Four Books Warren Buffett Particularly Treasure

“My intellectual odyssey ended, however, when I met Ben and Dave, first through their writings and then in person. They laid out a roadmap for investing that I have now been following for 57 years. There’s been no reason to look for another.”—Warren Buffett

Warren Buffett’s Forward to the Sixth Edition of Security Analysis

SAGD1“There are four books in my overflowing library that I particularly treasure, each of them written more than 50 years ago. All, though, would still be of enormous value to me if I were to read them today for the first time; their wisdom endures though their pages fade.

Two of those books are first editions of The Wealth of Nations (1776), by Adam Smith, and The Intelligent Investor (1949), by Benjamin Graham. A third is an original copy of the book you hold in your hands, Graham and Dodd’s Security Analysis. I studied from Security Analysis while I was at Columbia University in 1950 and 1951, when I had the extraordinary good luck to have Ben Graham and Dave Dodd as teachers. Together, the book and the men changed my life.

On the utilitarian side, what I learned then became the bedrock upon which all of my investment and business decisions have been built. Prior to meeting Ben and Dave, I had long been fascinated by the stock market. Before I bought my first stock at age 11—it took me until then to accumulate the $115 required for the purchase—I had read every book in the Omaha Public Library having to do with the stock market. I found many of them fascinating and all interesting. But none were really useful. My intellectual odyssey ended, however, when I met Ben and Dave, first through their writings and then in person. They laid out a roadmap for investing that I have now been following for 57 years. There’s been no reason to look for another.

WB2Beyond the ideas Ben and Dave gave me, they showered me with friendship, encouragement, and trust. They cared not a whit for reciprocation—toward a young student, they simply wanted to extend a one-way street of helpfulness. In the end, that’s probably what I admire most about the two men. It was ordained at birth that they would be brilliant; they elected to be generous and kind.

Misanthropes would have been puzzled by their behavior. Ben and Dave instructed literally thousands of potential competitors, young fellows like me who would buy bargain stocks or engage in arbitrage transactions, directly competing with the Graham-Newman Corporation, which was Ben’s investment company. Moreover, Ben and Dave would use current investing examples in the classroom and in their writings, in effect doing our work for us. The way they behaved made as deep an impression on me—and many of my classmates—as did their ideas. We were being taught not only how to invest wisely; we were also being taught how to live wisely.

The copy of Security Analysis that I keep in my library and that I used at Columbia is the 1940 edition. I’ve read it, I’m sure, at least four times, and obviously it is special.

But let’s get to the fourth book I mentioned, which is even more precious. In 2000, Barbara Dodd Anderson, Dave’s only child, gave me her father’s copy of the 1934 edition of Security Analysis, inscribed with hundreds of marginal notes. These were inked in by Dave as he prepared for publication of the 1940 revised edition. No gift has meant more to me.”

4BWBDisclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.


Q&A: The Intelligent Investor – Chapter 6: Portfolio Policy for the Enterprising Investor: Negative Approach

Below are my reflections and answers to the discussion questions posted at Modern Graham for chapter 6 – Portfolio Policy for the Enterprising Investor: Negative Approach – 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?

“The most useful generalizations for the enterprising investor are of a negative sort. Let him leave high-grade preferred stocks to corporate buyers. Let him also avoid inferior types of bonds and preferred stocks unless they can be bought at bargain levels—which means ordinarily at prices at least 30% under par for high-coupon issues, and much less for the lower coupons. He will let someone else buy foreign-government bond issues, even though the yield may be attractive. He will also be wary of all kinds of new issues, including convertible bonds and preferreds that seem quite tempting and common stocks with excellent earnings confined to the recent past.”

2. What do you think of Graham’s suggestions that Enterprising Investors avoid these types of investments?

I think it’s reasonable due to the risks inherent in these types of investments.

3. Have you invested in any such opportunities?

No, I have not.

4. How can we balance avoiding the risk inherent in these opportunities with the potential return they present?

Buy a basket of them and buy all of them at a great discount to intrinsic value. If this cannot be done, I think it’s best to stay away from all of them.

5. What other types of investments do you think should be added to the “Do not touch” list?

Stocks that are priced much too optimistic with expectations set too high compared to a reasonable and conservatively calculated intrinsic value. Except for this I’m not really sure I have anything to add, but clearly all kinds of investments that somebody tries to sell you where the incentives are not aligned with your own should be avoided. All businessmen promoting and selling investments that will make you rich should be kindly but definitely dismissed.

6. What did you think of the chapter overall?

Enjoyed the chapter and all the wisdom that is discussed by Graham in the text.

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.

Q&A: The Intelligent Investor – Chapter 4: General Portfolio Policy: The Defensive Investor

Below are my reflections and answers to the discussion questions posted at Modern Graham for chapter 4 – General Portfolio Policy: The Defensive Investor – 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?

