Intelligent Investor Intro and Ch.1 - Investment vs Speculation

Intro and Chapter 1

"By far the best book on investing ever written" --Warren E. Buffett

This is the quote of the front cover of the book, written by Benjamin Graham (born as Grossbaum in London). According to Warren Buffett, this is the best book on investing (especially if you follow the behavioral and business principles that Graham advocates in the book and if you pay special attention to the advice in Chapter 8 and 20)!

Jason Zweig summarizes well in his note at the beginning of the book Graham's core principles:

1. You are part owner of an actual business, not just owner of a stock
2. The market is a pendulum, swinging from totally optimistic to totally pessimistic. 
1. Optimistic market = Stocks expensive
2. Pessimistic market = Stock cheap 
3. The higher the price you pay, the lower your return will be. Shop only on discount!
4. To minimize risk and your odds of being wrong, insist on a margin-of-safety
5. Don't get carried away with your emotions, be disciplined, and have courage, refuse to follow the market, and people's mood between greed and fear - use those swings to your advantage!

Chapter 1 - Investment versus Speculation

Investor vs Speculator

So what is the difference or what is the definition of an Investor? I cite directly from the book:

"An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

The main three sentences here are thorough analysis, safety, and adequate return.

The description of an investor and speculator has changed over time, e.g. in 1929-1932, everyone was a speculator who bought and sold common stocks. - Later on, everyone became an investor and articles were written about "Small investor ....... selling short" or "reckless investors"

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"Selling short" or "shorting" a stock is that you bet that the share price will go down, you do it in 3 steps:

1. You "borrow" shares from someone who owns it
2. Immediately, you sell the borrowed shares
3. You replace them with shares you buy later

The difference between the borrowed shares and the one you buy later is your profit, minus your costs (interest charges + brokerage cost)

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Even people who operate on margin should defacto be called speculators. (With a "margin account" you buy stocks using money you borrow from the broker! By investing the borrowed money, you make more when the stocks go-up, but you can get wiped out when they go down).

From the book, Graham describes two types of Investors, i.e. Defensive Investor and Aggressive Investor.

The Defensive Investor is mostly interested in safety and the freedom not to think too much about the investments. The book mentions three concepts for the defensive investor

1. Purchase of share of well-established investment funds
2. Use services of a recognized investment-counsel firm
3. "Dollar-cost averaging" which means that you buy the same amount or the same number of stocks each month

The Aggressive Investor will desire and expect higher returns than the defensive or passive investor. But even here the first rule is, that the result will not be worse than the defensive investor, so protection on the downside.

It is very clear, that the Aggressive Investor is on the run for the long-term selective choice of businesses, as short-term is more guessing where the market is heading towards. As the book states:

"To enjoy a reasonable chance for continued better than average results, the investor must follow policies which are (1) inherently sound and promising, and (2) not popular on Wall Street"

Special situations though can be an attractive way of increasing high returns. Special situations, according to Grahams are:

• Inter-security arbitrages
• Liquidations of business
• Protected hedges
• Merger & Acquisitions (M&A)

And lastly, I write finally here, Grahams points to the bargain issues, identified as such by the fact that they were selling at less than their share in the net current assets (working capital) alone, not counting the plant account or other assets, and after deducting all liabilities ahead of the stock.

To summarize the approach of the Aggressive Investor is to find and identify securities undervalued by logical and reasonably dependable standards, to achieve better than average results.