Benjamin Graham Quotes

The intelligent investor is a realist who sells to optimists and buys from pessimists.

In the short run, the market is a voting machine but in the long run, it is a weighing machine.

Those who do not remember the past are condemned to repeat it.

But investing isn’t about beating others at their game. It’s about controlling yourself at your own game.

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 stock investor is neither right or wrong because others agreed or disagreed with him; he is right because his facts and analysis are right.

She felt dirty, ugly and tired. She felt like a marshmallow heading into a house fire armed with chocolate and graham crackers.

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

As the Danish philosopher Søren Kierkegaard noted, life can only be understood backwards—but it must be lived forwards.

The punches you miss are the ones that wear you out. —Boxing trainer Angelo Dundee

You will be much more in control, if you realize how much you are not in control.

invest only if you would be comfortable owning a stock even if you had no way of knowing its daily share price.3

Americans are getting stronger. Twenty years ago, it took two people to carry ten dollars’ worth of groceries. Today, a five-year-old can do it. —Henny Youngman

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.

plant trees that other men will sit under.

Buy cheap and sell dear.

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.

If the reason people invest is to make money, then in seeking advice they are asking others to tell them how to make money. That idea has some element of naïveté.

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.

Abnormally good or abnormally bad conditions do not last forever.

A cynic once told G. K. Chesterton, the British novelist and essayist, “Blessed is he who expecteth nothing, for he shall not be disappointed.” Chesterton’s rejoinder? “Blessed is he who expecteth nothing, for he shall enjoy everything.

The psychologists Daniel Kahnerman and Amos Tversky have shown when humans estimate the likelihood or frequency of an event, we make that judgment based not on how often the event has actually occurred, but on how vivid the past examples are.

Obvious prospects for physical growth in a business do not translate into obvious profits for investors.

while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster.

All things excellent are as difficult as they are rare.

It requires a great deal of boldness and a great deal of caution to make a great fortune; and when you have got it, it requires ten times as much wit to keep it. —Nathan Mayer Rothschild

With every new wave of optimism or pessimism, we are ready to abandon history and time-tested principles, but we cling tenaciously and unquestioningly to our prejudices.    

You’ve got to be careful if you don’t know where you’re going, ’cause you might not get there. —Yogi Berra

The investment world nevertheless has enough liars, cheaters, and thieves to keep Satan's check-in clerks frantically busy for decades to come.

The schoolteacher asks Billy Bob: "If you have 12 sheeps and one jumps over the fence, how many sheeps do you have left?" Billy Bob answers, "None." "Well" says the teacher, "you sure don't know your subtraction." "Maybe not," Billy Bob replies, "but i darn sure know my sheeps.

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

... Bond selection is primarily a negative art. It is a process of exclusion and rejection, rather than of search and acceptance.

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

Astute observers of corporate balance sheets are often the first to see business deterioration

The most dangerous untruths are truths slightly distorted. —G. C. Lichtenberg

Since the profits that companies can earn are finite, the price that investors should be willing to pay for stocks must also be finite.

While a trend shown in the past is a fact, a “future trend” is only an assumption.

intelligence has nothing to do with IQ or SAT scores. It simply means being patient, disciplined, and eager to learn;

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.

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

An elementary requirement for the intelligent investor is an ability to resist the blandishments of salesmen offering new common-stock issues during bull markets.

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.

In other words, the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. Rather should we say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion.

Hold an index fund for 20 years or more, adding new money every month, and you are all but certain to outper-forms the vast majority of professional and individual investors alike. Late in his life, Graham praised index funds as the best choice for individual investors, as does Warren Buffett.6

You are right not because others agree with you, but because your facts and reasoning are sound. —Benjamin Graham

The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go. In the end, what matters isn’t crossing the finish line before anybody else but just making sure that you do cross it.8

Likewise, investors were delighted to earn 11% on bank certificates of deposit (CDs) in 1980 and are bitterly disappointed to be earning only around 2% in 2003—even though they were losing money after inflation back then but are keeping up with inflation now.

