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Glucose Sensing Springer US Michael D. Heagy (auth.), Chris D. Geddes, Joseph R. Lakowicz (eds.) Year: 2006 Language: english File: PDF, 23.31 MB 0 / 0

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Surrealist Painters and Poets: An Anthology Mary Ann Caws Year: 2001 Language: english File: PDF, 8.40 MB 0 / 0

THE
INTELLIGENT
INVESTOR
A BOOK OF PRACTICAL COUNSEL
REVISED EDITION

B E NJAM I N G RAHAM
Updated with New Commentary by Jason Zweig

To E.M.G.

Through chances various, through all
vicissitudes, we make our way. . . .
Aeneid

Contents

Epigraph
Preface to the Fourth Edition, by Warren E. Buffett
A Note About Benjamin Graham, by Jason Zweig

x

Introduction: What This Book Expects to Accomplish
COMMENTARY ON THE INTRODUCTION

1.

2.
3.

4.

6.

7.

8.
iv

1
12

Investment versus Speculation: Results to Be
Expected by the Intelligent Investor

18

COMMENTARY ON CHAPTER 1

35

The Investor and Inflation

47

COMMENTARY ON CHAPTER 2

58

A Century of Stock-Market History:
The Level of Stock Prices in Early 1972

65

COMMENTARY ON CHAPTER 3

80

General Portfolio Policy: The Defensive Investor

88

COMMENTARY ON CHAPTER 4

5.

iii
viii

101

The Defensive Investor and Common Stocks

112

COMMENTARY ON CHAPTER 5

124

Portfolio Policy for the Enterprising Investor:
Negative Approach

133

COMMENTARY ON CHAPTER 6

145

Portfolio Policy for the Enterprising Investor:
The Positive Side

155

COMMENTARY ON CHAPTER 7

179

The Investor and Market Fluctuations

188

v

Contents
COMMENTARY ON CHAPTER 8

9. Investing in Investment Funds
COMMENTARY ON CHAPTER 9

213
226
242

10. The Investor and His Advisers

257

COMMENTARY ON CHAPTER 10

272

11. Security Analysis for the Lay Investor:
General Approach
COMMENTARY ON CHAPTER 11

12. Things to Consider About Per-Share Earnings
COMMENTARY ON CHAPTER 12

13. A Comparison of Four Listed Companies
COMMENTARY ON CHAPTER 13

14. Stock Selection for the Defensive Investor
COMMENTARY ON CHAPTER 14

15. Stock Selection for the Enterprising Investor
COMMENTARY ON CHAPTER 15

16. Convertible Issues and Warrants
COMMENTARY ON CHAPTER 16

17. Four Extremely Instructive Case Histories
COMMENTARY ON CHAPTER 17

18. A Comparison of Eight Pairs of Companies
COMMENTARY ON CHAPTER 18

19. Shareholders and Managements: Dividend Policy
COMMENTARY ON CHAPTER 19

20. “Margin of Safety” a; s the Central Concept
of Investment

280
302
310
322
330
339
347
367
376
396
403
418
422
438
446
473
487
497
512

COMMENTARY ON CHAPTER 20

525

Postscript

532

COMMENTARY ON POSTSCRIPT

535

Appendixes
1. The Superinvestors of Graham-and-Doddsville

537

Contents

vi

2. Important Rules Concerning Taxability of Investment
Income and Security Transactions (in 1972)
561
3. The Basics of Investment Taxation
(Updated as of 2003)

562

4. The New Speculation in Common Stocks

563

5. A Case History: Aetna Maintenance Co.

575

6. Tax Accounting for NVF’s Acquisition of
Sharon Steel Shares

576

7. Technological Companies as Investments

578

Endnotes

579

Acknowledgments from Jason Zweig

589

Index

591

About the Authors
Credits
Front Cover
Copyright
About the Publisher

The text reproduced here is the Fourth Revised Edition, updated by
Graham in 1971–1972 and initially published in 1973. Please be
advised that the text of Graham’s original footnotes (designated in his
chapters with superscript numerals) can be found in the Endnotes section beginning on p. 579. The new footnotes that Jason Zweig has introduced appear at the bottom of Graham’s pages (and, in the typeface
used here, as occasional additions to Graham’s endnotes).

Preface to the Fourth Edition,
by Warren E. Buffett

I read the first edition of this book early in 1950, when I was nine-

teen. I thought then that it was by far the best book about investing
ever written. I still think it is.
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.
If you follow the behavioral and business principles that Graham advocates—and if you pay special attention to the invaluable
advice in Chapters 8 and 20—you will not get a poor result from
your investments. (That represents more of an accomplishment
than you might think.) Whether you achieve outstanding results
will depend on the effort and intellect you apply to your investments, as well as on the amplitudes of stock-market folly that prevail during your investing career. The sillier the market’s behavior,
the greater the opportunity for the business-like investor. Follow
Graham and you will profit from folly rather than participate in it.
To me, Ben Graham was far more than an author or a teacher.
More than any other man except my father, he influenced my life.
Shortly after Ben’s death in 1976, I wrote the following short
remembrance about him in the Financial Analysts Journal. As you
read the book, I believe you’ll perceive some of the qualities I mentioned in this tribute.

viii

ix

Preface to the Fourth Edition

BENJAMIN GRAHAM
1894–1976
Several years ago Ben Graham, then almost eighty, expressed to a friend
the thought that he hoped every day to do “something foolish, something
creative and something generous.”
The inclusion of that first whimsical goal reflected his knack for packaging ideas in a form that avoided any overtones of sermonizing or
self-importance. Although his ideas were powerful, their delivery was
unfailingly gentle.
Readers of this magazine need no elaboration of his achievements as
measured by the standard of creativity. It is rare that the founder of a discipline does not find his work eclipsed in rather short order by successors.
But over forty years after publication of the book that brought structure
and logic to a disorderly and confused activity, it is difficult to think of possible candidates for even the runner-up position in the field of security
analysis. In an area where much looks foolish within weeks or months
after publication, Ben’s principles have remained sound—their value often
enhanced and better understood in the wake of financial storms that
demolished flimsier intellectual structures. His counsel of soundness
brought unfailing rewards to his followers—even to those with natural
abilities inferior to more gifted practitioners who stumbled while following counsels of brilliance or fashion.
A remarkable aspect of Ben’s dominance of his professional field was
that he achieved it without that narrowness of mental activity that concentrates all effort on a single end. It was, rather, the incidental by-product of
an intellect whose breadth almost exceeded definition. Certainly I have
never met anyone with a mind of similar scope. Virtually total recall,
unending fascination with new knowledge, and an ability to recast it in a
form applicable to seemingly unrelated problems made exposure to his
thinking in any field a delight.
But his third imperative—generosity—was where he succeeded beyond
all others. I knew Ben as my teacher, my employer, and my friend. In each
relationship—just as with all his students, employees, and friends—there
was an absolutely open-ended, no-scores-kept generosity of ideas, time,
and spirit. If clarity of thinking was required, there was no better place to
go. And if encouragement or counsel was needed, Ben was there.
Walter Lippmann spoke of men who plant trees that other men will sit
under. Ben Graham was such a man.
Reprinted from the Financial Analysts Journal, November/December 1976.

A Note About Benjamin Graham
by Jason Zweig

Who was Benjamin Graham, and why should you listen to him?
Graham was not only one of the best investors who ever lived; he was
also the greatest practical investment thinker of all time. Before Graham,
money managers behaved much like a medieval guild, guided largely by
superstition, guesswork, and arcane rituals. Graham’s Security Analysis
was the textbook that transformed this musty circle into a modern profession.1
And The Intelligent Investor is the first book ever to describe, for
individual investors, the emotional framework and analytical tools that
are essential to financial success. It remains the single best book on
investing ever written for the general public. The Intelligent Investor
was the first book I read when I joined Forbes Magazine as a cub
reporter in 1987, and I was struck by Graham’s certainty that, sooner
or later, all bull markets must end badly. That October, U.S. stocks suffered their worst one-day crash in history, and I was hooked. (Today,
after the wild bull market of the late 1990s and the brutal bear market
that began in early 2000, The Intelligent Investor reads more prophetically than ever.)
Graham came by his insights the hard way: by feeling firsthand the
anguish of financial loss and by studying for decades the history and
psychology of the markets. He was born Benjamin Grossbaum on
May 9, 1894, in London; his father was a dealer in china dishes and
figurines.2 The family moved to New York when Ben was a year old. At
first they lived the good life—with a maid, a cook, and a French gov1

Coauthored with David Dodd and first published in 1934.
The Grossbaums changed their name to Graham during World War I,
when German-sounding names were regarded with suspicion.
2

x

xi

A Note About Benjamin Graham

erness—on upper Fifth Avenue. But Ben’s father died in 1903, the
porcelain business faltered, and the family slid haltingly into poverty.
Ben’s mother turned their home into a boardinghouse; then, borrowing money to trade stocks “on margin,” she was wiped out in the crash
of 1907. For the rest of his life, Ben would recall the humiliation of
cashing a check for his mother and hearing the bank teller ask, “Is
Dorothy Grossbaum good for five dollars?”
Fortunately, Graham won a scholarship at Columbia, where his
brilliance burst into full flower. He graduated in 1914, second in his
class. Before the end of Graham’s final semester, three departments—
English, philosophy, and mathematics—asked him to join the faculty.
He was all of 20 years old.
Instead of academia, Graham decided to give Wall Street a shot.
He started as a clerk at a bond-trading firm, soon became an analyst,
then a partner, and before long was running his own investment partnership.
The Internet boom and bust would not have surprised Graham. In
April 1919, he earned a 250% return on the first day of trading for
Savold Tire, a new offering in the booming automotive business; by
October, the company had been exposed as a fraud and the stock
was worthless.
Graham became a master at researching stocks in microscopic,
almost molecular, detail. In 1925, plowing through the obscure
reports filed by oil pipelines with the U.S. Interstate Commerce Commission, he learned that Northern Pipe Line Co.—then trading at $65
per share—held at least $80 per share in high-quality bonds. (He
bought the stock, pestered its managers into raising the dividend, and
came away with $110 per share three years later.)
Despite a harrowing loss of nearly 70% during the Great Crash of
1929–1932, Graham survived and thrived in its aftermath, harvesting
bargains from the wreckage of the bull market. There is no exact
record of Graham’s earliest returns, but from 1936 until he retired in
1956, his Graham-Newman Corp. gained at least 14.7% annually,
versus 12.2% for the stock market as a whole—one of the best longterm track records on Wall Street history.3

3

Graham-Newman Corp. was an open-end mutual fund (see Chapter 9)
that Graham ran in partnership with Jerome Newman, a skilled investor in his
own right. For much of its history, the fund was closed to new investors. I am

A Note About Benjamin Graham

xii

How did Graham do it? Combining his extraordinary intellectual
powers with profound common sense and vast experience, Graham
developed his core principles, which are at least as valid today as they
were during his lifetime:
•

•

•
•

•

A stock is not just a ticker symbol or an electronic blip; it is an
ownership interest in an actual business, with an underlying value
that does not depend on its share price.
The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified
pessimism (which makes them too cheap). The intelligent investor
is a realist who sells to optimists and buys from pessimists.
The future value of every investment is a function of its present
price. The higher the price you pay, the lower your return will be.
No matter how careful you are, the one risk no investor can ever
eliminate is the risk of being wrong. Only by insisting on what
Graham called the “margin of safety”—never overpaying, no matter how exciting an investment seems to be—can you minimize
your odds of error.
The secret to your financial success is inside yourself. If you
become a critical thinker who takes no Wall Street “fact” on faith,
and you invest with patient confidence, you can take steady
advantage of even the worst bear markets. By developing your
discipline and courage, you can refuse to let other people’s mood
swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave.

