investor

An investment operation is one in which, upon through analysis promises safety of

principle and an adequate return. Operations not meeting these requirements are
considered speculative
Wall Street and the media have developed their own definitions of an investor, but
these are not important to worry about and should be shunned
It is his task to keep this component (speculative factor) within minor limits, and to be
prepared financially and psychologically for adverse results that may be of short or long
duration
Speculation is unintelligent when one things they are investing, without proper and
knowledge and skill for it, and risking more money in speculation than you can afford to
lose
The defensive investor should allocate his holdings 50-50 between equities and highgrade bonds, unless one asset class has a better outlook and/or valuation
If proper market conditions exist, this 50-50 ratio can be altered up to 25-75 for either
equities or high-grade bonds
The future of security prices is NEVER predictable
We can never allocate all of our holdings to one specific asset class because the future
is unpredictable and our predictions could be completely wrong
TIPS: Introduced in 1997, are bonds that increase in value if the CPI rises; These can be
better than equities for protecting against inflation
The defensive investor must confine himself to the shares of important companies with
a long record of profitable operations and in strong financial condition
Aggressive investors can hope to obtain better than average results by trading in the
market, using short-term selectivity, and using long-term selectivity
Aggressive investors must follow policies that are inherently sound and promising and
not popular on Wall Street in order to consistently beat the averages
Special situations including intersecurity arbitrages, payouts or workouts in liquidations,
and protected hedges of certain kinds
Companies selling at less than Net Current Assets (Working Capital) alone are Bargain
Issues
These companies are selling at a price well below the value of the enterprise as a
private business

Commentary on Chapter 1

Note that investing, according to Benjamin Graham, consists equally of three elements:
you must thoroughly analyze a company, and the soundness of its underlying business,

before you buy its stock; you must deliberately protect yourself against serious losses;
and you must aspire to adequate, not extraordinary, performance
An investor calculates what a stock is worth, based on the value of its businesses. A
speculator gambles that a stock will go up in price because someone else is willing to
pay more for it
Investing is a unique kind of casino-one where you cannot lose in the end, so long as
you play only by the rules that put the odds squarely in your favor
The 1990s was full of ridiculous stock valuations and run-ups in stocks that would
eventually come crashing back down in the face of the nave
The January Effect trading strategy has become less profitable because of the publics
widespread knowledge of its practice
The Foolish Four investing strategy bases nothing on the value or earnings of the
underlying companies and is a perfect example of speculation
Benjamin Grahams rules for speculating are that you must never delude yourself into
thinking that youre investing when youre speculating, speculating becomes more
dangerous the moment you begin to take it seriously, and you must put strict limits on
the amount that you are willing to wager

Chapter 2 The Investor and Infl ation

Even high-quality stocks cannot be a better purchase than bonds under all conditions
Inflation rises and falls at unsteady rates and can be quite unpredictable in the future
Even Benjamin Graham had trouble predicting the change in rates over the next years
There is no close time connection between inflationary (or deflationary) conditions and
the movement of common-stock earnings and prices
Benjamin Graham believes that inflation can add little to common stock values
From 1950 to 1959, the debt of corporations has expanded nearly fivefold while their
profits before taxes a little more than doubled
For then, if another bull market comes along, he will take the big rise not as a danger
signal of an inevitable fall, not as a chance to cash in on his handsome profits, but rather
as a vindication of the inflation hypothesis and as a reason to keep on buying common
stocks no matter how high the market level nor how low the dividend return
Gold has a rocky history of protecting investors against inflation and has at times
severely underperformed a simple savings account
Other types of investments could include real estate, coins, paintings, and event tickets,
but each have their own risks to take into account
There is no certainty that a stock component will insure adequately against such
inflation, but it should carry more protection than the bond component

Commentary on Chapter 2

Its so important to measure your investing success not just by what you make, but by
how much you keep after inflation
Three reasons to believe that inflation is not dead in the United States is because as
recently as 1973-1982, the Consumer Price Index more than doubled, a majority of the
worlds economies have had inflation in excess of 25% annualized per year, and inflation
makes it relatively easier for Uncle Sam to pay off his debts
The stock market tends to underperform when inflation is high (>6%) or massive
deflation is occurring (contraction of prices)

Two new ways to fight inflation are through the purchase of Real Estate Investment
Trusts (REITs) and Treasury Inflation-Protected Securities (OTC:TIPS)
REITs are companies that own and collect rent from commercial and residential
properties
While a REIT fund is unlikely to be a foolproof inflation-fighter, in the long run it should
give you some defense against the erosion of purchasing power without hampering your
overall returns
TIPS are U.S. government bonds, first issued in 1997, that automatically go up in value
when inflation rises
When the value of your TIPS bond rises as inflation heats up, the IRS regards that
increase in value as taxable income-even though it is purely a paper gain (unless you
sold the bond at its newly higher price)
TIPS are best suited for a tax-deferred retirement account where they will not jack up
your taxable income

