Henry David Thoreau, Walden

 

If you have built castles in the air, your work should not go to waste, they should remain there. Now start laying the foundation under them.– Henry David Thoreau, WaldenNote that Graham declares at the outset that this book will not teach you how to control the market. No true book can do that.Rather, this book will teach you three powerful lessons:. How you can avoid irreparable losses.How can you maximize consistent profits?How can you control self-destructive behaviour that prevents investors from realising their full potential?During the bull run of the late 1990s, when technology stocks seemed to double in value every day, the idea of losing all your money seemed absurd. But by the end of 2002, many dotcom and telecom giants had lost 95% or more. Once you lose 95%, you have to make a 1,000% profit to get back to where you started.' Any foolish risk can put you in a hole that is impossible to get out of. That's why Graham always emphasizes the importance of avoiding losses, not only in chapters 6, 14 and 20, but in the warnings he gives throughout the book.'To put this statement into perspective, consider how often it is that you buy a stock at $30 and are able to sell it for $600.

But no matter how careful you are, the value of your investments will fluctuate from time to time. Since no one can avoid this risk, Graham will tell you how to manage it and overcome all your fears.Are you an intelligent investor?Now let's answer an important question. What does Graham mean by an 'intelligent' investor? Graham defined it in the first edition of the book and he made it clear that this kind of intelligence has nothing to do with IQ or SAT. It simply means patience, discipline and a willingness to learn. You also need to be able to control your emotions and think for yourself. Graham describes this kind of intelligence as "more of a personality trait than a brain trait."It has been proven that high IQ and higher education are not enough to make an investor intelligent. In 1998, the hedge fund, Long-Term Capital Management LP was run by a battalion of mathematicians, computer scientists and two Nobel Prize winning economists. They lost $2 billion in a few weeks betting big that the bond market would return to 'normal', but the bond market kept getting more and more abnormal and LTCM borrowed so much money that its collapse upended the global financial system.As early as the spring of 1720, Sir Isaac Newton bought shares in the South Sea Company, the most popular stock in England. Sensing that the market was getting out of hand, the great physicist said that he could "calculate the motions of the outer planets, but not the madness of men." Newton sold his South Sea shares for $47,000, a 100% profit, but just a few months later, overwhelmed by the boom in the market, Newton bought them back at a higher price, losing $220,000 ($3 million today). For the rest of his life, he forbade anyone from even mentioning the name South Sea in front of him.* Benjamin Graham, The Intelligent Investor (Rape & Row, 1949), p. 4."Hedge funds are the flower of money. They are largely outside government control. They are used to invest aggressively on behalf of wealthy clients. For a brilliant account of the LTCM story, see How Genius Failed (Random House, 2000) by Roger Lowenstein.*See also John Caswell, The South Sea Book (Cassette Press, London, 1960), pp. 131, 199A.

When it comes to intelligence, Sir Isaac Newton was one of the most intelligent people who ever lived. Yet, according to Graham, Newton was far from being an intelligent investor. He let the roar of the crowd affect his decision. By doing this, the world's greatest scientist acted like a fool.In short, if you have failed at investing so far, it is not because you are stupid, but because you have not, like Sir Isaac Newton, developed the emotional discipline needed to succeed in investing. In Chapter 8, Graham explains how you can increase your intelligence by controlling your emotions and refusing to succumb to the irrationality of the market. Here you will master the lesson that to become an intelligent investor, 'personality' is more important than 'mood'.History of disasterSo let us now look at some of the major financial events of the past:

1. The value of U.S. stocks, the largest market decline since the Great Depression, fell 50.2% to $7.4 trillion between March 2000 and October 2012.

2. Some of the most popular companies whose stock prices fell sharply in the 1990s were AOL, Cisco, JDS Uniphase, Lucent, and Qualcomm Plus. Apart from this, the shares of hundreds of Internet companies also suffered huge losses.

3. In America, many large and respected corporations including Enron, Tyco and Xerox were accused of major financial fraud.

4. Once shining companies like Conseco, Global Cosing, WorldCom went bankrupt.

5. Accounting firms were accused of manipulating accounts and even destroying records to mislead their clients, the investing public.

6. Top executives of major companies were accused of embezzling hundreds of millions of dollars for their personal benefit.

7. It was proven that Wall Street securities analysts who publicly praised Labrie privately admitted that he was, in fact, a jack of all trades.

8. A stock market that, despite its stunning decline, appears to be only slightly valued at historical rates, with many analysts assuming stocks have more to fall.