The goal of this revised edition of The Intelligent Investor is to apply
Graham’s ideas to today’s financial markets while leaving his text
entirely intact (with the exception of footnotes for clarification).4 After
each of Graham’s chapters you’ll find a new commentary. In these
reader’s guides, I’ve added recent examples that should show you just
how relevant—and how liberating—Graham’s principles remain today.
grateful to Walter Schloss for providing data essential to estimating
Graham-Newman’s returns. The 20% annual average return that Graham
cites in his Postscript (p. 532) appears not to take management fees into
account.
4
The text reproduced here is the Fourth Revised Edition, updated by Graham in 1971–1972 and initially published in 1973.

xiii

A Note About Benjamin Graham

I envy you the excitement and enlightenment of reading Graham’s
masterpiece for the first time—or even the third or fourth time. Like all
classics, it alters how we view the world and renews itself by educating us. And the more you read it, the better it gets. With Graham as
your guide, you are guaranteed to become a vastly more intelligent
investor.

INTRODUCTION:

What This Book Expects to Accomplish

The purpose of this book is to supply, in a form suitable for lay-

men, guidance in the adoption and execution of an investment policy. Comparatively little will be said here about the technique of
analyzing securities; attention will be paid chiefly to investment
principles and investors’ attitudes. We shall, however, provide a
number of condensed comparisons of specific securities—chiefly in
pairs appearing side by side in the New York Stock Exchange list—
in order to bring home in concrete fashion the important elements
involved in specific choices of common stocks.
But much of our space will be devoted to the historical patterns
of financial markets, in some cases running back over many
decades. To invest intelligently in securities one should be forearmed with an adequate knowledge of how the various types of
bonds and stocks have actually behaved under varying conditions—some of which, at least, one is likely to meet again in one’s
own experience. No statement is more true and better applicable to
Wall Street than the famous warning of Santayana: “Those who do
not remember the past are condemned to repeat it.”
Our text is directed to investors as distinguished from speculators, and our first task will be to clarify and emphasize this now all
but forgotten distinction. We may say at the outset that this is not a
“how to make a million” book. There are no sure and easy paths to
riches on Wall Street or anywhere else. It may be well to point up
what we have just said by a bit of financial history—especially
since there is more than one moral to be drawn from it. In the climactic year 1929 John J. Raskob, a most important figure nationally
as well as on Wall Street, extolled the blessings of capitalism in an
article in the Ladies’ Home Journal, entitled “Everybody Ought to Be
1

2

Introduction

Rich.”* His thesis was that savings of only $15 per month invested
in good common stocks—with dividends reinvested—would produce an estate of $80,000 in twenty years against total contributions
of only $3,600. If the General Motors tycoon was right, this was
indeed a simple road to riches. How nearly right was he? Our
rough calculation—based on assumed investment in the 30 stocks
making up the Dow Jones Industrial Average (DJIA)—indicates
that if Raskob’s prescription had been followed during 1929–1948,
the investor’s holdings at the beginning of 1949 would have been
worth about $8,500. This is a far cry from the great man’s promise
of $80,000, and it shows how little reliance can be placed on such
optimistic forecasts and assurances. But, as an aside, we should
remark that the return actually realized by the 20-year operation
would have been better than 8% compounded annually—and this
despite the fact that the investor would have begun his purchases
with the DJIA at 300 and ended with a valuation based on the 1948
closing level of 177. This record may be regarded as a persuasive
argument for the principle of regular monthly purchases of strong
common stocks through thick and thin—a program known as
“dollar-cost averaging.”
Since our book is not addressed to speculators, it is not meant
for those who trade in the market. Most of these people are guided
by charts or other largely mechanical means of determining the
right moments to buy and sell. The one principle that applies to
nearly all these so-called “technical approaches” is that one should
buy because a stock or the market has gone up and one should sell
because it has declined. This is the exact opposite of sound business
sense everywhere else, and it is most unlikely that it can lead to

* Raskob (1879–1950) was a director of Du Pont, the giant chemical company, and chairman of the finance committee at General Motors. He also
served as national chairman of the Democratic Party and was the driving
force behind the construction of the Empire State Building. Calculations by
finance professor Jeremy Siegel confirm that Raskob’s plan would have
grown to just under $9,000 after 20 years, although inflation would have
eaten away much of that gain. For the best recent look at Raskob’s views on
long-term stock investing, see the essay by financial adviser William Bernstein at www.efficientfrontier.com/ef/197/raskob.htm.

What This Book Expects to Accomplish

3

lasting success on Wall Street. In our own stock-market experience
and observation, extending over 50 years, we have not known a
single person who has consistently or lastingly made money by
thus “following the market.” We do not hesitate to declare that this
approach is as fallacious as it is popular. We shall illustrate what
we have just said—though, of course this should not be taken as
proof—by a later brief discussion of the famous Dow theory for
trading in the stock market.*
Since its first publication in 1949, revisions of The Intelligent
Investor have appeared at intervals of approximately five years. In
updating the current version we shall have to deal with quite a
number of new developments since the 1965 edition was written.
These include:
1.
2.

3.

4.

An unprecedented advance in the interest rate on high-grade
bonds.
A fall of about 35% in the price level of leading common
stocks, ending in May 1970. This was the highest percentage
decline in some 30 years. (Countless issues of lower quality
had a much larger shrinkage.)
A persistent inflation of wholesale and consumer’s prices,
which gained momentum even in the face of a decline of general business in 1970.
The rapid development of “conglomerate” companies, franchise operations, and other relative novelties in business and
finance. (These include a number of tricky devices such as “letter stock,” 1 proliferation of stock-option warrants, misleading
names, use of foreign banks, and others.)†

* Graham’s “brief discussion” is in two parts, on p. 33 and pp. 191–192.
For more detail on the Dow Theory, see http://viking.som.yale.edu/will/
dow/dowpage.html.
† Mutual funds bought “letter stock” in private transactions, then immediately revalued these shares at a higher public price (see Graham’s definition
on p. 579). That enabled these “go-go” funds to report unsustainably high
returns in the mid-1960s. The U.S. Securities and Exchange Commission
cracked down on this abuse in 1969, and it is no longer a concern for fund
investors. Stock-option warrants are explained in Chapter 16.

4

5.

6.

Introduction

Bankruptcy of our largest railroad, excessive short- and longterm debt of many formerly strongly entrenched companies,
and even a disturbing problem of solvency among Wall Street
houses.*
The advent of the “performance” vogue in the management of
investment funds, including some bank-operated trust funds,
with disquieting results.

These phenomena will have our careful consideration, and some
will require changes in conclusions and emphasis from our previous edition. 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.
The last statement was put to the test during the writing of the
present edition, the first draft of which was finished in January
1971. At that time the DJIA was in a strong recovery from its 1970
low of 632 and was advancing toward a 1971 high of 951, with
attendant general optimism. As the last draft was finished, in
November 1971, the market was in the throes of a new decline, carrying it down to 797 with a renewed general uneasiness about its
future. We have not allowed these fluctuations to affect our general
attitude toward sound investment policy, which remains substantially unchanged since the first edition of this book in 1949.
The extent of the market’s shrinkage in 1969–70 should have
served to dispel an illusion that had been gaining ground during the past two decades. This was that leading common stocks
could be bought at any time and at any price, with the assurance not
only of ultimate profit but also that any intervening loss would soon
be recouped by a renewed advance of the market to new high lev-

* The Penn Central Transportation Co., then the biggest railroad in the
United States, sought bankruptcy protection on June 21, 1970—shocking
investors, who had never expected such a giant company to go under (see
p. 423). Among the companies with “excessive” debt Graham had in mind
were Ling-Temco-Vought and National General Corp. (see pp. 425 and
463). The “problem of solvency” on Wall Street emerged between 1968
and 1971, when several prestigious brokerages suddenly went bust.

What This Book Expects to Accomplish

5

els. That was too good to be true. At long last the stock market has
“returned to normal,” in the sense that both speculators and stock
investors must again be prepared to experience significant and perhaps protracted falls as well as rises in the value of their holdings.
In the area of many secondary and third-line common stocks,
especially recently floated enterprises, the havoc wrought by the
last market break was catastrophic. This was nothing new in
itself—it had happened to a similar degree in 1961–62—but there
was now a novel element in the fact that some of the investment
funds had large commitments in highly speculative and obviously
overvalued issues of this type. 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.
The major question we shall have to deal with grows out of the
huge rise in the rate of interest on first-quality bonds. Since late 1967
the investor has been able to obtain more than twice as much
income from such bonds as he could from dividends on representative common stocks. At the beginning of 1972 the return was 7.19%
on highest-grade bonds versus only 2.76% on industrial stocks.
(This compares with 4.40% and 2.92% respectively at the end of
1964.) It is hard to realize that when we first wrote this book in 1949
the figures were almost the exact opposite: the bonds returned only
2.66% and the stocks yielded 6.82%.2 In previous editions we have
consistently urged that at least 25% of the conservative investor’s
portfolio be held in common stocks, and we have favored in general
a 50–50 division between the two media. We must now consider
whether the current great advantage of bond yields over stock
yields would justify an all-bond policy until a more sensible relationship returns, as we expect it will. Naturally the question of continued inflation will be of great importance in reaching our decision
here. A chapter will be devoted to this discussion.*

* See Chapter 2. As of the beginning of 2003, U.S. Treasury bonds maturing in 10 years yielded 3.8%, while stocks (as measured by the Dow Jones
Industrial Average) yielded 1.9%. (Note that this relationship is not all that
different from the 1964 figures that Graham cites.) The income generated
by top-quality bonds has been falling steadily since 1981.