Chapter 3 A Century of Stock-Market History: The Level of Stock

Prices in 1972

There are three distinct market patterns for the years 1900-1972
The first runs from 1900-1924, and shows for the most part a series of rather similar
market cycles lasting from three to five years. The annual advance in the period
averaged about 3%
We move on to the New Era bull market, culminating in 1929, with its terrible aftermath
of collapse, followed by quite irregular fluctuations until 1949 the annual rate of
advance was a mere 1.5%
The third major market trend that took place from 1949-1968 consisted of the greatest
bull market run in the stock markets history
Following the 1968 high, the market was quite volatile leading up to 1972
Only two of the nine decades after the first show a decrease in earnings and average
prices (in 1891-1900 and 1931-1940), and no decade after 1900 shows a decrease in
average dividends
The average dividend yield fell steadily for equities from 1949-1970
The interest rates on high-grade bonds more than tripled from 1948 to 1971
The trailing PE for the S&P went from 6.3 in 1948 to 19.2 during 1971
The Stock-earnings yield /bond yield went from 3.96X in 1948 to .72X in 1971
The Dividend yield/bond yield went from 2.1X in 1948 to .41X in 1971
The Earnings/book value ratio remained in a stable range of 10%-13% for the time
period

Commentary on Chapter 3

During the 1990s, many books were written with prophecies of the DOW Jones
Industrial Average rising to 36,000, 40,000, and even 100,000
The stock market crushed everyone who had come to believe that the high returns of
the late 1990s were some kind of divine right
Since the profits that a company can earn are finite, the price that investors should be
willing to pay for stocks must also be finite

Even though investors all know theyre supposed to buy low and sell high, in practice
they often end up getting it backwards
The stock markets performance depends on three factors: real growth (the rise
companies earnings and dividends), inflationary growth (the general rise of prices
throughout the economy), and speculative growth-or decline (any increase or decrease
in the investing publics appetite for stocks)
In the long run, you can reasonably expect stocks to average roughly a 6% return (or
4% after inflation)
The only thing you can be confident of while forecasting future stock returns is that you
will probably turn out to be wrong
In the financial markets, the worse the future looks, the better it turns out to be

Chapter 4 General Portfolio Policy: The Defensive Investor

Depending on ones risk tolerance and time frame, the ratio of bonds to stocks held can
vary greatly or little at all from the golden 50-50 mark
Investors must ask themselves two questions when they are buying bonds, should I buy
tax-free or taxable bonds, and should I buy long or short term bonds
US Savings bonds E and H series are very safe investments, back by the government; E
series bonds accumulate interest on the principle, while H series bonds are sold at
discount to face value; Can be cashed in at any time upon borrower request
Other United States are available, with longer term bonds yielding a little more than 6%;
Subject to federal income tax, but not state income tax
State and Municipal bonds are free from federal tax and free from state income tax in the
state which it was issued
Corporation bonds are taxed by federal and state governments, but offer higher yields
than government bonds; Lower grade bonds yields higher returns than premium grade
Call provisions enable a company to recall bonds at a specified time in the future, if
conditions are advantageous for the company to do so
Preferred stocks offer the owner little legal right in tough times, so large reversals in the
market will cause these securities to fall; Best time to buy is at the trough of recession
when mispriced

Commentary on Chapter 4

There are two approaches to investing, active and enterprising and passive and
defensive
Benjamin Graham believes that age is not an important determining factor when
deciding how much of ones portfolio should be invested in stocks and bonds
Everyone must keep some assets in the riskless haven of cash
Instead of buying and holding their stocks, many people end up buying high, selling low,
and holding nothing but their own head in their hands
Taxable bonds should be bought inside of sheltered account like a 401-K
Tax-free bonds should be bought outside of sheltered accounts
Intermediate-term bonds provide the least amount of volatility in interest rates
Bond funds are great way to get bond exposure with keeping a diversified approach
Treasury Securities are obligations of the United States government and carry no credit
risk, because Uncle Sam can simply raise taxes or print more money

Savings bonds are not marketable, but are ideal for set-aside money
Mortgage Securities are bonds issued by Fannie Mae and Ginnie May that are derived
from pooling together thousands of mortgages in the United States
Annuities are insurance-like investments that enable one to defer current taxes and
collect income after one retires; Can be fixed or variable in nature
Preferred shares are a worst-of-both-worlds investment
Common Stocks are actually yielding higher than many bonds at the current time

Chapter 5 The Defensive Investor and Common Stocks

Stocks should be a major part of an investors portfolio because they offer better inflation
protection than bonds and because the yields can be quite high at certain time periods
Benjamin Grahams four rules for defensive investors are there should be adequate
diversification of between ten and thirty stocks, each company selected should be large,
prominent, and conservatively financed, each company should have a long record of
continuous dividend payment, and the investor should impose some limit on the price he
will pay for an issue in relation to its average past earnings
Growth Stocks should be avoided by defensive investors because of the wild gyrations
in their price that could scare the faint of heart away
Defensive investors should receive some type of investment advice on their personal
portfolio from a trusted , respectable brokerage house at least once a year
Dollar-Cost Averaging is at its most basic form when an investor puts adds a set amount
of money every month to his/her investments, regardless of price of the securities at the
time
Time and inclination must be taken into account when deciding whether one can
properly do the homework needed for maintaining a successful portfolio
Benjamin Graham defines a group of safe stocks as one that makes satisfactory returns
over a fair number of years
A large, prominent, and conservatively financed organization in todays terms means
that a defensive investor should only be looking at companies with a market cap
exceeding $10 billion

Commentary on Chapter 5

Dollar-cost averaging combined with a disciplined defensive investor can produce good
returns with minimal effort
Never just Buy what you know, unless you have done your homework and understand
why it is worth owning this company
Online brokerages make it easy for anyone to control their own investments and buy and
sell shares at a very small transaction cost
Defensive investors can also opt to receive help from index funds and/or professional
brokers
Best of all, once you build a permanent autopilot portfolio with index funds as its heart
and core, youll be able to answer every market question with the most powerful
response a defensive investor could ever have: I dont know and I dont care"

