The Intelligent Investor breakdown series: CHAPTER 1

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

Chapter 1 is what it’s heading suggest it to be. Part of chapter one was already explained in the introduction which laid down the basics. Chapter 1 goes into the details of what constitutes investment or speculation. It also goes into detail deconstructing the difference and therefore the accompanying results for a defensive and aggressive investor. So to keep it simple, chapter 1 is divided to three sections.

  1. Investment versus Speculation
  2. Results to Be Expected by the Defensive Investor
  3. Results to Be Expected by the Aggressive Investor

Technical words included:

  • Selling short: You borrow stock from someone else. You sell them for the price you received and buy them back at a lower price.

See introduction for rest.

Investment vs speculation

If you know Graham close and his disciple (Buffet), there is one thing they always warn you about and it is the dangers of speculation. Speculation, as opposed to investment, is a completely different activity and people, the media and the wall street itself always tend to mix them, disastrously so.

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

The book details how the meaning of the word “investor” has changed over time. This is hardened with the fact that anyone who buys or sells security is called an “investor” by the wall street. Graham observes that the distinction between investor and speculator is a useful one and its disappearance is a cause of concern.

The author urges Wall Street to put forth this concern and make the distinction clear. Graham goes on to warn about huge speculative losses that people will have to deal with due to lack of awareness. Some stock markets themselves included speculative stocks on their capital and results weren’t good.

As per Graham, intelligent speculation exists just like intelligent investing does. However few things can make speculation go wrong.

  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.
  3. Risking more money in speculation than you can afford to lose.

Graham here by laid the solid foundation to call any nonprofessional who is putting money in the stock market is speculating and not investing. These are people that go after hot common stocks expecting a quick fat return. The problem with the same people is that when you average their stock market earning over the long term, speculation will prove to be a zero-sum game.

Although I wanted to keep this series clean of Jason Zweig’s commentary, I am quoting one line that is way more powerful than the entire paragraphs of text you read in the book or this series.

“People who invest make money for themselves; people who speculate make money for their brokers.”

Jason Zweig on TII

Results to Be Expected by the Defensive Investor

The introduction section of the book has already described a defensive investor as one interested chiefly in safety plus freedom from bother. To derive an appropriate policy for the defensive investor, Graham would want to consider what he recommended 6 years ago (1965) and compare the changed market conditions to 1971- early 1972.

6 years ago (1965), Graham recommended “the proportion held in bonds be never less than 25% or more than 75%”. An easy pick would be to keep a 50-50 share between the two. The investor can alter his bond/stock holding according to the market keeping the 25-75% margin.

Graham then goes on to describe his learning from 1965 to early 1972 (book published in 1973) to which changes in the market, especially high-interest rates for bonds are indicating a different idea. At one point, the 25-75 split was put under suspicion because the high returns from bonds suggested a 100% capital allocation. In early 1972, both bonds and stocks were giving fair returns hence Graham’s idea of 25-75 splitting remains invincible.

Policy for a defensive investor

The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condition.

  • Purchasing shares of well-established investment funds as opposed to creating his own common-stock portfolio.
  • Finding and investing in common trust funds. (if possible, use a recognized investment-counsel firm.)
  • Utilize the method of dollar-cost averaging.

Results to Be Expected by the Aggressive Investor

The aggressive investor is looking to make more money than the defensive one but first, he should make sure he is not loosing all of it. Graham considers few ways in which investors/speculators attempt to make money.

  1. Trading in the market: Purchasing stocks by how they are “behaving”.
  2. Short term selectivity: Purchasing stocks showing the prospects of short term profit.
  3. Long term selectivity: Buying stocks with excellent past records or investing in promising future technologies.

However, most promising stocks can have two problems -human error and the nature of competition. Human error at least from the investor side can be brought to a minimum with a great deal of knowledge and skill. The nature of competition is an obvious fact and it is well understood from the airlines’ example in the introduction section.

Hereon, Graham suggests that the investor must follow policies which are (1) inherently sound and promising, and (2) not popular on Wall Street.

The chapter continues to details through more events and corresponding analysis as applied to aggressive investors. But the above line has concluded them all. If you want to take only one thing away from this chapter, this line is all of it.


Whether you are a defensive investor or an aggressive one, there are stocks that minimize risk and maximize guarantee. However, what Graham told must be kept close to your heart. You must look for adequate performance, not extra ordinary performance.

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