Common sense is the heart of investing and business management.

closed at $1.19 per share. Weighing the evidence objectively, the intelligent investor should conclude that IPO does not stand only for “initial public offering.” More accurately, it is also shorthand for: It’s Probably Overpriced, Imaginary Profits Only, Insiders’ Private Opportunity, or Idiotic, Preposterous, and Outrageous.

Here is an all-too-brief summary of Buffett’s approach: He looks for what he calls “franchise” companies with strong consumer brands, easily understandable businesses, robust financial health, and near-monopolies in their markets, like H & R Block, Gillette, and the Washington Post Co. Buffett likes to snap up a stock when a scandal, big loss, or other bad news passes over it like a storm cloud—as when he bought Coca-Cola soon after its disastrous rollout of “New Coke” and the market crash of 1987. He also wants to see managers who set and meet realistic goals; build their businesses from within rather than through acquisition; allocate capital wisely; and do not pay themselves hundred-million-dollar jackpots of stock options. Buffett insists on steady and sustainable growth in earnings, so the company will be worth more in the future than it is today.

A recent article in the Financial Analysts Journal confirmed what other studies (and the sad experience of many investors) have shown: that the fastest-growing companies tend to overheat and flame out.

When our government was in the process of being formed, Benjamin Franklin addressed the chairman of the Constitutional Convention, meeting at Philadelphia in 1787, saying, “I have lived, sir, a long time, and the longer I live the more convincing proofs I see of this truth: that God governs in the affairs of men. And if a sparrow cannot fall to the ground without His notice, it is probable that an empire cannot rise without His aid.

There is no room in this philosophy for a middle ground, or a series of gradations, between the passive and aggressive status. Many,

The heart of Graham’s argument is that the intelligent investor must never forecast the future exclusively by extrapolating the past.

The intelligent investor will remember the wise words of financial analyst Mark Schweber: “The one question never to ask a bureaucrat is ‘Why?

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.

To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.

As the famed investor Benjamin Graham said, “In the short term, the stock market is a voting machine; in the long term, it’s a weighing machine.

The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more.* Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment.†

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.

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.

I feel grateful to the Milesian wench who, seeing the philosopher Thales continually spending his time in contemplation of the heavenly vault and always keeping his eyes raised upward, put something in his way to make him stumble, to warn him that it would be time to amuse his thoughts with things in the clouds when he had seen to those at his feet. Indeed she gave him or her good counsel, to look rather to himself than to the sky. —Michel de Montaigne

The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell. It is far from certain that the typical investor should regularly hold off buying until low market levels appear, because this may involve a long wait, very likely the loss of income, and the possible missing of investment opportunities. On the whole it may be better for the investor to do his stock buying whenever he has money to put in stocks, except when the general market level is much higher than can be justified by well-established standards of value. If he wants to be shrewd he can look for the ever-present bargain opportunities in individual securities. Aside from forecasting the movements of the general market, much effort and ability are directed on Wall Street toward selecting stocks or industrial groups that in matter of price will “do better” than the rest over a fairly short period in the future. Logical as this endeavor may seem, we do not believe it is suited to the needs or temperament of the true investor—particularly since he would be competing with a large number of stock-market traders and first-class financial analysts who are trying to do the same thing. As in all other activities that emphasize price movements first and underlying values second, the work of many intelligent minds constantly engaged in this field tends to be self-neutralizing and self-defeating over the years. The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored. He should never buy a stock because it has gone up or sell one because it has gone down. He would not be far wrong if this motto read more simply: “Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop.” An

The investor's chief problem - and even his worst enemy - is likely to be himself.

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

Blessed is he who expecteth nothing, for he shall not be disappointed.

something foolish, something creative and something generous

Losing

The speculative public is incorrigible. In financial terms it cannot count beyond 3.

inversor representará una pequeña sección transversal

Human felicity is produc’d not so much by great Pieces of good Fortune that seldom happen, as by little Advantages that occur every day. —Benjamin Franklin

As a rule of thumb, investors should spend the bulk of their time on the disclosures of the security under study, and they should spend significant time on the reports of competitors.

