What to expect from this book

 The objective of this book is to provide layman-friendly guidance that can be adopted and applied to an investment strategy. There will be little discussion of comparative securities analysis techniques and the focus will be primarily on investment theories and investor behavior, although we will provide some substantial comparisons between certain securities that are listed side by side on the New York Stock Exchange to provide a solid understanding of the key factors involved in specific choices for common shares.But much of it is devoted to historical patterns of financial markets, going back in some cases many decades. To invest wisely in securities one must already know enough about how different types of bonds and stocks actually behave under a variety of circumstances, some or at least one of which one will surely encounter in one's own experience. Santiago's famous dictum that "those who do not remember the past are condemned to repeat it" applies more accurately and better to Wall Street than to anyone else.Our book is addressed to investors, as distinct from speculators, and our first task is to clarify and emphasize this now forgotten distinction. We say at the outset that this is not a book on how to get rich. There is no sure or easy way to get rich on Wall Street or anywhere. To illustrate what we have just said, a bit of financial history may be useful—especially since there is more than one lesson to be learned from it. At the height of the boom in 1929, John J. Raskob was one of the most powerful men in Wall Street and in the country.

He was a common man. He wrote an article in the Lehi Hum Journal extolling the blessings of capitalism, titled "Everyone Ought to Be Rich." His thesis was that by making just $15 a month and investing it in good common stock and reinvesting the dividends, you could have a fortune of $80,000 in twenty years, with your total contribution being just $3,600. If the General Motors tycoon is right, it certainly is an easy way to get rich. To what extent was he right? Our rough estimate - based on a hypothetical investment in the 30 stocks of the Dow Jeet Industrial Average (DJIA) - indicates that if Harkov's prescription had been followed during 1929-1948, the value of an investor's holding in early 1949 would have been about $8,500. This is a far cry from the $80,000 promised by the median and shows how little weight should be placed on such optimistic predictions and assurances, but as an aside, we would point out that the actual return over 20 years of operations would have been better than the annual growth, despite the fact that the investor would have started at 300 on the DJIA and ended 1948 with a valuation of 172. This release is taken as a reference to the persuasive argument for regular monthly purchases of FAT ordinary shares amid rising prices, a program known as 'dollar cost averaging.'Because our book is not addressed to speculators, it is not for those who trade the markets. Most of these people are guided by charts or other big bombs to identify the right moment to buy and sell. One principle that applies to almost all of these popular technical feats is that it

That one should buy because a stock or market is rising and sell because it is falling. This is the exact opposite of every common trading wisdom, and is the reason why there is no stable success on Wall Street. From our own experience and observation of the stock market, spanning more than 50 years, we do not know of a single person who has made consistent and stable money by 'trickling the market' in this way. We have no hesitation in declaring that this method is as popular as it is false. We will briefly summarize what we have said below, which is a well-known theory of trading in the stock market, although it should not be taken as proof.The book was first published in 1948 and revised editions of The Intelligent Investor have been published approximately every five years. To update the current edition we must go through several developments since the 1965 edition, including:1. Unprecedented increase in interest rates of high-grade bonds.2. The price level of major common denominators fell by almost 35% in the period ending May 1970. This was the biggest decline in the last 30 years. (This contraction was further aggravated by a large number of low quality issues).3. Persistent inflation in boco and retail prices, which had also accelerated in pace during the trade recession of the 1970s.4. The rapid growth of 'conglomerate' companies, franchise operations and other elements in business and finance. (These include the use of foreign banks offering a variety of complex instruments such as letter stock, stick-open warrants, among others.

5. The bankruptcy of our largest railroad, excessive short- and long-term debt of many formerly strong and safe companies, and the troubling problem of the ability to repay debts even among the Volkstrup houses.6. The advent and prevalence of 'performance' in investment fund management, including in bank-operated trust segments, which had disturbing results.We will carefully consider these developments. Some of the emphasis and conclusions we drew in the last edition may need to be modified. The basic principles of sound investing remain unchanged for decades, but the application of these principles must be adapted to the major changes in the financial system and environment.This last statement was hammered out during the writing of the first draft of the present edition, which we finished in January 1971. At that time the DJIA was continuing its strong upward trend, rising from its 1970 low of 632 to its 1971 high of 951, raising expectations. By the time the final draft was finished in November 1971, the market was in the throes of a new downturn that took it as low as 797 and led to a new general uneasiness about its future. We did not allow these fluctuations to affect our general approach to the Chop's investment policy, which has not changed much since the first edition of the book in 1949.The extent of the market contraction in 1969-70 should be used to dispel the illusion that had been gaining ground during the previous two decades. The idea was that major ordinary shares could be bought at any given price, with the proviso that a profit could eventually be made, as well as losses in the intervening period, and renewed gains could be expected when the market reached new lows. This is the crux of the truth. After all,

