Book Summary of The Intelligent Investor: The Classic Text on Value Investing

In this detailed book summary of The Intelligent Investor: The Classic Text on Value Investing, we will dive into a handful of chapters that I’ve deemed most important and ‘timely’ in 2024, 75 years after its first publication.

NB! Please note that the following summary is of the 2005 edition with foreword by John C. Bogle.

Chapter 1 – What the Intelligent Investor Can Accomplish

• The underlying principles for sensible investments should not change; but the application of these must be adapted to the financial landscape of the time.​

• Stocks become less risky in bear markets, and more risky in bull markets.​

• The difference between investing and speculation can be summed up as such: “An investment operation is one which, on thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.“

• The Defensive Investor can expect to a) avoid loss, b) with little effort and the freedom from having to make frequent investment decisions. The Enterprising Investor seeks a) better-than-average returns b) by dedicating time and effort in the selection of securities.​

Chapter 2 – The Investor and Stock Market Fluctuations

• A healthy attitude and understanding of price movements characterises the intelligent investor. Intelligent investing is more a matter of mentality and temperament than technique.​

• Price movements are essential for investors in two ways:​​ 1) Calculation of investment returns relative to the market; 2) Guide the selection of securities. The investor can select shares based on a) timing or b) pricing. The former involves speculation in the market’s direction (up/down). The latter involves buying when prices are below intrinsic value, and sell when they exceed said value. The investor who follows the pricing principle bases his stock selection on a value approach.​

• An index’ central value can be calculated by multiplying the average earnings per share by an appropriate multiplier based on the current interest rate: EPS / 2 * Interest Rate. One should buy when the central value is less than 80% and sell when it’s above 120%.​ The below table is an example provided in the book:

Year​	Average EPS	Interest on gov. bonds	Intrinsic Value	80% of IV	120% of IV
1946	9.88​	2.46​%	200.8​	160.7​	241.0​
1947	10.24	2.53%​	202.4​	161.9​	242.8​
1948	10.97​	2.78%​	197.3​	157.8​	236.8​

• The intelligent investor’s secret weapons are a) the courage to act based on his analysis and principles; b) to be relatively immune to optimism and pessimism in the market; c) to be psychologically ready to be a real investor, not a speculator disguised as an investor.​

Chapter 4 – General Portfolio Policy: The Defensive Investor​

• The Defensive Investor’s portfolio should consist of high-quality (investment grade) bonds and stocks in high quality businesses. Bonds should make up a minimum of 25%, but never more than 75%. For most defensive investors, the recommended split is 50-50.​

• Rules for the stock component in The Defensive Investor’s portfolio:​
  • 1. There should be sufficient, but not excessive, diversification (somewhere between 10-30 stocks).​
  • 2. Each company should be large, prominent, and conservatively financed. “Large and prominent” translates into a leading position in the given industry. An industrial company is not “conservatively financed” unless its equity represents at least half of the total enterprise value, including all bank debt.​
  • 3. Each company should have a long history of paying dividends.​
  • 4. The paid price for each share should be reasonable in relation to its average earnings for the past five years or longer; it is recommended that the price should not exceed 20 times the average earnings.​

• The Defensive Investor is advised to take indirect ownership of a wide range of stocks via investment funds.​