“It has been an old and sound principle that those who cannot afford to take risks should be content with a relatively low return on their invested funds. From this there has developed the general notion that the rate of return which the investor should aim for is more or less proportionate to the degree of risk he is ready to run. Our view is different. The rate of return sought should be dependent, rather, on the amount of intelligent effort the investor is willing and able to bring to bear on his task. The minimum return goes to our passive investor, who wants both safety and freedom from concern. The maximum return would be realized by the alert and enterprising investor who exercises maximum intelligence and skill.”

2. What is your portfolio’s allocation between stocks and bonds right now?

100 percent stocks.

3. What methods have you used for determining your allocation between stocks and bonds?

Graham’s framework for the enterprising investor and then also Zweig’s tests to the question “But is putting all your money into the stock market inadvisable for everyone?”

4. Graham explains several types of bonds, which bond do you prefer and why?

Neither of them. Right now I prefer stocks.

5. If you have the newer edition with Jason Zweig’s commentary, Zweig departs from Graham’s advice to never have more than 75% of your investments in stocks and instead states that some investors may be well served by having 100% in stocks (see the box on page 105).  What do you think of this idea?

I think that the approach sounds reasonable for someone that can honestly pass the tests laid out by Zweig.

6. What did you think of the chapter overall?

I like Graham’s distinction between risk and return. Still today, most people or at least the ones who makes their voice heard tend to connect returns to risks taken. I prefer to buy great companies at a fair or even cheap price. That to me is a low and acceptable risk coupled with the opportunity to get a satisfactory return.

Q&A: The Intelligent Investor – Chapter 3: A Century of Stock-Market History

Below are my reflections and answers to the discussion questions posted at Modern Graham for chapter 3 – A Century of Stock-Market History – 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?

“The investor’s portfolio of common stocks will represent a small cross-section of that immense and formidable institution known as the stock market. Prudence suggests that he have an adequate idea of stock-market history, in terms particularly of the major fluctuations in its price level and of the varying relationships between stock prices as a whole and their earnings and dividends. With this background he may be in a position to form some worthwhile judgment of the attractiveness or dangers of the level of the market as it presents itself at different times.”

2. Do you have any interesting anecdotes or experiences to share relating to some market highs or lows?

Not really. But in hindsight I wish that I had been a little less fearful, and a little greedier, during the financial crisis back in 2008-2009 and that I had taken better care of the opportunities present back then. With hindsight bias at your side I guess it’s always easy to feel that way.  

3. The market has been on a continued rise over the last couple of years.  Using data-based analysis, rather than emotion or “hunches” where do you expect the market to go in the next couple of years?

The hardest question of them all. Where do you expect the market to go? I don’t really know. Below is my expectations from the figures I’ve found at the moment for earnings growth, inflation and dividend yield.

If someone has some good resources where one can easily find data for earnings growth, dividend yield (S&P 500 etc) and inflation – feel free to share. Also, should share buy-backs be considered in the calculation below – money that could have been paid out as dividends and thus higher dividends and dividend yield? Any thought on this issue?

Earnings growth [1]             1.50% to 2.00%

Inflation [2]                                  + 1.58%

Dividend yield [3]                           + 1.81%

Expexted return:                 4.89% to 5.39%

Expexted return (after inflation): 3.31% to 3.81%

Earnings growth [4]              1.50% to 2.00%

Inflation [5]                                   + 2.00%

Dividend yield [6]                  2.03% to 3.30%

Expexted return:                   5.53% to 7.30%

Expexted return (after inflation): 3.53% to 4.03%

4. What did you think of the chapter overall?

I enjoyed the chapter. Interesting to see how history has emerged and how stock prices have fluctuated compared to earnings, dividends and CPI.

[1] Stocks for the Long Run (same as used by J. Zweig in the commentary chapter)