6

Introduction

In the past we have made a basic distinction between two kinds
of investors to whom this book was addressed—the “defensive”
and the “enterprising.” The defensive (or passive) investor will
place his chief emphasis on the avoidance of serious mistakes or
losses. His second aim will be freedom from effort, annoyance, and
the need for making frequent decisions. The determining trait of
the enterprising (or active, or aggressive) investor is his willingness
to devote time and care to the selection of securities that are both
sound and more attractive than the average. Over many decades
an enterprising investor of this sort could expect a worthwhile
reward for his extra skill and effort, in the form of a better average
return than that realized by the passive investor. We have some
doubt whether a really substantial extra recompense is promised to
the active investor under today’s conditions. But next year or the
years after may well be different. We shall accordingly continue to
devote attention to the possibilities for enterprising investment, as
they existed in former periods and may return.
It has long been the prevalent view that the art of successful investment lies first in the choice of those industries that
are most likely to grow in the future and then in identifying the
most promising companies in these industries. For example, smart
investors—or their smart advisers—would long ago have recognized the great growth possibilities of the computer industry as a
whole and of International Business Machines in particular. And
similarly for a number of other growth industries and growth companies. But this is not as easy as it always looks in retrospect. To
bring this point home at the outset let us add here a paragraph that
we included first in the 1949 edition of this book.
Such an investor may for example be a buyer of air-transport
stocks because he believes their future is even more brilliant than
the trend the market already reflects. For this class of investor the
value of our book will lie more in its warnings against the pitfalls
lurking in this favorite investment approach than in any positive
technique that will help him along his path.*

* “Air-transport stocks,” of course, generated as much excitement in the late
1940s and early 1950s as Internet stocks did a half century later. Among
the hottest mutual funds of that era were Aeronautical Securities and the

What This Book Expects to Accomplish

7

The pitfalls have proved particularly dangerous in the industry
we mentioned. It was, of course, easy to forecast that the volume of
air traffic would grow spectacularly over the years. Because of this
factor their shares became a favorite choice of the investment
funds. But despite the expansion of revenues—at a pace even
greater than in the computer industry—a combination of technological problems and overexpansion of capacity made for fluctuating and even disastrous profit figures. In the year 1970, despite a
new high in traffic figures, the airlines sustained a loss of some
$200 million for their shareholders. (They had shown losses also in
1945 and 1961.) The stocks of these companies once again showed a
greater decline in 1969–70 than did the general market. The record
shows that even the highly paid full-time experts of the mutual
funds were completely wrong about the fairly short-term future of
a major and nonesoteric industry.
On the other hand, while the investment funds had substantial
investments and substantial gains in IBM, the combination of its
apparently high price and the impossibility of being certain about
its rate of growth prevented them from having more than, say, 3%
of their funds in this wonderful performer. Hence the effect of
this excellent choice on their overall results was by no means
decisive. Furthermore, many—if not most—of their investments in
computer-industry companies other than IBM appear to have been
unprofitable. From these two broad examples we draw two morals
for our readers:
1.
2.

Obvious prospects for physical growth in a business do not
translate into obvious profits for investors.
The experts do not have dependable ways of selecting and
concentrating on the most promising companies in the most
promising industries.

Missiles-Rockets-Jets & Automation Fund. They, like the stocks they owned,
turned out to be an investing disaster. It is commonly accepted today that
the cumulative earnings of the airline industry over its entire history have
been negative. The lesson Graham is driving at is not that you should avoid
buying airline stocks, but that you should never succumb to the “certainty”
that any industry will outperform all others in the future.

8

Introduction

The author did not follow this approach in his financial career as
fund manager, and he cannot offer either specific counsel or much
encouragement to those who may wish to try it.
What then will we aim to accomplish in this book? Our main
objective will be to guide the reader against the areas of possible
substantial error and to develop policies with which he will be
comfortable. We shall say quite a bit about the psychology of
investors. For indeed, the investor’s chief problem—and even his
worst enemy—is likely to be himself. (“The fault, dear investor, is
not in our stars—and not in our stocks—but in ourselves. . . .”) This
has proved the more true over recent decades as it has become
more necessary for conservative investors to acquire common
stocks and thus to expose themselves, willy-nilly, to the excitement
and the temptations of the stock market. By arguments, examples,
and exhortation, we hope to aid our readers to establish the proper
mental and emotional attitudes toward their investment decisions.
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 stockmarket lore.
Additionally, we hope to implant in the reader a tendency to
measure or quantify. For 99 issues out of 100 we could say that at
some price they are cheap enough to buy and at some other price
they would be so dear that they should be sold. The habit of relating what is paid to what is being offered is an invaluable trait in
investment. In an article in a women’s magazine many years ago
we advised the readers to buy their stocks as they bought their groceries, not as they bought their perfume. 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
ask “How much?”
In June 1970 the question “How much?” could be answered by
the magic figure 9.40%—the yield obtainable on new offerings of
high-grade public-utility bonds. This has now dropped to about
7.3%, but even that return tempts us to ask, “Why give any other
answer?” But there are other possible answers, and these must be
carefully considered. Besides which, we repeat that both we and
our readers must be prepared in advance for the possibly quite different conditions of, say, 1973–1977.

What This Book Expects to Accomplish

9

We shall therefore present in some detail a positive program for
common-stock investment, part of which is within the purview of
both classes of investors and part is intended mainly for the enterprising group. Strangely enough, we shall suggest as one of our
chief requirements here that our readers limit themselves to issues
selling not far above their tangible-asset value.* The reason for
this seemingly outmoded counsel is both practical and psychological. Experience has taught us that, while there are many good
growth companies worth several times net assets, the buyer of
such shares will be too dependent on the vagaries and fluctuations
of the stock market. By contrast, the investor in shares, say, of
public-utility companies at about their net-asset value can always
consider himself the owner of an interest in sound and expanding
businesses, acquired at a rational price—regardless of what the
stock market might say to the contrary. The ultimate result of such
a conservative policy is likely to work out better than exciting
adventures into the glamorous and dangerous fields of anticipated
growth.
The art of investment has one characteristic that is not generally
appreciated. A creditable, if unspectacular, result can be achieved
by the lay investor with a minimum of effort and capability; but to
improve this easily attainable standard requires much application
and more than a trace of wisdom. If you merely try to bring just a
little extra knowledge and cleverness to bear upon your investment
program, instead of realizing a little better than normal results, you
may well find that you have done worse.
Since anyone—by just buying and holding a representative
list—can equal the performance of the market averages, 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. Even the majority of the investment funds,
with all their experienced personnel, have not performed so well

* Tangible assets include a company’s physical property (like real estate,
factories, equipment, and inventories) as well as its financial balances (such
as cash, short-term investments, and accounts receivable). Among the elements not included in tangible assets are brands, copyrights, patents, franchises, goodwill, and trademarks. To see how to calculate tangible-asset
value, see footnote † on p. 198.

10

Introduction

over the years as has the general market. 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.
In writing this book we have tried to keep this basic pitfall of
investment in mind. The virtues of a simple portfolio policy have
been emphasized—the purchase of high-grade bonds plus a diversified list of leading common stocks—which any investor can carry
out with a little expert assistance. The adventure beyond this safe
and sound territory has been presented as fraught with challenging difficulties, especially in the area of temperament. Before
attempting such a venture the investor should feel sure of himself
and 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.
A strong-minded approach to investment, firmly based on the
margin-of-safety principle, can yield handsome rewards. But a
decision to try for these emoluments rather than for the assured
fruits of defensive investment should not be made without much
self-examination.
A final retrospective thought. When the young author entered
Wall Street in June 1914 no one had any inkling of what the next
half-century had in store. (The stock market did not even suspect
that a World War was to break out in two months, and close down
the New York Stock Exchange.) Now, in 1972, we find ourselves the
richest and most powerful country on earth, but beset by all sorts
of major problems and more apprehensive than confident of the
future. Yet if we confine our attention to American investment
experience, there is some comfort to be gleaned from the last 57
years. 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.
Note to the Reader: This book does not address itself to the overall
financial policy of savers and investors; it deals only with that
portion of their funds which they are prepared to place in marketable (or redeemable) securities, that is, in bonds and stocks.

What This Book Expects to Accomplish

11

Consequently we do not discuss such important media as savings
and time desposits, savings-and-loan-association accounts, life
insurance, annuities, and real-estate mortgages or equity ownership. The reader should bear in mind that when he finds the word
“now,” or the equivalent, in the text, it refers to late 1971 or
early 1972.

COMMENTARY ON THE INTRODUCTION

If you have built castles in the air, your work need not be lost;
that is where they should be. Now put the foundations under
them.
—Henry David Thoreau, Walden

Notice that Graham announces from the start that this book will not
tell you how to beat the market. No truthful book can.
Instead, this book will teach you three powerful lessons:
•
•
•

how you can minimize the odds of suffering irreversible losses;
how you can maximize the chances of achieving sustainable gains;
how you can control the self-defeating behavior that keeps most
investors from reaching their full potential.