Chapter 6 Portfolio Policy for the Enterprising Investor: Negative

Approach

Avoid high-grade preferred stocks and inferior types of bonds, unless they can be
purchased at least at a 30% discount to par value
Also, look to avoid foreign government issues and be wary of new issues in general
The main difference between investing in first- and second-grade bonds is usually found
in the number of times the interest charges have been covered by earnings
Experience clearly shows us that it is unwise to buy a bond or preferred which lacks
adequate safety merely because the yield is attractive
If you are willing to assume some risk you should be certain that you can realize a really
substantial gain in principal value if things really go well
It is mere common sense to abstain from buying securities at around 100 if long
experience indicates that they can probably be bought at 70 or less in the next weak
market
Foreign bonds, as a whole, have had a bad investment history since 1914
Our one recommendation is that all investors should be wary of new issues
The heedlessness of the public and the willingness of selling organizations to sell
whatever may be profitably sold can have only one result-Price Collapse
Some of [new] issues may prove excellent buys- a few years later, when nobody wants
them and they can be had a small fraction of their true worth

Commentary of Chapter 6

Today, however, more than 130 mutual funds specialize in junk bonds
Most junk-bond funds charge high fees and do a poor job of preserving the original
principal amount of your investment
Junk-bond funds tend to outperform other bond funds when interest rates are rising
Many funds today specialize in emerging markets; tend to be more volatile than
domestic
When you trade instead of invest, you turn long-term gains into ordinary income
The more you trade, the less you keep
The people who profit the most from IPOs are the investment banks and the BIG BOYS
No matter how many other people want to buy a stock, you should buy only if the stock
is a cheap way to own a desirable business
But when were in public instead of in private, when valuation suddenly becomes a
popularity contest, the price of a stock seems more important than the value of the
business it represents

Chapter 7 Portfolio Policy for the Enterprising Investor: The

Positive Side

There are four situations that enterprising investors should look for in common stocks
are buying in low markets and selling in high markets, buying carefully chosen growth
stocks, buying bargain issues of various types, and buying into special situations
Grahams rules enable the enterprising investor to put up to 75% of portfolio into stocks
Growth stocks are dangerous because (1) common stocks with good records and
apparently good prospects sell at correspondingly high prices and (2) ones judgment to
the future of the companys performance may prove wrong
The implication here is that no outstanding rewards came from diversified investment in
growth companies as compared with that in common stocks generally

The investment caliber of such a company may not change over a long span of years,
but the risk characteristics of its stock will depend on what happens to it in the stock
market
Enterprising investors must (1) must meet objective or rational tests of underlying
soundness and (2) must follow strategies different from those followed by most investors
or speculators in order to obtain better than average results
Buying relatively large companies that are currently unpopular is one way to make large
returns
Buying bargain issues is another way to make outsized returns; Bargain issues must be
at least 50% less than the true value of the underlying enterprise
One must make a clear choice on whether to be a defensive or enterprising investor

Commentary on Chapter 7

Its easy to look back and see what would have worked, but timing the market in realtime is nearly impossible for all but the most informed investors
A great company is not a great investment if you pay too much for the stock
Growth stocks are worth buying when their prices are reasonable
No one ever kept their wealth by keeping all their eggs in one basket
But on the very rare occasions when Mr. Market generates that many true bargains,
youre all but certain to make money
To be prudent, you should some of your investment portfolio elsewhere-simply because
no one, anywhere, can ever know what the future will bring at home or abroad

Chapter 8 The Investor and Market Fluctuations

The only certainty in the markets are that there will be large and volatile swings in pricing
Two ways to take advantage of the price swings are through timing and pricing
What this means is that timing is of no real value to the investor unless it coincides with
pricing- that is, unless it enables him to repurchase his shares at substantially under his
previous selling price
Finding the tops and bottoms of markets is no longer clear-cut like it was in the past
All things excellent are as difficult as they are rare Spinoza
Serious investors are not worried in the day-to-day or month-to-month fluctuations
The ideal strategy for dealing with varying market valuations is rebalancing
The better the quality of a common stock, the more speculative it is likely to be- at least
as compared with the unspectacular middle-grade issues
Focus on companies that are trading at or close to tangible-asset value
Additionally, desirable stocks must also have a satisfactory P/E ratio, strong financial
position, and the prospect that its earnings will be maintained over the years
Portfolios of strong companies trading around book value can neglect the day-to-day
changes in market pricing and may even put let the manager take advantage of pricing
irregularities
The investor who permits himself to be stampeded or unduly worried by unjustified
market declines in his holdings is perversely transforming his basic advantage into a
basic disadvantage
Having a quoted market for securities gives an investor more options, but does not
require him to appraise the value of the stock based on the markets going price

True investors use price fluctuations to either purchases or sell shares of a company
At other times he [investor] will do better if he forgets about the stock market and pays
attention to his dividend returns and to the operating results of his companies
Stock quotations are there for convenience and can either be taken advantage of or
ignored
Good managements produce good average market price, and bad managements
produce bad market prices
Predicting the movements of stocks and bonds is a waste of time and nearly impossible
Be wary of buying nonconvertible common stocks