Investment Owner’s Contract I, _____________ ___________________, hereby state that I am an investor who is seeking to accumulate wealth for many years into the future. I know that there will be many times when I will be tempted to invest in stocks or bonds because they have gone (or “are going”) up in price, and other times when I will be tempted to sell my investments because they have gone (or “are going”) down. I hereby declare my refusal to let a herd of strangers make my financial decisions for me. I further make a solemn commitment never to invest because the stock market has gone up, and never to sell because it has gone down. Instead, I will invest $______.00 per month, every month, through an automatic investment plan or “dollar-cost averaging program,” into the following mutual fund(s) or diversified portfolio(s): _________________________________, _________________________________, _________________________________. I will also invest additional amounts whenever I can afford to spare the cash (and can afford to lose it in the short run). I hereby declare that I will hold each of these investments continually through at least the following date (which must be a minimum of 10 years after the date of this contact): _________________ _____, 20__. The only exceptions allowed under the terms of this contract are a sudden, pressing need for cash, like a health-care emergency or the loss of my job, or a planned expenditure like a housing down payment or a tuition bill. I am, by signing below, stating my intention not only to abide by the terms of this contract, but to re-read this document whenever I am tempted to sell any of my investments. This contract is valid only when signed by at least one witness, and must be kept in a safe place that is easily accessible for future reference.

Many skeptics, it is true, are inclined to dismiss the whole procedure [chart reading] as akin to astrology or necromancy; but the sheer weight of its importance in Wall Street requires that its pretensions be examined with some degree of care.

On 3 timeless ideas for investing Benjamin Graham, three fundamentally basic ideas: 1. You should look at stocks as part of ownership of a business. 2. You should look at market fluctuations in terms of his "Mr. Market" example & make them your friend rather than your enemy by essentially profiting from folly rather participating in it, & finally, 3. The 3 most important words in investing are "margin of safety" - ...always building a 15,000 pound bridge if you're going to be driving 10,000 pound truck across it...

The only thing you can be confident of while forecasting future stock returns is that you will probably turn out to be wrong. The only indisputable truth that the past teaches us is that the future will always surprise us—always! And the corollary to that law of financial history is that the markets will most brutally surprise the very people who are most certain that their views about the future are right. Staying humble about your forecasting powers, as Graham did, will keep you from risking too much on a view of the future that may well turn out to be wrong.

The Interborough issues are an example of a rather special group of situations in which analysis may reach more definite conclusions respecting intrinsic value than in the ordinary case. These situations may involve a liquidation or give rise to technical operations known as “arbitrage” or “hedging.

The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more.* Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment.

don’t invest in only one stock—or even just a handful of different stocks. Unless you are not willing to spread your bets, you shouldn’t bet at all. Graham’s guideline of owning between 10 and 30 stocks remains a good starting point for investors who want to pick their own stocks, but you must make sure that you are not overexposed to one industry.

Looking back, you can always see exactly when you should have bought and sold your stocks. But don’t let that fool you into thinking you can see, in real time, just when to get in and out. In the financial markets, hindsight is forever 20/20, but foresight is legally blind. And thus, for most investors, market timing is a practical and emotional impossibility.5

Dividend Record. One of the most persuasive tests of high quality is an uninterrupted record of dividend payments going back over many years. We think that a record of continuous dividend payments for the last 20 years or more is an important plus factor in the company’s quality rating. Indeed the defensive investor might be justified in limiting his purchases to those meeting this test.