Back in the boom years of the late 1990s, when technology stocks
seemed to be doubling in value every day, the notion that you could
lose almost all your money seemed absurd. But, by the end of 2002,
many of the dot-com and telecom stocks had lost 95% of their value
or more. Once you lose 95% of your money, you have to gain 1,900%
just to get back to where you started.1 Taking a foolish risk can put
you so deep in the hole that it’s virtually impossible to get out. That’s
why Graham constantly emphasizes the importance of avoiding
losses—not just in Chapters 6, 14, and 20, but in the threads of warning that he has woven throughout his entire text.
But no matter how careful you are, the price of your investments
will go down from time to time. While no one can eliminate that risk,

1

To put this statement in perspective, consider how often you are likely to
buy a stock at $30 and be able to sell it at $600.
12

Commentary on the Introduction

13

Graham will show you how to manage it—and how to get your fears
under control.
A R E YO U A N I N T E L L I G E N T I N V E S TO R ?
Now let’s answer a vitally important question. What exactly does Graham mean by an “intelligent” investor? Back in the first edition of this
book, Graham defines the term—and he makes it clear that this kind of
intelligence has nothing to do with IQ or SAT scores. It simply means
being patient, disciplined, and eager to learn; you must also be able to
harness your emotions and think for yourself. This kind of intelligence,
explains Graham, “is a trait more of the character than of the brain.” 2
There’s proof that high IQ and higher education are not enough to
make an investor intelligent. In 1998, Long-Term Capital Management
L.P., a hedge fund run by a battalion of mathematicians, computer
scientists, and two Nobel Prize–winning economists, lost more than
$2 billion in a matter of weeks on a huge bet that the bond market
would return to “normal.” But the bond market kept right on becoming
more and more abnormal—and LTCM had borrowed so much money
that its collapse nearly capsized the global financial system.3
And back in the spring of 1720, Sir Isaac Newton owned shares in
the South Sea Company, the hottest stock in England. Sensing that
the market was getting out of hand, the great physicist muttered that
he “could calculate the motions of the heavenly bodies, but not the
madness of the people.” Newton dumped his South Sea shares, pocketing a 100% profit totaling £7,000. But just months later, swept up in
the wild enthusiasm of the market, Newton jumped back in at a much
higher price—and lost £20,000 (or more than $3 million in today’s
money). For the rest of his life, he forbade anyone to speak the words
“South Sea” in his presence.4

2

Benjamin Graham, The Intelligent Investor (Harper & Row, 1949), p. 4.
A “hedge fund” is a pool of money, largely unregulated by the government,
invested aggressively for wealthy clients. For a superb telling of the LTCM
story, see Roger Lowenstein, When Genius Failed (Random House, 2000).
4
John Carswell, The South Sea Bubble (Cresset Press, London, 1960),
pp. 131, 199. Also see www.harvard-magazine.com/issues/mj99/damnd.
html.
3

14

Commentary on the Introduction

Sir Isaac Newton was one of the most intelligent people who ever
lived, as most of us would define intelligence. But, in Graham’s terms,
Newton was far from an intelligent investor. By letting the roar of the
crowd override his own judgment, the world’s greatest scientist acted
like a fool.
In short, if you’ve failed at investing so far, it’s not because you’re
stupid. It’s because, like Sir Isaac Newton, you haven’t developed the
emotional discipline that successful investing requires. In Chapter 8,
Graham describes how to enhance your intelligence by harnessing
your emotions and refusing to stoop to the market’s level of irrationality. There you can master his lesson that being an intelligent investor is
more a matter of “character” than “brain.”
A CH R ON I CLE OF CALAM ITY
Now let’s take a moment to look at some of the major financial developments of the past few years:
1.

2.

3.

4.
5.
6.
7.
8.

The worst market crash since the Great Depression, with U.S.
stocks losing 50.2% of their value—or $7.4 trillion—between
March 2000 and October 2002.
Far deeper drops in the share prices of the hottest companies of
the 1990s, including AOL, Cisco, JDS Uniphase, Lucent, and
Qualcomm—plus the utter destruction of hundreds of Internet
stocks.
Accusations of massive financial fraud at some of the largest and
most respected corporations in America, including Enron, Tyco,
and Xerox.
The bankruptcies of such once-glistening companies as Conseco, Global Crossing, and WorldCom.
Allegations that accounting firms cooked the books, and even
destroyed records, to help their clients mislead the investing public.
Charges that top executives at leading companies siphoned off
hundreds of millions of dollars for their own personal gain.
Proof that security analysts on Wall Street praised stocks publicly
but admitted privately that they were garbage.
A stock market that, even after its bloodcurdling decline, seems
overvalued by historical measures, suggesting to many experts
that stocks have further yet to fall.

Commentary on the Introduction

15

9. A relentless decline in interest rates that has left investors with no
attractive alternative to stocks.
10. An investing environment bristling with the unpredictable menace
of global terrorism and war in the Middle East.
Much of this damage could have been (and was!) avoided by
investors who learned and lived by Graham’s principles. As Graham
puts it, “while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster.”
By letting themselves get carried away—on Internet stocks, on big
“growth” stocks, on stocks as a whole—many people made the same
stupid mistakes as Sir Isaac Newton. They let other investors’ judgments determine their own. They ignored Graham’s warning that “the
really dreadful losses” always occur after “the buyer forgot to ask
‘How much?’ ” Most painfully of all, by losing their self-control just
when they needed it the most, these people proved Graham’s assertion that “the investor’s chief problem—and even his worst enemy—is
likely to be himself.”
T H E S U R E T H I N G T H AT WA S N ’ T
Many of those people got especially carried away on technology and
Internet stocks, believing the high-tech hype that this industry would
keep outgrowing every other for years to come, if not forever:
•

5

In mid-1999, after earning a 117.3% return in just the first five
months of the year, Monument Internet Fund portfolio manager
Alexander Cheung predicted that his fund would gain 50% a year
over the next three to five years and an annual average of 35%
“over the next 20 years.” 5

Constance Loizos, “Q&A: Alex Cheung,” InvestmentNews, May 17, 1999,
p. 38. The highest 20-year return in mutual fund history was 25.8% per year,
achieved by the legendary Peter Lynch of Fidelity Magellan over the two
decades ending December 31, 1994. Lynch’s performance turned $10,000
into more than $982,000 in 20 years. Cheung was predicting that his fund
would turn $10,000 into more than $4 million over the same length of time.
Instead of regarding Cheung as ridiculously overoptimistic, investors threw

16

•

•

Commentary on the Introduction

After his Amerindo Technology Fund rose an incredible 248.9%
in 1999, portfolio manager Alberto Vilar ridiculed anyone who
dared to doubt that the Internet was a perpetual moneymaking
machine: “If you’re out of this sector, you’re going to underperform. You’re in a horse and buggy, and I’m in a Porsche. You
don’t like tenfold growth opportunities? Then go with someone
else.” 6
In February 2000, hedge-fund manager James J. Cramer proclaimed that Internet-related companies “are the only ones worth
owning right now.” These “winners of the new world,” as he called
them, “are the only ones that are going higher consistently in
good days and bad.” Cramer even took a potshot at Graham: “You
have to throw out all of the matrices and formulas and texts that
existed before the Web. . . . If we used any of what Graham and
Dodd teach us, we wouldn’t have a dime under management.” 7

All these so-called experts ignored Graham’s sober words of warning: “Obvious prospects for physical growth in a business do not
translate into obvious profits for investors.” While it seems easy to
foresee which industry will grow the fastest, that foresight has no real
value if most other investors are already expecting the same thing. By
the time everyone decides that a given industry is “obviously” the best

money at him, flinging more than $100 million into his fund over the next
year. A $10,000 investment in the Monument Internet Fund in May 1999
would have shrunk to roughly $2,000 by year-end 2002. (The Monument
fund no longer exists in its original form and is now known as Orbitex
Emerging Technology Fund.)
6
Lisa Reilly Cullen, “The Triple Digit Club,” Money, December, 1999, p. 170.
If you had invested $10,000 in Vilar’s fund at the end of 1999, you would
have finished 2002 with just $1,195 left—one of the worst destructions of
wealth in the history of the mutual-fund industry.
7
See www.thestreet.com/funds/smarter/891820.html. Cramer’s favorite
stocks did not go “higher consistently in good days and bad.” By year-end
2002, one of the 10 had already gone bankrupt, and a $10,000 investment
spread equally across Cramer’s picks would have lost 94%, leaving you
with a grand total of $597.44. Perhaps Cramer meant that his stocks would
be “winners” not in “the new world,” but in the world to come.

Commentary on the Introduction

17

one to invest in, the prices of its stocks have been bid up so high that
its future returns have nowhere to go but down.
For now at least, no one has the gall to try claiming that technology
will still be the world’s greatest growth industry. But make sure you
remember this: The people who now claim that the next “sure thing”
will be health care, or energy, or real estate, or gold, are no more likely
to be right in the end than the hypesters of high tech turned out to be.
T H E S I LV E R L I N I N G
If no price seemed too high for stocks in the 1990s, in 2003 we’ve
reached the point at which no price appears to be low enough. The
pendulum has swung, as Graham knew it always does, from irrational
exuberance to unjustifiable pessimism. In 2002, investors yanked $27
billion out of stock mutual funds, and a survey conducted by the Securities Industry Association found that one out of 10 investors had cut
back on stocks by at least 25%. The same people who were eager to
buy stocks in the late 1990s—when they were going up in price and,
therefore, becoming expensive—sold stocks as they went down in
price and, by definition, became cheaper.
As Graham shows so brilliantly in Chapter 8, this is exactly backwards. The intelligent investor realizes that stocks become more risky,
not less, as their prices rise—and less risky, not more, as their prices
fall. The intelligent investor dreads a bull market, since it makes stocks
more costly to buy. And conversely (so long as you keep enough cash
on hand to meet your spending needs), you should welcome a bear
market, since it puts stocks back on sale.8
So take heart: The death of the bull market is not the bad news
everyone believes it to be. Thanks to the decline in stock prices, now
is a considerably safer—and saner—time to be building wealth. Read
on, and let Graham show you how.

8

The only exception to this rule is an investor in the advanced stage of
retirement, who may not be able to outlast a long bear market. Yet even an
elderly investor should not sell her stocks merely because they have gone
down in price; that approach not only turns her paper losses into real ones
but deprives her heirs of the potential to inherit those stocks at lower costs
for tax purposes.

CHAPTER 1

Investment versus Speculation: Results to
Be Expected by the Intelligent Investor

This chapter will outline the viewpoints that will be set forth in

the remainder of the book. In particular we wish to develop at the
outset our concept of appropriate portfolio policy for the individual, nonprofessional investor.