Q&A: The Intelligent Investor – Chapter 2: The Investor and Inflation

Below are my reflections and answers to the discussion questions posted at Modern Graham for chapter 2 – The Investor and Inflation – 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?
    Stocks, as other asset classes, will be affected by inflation. Graham states, which I think is essential for any investor to remember, that “…the possibility of large-scale inflation remains, and the investor must carry some insurance against it. There is no certainty that a stock component will insure adequately against such inflation, but it should carry more protection than the bond component.”
  1. What projection do you have for the inflation rate going forward?
    In general I think that the inflation rate going forward will be higher (the question being “How high?) than it has been during the last 5 to 7 years. The financial crisis has kept inflation at a low level. At the same time we have seen large interventions made by central banks around the world. Any projection made should take into account that the future inflation rate will probably not be the same as in the last 5 to 10 year period. Maybe I should have a better grasp, but at the moment I don’t. I focus on buying businesses that I think, in some way, can protect themselves against inflation – see question four below.
  2. Why do you think that some people choose to ignore inflation when making financial decisions?
    Most people don’t have a long-term horizon when it comes to buying stocks, they’re in it for the short-term – i.e. more kind of speculators than investors. That’s the main reason why I think inflation is not a big issue for them. For someone only in it for the short run the issue about inflation won’t be as important to them compared to someone who’s to buy and hold for 10 to 15 years.
  3. How do you hedge your portfolio against inflation?
    I try to hedge against inflation by buying great businesses with high and stable cash flows, low capex requirements, financially strength and pricing power. Inflation is one aspect in my investment analysis and when I look at a business I try to understand how it will be affected by inflation. Is the business asset heavy, i.e., a lot of fixed assets needed to run the business, high capex requirements etc. I also look at the expense structure of the business, competitors, industry, and then I try make a reasonable assumption as to whether the business will be able to pass on higher future input costs to customers?

Q&A: The Intelligent Investor – Chapter 1

Below are my reflections and answers to the discussion questions posted at Modern Graham for chapter 1 of the Intelligent Investor written by Ben Graham.The Intelligent Investor

  1. How can we summarize Graham’s definition of the difference between a speculator and investor?

    In the beginning of chapter one Graham asks the question “What do we mean by “investor”?” and goes on to explain the difference between an investor and a speculator by going back to the 1934 edition of Security Analysis and the quote: “An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”

  2. Graham mentions on page 19 that in the 1940s most people would consider stocks too speculative. How do you think the average person feels about stocks today? How should an intelligent investor feel about stocks?

    To start with, the average person probably has an insufficient understand of what a stock really is. In general I think that most people considers stocks too speculative. At the same time the intelligent investor should probably not feel too exited, about either the general market or most common stocks, due to the levels they are trading at right now. The number of bargains has fallen as the market has risen.

  3. Graham states that some amount of speculation is necessary. What amount of speculation do you feel comfortable with?

    I like to buy stocks without paying for growth, though I’m willing to accept some amount of speculation, first in the form of a conservative estimate of expected future growth that is deemed reasonable compared to the facts and circumstances known today.

  4. What was your favorite quote from Graham in this chapter?

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

    “Outright speculation is neither illegal, immoral, nor (for most people) fattening to the pocketbook.”

  5. Have you ever speculated? If so, what were your results?

    Yes, by buying shares in a business without having the proper knowledge of the fundamentals. The result… disaster.

  6. Despite continued examples of the success of those who follow Graham’s methods, they remain unpopular on Wall Street.  Why do you think that is?
    Wall Street is all about activity, which implies transaction fees. If everyone followed Graham’s methods the amount of transactions would go down drastically and many brokers would go… broke. To quote Warren Buffett: “One of the ironies of the stock market is the emphasis on activity. Brokers, using terms such as “marketability” and “liquidity,” using the praises of companies with high share turnover… but investors should understand that what is good for the croupier is not good for the customer. A hyperactive stock market is the pick pocket of enterprise.”
  7. In his commentary to this chapter (found in the newer published edition), Jason Zweig pointed out in the “investing” craze that happened during the late 1990s, and how many people did not follow Graham’s suggested requirements for investing.  How do you think the principles Graham taught in this chapter would apply to the market today?

    If you look at how fast the consensus can change and prices go up and down, it seems like Graham’s principles are not that widely practiced. If they were, stock prices would be more stable. From looking at the market today, it seems like too many people are willing to pay too much to own stocks. It is easily forgotten that higher stock prices as of today, implies lower returns going forward.

Q&A: The Intelligent Investor – Introduction

Below are my reflections and answers to the discussion questions, posted at Modern Graham, regarding the introduction of the Intelligent Investor written by Ben Graham.

The Intelligent Investor

1. Please introduce yourself, giving particular emphasis on your background in investing.

I live in Stockholm, Sweden. Moved to Stockholm when I began to study at the School of Business at the university.The first investing book I ever bought was a used copy of Peter Lynch’s One Up on Wall Street, which became my starting point for getting to know the names of other great investors of which Warren Buffett was the first one. I then started to read and learn more about Buffett which got me introduced to Ben Graham, Charlie Munger, Phil Fischer, Irving Kahn, Walter Schloss, Joel Greenblatt and many other great investors.I read the Intelligent Investor pretty early, much because I read somewhere that Buffett had said that the Intelligent Investor was the greatest investing book ever written.

I don’t work in the area of investing, but I spend most of my spare time reading about different companies, industries, investors, investing principles, how to value a business and also how to think about market prices. I am also interested in human psychology and enjoy reading about different kinds of heuristics and human biases.

I use to say that I have read about investing for ten years and been investing for five years.