Read the notes.Never buy a stock without reading the footnotes to the financial statements in the annual report. Usually labeled “summary of significant accounting policies,” one key note describes how the company recognizes revenue, records inventories, treats installment or contract sales, expenses its marketing costs, and accounts for the other major aspects of its business.7 In the other footnotes, watch for disclosures about debt, stock options, loans to customers, reserves against losses, and other “risk factors” that can take a big chomp out of earnings

Asset elephantiasis. When a fund earns high returns, investors notice—often pouring in hundreds of millions of dollars in a matter of weeks. That leaves the fund manager with few choices—all of them bad. He can keep that money safe for a rainy day, but then the low returns on cash will crimp the fund’s results if stocks keep going up. He can put the new money into the stocks he already owns—which have probably gone up since he first bought them and will become dangerously overvalued if he pumps in millions of dollars more. Or he can buy new stocks he didn’t like well enough to own already—but he will have to research them from s

The average well-selected secondary company may be fully as promising as the average industrial leader. What the smaller concern lacks in inherent stability it may readily make up in superior possibilities of growth. Consequently it may appear illogical to many readers to term “unintelligent” the purchase of such secondary issues at their full “enterprise value.” We think that the strongest logic is that of experience. Financial history says clearly that the investor may expect satisfactory results, on the average, from secondary common stocks only if he buys them for less than their value to a private owner, that is, on a bargain basis.

We have advised against the purchase at “full prices” of three important categories of securities: (1) foreign bonds, (2) ordinary preferred stocks, and (3) secondary common stocks, including, of course, original offerings of such issues. By “full prices” we mean prices close to par for bonds or preferred stocks, and prices that represent about the fair business value of the enterprise in the case of common stocks. The greater number of defensive investors are to avoid these categories regardless of price; the enterprising investor is to buy them only when obtainable at bargain prices—which we define as prices not more than two-thirds of the appraisal value of the securities.

One example of a high-tech company that submits to a Graham type of analysis is Amazon.com. Though it does business exclusively on the Web, Amazon is essentially a retailer, and it may be evaluated in the same way as Wal-Mart, Sears, and so forth. The question, as always, is, does the business provide an adequate margin of safety at a given market price. For much of Amazon’s short life, the stock was wildly overpriced. But when the dot-com bubble burst, its securities collapsed. Buffett himself bought Amazon’s deeply discounted bonds after the crash, when there was much fearful talk that Amazon was headed for bankruptcy. The bonds subsequently rose to par, and Buffett made a killing.

The average doctor may be more likely than the average widow to elect to become an enterprising investor, and he is perhaps more likely to succeed in the undertaking. He has one important handicap, however—the fact that he has less time available to give to his investment education and to the administration of his funds. In fact, medical men have been notoriously unsuccessful in their security dealings. The reason for this is that they usually have an ample confidence in their own intelligence and a strong desire to make a good return on their money, without the realization that to do so successfully requires both considerable attention to the matter and something of a professional approach to security values.

Most of the time, the market is mostly accurate in pricing most stocks. Millions of buyers and sellers haggling over price do a remarkably good job of valuing companies—on average. But sometimes, the price is not right; occasionally, it is very wrong indeed. And at such times, you need to understand Graham’s image of Mr. Market, probably the most brilliant metaphor ever created for explaining how stocks can become mispriced.1 The manic-depressive Mr. Market does not always price stocks the way an appraiser or a private buyer would value a business. Instead, when stocks are going up, he happily pays more than their objective value; and, when they are going down, he is desperate to dump them for less than their true worth.

The market is fond of making mountains out of molehills and exaggerating ordinary vicissitudes into major setbacks.* Even a mere lack of interest or enthusiasm may impel a price decline to absurdly low levels. Thus we have what appear to be two major sources of undervaluation: (1) currently disappointing results and (2) protracted neglect or unpopularity. However, neither of these causes, if considered by itself alone, can be relied on as a guide to successful common-stock investment. How can we be sure that the currently disappointing results are indeed going to be only temporary? True, we can supply excellent examples of that happening. The steel stocks used to be famous for their cyclical quality, and the shrewd buyer could acquire them at low prices when earnings were low and sell them out in boom years at a fine profit.

