Q&A: The Intelligent Investor – Chapter 5: The Defensive Investor and Common Stocks

Below are my reflections and answers to the discussion questions posted at Modern Graham for chapter 5 – The Defensive Investor and Common Stocks – of the Intelligent Investor written by Benjamin Graham. The Intelligent Investor

1. What quote from this chapter do you think best summarizes the point Graham is making?

This is a rather long quotation, but it also points out the four rules that Grahams suggests the defensive investor to follow to make the selection of common stocks a relatively simple matter.

“The selection of common stocks for the portfolio of the defensive investor should be a relatively simple matter. Here we would suggest four rules to be followed:

1. There should be adequate though not excessive diversification. This might mean a minimum of ten different issues and a maximum of about thirty.

2. Each company selected should be large, prominent, and conservatively financed. Indefinite as these adjectives must be, their general sense is clear. Observations on this point are added at the end of the chapter.

3. Each company should have a long record of continuous dividend payments. (All the issues in the Dow Jones Industrial Average met this dividend requirement in 1971.) To be specific on this point we would suggest the requirement of continuous dividend payments beginning at least in 1950.

4. The investor should impose some limit on the price he will pay for an issue in relation to its average earnings over, say, the past seven years. We suggest that this limit be set at 25 times such average earnings, and not more than 20 times those of the last twelve-month period. But such a restriction would eliminate nearly all the strongest and most popular companies from the portfolio. In particular, it would ban virtually the entire category of “growth stocks,” which have for some years past been the favorites of both speculators and institutional investors. We must give our reasons for proposing so drastic an exclusion.”

2. What do you think of Graham’s general rules for Defensive Investors?

I like Graham’s general rules because they include important aspects regarding portfolio composition, companies with a favorable business and dividend payments history and also, maybe the most important thing, the aspect of how much to pay for a business average earnings.

3. How many companies do you have in your portfolio today?

Right now I have two companies in my portfolio. The remaining part of the portfolio is in cash, so I constantly look for great businesses at fair or great prices to buy to increase the number of companies.  But at the moment I cannot say that there are a lot of companies that meet my requirements.

4. How can we balance “buying what we know” with the neutrality that is needed for proper research?

By constantly being aware heuristics and human biases that affect us in our daily life, especially in the daily life of an business analyst and investor.

5. Do any of you experience differences of opinion with your partner about investing? How do you handle those situations?

Not applicable to me at the moment.

6. What did you think of the chapter overall?

Great chapter. Graham makes everything sound so obvious. The four rules for the defensive investor and the discussion about growth stocks and the note on the concept of risk are all great reads.

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