Commentary on Chapter 8

Mr. Markets wild pricing inconsistencies can wildly undervalue or overvalue equities
You do not have to trade with him [Mr. Market] just because he constantly begs you to
In the short run, our returns will always be hostage to Mr. Market and his whims
You can control your brokerage costs, ownership costs, expectations, risk, tax bills, and
your OWN Behavior
But investing isnt about beating others at their game. Its about controlling yourself at
your own game
In the end, what matters isnt crossing the finish line before anybody else but just
making sure that you do cross it
As Graham puts it, the typical investor would be better off if his stocks had no market
quotation at all, for he would then be spared the mental anguish caused him by other
persons mistakes of judgment
For the Intelligent Investor, falling stock prices are a great for the long-term
Selling into a bear market can make sense if it creates a tax windfall
The Investment Owners Contract outlines all the key teachings of Benjamin Graham

Chapter 9 Investing in Investment Funds

Investment funds can either be open-end or close-end; Also, either front, back, or no
load
Most of the companies operate under special provisions of the income-tax law,
designed to relieve the shareholders from double taxation on their earnings
Investment funds have done a good job at keeping many people from making large
mistakes
The decisions of the mutual fund managers determine the movement of the market itself
Performance funds can beat the averages for a few years, but rarely ever keep-up in the
long-run with the overall market averages
Large-cap, well managed performance funds can at best gain a slightly better than
average return than the market as a whole
In Grahams day, the close-end funds offered much better returns than open-end funds
solely based on the fact of how much less one had to pay to enter the funds
Graham states that in 1970 U.S. Savings bonds were a much better investment than
bond funds

Commentary on Chapter 9

Mutual funds are a great advancement because it brought so many new people into
investing
Past Performance is a poor indicator for predicting future performance of mutual funds
Very, very few funds can keep beating the averages over an extended amount of time
Winning mutual funds face many problems going forward that include migrating
managers, enlarged investable assets, inability to use tricks to increase funds
performance, rising expenses, and sheepish behavior of funds managers
An index fund will beat most funds over the long run
As the years pass, the cost advantage of indexing will keep accruing relentlessly
Later in his life, Graham praised index funds as the best choice for individual investors,
as does Warren Buffet
Funds that consistently beat the averages have managers who are large shareholders,
have low fees, dare to be different (Peter Lynch, Fidelity Magellan), eventually close their
funds, and do not advertise
When finding the right fund, first evaluate its expenses, then evaluate its risk using a
prospectus, and then look at the managers reputation and past performance of the fund
Close-end stock funds have dwindled in recent years; some bond funds are worth
looking at
Low-cost ETFs are worth looking at for investors looking to gain exposure to specific
areas
Sell a fund if there is a sharp and unexpected change in strategy, an increase in
expenses, large and frequent tax bills, and/or suddenly erratic returns in either direction
If youre not prepared to stick with a fund through at least three lean years, you
shouldnt buy it in the first place. Patience is the fund investors single most powerful
ally

Chapter 10 The Investor and His Advisors

Investment advice can be gained from a variety of sources

Graham believes that people who turn over their money to other people to handle for
them must set modest goals, be conservative, and not worry about beating the market
Financial services companies provide analysis and outlooks for thousands of stocks;
These analysis only reflect whether a company is worth buying or selling in the shortterm
Graham points out that this analysis overlooks whether a stock is undervalued or
overvalued at the current price given the companys long-term earning power
The Intelligent Investor will not do his buying and selling solely on the basis of
recommendations received from a financial service
Advice from brokerage houses will be of little help unless the broker understands that
the client is an Intelligent Investor
Once the analyst is convinced that he is dealing with a man who is value-minded rather
than quotation-minded, there is an excellent chance that his recommendations will prove
of real overall benefit
The title CFA is given to senior practitioners who pass exams and understand the
industry
Benjamin Graham notes that it is inexcusable that certain brokerage houses became
insolvent in the late 60s, as too much speculation and unwarranted risks were being
taken by them

Investment bankers are the people that bring new companies to market, perform
mergers, spinoffs, and other corporate underwriting
Investment banking is perhaps the most respectable department of the Wall Street
Community, because it is here that finance plays its constructive role of supplying new
capital for the expansion of industry
Graham advises the Intelligent Investor to pay attention to the advice of Investment
Banks

Commentary on Chapter 10

The public should turn over investments to professionals if they had big losses
exceeding those of the major indexes during the last bear markets, have poor or nonexistent budgets, have undiversified, volatile portfolios, and/or have recently made major
life changes
Make sure you trust the person that you want to handle your money
The financial manager and client should both ask tough questions to test one another
The financial advisor should have a comprehensive financial plan, investment policy
statement, and asset-allocation plan made specifically for his client
Chapter 11 Security Analysis for the Lay Investor: General
Approach

Security analysts look at the past performance of a company, take a look at the current
state of the company, and then form an opinion for the companys performance over the
next year
Properly valuing growth stocks is the most difficult activity for security analysts
Whenever calculus is brought in, or higher algebra, you could take it as a warning signal
that the operator was trying to substitute theory for experience, and usually also to give
to speculation the deceptive guise of investment
The most dependable and respectable branch of security analysis deals with the safety
and quality of bond issuances and investment-grade preferred stocks
The chief criterion used for corporate bonds is the number of times that total interest
charges have been covered by available earnings for some years in the past
Other tests that are employed for bonds and preferred issues include the size of
enterprise, stock to equity ratio, and the property value ratio
Though Graham shuns upon using past performance as a major decision-making tool for
the Intelligent Investor, looking at the prospective entitys ability to whether past storms is
vital to choosing sound bond investments for a diversified portfolio
At the time, Graham stated that the now-standard procedure for estimating future
earning power starts with average past data for physical volume, prices received, and
operating margin; Future sales in dollars are then projected on the basis of assumptions
as to the amount of change in volume and price level over the previous base
Factors that can affect the valuation of stocks include the general long-term prospects,
management, financial strength and capital structure, dividend record, and current
dividend
There is really no way of valuing a high-growth company in which the analyst can make
realistic assumptions of both the proper multiplier for the current earnings and the
expectable multiplier for the future earnings
Industry analysis provides few major convictions towards opinions on various industries
Graham advocates that analysts should first work out the past-performance value