Investment versus Speculation
What do we mean by “investor”? Throughout this book the
term will be used in contradistinction to “speculator.” As far back
as 1934, in our textbook Security Analysis,1 we attempted a precise
formulation of the difference between the two, as follows: “An
investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not
meeting these requirements are speculative.”
While we have clung tenaciously to this definition over the
ensuing 38 years, it is worthwhile noting the radical changes that
have occurred in the use of the term “investor” during this period.
After the great market decline of 1929–1932 all common stocks
were widely regarded as speculative by nature. (A leading authority stated flatly that only bonds could be bought for investment.2)
Thus we had then to defend our definition against the charge that
it gave too wide scope to the concept of investment.
Now our concern is of the opposite sort. We must prevent our
readers from accepting the common jargon which applies the term
“investor” to anybody and everybody in the stock market. In our
last edition we cited the following headline of a front-page article
of our leading financial journal in June 1962:
18

Investment versus Speculation

19

SMALL INVESTORS BEARISH, THEY ARE SELLING ODD-LOTS SHORT

In October 1970 the same journal had an editorial critical of what it
called “reckless investors,” who this time were rushing in on the
buying side.
These quotations well illustrate the confusion that has been
dominant for many years in the use of the words investment and
speculation. Think of our suggested definition of investment given
above, and compare it with the sale of a few shares of stock by an
inexperienced member of the public, who does not even own what
he is selling, and has some largely emotional conviction that he
will be able to buy them back at a much lower price. (It is not irrelevant to point out that when the 1962 article appeared the market
had already experienced a decline of major size, and was now getting ready for an even greater upswing. It was about as poor a time
as possible for selling short.) In a more general sense, the later-used
phrase “reckless investors” could be regarded as a laughable contradiction in terms—something like “spendthrift misers”—were
this misuse of language not so mischievous.
The newspaper employed the word “investor” in these
instances because, in the easy language of Wall Street, everyone
who buys or sells a security has become an investor, regardless of
what he buys, or for what purpose, or at what price, or whether for
cash or on margin. Compare this with the attitude of the public
toward common stocks in 1948, when over 90% of those queried
expressed themselves as opposed to the purchase of common
stocks.3 About half gave as their reason “not safe, a gamble,” and
about half, the reason “not familiar with.”* It is indeed ironical

* The survey Graham cites was conducted for the Fed by the University of
Michigan and was published in the Federal Reserve Bulletin, July, 1948.
People were asked, “Suppose a man decides not to spend his money. He
can either put it in a bank or in bonds or he can invest it. What do you think
would be the wisest thing for him to do with the money nowadays—put it in
the bank, buy savings bonds with it, invest it in real estate, or buy common
stock with it?” Only 4% thought common stock would offer a “satisfactory”
return; 26% considered it “not safe” or a “gamble.” From 1949 through
1958, the stock market earned one of its highest 10-year returns in history,

20

The Intelligent Investor

(though not surprising) that common-stock purchases of all kinds
were quite generally regarded as highly speculative or risky at a
time when they were selling on a most attractive basis, and due
soon to begin their greatest advance in history; conversely the very
fact they had advanced to what were undoubtedly dangerous levels as judged by past experience later transformed them into “investments,” and the entire stock-buying public into “investors.”
The distinction between investment and speculation in common
stocks has always been a useful one and its disappearance is a
cause for concern. We have often said that Wall Street as an institution would be well advised to reinstate this distinction and to
emphasize it in all its dealings with the public. Otherwise the stock
exchanges may some day be blamed for heavy speculative losses,
which those who suffered them had not been properly warned
against. Ironically, once more, much of the recent financial embarrassment of some stock-exchange firms seems to have come from
the inclusion of speculative common stocks in their own capital
funds. We trust that the reader of this book will gain a reasonably
clear idea of the risks that are inherent in common-stock commitments—risks which are inseparable from the opportunities of
profit that they offer, and both of which must be allowed for in the
investor’s calculations.
What we have just said indicates that there may no longer be
such a thing as a simon-pure investment policy comprising representative common stocks—in the sense that one can always wait to
buy them at a price that involves no risk of a market or “quotational” loss large enough to be disquieting. In most periods the
investor must recognize the existence of a speculative factor in his
common-stock holdings. It is his task to keep this component
within minor limits, and to be prepared financially and psychologically for adverse results that may be of short or long duration.
Two paragraphs should be added about stock speculation per
se, as distinguished from the speculative component now inherent

averaging 18.7% annually. In a fascinating echo of that early Fed survey, a
poll conducted by BusinessWeek at year-end 2002 found that only 24% of
investors were willing to invest more in their mutual funds or stock portfolios,
down from 47% just three years earlier.

Investment versus Speculation

21

in most representative common stocks. Outright speculation is
neither illegal, immoral, nor (for most people) fattening to the
pocketbook. More than that, some speculation is necessary and
unavoidable, for in many common-stock situations there are substantial possibilities of both profit and loss, and the risks therein
must be assumed by someone.* There is intelligent speculation as
there is intelligent investing. But there are many ways in which
speculation may be unintelligent. Of these the foremost are: (1)
speculating when you think you are investing; (2) speculating seriously instead of as a pastime, when you lack proper knowledge
and skill for it; and (3) risking more money in speculation than you
can afford to lose.
In our conservative view every nonprofessional who operates
on margin† should recognize that he is ipso facto speculating, and it
is his broker’s duty so to advise him. And everyone who buys a
so-called “hot” common-stock issue, or makes a purchase in any
way similar thereto, is either speculating or gambling. Speculation
is always fascinating, and it can be a lot of fun while you are ahead
of the game. If you want to try your luck at it, put aside a portion—
the smaller the better—of your capital in a separate fund for this
purpose. Never add more money to this account just because the

* Speculation is beneficial on two levels: First, without speculation, untested
new companies (like Amazon.com or, in earlier times, the Edison Electric
Light Co.) would never be able to raise the necessary capital for expansion.
The alluring, long-shot chance of a huge gain is the grease that lubricates
the machinery of innovation. Secondly, risk is exchanged (but never eliminated) every time a stock is bought or sold. The buyer purchases the primary
risk that this stock may go down. Meanwhile, the seller still retains a residual
risk—the chance that the stock he just sold may go up!
† A margin account enables you to buy stocks using money you borrow
from the brokerage firm. By investing with borrowed money, you make more
when your stocks go up—but you can be wiped out when they go down. The
collateral for the loan is the value of the investments in your account—so you
must put up more money if that value falls below the amount you borrowed.
For more information about margin accounts, see www.sec.gov/investor/
pubs/margin.htm, www.sia.com/publications/pdf/MarginsA.pdf, and www.
nyse.com/pdfs/2001_factbook_09.pdf.

22

The Intelligent Investor

market has gone up and profits are rolling in. (That’s the time to
think of taking money out of your speculative fund.) Never mingle
your speculative and investment operations in the same account,
nor in any part of your thinking.

Results to Be Expected by the Defensive Investor
We have already defined the defensive investor as one interested chiefly in safety plus freedom from bother. In general what
course should he follow and what return can he expect under
“average normal conditions”—if such conditions really exist? To
answer these questions we shall consider first what we wrote on
the subject seven years ago, next what significant changes have
occurred since then in the underlying factors governing the
investor’s expectable return, and finally what he should do and
what he should expect under present-day (early 1972) conditions.
1. What We Said Six Years Ago
We recommended that the investor divide his holdings between
high-grade bonds and leading common stocks; that the proportion
held in bonds be never less than 25% or more than 75%, with the
converse being necessarily true for the common-stock component;
that his simplest choice would be to maintain a 50–50 proportion
between the two, with adjustments to restore the equality when
market developments had disturbed it by as much as, say, 5%. As
an alternative policy he might choose to reduce his common-stock
component to 25% “if he felt the market was dangerously high,”
and conversely to advance it toward the maximum of 75% “if he
felt that a decline in stock prices was making them increasingly
attractive.”
In 1965 the investor could obtain about 41⁄2% on high-grade taxable bonds and 31⁄4% on good tax-free bonds. The dividend return
on leading common stocks (with the DJIA at 892) was only about
3.2%. This fact, and others, suggested caution. We implied that “at
normal levels of the market” the investor should be able to obtain
an initial dividend return of between 31⁄2% and 41⁄2% on his stock
purchases, to which should be added a steady increase in underlying value (and in the “normal market price”) of a representative

Investment versus Speculation

23

stock list of about the same amount, giving a return from dividends and appreciation combined of about 71⁄2% per year. The half
and half division between bonds and stocks would yield about 6%
before income tax. We added that the stock component should
carry a fair degree of protection against a loss of purchasing power
caused by large-scale inflation.
It should be pointed out that the above arithmetic indicated
expectation of a much lower rate of advance in the stock market
than had been realized between 1949 and 1964. That rate had averaged a good deal better than 10% for listed stocks as a whole, and it
was quite generally regarded as a sort of guarantee that similarly
satisfactory results could be counted on in the future. Few people
were willing to consider seriously the possibility that the high rate
of advance in the past means that stock prices are “now too high,”
and hence that “the wonderful results since 1949 would imply not
very good but bad results for the future.” 4
2. What Has Happened Since 1964
The major change since 1964 has been the rise in interest rates on
first-grade bonds to record high levels, although there has since
been a considerable recovery from the lowest prices of 1970. The
obtainable return on good corporate issues is now about 71⁄2% and
even more against 41⁄2% in 1964. In the meantime the dividend
return on DJIA-type stocks had a fair advance also during the market decline of 1969–70, but as we write (with “the Dow” at 900) it is
less than 3.5% against 3.2% at the end of 1964. The change in going
interest rates produced a maximum decline of about 38% in the
market price of medium-term (say 20-year) bonds during this
period.
There is a paradoxical aspect to these developments. In 1964 we
discussed at length the possibility that the price of stocks might be
too high and subject ultimately to a serious decline; but we did not
consider specifically the possibility that the same might happen to
the price of high-grade bonds. (Neither did anyone else that we
know of.) We did warn (on p. 90) that “a long-term bond may vary
widely in price in response to changes in interest rates.” In the light
of what has since happened we think that this warning—with
attendant examples—was insufficiently stressed. For the fact is that

24

The Intelligent Investor

if the investor had a given sum in the DJIA at its closing price of
874 in 1964 he would have had a small profit thereon in late 1971;
even at the lowest level (631) in 1970 his indicated loss would have
been less than that shown on good long-term bonds. On the other
hand, if he had confined his bond-type investments to U.S. savings
bonds, short-term corporate issues, or savings accounts, he would
have had no loss in market value of his principal during this period
and he would have enjoyed a higher income return than was
offered by good stocks. It turned out, therefore, that true “cash
equivalents” proved to be better investments in 1964 than common
stocks—in spite of the inflation experience that in theory should
have favored stocks over cash. The decline in quoted principal
value of good longer-term bonds was due to developments in the
money market, an abstruse area which ordinarily does not have an
important bearing on the investment policy of individuals.
This is just another of an endless series of experiences over time
that have demonstrated that the future of security prices is never
predictable.* Almost always bonds have fluctuated much less than
stock prices, and investors generally could buy good bonds of any
maturity without having to worry about changes in their market
value. There were a few exceptions to this rule, and the period after
1964 proved to be one of them. We shall have more to say about
change in bond prices in a later chapter.
3. Expectations and Policy in Late 1971 and Early 1972
Toward the end of 1971 it was possible to obtain 8% taxable
interest on good medium-term corporate bonds, and 5.7% tax-free
on good state or municipal securities. In the shorter-term field the
investor could realize about 6% on U.S. government issues due in
five years. In the latter case the buyer need not be concerned about

* Read Graham’s sentence again, and note what this greatest of investing
experts is saying: The future of security prices is never predictable. And as
you read ahead in the book, notice how everything else Graham tells you is
designed to help you grapple with that truth. Since you cannot predict the
behavior of the markets, you must learn how to predict and control your own
behavior.

