CFA Institute

The Intelligent Investor by Benjamin Graham

Review by: Irving Kahn
Financial Analysts Journal, Vol. 29, No. 4 (Jul. - Aug., 1973), pp. 96-98
Published by: CFA Institute
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 Book
Reviews
Robert 1. Cummin, The Fidelity Bank, Editor

THE INTELLIGENT INVESTOR. By been historically to either corporate book Security A nalysis, he summar-
Benjamin Graham. Fourth Re- earnings or stock prices. izes the full range of bond choices
vised Edition, Harper & Row, The net debt of all U. S. corpora- available, including the varieties of
1973. 318 pages, $7.95. tions, from 1950 to 1970, increased U. S. Government, state, municipal,
Reviewed by IRVING KAHN
over 400 per cent, but income avail- and corporate issues.
Abraham & Co. able to support and repay this debt Graham discusses the basic, but
increased only 200 per cent-hardly usually confused, differences be-
Ben Graham's Fourth Revision an argument for the ability of com- tween changes in price and changes
of The Intelligent Investor up-dates mon stock earnings to keep pace in value. His analogy is with a build-
and enlarges the classic original ver- with inflation. ing mortgage that could be sold only
sion published in 1940. It is "in a He emphasizes the importance of at a loss if offered in an inactive
form suitable for laymen"-assum- avoiding borrowing against invest- market. Too, the current cry for in-
ing the laymen in question are in- ments in bonds. He also argues that stant marketability has created price
telligent. the fraction of the investor's port- extremes on both the up and down
In content and style it is above folio devoted to bonds be varied sides. He further distinguishes be-
the level of both novices and stock within the range of from 25 per cent tween a corporation that is larger in
traders. Those breeds will lack the to 75 per cent, with the remainder sales and assets and one that is
motivation to master the rich fare in shares. smaller in both but far more sound
packed into its pages. As in Graham & Dodd's earlier for the owner of its bonds or shares.
But for the serious investor, secu-
rity analyst, industry specialist, and
investment manager this revision is
surely a best buy. Among the hun-
dreds of investing guides offered for
sale, they won't find any as docu-
mented, factual or as well reasoned.
The Intelligent Investor starts
with a nine-page introduction, set-
ting Ben Graham's basic premises
against actual market results for the
last six years.
This author does what so few
have courage to do: he reprints
statements he made in the last, or
1964 edition. He frankly admits not
anticipating the subsequent sharp
rise in long-term bond rates and fall
in bond prices. Despite this over-
sight, his 1964 advice was valuable
protection for the 1964 investor.
He examines former and current
bond and stock yield relations and
lists the ways open to both the de-
fensive and the aggressive investor. - V:0
---- 1972was a turn-aroundyear for
Graham cites a wide range of in- AlleghenyLudlumhidustries:recordsalesof almost $575
vesting vehicles, purporting to pro- million, profitsthe best since 1969.The 1972Annual Reporttells of our
tect against the substantial inflation continuing developmentin growthmarketsand technologicalfrontiers.A major
factorin specialtysteels,AlleghenyLudlumreachesout into magnetics,electronics,industrialtools,
of general prices. His table of five- leisureitems like Jacobsenmowersand lawn tractorsand True Temper gardentools and recreational
year consumer price changes shows items ... whereverthere is growthopportunityand profit.There'smore; write for your copy today.
how unrelated this inflation has AlleghenyLudlumIndustries,Inc., 2024OliverBuilding,Pittsburgh,Pa. 15222.