The second step in Grahams process is to see how much the past performance should
be modified based on what is expected in the future

Commentary on Chapter 11

Two questions to ask when looking for investable companies that meet the demands of
the Intelligent Investor are what makes this company grow and where do and where will
its profits come from
Watch out for companies that are serial acquirers, companies raising boatloads of
Other Peoples Money (OPM), and companies that rely on one customer
Look for companies with large competitive advantages, companies that consistently
grow earnings at a steady pace (10% pre-tax long-term), and that spend on R&D
In past company filings, make sure that management has lived up to their outlooks and
that they take responsibility for any shortcomings that may have occurred
If a company reprices its stock options for insiders, stay away
Form 4 shows whether senior executives have bought or sold shares
Executives should spend most of their time managing their company in private, not
promoting it to the investing public
The most basic possible definition of a good business is this: It generates more cash
than it consumes. Good managers keep finding ways of putting that cash to productive
use
Warren Buffet has popularized the concept of owner earnings, or net income plus
amortization and depreciation, minus normal capital expenditures; If you owned 100% of
this business, how much cash would you have in your pocket at the end of the year
Additionally, subtract costs of granting stock options, any unusual, nonrecurring, or
extraordinary charges, and any income from the companys pension fund
If owner earnings per share have grown at a steady average of at least 6% or 7% over
the past 10 years, the company is a stable generator of cash, and its prospects for
growth are good
Make sure the company has a prudent amount of debt and can cover its fixed charges
Evaluate the companys dividend policy, split policy, and buy-back policies
In investing, as with life in general, ultimate victory usually goes to the doers, not the
talkers

Chapter 12 Things to Consider About Per-Share Earnings

EPS reports can be misleading after looking at special charges and dilution

Valuing a company in the future is difficult because one may not know whether to look at
primary earnings or net income after special charges in different situations

Companies that continually have reoccurring extraordinary or nonrecurring items in

statements should be avoided or highly scrutinized before becoming a position

Factors that can skew earnings reported by companies are special charges, reduction in
normal income-tax deduction by reason of past losses, dilution, and the method of treating
depreciation, method of charging R&D costs, and choice between LIFO and FIFO

Corporate accounting is often tricky, security analysis can be complicated; stock

valuations are really dependable only in exceptional cases

Graham advocates using the average earnings from the past seven to ten years, which
include the special charges, in order to get a better picture of the companys performance

Companies with higher short-term growth rates can be looked at over a shorter three year
horizon, instead of the longer 7 to 10 years for more stable growers


Over long periods of time, certain stocks may trade at wildly varying P/E ratios
Commentary on Chapter 12

Though pro forma earnings were enacted to provide a better look at the long-term
growth of earnings, Wall Street took advantage of this and skewed it to paint an unrealistic
picture

The only thing you should do with pro forma earnings is ignore them

Aggressive revenue recognition is often a sign of dangers that run deep and loom large

In the 1990s, Global Crossing Ltd. was able to inflate reported profits by transforming
normal operating expenses into capital assets

The Intelligent Investor should be sure to understand what, and why, a company
capitalizes

The Intelligent Investor must always be on guard for nonrecurring costs that, like the
Energizer bunny, just keep on going

A portion of a companys income may be coming from pension plans that could go away

Three tips to avoid investing in accounting time bombs are to read the companys report
backwards, read the footnotes in entirety, and read other books about financial reporting
Chapter 13 A Comparison of Four Listed Companies

The four companies that Graham chose to compare in this chapter are ELTRA, Emerson
Electric, Emery Air Freight, and Emhart Corp.

First, Benjamin Graham compares the companies of their chief elements of performance
which include profitability, stability, growth, financial position, dividends, and price history

Emerson Electric and Emery Air Freight both traded at extremely high multiples compared
to Emhart Corp. and ELTRA

Graham desires to look at Emhart Corp. and ELTRA because of their attractively priced
stocks relative to P/E and book value and because both have stable earnings

The seven statistical requirements for inclusion in the defensive investors portfolio are (1)
adequate size, (2) sufficiently strong financial condition, (3) continued dividend for at least the
past 20 years, (4) no earnings deficit in the past ten years, (5) Ten-year growth of at least onethird in per-share earnings, (6) price of stock no more than 1.5X net asset value, and (7) price
no more than 15X average earnings of the past 3 years
Commentary on Chapter 13

Jason Zweig does a modern-day four stock comparison with the companies Emerson
Electric, EMC Corp., Expeditors International of Washington, Inc., and Exodus Communications

Emerson Electric made it through the bear market of 2000-2002 relatively unscathed,
while Expeditors actually closed 51% from the start to finish of the recession

On the other hand, however, EMC Corp. and Exodus Communications both experienced
colossal stock losses during 2001 and 2002, negating any gains made during the roaring 1990s

This should serve as a reminder that many companies trade at valuations that are not
justified, even when outstanding growth and performance are present
Chapter 14 Stock Selection for the Defensive Investor