The stock market has to return to normal, in the sense that while both speculators and stock investors see an increase in the value of their holdings, they also begin preparing to experience a sharp and long downturn again.Previous market crashes in the sector of many secondary and third-order ordinary shares, especially in recently emerging industries, were disastrous and led to disaster. This is nothing new. The same thing happened in 1961-62, but now there was a novel element in that some investment funds had large commitments to apparently overvalued issues and maximum speculation. Clearly it was not only novices who had to be warned that enthusiasm is necessary to make it big anywhere, but on Wall Street it is almost always disastrous.The key question of whether the interest rates of first-grade bonds will increase significantly remains the issue. Since 1967, investors have earned more than twice as much from such bonds as they would have earned from dividends on representative ordinary shares. In early 1972, the highest-grade bonds had a return of 7.19%, compared with only 2.76% on industrial shares. (Compare this with 4.40% and 2.92% respectively at the end of 1964. This was hard to imagine because when we first wrote this book in 1949, the figures were almost exactly the opposite: bonds returned just 2.66% and shares a whopping 6.82%. In previous editions we have consistently urged conservative investors to put at least 25% of their portfolios in ordinary shares, and we have been in favour of a 50-50 split between the two instruments. We must now consider whether the current spectacular run-up of bond yields over share yields fully justifies a hawkish policy, as long as it continues to deliver a more relative return, as we expect. Naturally, the question of persistent inflation will be a key factor in making the decision here. There is an entire chapter devoted to this discussion.In the past we have spoken of there being basically two types of investors, to whom this book is addressed: the 'creative' and the 'entrepreneurial'.

The whole point of investing is to avoid being overwhelmed. The other is to avoid the need to make quick and frequent decisions. The key quality of the enterprising (or active) investor is his ability to put in the time and effort to select domestic securities that are both cheap and more attractive than the average. For decades such patient investors have been rewarded for their extra effort in the form of better than average returns to the average investor. We are skeptical whether today's conditions really hold true for the active investor's promise of greater compensation, but next year or the years ahead may be different. We should view the enterprising investor's prospects accordingly, as they have been in earlier times and may return.The view has long held that the key to successful investing lies first in choosing industries that are likely to grow in the future and then in identifying the most promising companies in those industries. Astute investors or their shrewd advisers long ago recognized the tremendous growth that was to be made in the computer industry as a whole and International Business Machines in particular. And there are other industries and companies that are growing in a similar way, but in retrospect, it is not as simple as it may seem. To illustrate the point, here is a paragraph from Hopf, which we included in the first edition of this book in 1949.For example, an investor buys an air transport stock because he thinks its future is going to be even brighter than the market is already showing. More than any positive technology to help along the way, the value of our book to this type of investor lies in the fact that it warns them against falling into the trap of the hidden pitfalls of this favorite investment method.

These hidden problems have proved particularly dangerous for the industries we have mentioned. Of course, it was easy to predict that air traffic would grow substantially in the years ahead. For that reason alone, their stocks remained a favorite choice for investment funds, but despite revenue expansion—at a pace that was even faster than the computer industry—the combination of technical problems and overexpansion of capacity led to volatility and disastrous profit figures. In 1970, airline shareholders lost $200 million even as traffic figures hit new highs. (They had also posted losses in 1945 and 1961). In 1969-70, too, these companies' shares fell more than the general market. The record shows that even the highest-paid full-time experts in mutual funds were completely wrong about such a short-term future for a major and well-known industry.On the other hand, while investment funds had significant exposure to IBM and significant profits, its high price and lack of certainty in growth rates prevented this strong fund from exceeding 3%. Thus, this strong selection was in no way decisive in overall results. In addition, some, if not most, investments in computer-industry companies other than IBM did not produce significant profits. These two great examples offer our readers two lessons:1. Clear physical growth prospects in any business do not translate into clear profits for investors.2. Experts have no reliable method to select the most promising companies across all promising industries and focus statements on them.