Investment versus Speculation

25

a possible loss in market value, since he is sure of full repayment,
including the 6% interest return, at the end of a comparatively
short holding period. The DJIA at its recurrent price level of 900 in
1971 yields only 3.5%.
Let us assume that now, as in the past, the basic policy decision
to be made is how to divide the fund between high-grade bonds
(or other so-called “cash equivalents”) and leading DJIA-type
stocks. What course should the investor follow under present conditions, if we have no strong reason to predict either a significant
upward or a significant downward movement for some time in the
future? First let us point out that if there is no serious adverse
change, the defensive investor should be able to count on the current 3.5% dividend return on his stocks and also on an average
annual appreciation of about 4%. As we shall explain later this
appreciation is based essentially on the reinvestment by the various companies of a corresponding amount annually out of undistributed profits. On a before-tax basis the combined return of his
stocks would then average, say, 7.5%, somewhat less than his interest on high-grade bonds.* On an after-tax basis the average return
on stocks would work out at some 5.3%.5 This would be about the
same as is now obtainable on good tax-free medium-term bonds.
These expectations are much less favorable for stocks against
bonds than they were in our 1964 analysis. (That conclusion follows inevitably from the basic fact that bond yields have gone up
much more than stock yields since 1964.) We must never lose sight

* How well did Graham’s forecast pan out? At first blush, it seems, very
well: From the beginning of 1972 through the end of 1981, stocks earned
an annual average return of 6.5%. (Graham did not specify the time period
for his forecast, but it’s plausible to assume that he was thinking of a 10year time horizon.) However, inflation raged at 8.6% annually over this
period, eating up the entire gain that stocks produced. In this section of his
chapter, Graham is summarizing what is known as the “Gordon equation,”
which essentially holds that the stock market’s future return is the sum of the
current dividend yield plus expected earnings growth. With a dividend yield
of just under 2% in early 2003, and long-term earnings growth of around
2%, plus inflation at a bit over 2%, a future average annual return of roughly
6% is plausible. (See the commentary on Chapter 3.)

26

The Intelligent Investor

of the fact that the interest and principal payments on good bonds
are much better protected and therefore more certain than the dividends and price appreciation on stocks. Consequently we are
forced to the conclusion that now, toward the end of 1971, bond
investment appears clearly preferable to stock investment. If we
could be sure that this conclusion is right we would have to advise
the defensive investor to put all his money in bonds and none in
common stocks until the current yield relationship changes significantly in favor of stocks.
But of course we cannot be certain that bonds will work out better than stocks from today’s levels. The reader will immediately
think of the inflation factor as a potent reason on the other side. In
the next chapter we shall argue that our considerable experience
with inflation in the United States during this century would not
support the choice of stocks against bonds at present differentials
in yield. But there is always the possibility—though we consider it
remote—of an accelerating inflation, which in one way or another
would have to make stock equities preferable to bonds payable in a
fixed amount of dollars.* There is the alternative possibility—
which we also consider highly unlikely—that American business
will become so profitable, without stepped-up inflation, as to justify a large increase in common-stock values in the next few years.
Finally, there is the more familiar possibility that we shall witness
another great speculative rise in the stock market without a real
justification in the underlying values. Any of these reasons, and
perhaps others we haven’t thought of, might cause the investor to
regret a 100% concentration on bonds even at their more favorable
yield levels.
Hence, after this foreshortened discussion of the major considerations, we once again enunciate the same basic compromise policy

* Since 1997, when Treasury Inflation-Protected Securities (or TIPS) were
introduced, stocks have no longer been the automatically superior choice
for investors who expect inflation to increase. TIPS, unlike other bonds, rise
in value if the Consumer Price Index goes up, effectively immunizing the
investor against losing money after inflation. Stocks carry no such guarantee
and, in fact, are a relatively poor hedge against high rates of inflation. (For
more details, see the commentary to Chapter 2.)

Investment versus Speculation

27

for defensive investors—namely that at all times they have a significant part of their funds in bond-type holdings and a significant
part also in equities. It is still true that they may choose between
maintaining a simple 50–50 division between the two components
or a ratio, dependent on their judgment, varying between a minimum of 25% and a maximum of 75% of either. We shall give our
more detailed view of these alternative policies in a later chapter.
Since at present the overall return envisaged from common stocks
is nearly the same as that from bonds, the presently expectable
return (including growth of stock values) for the investor would
change little regardless of how he divides his fund between the
two components. As calculated above, the aggregate return from
both parts should be about 7.8% before taxes or 5.5% on a tax-free
(or estimated tax-paid) basis. A return of this order is appreciably
higher than that realized by the typical conservative investor over
most of the long-term past. It may not seem attractive in relation to
the 14%, or so, return shown by common stocks during the 20
years of the predominantly bull market after 1949. But it should be
remembered that between 1949 and 1969 the price of the DJIA had
advanced more than fivefold while its earnings and dividends had
about doubled. Hence the greater part of the impressive market
record for that period was based on a change in investors’ and
speculators’ attitudes rather than in underlying corporate values.
To that extent it might well be called a “bootstrap operation.”
In discussing the common-stock portfolio of the defensive
investor, we have spoken only of leading issues of the type
included in the 30 components of the Dow Jones Industrial Average. We have done this for convenience, and not to imply that these
30 issues alone are suitable for purchase by him. Actually, there are
many other companies of quality equal to or excelling the average
of the Dow Jones list; these would include a host of public utilities
(which have a separate Dow Jones average to represent them).* But

* Today, the most widely available alternatives to the Dow Jones Industrial
Average are the Standard & Poor’s 500-stock index (the “S & P”) and the
Wilshire 5000 index. The S & P focuses on 500 large, well-known companies that make up roughly 70% of the total value of the U.S. equity market.
The Wilshire 5000 follows the returns of nearly every significant, publicly

28

The Intelligent Investor

the major point here is that the defensive investor’s overall results
are not likely to be decisively different from one diversified or representative list than from another, or—more accurately—that neither he nor his advisers could predict with certainty whatever
differences would ultimately develop. It is true that the art of skillful or shrewd investment is supposed to lie particularly in the
selection of issues that will give better results than the general market. For reasons to be developed elsewhere we are skeptical of the
ability of defensive investors generally to get better than average
results—which in fact would mean to beat their own overall performance.* (Our skepticism extends to the management of large
funds by experts.)
Let us illustrate our point by an example that at first may seem
to prove the opposite. Between December 1960 and December 1970
the DJIA advanced from 616 to 839, or 36%. But in the same period
the much larger Standard & Poor’s weighted index of 500 stocks
rose from 58.11 to 92.15, or 58%. Obviously the second group had
proved a better “buy” than the first. But who would have been so
rash as to predict in 1960 that what seemed like a miscellaneous
assortment of all sorts of common stocks would definitely outperform the aristocratic “thirty tyrants” of the Dow? All this proves,
we insist, that only rarely can one make dependable predictions
about price changes, absolute or relative.
We shall repeat here without apology—for the warning cannot
be given too often—that the investor cannot hope for better than
average results by buying new offerings, or “hot” issues of any
sort, meaning thereby those recommended for a quick profit.† The
contrary is almost certain to be true in the long run. The defensive
investor must confine himself to the shares of important companies
with a long record of profitable operations and in strong financial
condition. (Any security analyst worth his salt could make up such

traded stock in America, roughly 6,700 in all; but, since the largest companies account for most of the total value of the index, the return of the
Wilshire 5000 is usually quite similar to that of the S & P 500. Several lowcost mutual funds enable investors to hold the stocks in these indexes as a
single, convenient portfolio. (See Chapter 9.)
* See pp. 363–366 and pp. 376–380.
† For greater detail, see Chapter 6.

Investment versus Speculation

29

a list.) Aggressive investors may buy other types of common
stocks, but they should be on a definitely attractive basis as established by intelligent analysis.
To conclude this section, let us mention briefly three supplementary concepts or practices for the defensive investor. The first is the
purchase of the shares of well-established investment funds as an
alternative to creating his own common-stock portfolio. He might
also utilize one of the “common trust funds,” or “commingled
funds,” operated by trust companies and banks in many states; or,
if his funds are substantial, use the services of a recognized investment-counsel firm. This will give him professional administration
of his investment program along standard lines. The third is the
device of “dollar-cost averaging,” which means simply that the
practitioner invests in common stocks the same number of dollars
each month or each quarter. In this way he buys more shares when
the market is low than when it is high, and he is likely to end up
with a satisfactory overall price for all his holdings. Strictly speaking, this method is an application of a broader approach known as
“formula investing.” The latter was already alluded to in our suggestion that the investor may vary his holdings of common stocks
between the 25% minimum and the 75% maximum, in inverse relationship to the action of the market. These ideas have merit for the
defensive investor, and they will be discussed more amply in later
chapters.*

Results to Be Expected by the Aggressive Investor
Our enterprising security buyer, of course, will desire and
expect to attain better overall results than his defensive or passive
companion. But first he must make sure that his results will not be
worse. It is no difficult trick to bring a great deal of energy, study,
and native ability into Wall Street and to end up with losses instead
of profits. These virtues, if channeled in the wrong directions,
become indistinguishable from handicaps. Thus it is most essential
that the enterprising investor start with a clear conception as to

* For more advice on “well-established investment funds,” see Chapter 9.
“Professional administration” by “a recognized investment-counsel firm” is
discussed in Chapter 10. “Dollar-cost averaging” is explained in Chapter 5.