Graham outlines two ways for the defensive investor to gain exposure to stocks: (1)
purchase all 30 issues of the DJIA (or an index fund today) or (2) find companies that meet
minimum quality of past performance and financial position, along with minimum quantity in
earnings and assets per dollar of price

The seven quality and quantity criteria that Graham for picking individual equities are (1)
adequate size, (2) strong financial condition, (3) earnings stability, (4) consistent dividend
record, (5) continued earnings growth, (6) moderate P/E, and (7) moderate price/assets ratio

Graham points out that at the end of 1970, five of the DJIA components met all of his
criteria for being part of the defensive investors portfolio


Benjamin Graham advocates using many public utilities because of their prices that tend
to trade around book value, steady earnings, and high dividend rate

With financial companies, Graham advises to picking attractively priced companies

At time of publication, Graham advocated There is no compelling reason for the investor
to own railroad shares; before he buys any he should make sure that he is getting so much
value for his money that it would be unreasonable to look for something else instead

The future itself can be approached in two different ways, which may be called the way
of prediction (or projection) and the way of protection

Investing on the basis of projection is a fools errand; Investing on the basis of protection
is the best solution

The Intelligent Investor must make sure that the company first passes the quantitative
threshold (good value and solid growth prospects) and then worry about the qualitative
measures (future prospects and management effectiveness)
Commentary on Chapter 14

Jason Zweig advocates that the defensive investor should keep at least 90% of his
money in an index fund and pick other defensive names with the remaining amount, if desired

Referring to Index Funds: By owning the entire haystack you can be sure to find every
needle, thus capturing returns of all the superstocks. Especially if you are a defensive investor,
why look for the needles when you can own the whole haystack

Jason Zweig states that defensive investors should stick to stocks worth +$2 billion
market cap

Grahams criterion of financial strength still works: If you build a diversified basket of
stocks whose current assets are at least double their current liabilities, and whose long-term
debt does exceed working capital, you should end up with a group of conservatively financed
companies with plenty of staying power

Grahams insistence on some earnings for the common stock in each of the past ten
years remains a valid test

Many companies have consistent and strong dividend records for the past 25 years

More than half of the companies in the S&P 500 were able to meet Grahams ten-year
earnings growth requirement; The growth requirement could actually be raised a little today

Almost 40% of the companies met Grahams goal of trading at or below 15X average
earnings over the past 3 years

123 of the S&P 500 companies traded at or below 1.5X book value; Can be raised a little

Be cautious toward companies which have too much institutional ownership

Chapter 15 Stock Selection for the Enterprising Investor

In the long-run, all common-stock have failed to keep pace with the S&P 500 or DJIA

Two reasons that it is extremely difficult for any investors, amateur or professional, to beat
the market indexes is that there are so many smart people working on Wall Street who cancel
out each others relative advantages and effectiveness and that many analysts are more worried
about growth and current prospects rather than true value and stable, long-term growth

Extremely few companies have been able to show a high rate of uninterrupted growth for
long periods of time. Remarkably few, also, of the larger companies suffer ultimate extinction

In order to beat the market, one must follow specific methods that are not generally
accepted on Wall Street, since those that are so accepted do not seem to produce the results
everyone would like to achieve

At Graham-Newton Corporation, the men classified their trading strategies into the
following categories: Arbitrages, Liquidations, Related Hedges, Net-Current-Asset (or Bargain)
Issues

The professional techniques that we followed are not suitable for the defensive investor

The enterprising investor should look to take full advantage of high-quality, stable stocks
that have overly-pessimistic sentiment at the current time, but have positive long-term prospects


Benjamin Graham highly recommended Standard and Poors Stock Guide as a research
tool to help with looking at the majority of information that the Intelligent Investor needs to know

Rules that the enterprising investor must follow when picking individual stocks are (1) a
strong financial condition, with current ratio of +1.5 and debt no more than 110% of net current
assets, (2) earnings stability, having no losses in the last 5 years, (3) a current dividend, (4)
earnings more than in the same period 5 years prior, and (5) a price less than 120% net tangible
assets

Another factor that may be taken into account is the S&P Ranking attached to the
company

The two methods of this sort that we found to give quite consistently good results in the
longer past have been (a) the purchase of low-multiplier stocks of important companies (such as
the DJIA list), and (b) the choice of a diversified group of stocks selling under their net-currentasset value (or working-capital value)

Low-multiplier issues had a smaller decline in this period than high-multiplier issues, and
long-term dividend payers lost less than those that were not paying dividends

If one can acquire a diversified group of common stocks at a price less than the
applicable net current assets alone- after deducting all prior claims, and counting as zero the
fixed and other assets- the results should be quite satisfactory

Graham talks briefly about arbitrage opportunities, but individuals should not take part
Commentary on Chapter 15

A small percentage of investors can excel at picking their own stocks. Everyone else
would be better off getting help, ideally through an index fund

Graham advised to practice with fake money for one year and then decide whether to
continue

Return on Invested Capital (NASDAQ:ROIC)shows what the company the company

earns from its operating businesses- and how efficiently it has used the shareholders money to
generate that return; This formula can help find great bargains and help provide a margin of
safety

Make sure there are not too many extraordinary expenses, management who are
stakeholders and actively engaged, and companies that perform in-line with past expectations

Successful investing professionals are disciplined and consistent and they think a great
deal about what they do and how they do it
Chapter 16 Convertible Issues and Warrants