The author never followed this method during his financial career as a fund manager, and cannot offer any specific advice or much encouragement to those who might want to try it.So what do we hope to achieve with this book? Our main goal is to help readers avoid making potentially costly mistakes and develop strategies that will work for them. We would also like to touch upon the mindset of the investor. Of course, the biggest problem, or rather the worst enemy, for the investor is probably himself. ("Dear investors, the fault lies not in our stars nor in our stocks, but in ourselves..."). This has been even more true in recent decades, as it has become increasingly common for even conservative investors to buy ordinary stocks and thus, unwittingly, fall prey to the excitement and thrills of the stock market. But we hope that by reasoning, example, and encouragement we can instill in our readers the proper mindset and emotional approach to their investment decisions. We have seen many more 'ordinary people' make and keep more money with the right mindset for the investment process than with those who lacked this quality, despite having a great deal of knowledge of finance, accounting, and stock market lore.In addition, we hope to inculcate in our readers the habit of measuring and quantifying. In 99 out of 100 issues we can say that at one price they are cheap enough to buy and at another price they are expensive enough to sell. This habit of relating what is paid to what is received is a valuable asset in investing. In an article we wrote for a women's magazine several years ago, we advised readers to buy stocks as they buy groceries, not as they buy perfume. Some of the really terrible losses of the last few years (and many before) were in ordinary shaver issues in which buyers forgot to ask "How much will I get?"In June 1970, the question of "how much will you get" could be answered by the magic number of 9.4%, the return possible on new shy-bed public utility bonds. It has since fallen to about 7.3%, but even at this return we are tempted to ask, "Why another year?" But there are other possibilities and these too should be considered with seriousness. Also, we would like to reiterate that we and our readers should be prepared for the possibility of a different scenario, such as 1923-4977.

We therefore offer a broad positive plan for ordinary share investment, partly for both types of investors and partly for the entrepreneurial group. It is strange that we should advise our readers, as a prime requirement, to limit themselves to issues which are not selling for much more than their current asset value. The reason for this seemingly outdated advice is both psychological and practical. We have learned from experience that while there are many good companies which are worth many times more than their net assets, the purchaser of such shares is very much dependent on the vagaries and volatility of the stock market. In contrast, an investor in shares who buys shares in companies standing at a net asset value, assuming these companies are publicly owned, should always consider himself to be owning a solid and growing business which has been acquired at a reasonable price - even if the stock market suggests otherwise. The end result of such conservative policies is likely to be better than that of enthusiastic adventures into the tempting and risky field of anticipated growth.There is a characteristic of the art of investing that is not generally appreciated. The average investor can achieve reliable and modest results with a minimum of effort and ability, but to improve on this easily attainable scale requires a great deal of effort and more than a modicum of knowledge. If you apply only a little extra knowledge and ingenuity to your investment plan, instead of achieving a far better result than usual, you may do much worse.Since anyone can perform as well as the market average simply by buying and holding from a representative list, it may seem a relatively simple case of being 'better than average', but the reality is that the proportion of smart people who try this and fail is surprisingly large. Even major investment funds, all staffed with experienced individuals, have not performed as well as the general market in the past. Continuing on this record, stock market forecasts published by brokerage houses, are a great indication of the fact that investors are not necessarily buying stocks.

There is strong evidence that their predictions are less reliable than decisions made by simply tossing a coin.In writing this book we have kept this fundamental difficulty of investing in mind. The merits of a simple portfolio policy of buying high-grade stocks and a diversified list of leading ordinary shares are emphasized - which an investor can build with a little expert help. Venturing outside this safe and solid territory, particularly in the area of idiosyncrasy, will be fraught with daunting difficulties. Before making any such attempt the investor needs to be sure of himself and his advisers - particularly whether they clearly understand the difference between investing and speculation and between market price and underlying value.A solid-minded approach to investing, based on the margin-of-safety principle, can yield impressive results, but the decision to pursue these gains instead of the surer fruits of defensive investing should not be made without thorough self-analysis.A final retrospective thought is that, when the young author entered Wall Street in June 1914, no one had any idea what the next half century would hold. (The stock market had little idea that World War II was about to break out in two months, and that the New York Stock Exchange would be closed.) In 1972 we found ourselves the richest and most powerful nation in the world, but with all the distractions of major problems we are more fearful than confident about the future. Still, if we limit our focus to the American investment experience, the past six decades offer some relief. Amid all the unexpected upheavals and losses that have rocked the world, it has proven true that solid investment principles usually yield solid results. We should assume that this will continue to be the case.Message to readers: This book is not a comprehensive financial policy for savers and investors. It deals only with the portion of funds they are willing to invest in marketable (or redeemable) securities, i.e. bonds and stocks. Hence, we will not discuss such instruments as savings and time deposits, savings and loan association accounts, life insurance, annuities, real estate assets or equity ownership. The reader should keep in mind that whenever he comes across the words now or similar in the book, it means the end of 1971 or the beginning of 1972.