Chapter 6 – Portfolio Policy for the Enterprising Investor: The Positive Side

• There are four ways the Enterprising Investor can achieve better-than-average returns:​
  • 1. Market movements: Anticipate and participate in market movements. Using the ”central value” table in chapter 2, one can ”buy low” and “sell high”. This sounds simple, but it’s not fool-proof. Historically, investors have suffered losses by buying/selling everything at once when they judge that a bull market turns into a bear market and vice versa. Investors can buy/sell in pieces so that they can continue to take advantage of price fluctuations even if they do not fall exactly within their calculations.
  • ​2. Growth stocks: Select businesses that will grow more than the average enterprise when they’re available at a reasonable price. There are two problems with just selecting a range of growth stocks and believing that you have a ‘winning portfolio’: ​
    • a) Stocks with a good history and future prospects are sold at correspondingly high prices. Therefore, you may be right in its prospects, but still suffer a loss if you overpaid.​
    • b) Your assessment of future performance/growth may not be fulfilled; extraordinary growth cannot continue forever.​
  • 3. Bargains: Select companies that are sold significantly below their intrinsic value. These are often considered “unpopular” (as opposed to growth stocks), usually due to bleak prospects or circumstances. This creates opportunities for the intelligent investor. A security is not a “true bargain” unless the the market price is at least 50% of its intrinsic value (a dollar for fifty cents).​
  • 4. Special situations: This includes spin-offs, mergers, lawsuits, restructurings and liquidations. The market tends to undervalue securities involved in “complicated situations”, which can create ‘bargain buying opportunities’.​

Chapter 8 – Security Analysis for the Lay Investor: General Approach​

• Security analysis involves the past, present, and future of a given security. A security analyst describes the company; summarises its operating results and financial position, presents its strengths and weaknesses as well as its opportunities and risks, estimates its future earning power under various assumptions before finally making a recommendation on buying or selling a security based on the margin of safety between one’s estimated intrinsic value vis-à-vis the current price.​

• The valuation will often be measured based on an estimate of future average earnings over a number of years multiplied by an appropriate multiplier. How does the analyst find a) average future earnings and b) a suitable multiplier.​
  • a) By looking at the company’s historical earnings, the analyst has a logical foundation to estimate the future. By looking at historical profit margins and estimated future sales as well as movements in the industry, the analyst can make some qualified assumptions.​
  • b) The capitalization factor indicates the expected return over a number of years. There are five factors one should take into account when deciding whether to apply a high or low multiplier: 1) general long-term prospects; 2) quality of management​; 3) financial strength and capital structure​; 4) dividend payment history​; 5) current dividend rate​.

• Graham estimated that General Motors’ future EPS would be $5; multiplying this by 15 values the company at $75 per share. As it traded at $50 in 1948, it had an decent margin of safety and could be considered a ‘buy’.​

Chapter 10 – Stock Selection for the Enterprising Investor: The Appraisal Method

• A stock’s “fair value” is what it should be sold for in a normal market governed by intelligent buyers and sellers.​

• The Enterprising Investor performs valuations of a range of stocks and selects the one(s) that offer the greatest discount (margin of safety) relative to the market price. These values are primarily based on estimated future earning power multiplied by a capitalisation factor that reflects the quality of the given stock. ​

• Utilities (electricity, water, heat) are best suited for valuation as their operations have a strong underlying stability, which is why estimates for the future can be set with greater certainty than other industries.​

• The valuation method starts by normalising the business’ earnings per share (EPS) over a given period, e.g. 7-10 years (as this includes a ‘full’ cycle incl. a boom and recession). The EPS is then multiplied by an appropriate multiplier, usually between 10-20. The multiplier for a stock with neutral prospects is 12. The maximum should be 20 and the minimum 8.​ The intrinsic value formula as proposed by Benjamin Graham is as follows:

Chapter 16 – “Margin of Safety” as the Central Concept of Investment

• The “margin of safety” concept is a central component throughout the book. Simply put, it’s the difference between your estimate of a business’ intrinsic value and the stock price. There needs to be a margin of minimum 30% in order for it to be considered a ‘bargain’.

• The presence of a margin of safety is not a failsafe. Though it provides the investor with a greater chance of profit, one should combine the margin of safety approach to investing with a diversified portfolio in order to reduce risk.

• “Investments are most intelligent when it is most businesslike.”

If you enjoyed this book summary of The Intelligent Investor: The Classic Text on Value Investing, you would also enjoy the chapter-by-chapter summaries of The Psychology of Money: Timeless Lessons on Wealth, Greed and Happiness and Where the Money Is: Value Investing in the Digital Age.