Convertible issues are claimed to be especially advantageous to both the investor and
the issuing corporation

The safest conclusion that can be reached is that convertible issues are like any other
form of security, in that their form itself guarantees neither attractiveness nor unattractiveness.
The question will depend on all the facts surrounding the individual issue

During the tail of bull markets, convertible issues perform the worst

Even when a profit appears it brings a dilemma with it. Should the holder sell on a small
rise; should he hold for a much bigger advance; if the issue is called-as often happens when the
common has gone up considerably- should he sell out then or convert into and retain the
common stock

Convertibles should only be bought when there are exceptional upside opportunities that
justify the amount of risk being taken

When companies are merging or being bought out, watch out for the possible dilution that
could occur down the road if all convertible shares or bonds were converted to common

Because preferred now yield more than common, there are instances where the preferred
stock is much more desirable of an investment because of its flexibility and higher income
stream

We consider the recent development of stock-option warrants as a near fraud


A footnote points out that warrants are no longer used in practice at large exchanges

The common stock is diluted and is worth less if there are warrants outstanding

Once more we assert that large issues of stock-option warrants serve no purpose,
except to fabricate imaginary market values
Commentary on Chapter 16

Convertibles bonds are stocks for chickens; More correlated to stocks than bonds

Most converts are now medium-term, in the seven-to-10-year range; roughly half are
investment-grade; and many issues now carry some call protection (an assurance against early
redemption). All of these factors make them less risky than they used to be

You can buy a convertible fund, but there is no real need for the Intelligent Investor to do
this

Jason Zweig states that covered calls cap your upside too much to justify their use
Chapter 17 Four Extremely Instructive Case Histories

Four cases of terrible and outright dangerous stocks that Graham discusses are Penn
Central (Railroad) Co., Ling-Temco-Vought Inc., NVF Corp., and AAA Enterprises

Penn Central was a massive company that was forced into bankruptcy in 1970 because it
was unable to cover all the interest charges that came due

The company had an inefficient transportation ratio, overstated its earnings, similar to
pro forma style today, and took too much debt on to be able to survive

Ling-Temco-Vought (LTV) had similar debt problems just like Penn Central, but also had a
very overstated equity per share because all of the preferred stock that was not taken into
account

Additionally, banks continued to pour money into LTV, which only worsened the problem

NVF Corp. took over Sharon Steel, which was 7X larger than the company itself

This proved disastrous and NVF attempted to use nifty accounting to skew true valuations

AAA Enterprises started as a mobile home business that became grossly overvalued
when it went public, eventually hitting a P/E ratio of 115

The company was forced into bankruptcy, while shareholders had been completely
burned

It will be difficult to impose worthwhile changes in the field of new offerings, because the
abuses are so largely the result of the publics own heedlessness and greed
Commentary on Chapter 17

Jason Zweig exposes four modern-day examples of hyped-up stocks gone bad

Lucent Technologies Inc. went from an operating income of $763 million to a net loss of
$301 million from June 30, 1999 to June 30, 2000

Lucents $4.8 billion acquisition of Chromatis netted the company no future profits and the
company eventually would have to write-down the value of this purchase

Lucent went on to lose almost $30 billion dollars in 2001 and 2002

The company lost market value of $190 billion in a matter of two years

Tyco International Ltd. did not have any organic growth and was a serial acquirer

Tyco would continually try to hide many of its expenses as nonrecurring year after year

Tyco lost $9.4 billion in 2002 and lost 71% of its market value

The AOL Online, Inc./Time Warner Inc. merger proved a costly move for the latter as AOL
had such a high stock valuation and a market cap similar to that of TW, but only had 1/5 the
sales

AOL was trading at 164X earnings, which meant that TW grossly overpaid for the
enterprise

AOL Time Warner Inc. ended up losing $98.7 billion in 2002 alone

eToys went public with their IPO and attained a market value of $7.8 billion


eToys had a higher market value than Toys R Us, even though the retail giant had over
$2 billion in sales, compared to $30 million for eToys, and it reported a net income, while eToys
reported a net loss of $29 million, nearly as much as its entire revenue

eToys filed for bankruptcy in 2001, after reaching a high of $86 per share only 2 years
before
Chapter 18 A Comparison of Eight Pairs of Companies

Graham first compares Real Estate Investment Trust and Realty Equities Corp. of New
York

Real Estate Investment Trust was a prudently managed company that paid a dividend
dating back to 1889

Real Estate Investment Trust was a fast-growing venture that came into the limelight in
the past decade, exploding its revenue and liabilities simultaneously

The debt that Real Estate Investment Trust carried brought it down quite fast by 1973

The second pair compared is Air Products and Chemicals and Air Reduction Co.

Air Reduction only traded at 9.1X earnings while Air Products and Chemicals traded
16.5X

Additionally, Air Reduction only traded at 75% of book value, compared to 165%

Both companies performed similar, with Air Reduction posting slightly better results

The third example compares two massive health-care companies; American Home
Products Co. and American Hospital Supply Co.

