by Srikanth Agaram
2009-10-30

I've read my share of "… for dummies" books and they're usually a good guide for beginners in many disparate fields. I believe, however, that investment should not be one of those fields. We all spend a good deal of time and effort earning money and saving it. However when it comes to investment, people don't seem too keen to spend time and effort to in protecting their savings. I've picked up this book called The Intelligent Investor that provides rational advice to investment. I think it would be even better named "The Rational Investor" since actual intelligence is not required. Much more important is dilligence in fact-checking and courage to ride through the good and bad times.

This book makes three important distinctions:

  • Price vs. Value
  • Speculation vs. Investment
  • Company growth vs. Return on investment

Each of these distinctions is an important revelation steering the reader away from common mistakes and pitfalls of investment. The reason it's called a "share" is because it represents a share of the company's ownership. Each company has an intrinsic business value that can be objectively determined by looking at the financial statements. These financials determine whether the company is worth investing in at all. If those check out, the next thing is to determine the right price at which you would buy it. The stock market often swings from underpriced to overpriced. The rational investor would buy when a stock is well underpriced (underpriced with a margin of safety). Similarly one would sell the stock when it's well overpriced.

The next important distinction is that between investment and speculation. According to Graham:

An investment operation is one which, upon thorough analysis promises safety of principal and adequate return.

Most wall street and regular "investors" do not conform to this definition. I think that is consistent with the boom and bust results that these people are able to realize. The rational investor would not be caught unawares by swings to either extreme. The analysis doesn't take a lot of smarts either. It does require time and effort to do the dilligent research to find businesses that have sound fundamentals and to figure out the fair price for it.

The third important distinction is that the projected future growth of a company is not a guarantee of increase in stock price. More often than not, the growth projections are public knowledge and have already inflated the price of the stock. Thus stocks that are touted by the so called "experts" are the ones that are most likely to be overpriced.

In the end, the rational investor must have the fortitude to ignore the swings of the market and operate by the sound fundamental principles laid out in this book.