2. What do you expect to get out of reading The Intelligent Investor? What is your motivation for reading?

I except to revisit the great principles laid out in the book and update my own thinking about them. I have read the Intelligent Investor two times before, so this will be my third and I hopefully it won’t be the last time. It’s really a great book and a great book should be read multiple times.Last time I read the Intelligent Investor I thought that I should read it once every year. I haven’t. But I think the intention was good. When I read about the MG Book Club I thought that it would be a great opportunity to read the Intelligent Investor once again together with other people sharing the same interest. Becoming a better investor is my motivation for reading the Intelligent Investor once again.

3. Did you find anything particularly interesting in the Introduction?Here are some parts I find interesting from reading the introduction:

“The underlying principles of sound investment should not alter from decade to decade, but the application of these principles must be adapted to significant changes in the financial mechanisms and climate.”“Evidently it is not only the tyro who needs to be warned that while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster.”“We have seen much more money made and kept by “ordinary people” who were temperamentally well suited for the investment process than by those who lacked this quality, even though they had an extensive knowledge of finance, accounting, and stock-market lore.”

“The really dreadful losses of the past few years (and on many similar occasions before) were realized in those common-stock issues where the buyer forgot to as “How much?”.

“…it would seem a comparatively simple matter to “beat the averages”; but as a matter of fact the proportion of smart people who try this and fail is surprisingly large.”

“Allied to the foregoing is the record of the published stock-market predictions of the brokerage houses, for there is strong evidence that their calculated forecasts have been somewhat less reliable than the simple tossing of a coin.”

“Before attempting such a venture the investor should feel sure of himself an

d of his advisers–particularly as to whether they have a clear concept of the differences between investment and speculation and between market-price and underlying value.”

“Through all their vicissitudes and casualties, as earthshaking as they were unforeseen, it remained true that sound investment principles produced generally sound results. We must act on the assumption that they will continue to do so.”

4. Graham said that “the investor’s chief problem – and even his worst enemy – is likely to be himself.” Has this been true in your own investing experience? What do you think you can do to not get in your own way?

Agree. First, it takes time to accumulate knowledge–a never-ending journey, and then it takes time to getting to know how to use it in a proper way. Second, you also need to learn how to handle your own emotions and biases and connect that part to your own decisions about what businesses to invest in based on your own analysis.

It pretty much comes down to what Buffett wrote in the preface to the Fourth Edition; “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. This book precisely and clearly prescribes the proper framework. You must supply the emotional discipline.”

5. When Graham wrote the 4th Edition, the investing environment was replete with very high interest rates, which affected at least in part his general outlook on bonds versus equities. Today we are seeing historically low interest rates. How do you think Graham would react to the current market? Would he put a greater emphasis on equities, focusing specifically on strong dividend yields, or would he continue to advocate in general a 50-50 split between bonds and equities? What other things do you think should be taken into consideration when investing?

Ben would probably emphasize the need to find great businesses at reasonable prices compared to value, and to find businesses with a strong history of earning power and dividends. Maybe Ben would put greater emphasis on equities due to the fact that interest rates currently are at a very low level. Low bond yields today, and also the risk, which is more of a certainty, of rising interest rates going forward most certainly implies lower bond values in the future as interest rates rise. Even though the question “When?” is hard to answer, over time it seems likely that interest rates will rise. Also, there is the question of inflation and where the inflation rate will go from here. I think Ben would have gone after equities in sound businesses with a strong history of earning power, dividend yield and financial strength, plus the pricing power to be able to raise prices if inflation kicks in.

6. Why do you think that Graham stresses that anyone can invest?

Graham saw what it was like in Wall Street, a place in which stocks were bought and sold more as pieces of paper than part ownership of a business. A place where activity is valued higher than inactivity.

7. Do you consider yourself to be a Defensive Investor or an Enterprising Investor? (see What Kind of Investor Are You? for more information)

Enterprising Investor.

8. Zweig writes in his commentary “…foresight has no real value if most other investors are already expecting the same thing” (p. 16). In a world with instant communication and free access of information, do you think exclusive foresight is possible?

There is also a problem with the flood of information you have free access to. You have to be able to sort out all the noise and find the signal, the things that really matters. I think it’s difficult to get exclusive foresight; one should not count on that. But due to the fact that the information flow is so high, I think having sound proven investment principles and being able to keep them in mind when evaluating the information thrown at you; these principles will give you an opportunity to invest in a way that hopefully will save you from permanent loss of capital.

MGBookClub: The Intelligent Investor

I want to share a link to the Modern Graham where you will find a forum and a chance to learn about investing by reading Ben Graham’s the Intelligent Investor coupled with the opportunity to discuss the topics in each chapter of the book with other participants.

Check out the following link: MGBookClub: The Intelligent Investor – Introduction