Graham correctly points out that both are too expensive for the Intelligent Investor
because both trade way over their book value

Though both had great growth prospects, both stocks did not produce positive returns

The fourth pair of stocks compared is H & R Block and Blue Bell

Blue Bell traded at only 1.42X book value, while Block sold at nearly 30X

Both stocks performed very well during the recovery, even with Blocks ridiculous
valuation

In the fifth comparison, International Flavors & Fragrances, a high-growth stock, is

compared to International Harvester Co., a large DJIA component

Though Harvester was only 59% of book value, it grew too little to justify stock ownership

On the other hand, Flavors traded at an excessively high P/E ratio, as well as 10.5X book

There are three more examples that point out arbitrary and obvious differences

These comparisons show that there is over-valued and under-valued companies all the
time
Commentary on Chapter 18

Although there are good and bad companies, there is no such thing as a good stock;
there are only good stock prices, which come and go

In all of Jason Zweigs examples, the growth companies may win in the short-run, but get
utterly destroyed once they come crashing back down to earth

The market scoffs at Grahams principles in the short run, but they are always revalidated
in the end. If you buy a stock purely because its price has been going up- instead of asking
whether the underlying companys value is increasing- then sooner or later you will be extremely
sorry. Thats not likelihood. Its a certainty
Chapter 19 Shareholder and Managements: Dividend Policy

Graham is crying out in this last edition for shareholders to stand-up to bad management

The amount that companies are giving out in dividends has greatly decreased from the
publication of the book to the modern day

Interestingly, higher quality companies are not paying-out the largest dividends, while
instead re-investing money, while the less profitable companies are expected to have large
yields

Graham believes that a company should definitely pay a dividend if it has the means to


All stock splits today are carried out by a change of value

Special dividends are rare toady, but were much more popular when Graham worked

Dividend policy is also greatly affected by the current rate at which they are taxed

Graham really pushed the idea of rewarding shareholders through dividend payments
Commentary on Chapter 19

In light of recent corporate scandals, shareholders need to be more vigilant than ever

Graham wanted to invigorate shareholders to exercise their authority as owners

However, Graham noted that shareholders in practice just followed the path of
management

Graham believes that shareholders should think of two questions about management; Is
the management reasonably efficient and are the interests of the average outside shareholder
receiving proper recognition

Graham believes that it is the shareholders duty to vote on proxy material

1/3 of all individual investors do not even vote on their proxy statements

Always read the proxy statements before and after you buy a stock

The current trend is for companies to pay less and less in dividends

Research reports have shown that companies that pay out higher dividends actually have
higher future corporate earnings

Stock buybacks are great in theory, but are often difficult to time for a good price and are
sometimes motivated by tax breaks that management is looking to garner

Stock buybacks are also used to make-up for the dilution of shares after stock options are
issued

Stock buybacks are a lot more dangerous to companies than paying out dividends

Stockholders must watch out for compensation plans that can quickly be cashed in

Stockholders should look for plans that reward management on meeting stringent
benchmarks

Jason Zweig closes this section with the idea of if the independent board members having
to report why they believe management was not overpaid for the particular year
Chapter 20 Margin of Safety as the Central Concept of Investment

The Margin of Safety ensures that the Intelligent Investor will not overpay for securities

The Margin of Safety is instituted to make sure that the Intelligent Investor becomes an
owner of securities that are priced so that ample returns can be made, while limiting relative risk

Though future earnings forecasts are necessary for growth stocks, people must err on the
side of caution when valuing issues in the future

If these are bought on a bargain basis, even a moderate decline in the earning power
need not prevent the investment from showing satisfactory results. The margin of safety will
then have served its proper purpose

Diversification is an established tenet of conservative investment

Maximizing investors total number of invested companies offers a better chance for profit
than for loss

We suggest that the margin-of-safety concept may be used to advantage as the

touchstone to distinguish an investment operation from a speculative one

The defensive investor will stick to U.S. government issues and high-grade dividend
paying stocks, as well as first-quality bonds when the yield is justifiable

The enterprising investor will take advantage of severe depreciation in lower-grade

issues, including stocks, bonds, and convertibles

Investment is most intelligent when it is most businesslike

First Principle: Know what you are doing- know you business

Second Principle: Do not let anyone else run your business, unless you can supervise
his performance with adequate care and comprehension or you have unusually strong reasons
for placing implicit confidence in his integrity and ability


Third Principle: Do not enter upon an operation unless a reliable calculation shows that it
has a fair chance to yield a reasonable profit

Fourth Principle: Have the courage of your knowledge and experience

You are neither right nor wrong because the crowd disagrees with you. You are right
because your data and reasoning are right

To achieve satisfactory investment results is easier than most people realize; to achieve
superior results is harder than it looks
Commentary on Chapter 20

No wonder, when he was asked to sum up everything he had learned in his long career
about how to get rich, the legendary financier J.K. Klingenstein of Wertheim & Co. answered
simply: DONT LOSE

Ultimately, financial risk resides not in what kinds of investments you have, but in what
kind of investor you are

Before you invest, you must ensure that you have realistically assessed your probability
to being right and how you will react to the consequences of being wrong

Simply by keeping your holdings permanently diversified, and refusing to fling money at
Mr. Markets latest, craziest fashions, you can ensure that the consequences of your mistakes
will never be catastrophic. No matter what Mr. Market throws at you, you will always be able to
say, with a quiet confidence, This, too, shall pass away
Postscript

Graham averaged a return of close to 20% per year, an amazing feat for anyone during
anytime

Graham actually made a ton of money off his stake in GEICO

Graham points out that behind his successful enterprise was a background of preparation
and disciplined capacity, along with his courage and judgment to seize the moment
Commentary on Postscript

Without a saving faith in the future, no one would ever invest at all. To be an investor, you
must be a believer in a better tomorrow

Investing, too, is an adventure; the financial future is always an uncharted world. With
Graham as your guide, you lifelong investing voyage should be as safe and confident as it is
adventuruous