If we assume that it is the habit of the market to overvalue common stocks which have been showing excellent growth or are glamorous for some other reason, it is logical to expect that it will undervalue—relatively, at least—companies that are out of favor because of unsatisfactory developments of a temporary nature. This may be set down as a fundamental law of the stock market, and it suggests an investment approach that should prove both conservative and promising. The key requirement here is that the enterprising investor concentrate on the larger companies that are going through a period of unpopularity. While small companies may also be undervalued for similar reasons, and in many cases may later increase their earnings and share price, they entail the risk of a definitive loss of profitability and also of protracted neglect by the market in spite of better earnings. The large companies thus have a double advantage over the others. First, they have the resources in capital and brain power to carry them through adversity and back to a satisfactory earnings base. Second, the market is likely to respond with reasonable speed to any improvement shown. A

For years the financial services have been making stock-market forecasts without anyone taking this activity very seriously. Like everyone else in the field they are sometimes right and sometimes wrong. Wherever possible they hedge their opinions so as to avoid the risk of being proved completely wrong. (There is a well-developed art of Delphic phrasing that adjusts itself successfully to whatever the future brings.) In our view—perhaps a prejudiced one—this segment of their work has no real significance except for the light it throws on human nature in the securities markets. Nearly everyone interested in common stocks wants to be told by someone else what he thinks the market is going to do. The demand being there, it must be supplied. Their interpretations and forecasts of business conditions, of course, are much more authoritative and informing. These are an important part of the great body of economic intelligence which is spread continuously among buyers and sellers of securities and tends to create fairly rational prices for stocks and bonds under most circumstances. Undoubtedly the material published by the financial services adds to the store of information available and fortifies the investment judgment of their clients.

Like spacecraft that pick up speed as they rise into the Earth’s stratosphere, growth stocks often seem to defy gravity. Let’s look at the trajectories of three of the hottest growth stocks of the 1990s: General Electric, Home Depot, and Sun Microsystems. (See Figure 7-1.) In every year from 1995 through 1999, each grew bigger and more profitable. Revenues doubled at Sun and more than doubled at Home Depot. According to Value Line, GE’s revenues grew 29%; its earnings rose 65%. At Home Depot and Sun, earnings per share roughly tripled. But something else was happening—and it wouldn’t have surprised Graham one bit. The faster these companies grew, the more expensive their stocks became. And when stocks grow faster than companies, investors always end up sorry. As Figure 7-2 shows: A great company is not a great investment if you pay too much for the stock. The more a stock has gone up, the more it seems likely to keep going up. But that instinctive belief is flatly contradicted by a fundamental law of financial physics: The bigger they get, the slower they grow. A $1-billion company can double its sales fairly easily; but where can a $50-billion company turn to find another $50 billion in business? Growth stocks are worth buying when their prices are reasonable, but when their price/earnings ratios go much above 25 or 30 the odds get ugly: Journalist Carol Loomis found that, from 1960 through 1999, only eight of the largest 150 companies on the Fortune 500 list managed to raise their earnings by an annual average of at least 15% for two decades.

the investor would need more than a mere falling off in both earnings and price to give him a sound basis for purchase. He should require an indication of at least reasonable stability of earnings over the past decade or more—i.e., no year of earnings deficit—plus sufficient size and financial strength to meet possible setbacks in the future. The ideal combination here is thus that of a large and prominent company selling both well below its past average price and its past average price/earnings multiplier. This would no doubt have ruled out most of the profitable opportunities in companies such as Chrysler, since their low-price years are generally accompanied by high price/earnings ratios. But let us assure the reader now—and no doubt we shall do it again—that there is a world of difference between “hindsight profits” and “real-money profits.” We doubt seriously whether the Chrysler type of roller coaster is a suitable medium for operations by our enterprising investor. We have mentioned protracted neglect or unpopularity as a second cause of price declines to unduly low levels. A current case of this kind would appear to be National Presto Industries. In the bull market of 1968 it sold at a high of 45, which was only 8 times the $5.61 earnings for that year. The per-share profits increased in both 1969 and 1970, but the price declined to only 21 in 1970. This was less than 4 times the (record) earnings in that year and less than its net-current-asset value. In March 1972 it was selling at 34, still only 5½ times the last reported earnings, and at about its enlarged net-current-asset value.