96 Z FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1973

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 There are so many specific nug-
gets of wisdom in this book that an
adequate review would require sev-
eral more installments. A summary
of the chapter headings gives some
idea of its breadth:
1. Investment versus Speculation.
2. The Investor and Inflation.
3. A Century of Stock-Market
History.
4. The Defensive Investor.
5. The Defensive Investor and
Common Stocks.
6. The Enterprising Investor-
His Risks.
7. The Enterprising Investor-
His Opportunities.
8. Market Fluctuations.
9. Investment Funds.
10. Investment Adviser.
11. Security Analysis for the
Lay Investor.
12. Per Share Earnings.
13. Comparing Four Listed
Companies.
14. Stock Selection for the
Defensive Investor.
15. Stock Selection for the Enter-
prising Investor.
16. Convertible Issues and
Warrrants.
17. Four Case Histories.
18. Pairwise Comparisons, Using
Eight Pairs of Companies.
19. Dividend Policy.
20. Margin of Safety.
These are followed by five Ap-
pendices with fruitful comments on
the effect of taxes on the investor.
The greatest value of this book
is to the new generation of Wall
Streeters: Guys and dolls still in
their 20's, 30's and 40's. From it
they can spy out the cracks and pit-
falls before, not after, the many dis-
asters that happened in 1962, 1966,
1969, 1970 and also in 1973!
Ben Graham vastly influenced the
tens of thousands of security ana-
lysts of the past 40 years for whom
Security Analysis was the bible. It
is accurate to say that he made our
trade into a profession. The thou-
sands who qualified under the Char-
This content downloaded from 185.2.32.89 on Tue, 17 Jun 2014 17:25:29 PM
tered Financial Analyst designation in contrast to the stocks of problem
followed his pioneering efforts to companies. Very briefly, the O'Con-
win recognition for the C.F.A. pro- nor quality measurement system is
gram. designed to show "how much confi-
In sum, buy the book and keep it dence to put in a growth projection"
on your desk or night table. When and "how much premium or dis-
all goes wrong, go back and re-read count is warranted in the price of a
The Intelligent Investor. It will help stock."
you avoid repeating your mistakes. The points to be appraised are as
* * * follows:
INDUSTRY
THE 14 POINT METHOD FOR BEAT-
1) Industry dynamism
ING THE MARKET. By William P.
2) Stability
O'Connor, Jr. Henry Regnery
3) Service rating
Company, Chicago, 1972, $8.95.
COMPANY
Reviewed by ROBERTI. CUMMIN 4) Management
The original title for this book 5) Organization depth
was, I understand, Quality Stocks 6) Research
Beat the Market. But Mr. O'Con- 7) Plant
nor's firm, Moore &Schley, Cameron FINANCIAL
& Co., a New York Stock Exchange 8) Return on equity
member, understandably wanted to 9) Plowback
Debt/equity
use the book for promotional pur- 10)
11) Persistence
poses. The original title failed of
12) Dividends
clearance by the N.Y.S.E. on the
MARKET
ground that it improperly extrapo-
13) Volatility
lated past performance to the future. 14) Acceptance
You would-be extrapolaters take
warning. Each point is scored on a 1 - 5
Nevertheless, Quality is the theme basis, yielding a possible perfect
of the book. Quality stocks, as de- score of 70. The Dow-Jones Indus-
fined by the author, have consistent- trial Average scores 34 points. For
ly outperformed the run-of-the-mill convenience, stocks are divided into
stocks right up to this moment. The five quality grades.
book is devoted to explaining why GRADE SCORE
this is so and to describing how I Above 50
quality ratings may be determined- II 43 - 50
the 14 points. It sets the stage for III 34 - 42
Mr. O'Connor's more recent work IV 26 - 33
of determining the appropriate rela- V Below 26
tive price/earnings ratios at which
The point by point calculation as
price and earnings growth of indi-
described is fairly simple, and sub-
vidual stocks can be expected to
jective judgments are held to a mini-
move together. The result is a book
mum. A security analyst ought to be
of extraordinary importance to the
able to rate a stock in an hour or so.
serious investor, whose problem it
Cash Plowback (Point 9) requires
immensely simplifies, and to the
some explanation. It is a measure of
security analyst, whose function it growth potential from retained in-
exalts.
ternal cash flow, expressed as a per-
The 14 Point Method substitutes
centage.
nuts-and-bolts calculation for the in-
sight of Knowlton & Furth's Shakinig Plowback - Cash flow - dividends *
the Money Tree (FAJ Sept.-Oct. gross plant + net working capital
and investments + other assets.
'72), which advocated investment in
the stocks of successful companies This measure is, I think, a consid-
FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1973 E 97
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Book Reviews

weaken the series. The table sug-

PERCENTAGE INVESTMENT RETURNS BY QUALITY GRADE gests that the high quality stocks are
Grade 1960-65 1961-66 1962-67 1963-68 1964-69 1965-70 1966-71 a small, special group that behaves
differently from the stock universe.
I 17.0 14.4 16.1 16.9 14.3 10.0 16.3 For instance the investment risk of
II 14.0 8.2 15.9 16.3 14.6 8.1 8.7 owning the real growth stocks ap-
III 9.9 9.1 13.2 12.3 10.5 -0.3 6.6 pears to be less than the risk of own-
IV 15.0 9.7 11.0 10.2 4.4 -1.5 2.7 ing the slow growers, despite the
V 6.7 3.1 9.1 14.2 8.1 -1.5 -1.2 lower investment return afforded by
the latter. And although part of the
S&P 425 Industrials Average
superior performance of Grade I
12.4 7.7 11.1 8.5 6.8 2.2 6.7
was the result of marking up of P/E
Dow Jones Industrials ratios, there is surely enough in the
11.0 8.7 9.1 8.7 4.6 0 2.5 above table to justify a little ex-
trapolation by consenting profes-
erable refinement over the more vestment return? Using the average sionals.
primitive annual price of each stock and add- Most of Mr. O'Connor's message
Growth potential = Retained earnings ing the dividends to the selling price, is contained in just one glorious
per share . book value per share. total investment returns were calcu- chapter. There are other parts of
lated for five-year periods from 1960 the book that may prove tedious to
(See my Mechanics of Corporate through 1971. About 200 stocks
the analyst. However, there are ex-
Growth FAJ Aug. 1957). The older were used for the sample, including,
cellent essays on debt as a quality
measure is an oversimplification that however, all the Grade I and most
defect and on appraising the quality
overcredits companies with leveraged of the Grade II. Mr. O'Connor's re-
of earnings. In my view, this book
capitalizations. Plowback ranges sults, which speak for themselves, is an outstanding contribution to the
from five per cent for the Dow to are shown in the above table.
field of investment analysis. It is
12 per cent or more for the leading
Judging from the price perform- compulsory reading in my shop, and
growth stocks. ance of the Grade I stocks during I recommend it to every security
I find one measure - return on 1972, the 1967-72 period did not analyst and portfolio manager. *
sales - missing from the all-impor-
tant financial group. This measure
has much to do with stability of re-
turn and might some day be added
to the 14 points to make 15.
Note that the grading is done by for
points, not by percentile of the stock
universe. There are only 24 stocks
Counsel
in Grade I, 19 of them the leading in matters of
growth stocks. The elements that
make for quality also make for suc- RealEstate
cess, and success is growth, year
after year. The emerging growth &>
stocks carry a low quality rating. Asset Management
The top six in quality ratings are:
IBM 63 consult the
Eastman Kodak 62 Henry S. Miller Real Estate Council
Minnesota Mining 61 2500 One Main Place
Coca-Cola 60 Dallas, Texas 75250 (214) 748-9171
Avon Products 59
Merck 57
The great bulk of stocks rate IV
and V. Ft. Worth, Houston, Austin, San Antonio, Oklahoma City
How does Quality equate with in-

9D 7 FINANCIALANALYSTSJOURNAL/ JULY-AUGUST1973

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