30

The Intelligent Investor

which courses of action offer reasonable chances of success and
which do not.
First let us consider several ways in which investors and speculators generally have endeavored to obtain better than average
results. These include:
1. Trading in the market. This usually means buying stocks
when the market has been advancing and selling them after it has
turned downward. The stocks selected are likely to be among those
which have been “behaving” better than the market average. A
small number of professionals frequently engage in short selling.
Here they will sell issues they do not own but borrow through the
established mechanism of the stock exchanges. Their object is to
benefit from a subsequent decline in the price of these issues, by
buying them back at a price lower than they sold them for. (As our
quotation from the Wall Street Journal on p. 19 indicates, even
“small investors”—perish the term!—sometimes try their unskilled
hand at short selling.)
2. Short-term selectivity. This means buying stocks of companies which are reporting or expected to report increased earnings,
or for which some other favorable development is anticipated.
3. Long-term selectivity. Here the usual emphasis is on an
excellent record of past growth, which is considered likely to continue in the future. In some cases also the “investor” may choose
companies which have not yet shown impressive results, but are
expected to establish a high earning power later. (Such companies
belong frequently in some technological area—e.g., computers,
drugs, electronics—and they often are developing new processes
or products that are deemed to be especially promising.)
We have already expressed a negative view about the investor’s
overall chances of success in these areas of activity. The first we
have ruled out, on both theoretical and realistic grounds, from the
domain of investment. Stock trading is not an operation “which, on
thorough analysis, offers safety of principal and a satisfactory
return.” More will be said on stock trading in a later chapter.*

* See Chapter 8.

Investment versus Speculation

31

In his endeavor to select the most promising stocks either for the
near term or the longer future, the investor faces obstacles of two
kinds—the first stemming from human fallibility and the second
from the nature of his competition. He may be wrong in his estimate of the future; or even if he is right, the current market price
may already fully reflect what he is anticipating. In the area of
near-term selectivity, the current year’s results of the company are
generally common property on Wall Street; next year’s results, to
the extent they are predictable, are already being carefully considered. Hence the investor who selects issues chiefly on the basis of
this year’s superior results, or on what he is told he may expect for
next year, is likely to find that others have done the same thing for
the same reason.
In choosing stocks for their long-term prospects, the investor’s
handicaps are basically the same. The possibility of outright error
in the prediction—which we illustrated by our airlines example on
p. 6—is no doubt greater than when dealing with near-term earnings. Because the experts frequently go astray in such forecasts, it is
theoretically possible for an investor to benefit greatly by making
correct predictions when Wall Street as a whole is making incorrect
ones. But that is only theoretical. How many enterprising investors
could count on having the acumen or prophetic gift to beat the professional analysts at their favorite game of estimating long-term
future earnings?
We are thus led to the following logical if disconcerting conclusion: To enjoy a reasonable chance for continued better than average
results, the investor must follow policies which are (1) inherently
sound and promising, and (2) not popular on Wall Street.
Are there any such policies available for the enterprising
investor? In theory once again, the answer should be yes; and there
are broad reasons to think that the answer should be affirmative in
practice as well. Everyone knows that speculative stock movements are carried too far in both directions, frequently in the general market and at all times in at least some of the individual
issues. Furthermore, a common stock may be undervalued because
of lack of interest or unjustified popular prejudice. We can go further and assert that in an astonishingly large proportion of the
trading in common stocks, those engaged therein don’t appear to
know—in polite terms—one part of their anatomy from another. In
this book we shall point out numerous examples of (past) dis-

32

The Intelligent Investor

crepancies between price and value. Thus it seems that any intelligent person, with a good head for figures, should have a veritable
picnic on Wall Street, battening off other people’s foolishness. So it
seems, but somehow it doesn’t work out that simply. Buying a neglected and therefore undervalued issue for profit generally proves
a protracted and patience-trying experience. And selling short a
too popular and therefore overvalued issue is apt to be a test not
only of one’s courage and stamina but also of the depth of one’s
pocketbook.* The principle is sound, its successful application is
not impossible, but it is distinctly not an easy art to master.
There is also a fairly wide group of “special situations,” which
over many years could be counted on to bring a nice annual return
of 20% or better, with a minimum of overall risk to those who knew
their way around in this field. They include intersecurity arbitrages, payouts or workouts in liquidations, protected hedges of
certain kinds. The most typical case is a projected merger or acquisition which offers a substantially higher value for certain shares
than their price on the date of the announcement. The number of
such deals increased greatly in recent years, and it should have
been a highly profitable period for the cognoscenti. But with the
multiplication of merger announcements came a multiplication of
obstacles to mergers and of deals that didn’t go through; quite a
few individual losses were thus realized in these once-reliable
operations. Perhaps, too, the overall rate of profit was diminished
by too much competition.†

* In “selling short” (or “shorting”) a stock, you make a bet that its share
price will go down, not up. Shorting is a three-step process: First, you borrow shares from someone who owns them; then you immediately sell the
borrowed shares; finally, you replace them with shares you buy later. If the
stock drops, you will be able to buy your replacement shares at a lower
price. The difference between the price at which you sold your borrowed
shares and the price you paid for the replacement shares is your gross profit
(reduced by dividend or interest charges, along with brokerage costs). However, if the stock goes up in price instead of down, your potential loss is
unlimited—making short sales unacceptably speculative for most individual
investors.
† In the late 1980s, as hostile corporate takeovers and leveraged buyouts
multiplied, Wall Street set up institutional arbitrage desks to profit from any

Investment versus Speculation

33

The lessened profitability of these special situations appears one
manifestation of a kind of self-destructive process—akin to the law
of diminishing returns—which has developed during the lifetime
of this book. In 1949 we could present a study of stock-market fluctuations over the preceding 75 years, which supported a formula—
based on earnings and current interest rates—for determining a
level to buy the DJIA below its “central” or “intrinsic” value,
and to sell out above such value. It was an application of the governing maxim of the Rothschilds: “Buy cheap and sell dear.” * And
it had the advantage of running directly counter to the ingrained
and pernicious maxim of Wall Street that stocks should be bought
because they have gone up and sold because they have gone down.
Alas, after 1949 this formula no longer worked. A second illustration is provided by the famous “Dow Theory” of stock-market
movements, in a comparison of its indicated splendid results for
1897–1933 and its much more questionable performance since
1934.
A third and final example of the golden opportunities not
recently available: A good part of our own operations on Wall
Street had been concentrated on the purchase of bargain issues easily identified as such by the fact that they were selling at less than
their share in the net current assets (working capital) alone, not
counting the plant account and other assets, and after deducting all
liabilities ahead of the stock. It is clear that these issues were selling
at a price well below the value of the enterprise as a private business. No proprietor or majority holder would think of selling what
he owned at so ridiculously low a figure. Strangely enough, such

errors in pricing these complex deals. They became so good at it that the
easy profits disappeared and many of these desks have been closed down.
Although Graham does discuss it again (see pp. 174–175), this sort of trading is no longer feasible or appropriate for most people, since only multimillion-dollar trades are large enough to generate worthwhile profits.
Wealthy individuals and institutions can utilize this strategy through hedge
funds that specialize in merger or “event” arbitrage.
* The Rothschild family, led by Nathan Mayer Rothschild, was the dominant
power in European investment banking and brokerage in the nineteenth
century. For a brilliant history, see Niall Ferguson, The House of Rothschild:
Money’s Prophets, 1798–1848 (Viking, 1998).

34

The Intelligent Investor

anomalies were not hard to find. In 1957 a list was published showing nearly 200 issues of this type available in the market. In various
ways practically all these bargain issues turned out to be profitable,
and the average annual result proved much more remunerative
than most other investments. But they too virtually disappeared
from the stock market in the next decade, and with them a dependable area for shrewd and successful operation by the enterprising
investor. However, at the low prices of 1970 there again appeared a
considerable number of such “sub-working-capital” issues, and
despite the strong recovery of the market, enough of them
remained at the end of the year to make up a full-sized portfolio.
The enterprising investor under today’s conditions still has various possibilities of achieving better than average results. The huge
list of marketable securities must include a fair number that can be
identified as undervalued by logical and reasonably dependable
standards. These should yield more satisfactory results on the
average than will the DJIA or any similarly representative list. In
our view the search for these would not be worth the investor’s
effort unless he could hope to add, say, 5% before taxes to the average annual return from the stock portion of his portfolio. We shall
try to develop one or more such approaches to stock selection for
use by the active investor.

COMMENTARY ON CHAPTER 1

All of human unhappiness comes from one single thing: not
knowing how to remain at rest in a room.
—Blaise Pascal

W

hy do you suppose the brokers on the floor of the New York Stock
Exchange always cheer at the sound of the closing bell—no matter
what the market did that day? Because whenever you trade, they
make money—whether you did or not. By speculating instead of investing, you lower your own odds of building wealth and raise someone
else’s.
Graham’s definition of investing could not be clearer: “An investment operation is one which, upon thorough analysis, promises safety
of principal and an adequate return.” 1 Note that investing, according to
Graham, consists equally of three elements:
•
•
•

you must thoroughly analyze a company, and the soundness of its
underlying businesses, before you buy its stock;
you must deliberately protect yourself against serious losses;
you must aspire to “adequate,” not extraordinary, performance.