9. The continued fall in interest rates has left investors with no attractive option other than shares.

10. The investment environment was fraught with the unexpected threat of global terrorism and war in the Middle East.Investors who learned and followed Graham's principles largely avoided such losses. As Graham said, "While enthusiasm is a good thing for moderate gains, it is a sure way to ruin on Wall Street. Those who went along with the flow of Internet stocks, 'high growth' stocks, and frothy stocks made the same mistake as Sir Isaac Newton. They allowed the judgments of other investors to cloud their own judgment. They ignored Graham's classic warning that the really terrible fortunes always occur when the buyer forgets to ask 'How much will it cost?' And, most tragic of all, they lost self-control just when they needed it most." These people confirmed Graham's claim that "the investor's chief problem—and even his greatest enemy—is himself."thing that was not certainMany of these people got carried away by their impulse buying, particularly because they believed the hype surrounding technology and internet stocks, claiming that these industries would remain the top performers for at least a few years, if not forever.In mid-1999, after earning a return of 117.3% in the first five months of the year, Alexander Gheung, portfolio manager of the Monument Internet Fund, predicted that his fund would grow by 50% over the next three to five years and average 35% annually over the next 20 years.'Constance Loilos, 'Few and Alex Chetang, Investment Sutra, May 17, 1999 page 381 The highest 20-year return in mutual fund history has been 25.9 percent per annum. Peter Liew of Fidelity Magellan achieved this return in the short period ending December 31, 1994. Liew had turned $10,000 into $922,000 in 20 years. Liew had predicted that his fund would turn $10,000 into 4% in this period.

After his Amerindo Technology Fund rose by a spectacular 240.9% in 1999, portfolio manager Alberto Villar defied anyone who doubted the Internet's potential as a perpetual money-making machine: "If you're out of the loop, you're not doing optimally. You're in a horse-drawn carriage, and I'm in a Porsche. If you don't want to grow tenfold, invest somewhere else."In February 2000, hedge-fund manager James J. Camer declared that Internet-related companies were the ones to buy. "They are the new champions of the universe," as he called them, "the only ones that will continue to grow in good times and bad." Camer even attacked Graham, saying, "You should throw away all your pre-Web formulas and models ... If we followed anything Graham and Dodd taught, we wouldn't be a dime a dozen."All of these so-called experts ignored Graham's polite warning that "apparent prospects for material advancement in business do not necessarily translate into apparent profits for investors." While it is easy to foresee which industries will grow the fastest, this foreknowledge is of little value if most investors already expect it to grow. Unless everyone decides that it is a business, it will grow rapidly...Instead of dismissing Cheung's overoptimism, people showered him with money. Over the next year, people invested more than $100 million in his fund. Meanwhile, a $10,000 investment in the Monument Internet Fund in May 1999 would have turned into about $2,000 by the end of 2002. (The Monument Fund no longer exists in its original form. It is now known as the Orbitex Emerging Technology Fund.)* Lipsa Reilly Cullen, The Triple Digit Club, Money, December 1999, page 120. If you had invested $10,000 in Villar's fund at the end of 1999, you would have had $1,195 by the end of 2002—the largest asset value drop in mutual fund history.7 See Kaiser's preferred stock prices did not go up consistently through good times and bad. By the end of 2002, one of the 10 stocks Kaiser chose had gone bankrupt. Moreover, a $10,000 investment in Kaiser's chosen stocks would have lost 15 percent in value to just $597.44 during that period. Kaiser probably meant that his stocks would be winners not in the "new world," but in the world to come.

The industry is clearly the best place to invest in. By then, its shaver prices would have become so high that its future returns would simply go down.At least no one will have the nerve to still try to claim technology is the world’s biggest growth industry: “Those who claim that the next sure thing will be health care, or energy, or real estate, or gold, are likely to be proven wrong in the end, just as the technology evangelists have been.”silver liningIf no price seemed too high for stocks in the 1990s, in 2003 we reached a point where no price seemed low enough. The pendulum was swinging from irrational exuberance to irrational pessimism just as we always knew it. In 2002, investors withdrew $27 billion from stock mutual funds, and a survey by the Securities Industry Association found that one in 10 investors cut their holdings in stocks by at least 25%. People who were tempted to buy stocks in the late 1990s when prices were rising and making them expensive sold them when prices fell, or were clearly cheap.As Graham brilliantly shows in Chapter 8, it's just the opposite. The intelligent investor knows that a stock becomes more risky, not less, as its price rises, and less risky, not more, as its price falls. The intelligent investor avoids a bull market, because it is more expensive to buy stocks in one. And conversely (as long as you have enough money to cover your needs), you should welcome a bear market, because stocks tend to sell off again.* The only exception to this rule may be an investor who is long retired and will not live to see a prolonged downturn in the market. However, even an older investor should not sell his shavers just because their value has fallen. Such a move not only turns a loss on paper into a real loss, but also deprives his heirs of the opportunity to acquire the stock at a lower price from a tax perspective.

So stay motivated. A bull market ending is not as bad a sign as many assume. Thank God stock prices are down, now is a safer and more sensible time to build wealth. Read this book and Graham will show you how to do it.