1

Graham goes even further, fleshing out each of the key terms in his definition: “thorough analysis” means “the study of the facts in the light of established standards of safety and value” while “safety of principal” signifies
“protection against loss under all normal or reasonably likely conditions or
variations” and “adequate” (or “satisfactory”) return refers to “any rate or
amount of return, however low, which the investor is willing to accept, provided he acts with reasonable intelligence.” (Security Analysis, 1934 ed.,
pp. 55–56).
35

36

Commentary on Chapter 1

An investor calculates what a stock is worth, based on the value of
its businesses. A speculator gambles that a stock will go up in price
because somebody else will pay even more for it. As Graham once
put it, investors judge “the market price by established standards of
value,” while speculators “base [their] standards of value upon the
market price.” 2 For a speculator, the incessant stream of stock quotes
is like oxygen; cut it off and he dies. For an investor, what Graham
called “quotational” values matter much less. Graham urges you to
invest only if you would be comfortable owning a stock even if you had
no way of knowing its daily share price.3
Like casino gambling or betting on the horses, speculating in the
market can be exciting or even rewarding (if you happen to get lucky).
But it’s the worst imaginable way to build your wealth. That’s because
Wall Street, like Las Vegas or the racetrack, has calibrated the odds
so that the house always prevails, in the end, against everyone who
tries to beat the house at its own speculative game.
On the other hand, investing is a unique kind of casino—one where
you cannot lose in the end, so long as you play only by the rules that
put the odds squarely in your favor. People who invest make money for
themselves; people who speculate make money for their brokers. And
that, in turn, is why Wall Street perennially downplays the durable
virtues of investing and hypes the gaudy appeal of speculation.
U N S A F E AT H I G H S P E E D
Confusing speculation with investment, Graham warns, is always a
mistake. In the 1990s, that confusion led to mass destruction. Almost
everyone, it seems, ran out of patience at once, and America became
the Speculation Nation, populated with traders who went shooting
from stock to stock like grasshoppers whizzing around in an August
hay field.
People began believing that the test of an investment technique
was simply whether it “worked.” If they beat the market over any

2

Security Analysis, 1934 ed., p. 310.
As Graham advised in an interview, “Ask yourself: If there was no market
for these shares, would I be willing to have an investment in this company on
these terms?” (Forbes, January 1, 1972, p. 90.)
3

Commentary on Chapter 1

37

period, no matter how dangerous or dumb their tactics, people
boasted that they were “right.” But the intelligent investor has no interest in being temporarily right. To reach your long-term financial goals,
you must be sustainably and reliably right. The techniques that
became so trendy in the 1990s—day trading, ignoring diversification,
flipping hot mutual funds, following stock-picking “systems”—seemed
to work. But they had no chance of prevailing in the long run, because
they failed to meet all three of Graham’s criteria for investing.
To see why temporarily high returns don’t prove anything, imagine
that two places are 130 miles apart. If I observe the 65-mph speed
limit, I can drive that distance in two hours. But if I drive 130 mph, I
can get there in one hour. If I try this and survive, am I “right”? Should
you be tempted to try it, too, because you hear me bragging that it
“worked”? Flashy gimmicks for beating the market are much the
same: In short streaks, so long as your luck holds out, they work. Over
time, they will get you killed.
In 1973, when Graham last revised The Intelligent Investor, the
annual turnover rate on the New York Stock Exchange was 20%,
meaning that the typical shareholder held a stock for five years before
selling it. By 2002, the turnover rate had hit 105%—a holding period of
only 11.4 months. Back in 1973, the average mutual fund held on to a
stock for nearly three years; by 2002, that ownership period had
shrunk to just 10.9 months. It’s as if mutual-fund managers were
studying their stocks just long enough to learn they shouldn’t have
bought them in the first place, then promptly dumping them and starting all over.
Even the most respected money-management firms got antsy. In
early 1995, Jeffrey Vinik, manager of Fidelity Magellan (then the
world’s largest mutual fund), had 42.5% of its assets in technology
stocks. Vinik proclaimed that most of his shareholders “have invested
in the fund for goals that are years away. . . . I think their objectives are
the same as mine, and that they believe, as I do, that a long-term
approach is best.” But six months after he wrote those high-minded
words, Vinik sold off almost all his technology shares, unloading nearly
$19 billion worth in eight frenzied weeks. So much for the “long term”!
And by 1999, Fidelity’s discount brokerage division was egging on its
clients to trade anywhere, anytime, using a Palm handheld computer—
which was perfectly in tune with the firm’s new slogan, “Every second
counts.”

38

Commentary on Chapter 1

FIGURE 1-1

Stocks on Speed

20

15

10

5

ol
og
y

ig
n

ch
n

riS

Te
Pu

m

a

Br

oa

Ve

dV

om
Q

ua

lc

w
et
N
al
Re

is
io
n

m

s
or
k

i
om
kt
In

Tr
e*

.c
on
az

ad
e

om

I
CM

G
Am

ou

bl

eC

lic
k

0

D

Average length of ownership (in days)

25

And on the NASDAQ exchange, turnover hit warp speed, as Figure 1-1 shows.4
In 1999, shares in Puma Technology, for instance, changed hands
an average of once every 5.7 days. Despite NASDAQ’s grandiose
motto—“The Stock Market for the Next Hundred Years”—many of its
customers could barely hold on to a stock for a hundred hours.
THE FINANCIAL VIDEO GAME
Wall Street made online trading sound like an instant way to mint
money: Discover Brokerage, the online arm of the venerable firm of

4

Source: Steve Galbraith, Sanford C. Bernstein & Co. research report, January 10, 2000. The stocks in this table had an average return of 1196.4% in
1999. They lost an average of 79.1% in 2000, 35.5% in 2001, and 44.5%
in 2002—destroying all the gains of 1999, and then some.

Commentary on Chapter 1

39

Morgan Stanley, ran a TV commercial in which a scruffy tow-truck
driver picks up a prosperous-looking executive. Spotting a photo of a
tropical beachfront posted on the dashboard, the executive asks,
“Vacation?” “Actually,” replies the driver, “that’s my home.” Taken
aback, the suit says, “Looks like an island.” With quiet triumph, the
driver answers, “Technically, it’s a country.”
The propaganda went further. Online trading would take no work
and require no thought. A television ad from Ameritrade, the online
broker, showed two housewives just back from jogging; one logs on
to her computer, clicks the mouse a few times, and exults, “I think I just
made about $1,700!” In a TV commercial for the Waterhouse brokerage firm, someone asked basketball coach Phil Jackson, “You know
anything about the trade?” His answer: “I’m going to make it right
now.” (How many games would Jackson’s NBA teams have won if he
had brought that philosophy to courtside? Somehow, knowing nothing about the other team, but saying, “I’m ready to play them right
now,” doesn’t sound like a championship formula.)
By 1999 at least six million people were trading online—and roughly
a tenth of them were “day trading,” using the Internet to buy and sell
stocks at lightning speed. Everyone from showbiz diva Barbra
Streisand to Nicholas Birbas, a 25-year-old former waiter in Queens,
New York, was flinging stocks around like live coals. “Before,” scoffed
Birbas, “I was investing for the long term and I found out that it was not
smart.” Now, Birbas traded stocks up to 10 times a day and expected
to earn $100,000 in a year. “I can’t stand to see red in my profit-or-loss
column,” Streisand shuddered in an interview with Fortune. “I’m Taurus
the bull, so I react to red. If I see red, I sell my stocks quickly.” 5
By pouring continuous data about stocks into bars and barbershops, kitchens and cafés, taxicabs and truck stops, financial websites and financial TV turned the stock market into a nonstop national
video game. The public felt more knowledgeable about the markets
than ever before. Unfortunately, while people were drowning in data,
knowledge was nowhere to be found. Stocks became entirely decou-

5

Instead of stargazing, Streisand should have been channeling Graham.
The intelligent investor never dumps a stock purely because its share price
has fallen; she always asks first whether the value of the company’s underlying businesses has changed.

40

Commentary on Chapter 1

pled from the companies that had issued them—pure abstractions, just
blips moving across a TV or computer screen. If the blips were moving
up, nothing else mattered.
On December 20, 1999, Juno Online Services unveiled a trailblazing business plan: to lose as much money as possible, on purpose.
Juno announced that it would henceforth offer all its retail services for
free—no charge for e-mail, no charge for Internet access—and that it
would spend millions of dollars more on advertising over the next year.
On this declaration of corporate hara-kiri, Juno’s stock roared up from
$16.375 to $66.75 in two days.6
Why bother learning whether a business was profitable, or what
goods or services a company produced, or who its management was,
or even what the company’s name was? All you needed to know
about stocks was the catchy code of their ticker symbols: CBLT, INKT,
PCLN, TGLO, VRSN, WBVN.7 That way you could buy them even
faster, without the pesky two-second delay of looking them up on an
Internet search engine. In late 1998, the stock of a tiny, rarely traded
building-maintenance company, Temco Services, nearly tripled in a
matter of minutes on record-high volume. Why? In a bizarre form of
financial dyslexia, thousands of traders bought Temco after mistaking
its ticker symbol, TMCO, for that of Ticketmaster Online (TMCS), an
Internet darling whose stock began trading publicly for the first time
that day.8
Oscar Wilde joked that a cynic “knows the price of everything, and
the value of nothing.” Under that definition, the stock market is always
cynical, but by the late 1990s it would have shocked Oscar himself. A
single half-baked opinion on price could double a company’s stock
even as its value went entirely unexamined. In late 1998, Henry Blodget, an analyst at CIBC Oppenheimer, warned that “as with all Internet stocks, a valuation is clearly more art than science.” Then, citing
only the possibility of future growth, he jacked up his “price target” on

6

Just 12 months later, Juno’s shares had shriveled to $1.093.
A ticker symbol is an abbreviation, usually one to four letters long, of a
company’s name used as shorthand to identify a stock for trading purposes.
8
This was not an isolated incident; on at least three other occasions in the
late 1990s, day traders sent the wrong stock soaring when they mistook its
ticker symbol for that of a newly minted Internet company.
7

Commentary on Chapter 1

41

Amazon.com from $150 to $400 in one fell swoop. Amazon.com shot
up 19% that day and—despite Blodget’s protest that his price target
was a one-year forecast—soared past $400 in just three weeks. A year
later, PaineWebber analyst Walter Piecyk predicted that Qualcomm
stock would hit $1,000 a share over the next 12 months. The stock—
already up 1,842% that year—soared another 31% that day, hitting
$659 a share.9
FROM FOR M U LA TO FIASCO
But trading as if your underpants are on fire is not the only form of
speculation. Throughout the past decade or so, one speculative formula after another was promoted, popularized, and then thrown aside.
All of them shared a few traits—This is quick! This is easy! And it won’t
hurt a bit!—and all of them violated at least one of Gra