Here are some of the handicaps mutual-fund managers and other professional investors are saddled with: With billions of dollars under management, they must gravitate toward the biggest stocks—the only ones they can buy in the multimillion-dollar quantities they need to fill their portfolios. Thus many funds end up owning the same few overpriced giants. Investors tend to pour more money into funds as the market rises. The managers use that new cash to buy more of the stocks they already own, driving prices to even more dangerous heights. If fund investors ask for their money back when the market drops, the managers may need to sell stocks to cash them out. Just as the funds are forced to buy stocks at inflated prices in a rising market, they become forced sellers as stocks get cheap again. Many portfolio managers get bonuses for beating the market, so they obsessively measure their returns against benchmarks like the S & P 500 index. If a company gets added to an index, hundreds of funds compulsively buy it. (If they don’t, and that stock then does well, the managers look foolish; on the other hand, if they buy it and it does poorly, no one will blame them.) Increasingly, fund managers are expected to specialize. Just as in medicine the general practitioner has given way to the pediatric allergist and the geriatric otolaryngologist, fund managers must buy only “small growth” stocks, or only “mid-sized value” stocks, or nothing but “large blend” stocks.6 If a company gets too big, or too small, or too cheap, or an itty bit too expensive, the fund has to sell it—even if the manager loves the stock. So

We lack space here to discuss in detail the pros and cons of market forecasting. A great deal of brain power goes into this field, and undoubtedly some people can make money by being good stock-market analysts. But it is absurd to think that the general public can ever make money out of market forecasts. For who will buy when the general public, at a given signal, rushes to sell out at a profit? If you, the reader, expect to get rich over the years by following some system or leadership in market forecasting, you must be expecting to try to do what countless others are aiming at, and to be able to do it better than your numerous competitors in the market. There is no basis either in logic or in experience for assuming that any typical or average investor can anticipate market movements more successfully than the general public, of which he is himself a part. There is one aspect of the “timing” philosophy which seems to have escaped everyone’s notice. Timing is of great psychological importance to the speculator because he wants to make his profit in a hurry. The idea of waiting a year before his stock moves up is repugnant to him. But a waiting period, as such, is of no consequence to the investor. What advantage is there to him in having his money uninvested until he receives some (presumably) trustworthy signal that the time has come to buy? He enjoys an advantage only if by waiting he succeeds in buying later at a sufficiently lower price to offset his loss of dividend income. What this means is that timing is of no real value to the investor unless it coincides with pricing—that is, unless it enables him to repurchase his shares at substantially under his previous selling price.

There is no reason at all for thinking that the average intelligent investor, even with much devoted effort, can derive better results over the years from the purchase of growth stocks than the investment companies specializing in this area. Surely these organizations have more brains and better research facilities at their disposal than you do. Consequently we should advise against the usual type of growth-stock commitment for the enterprising investor.* This is one in which the excellent prospects are fully recognized in the market and already reflected in a current price-earnings ratio of, say, higher than 20. (For the defensive investor we suggested an upper limit of purchase price at 25 times average earnings of the past seven years. The two criteria would be about equivalent in most cases.)† The striking thing about growth stocks as a class is their tendency toward wide swings in market price. This is true of the largest and longest-established companies—such as General Electric and International Business Machines—and even more so of newer and smaller successful companies. They illustrate our thesis that the main characteristic of the stock market since 1949 has been the injection of a highly speculative element into the shares of companies which have scored the most brilliant successes, and which themselves would be entitled to a high investment rating. (Their credit standing is of the best, and they pay the lowest interest rates on their borrowings.) The investment caliber of such a company may not change over a long span of years, but the risk characteristics of its stock will depend on what happens to it in the stock market. The more enthusiastic the public grows about it, and the faster its advance as compared with the actual growth in its earnings, the riskier a proposition it becomes.

In an ideal world, the intelligent investor would hold stocks only when they are cheap and sell them when they become overpriced, then duck into the bunker of bonds and cash until stocks again become cheap enough to buy. From 1966 through late 2001, one study claimed, $1 held continuously in stocks would have grown to $11.71. But if you had gotten out of stocks right before the five worst days of each year, your original $1 would have grown to $987.12.1 Like most magical market ideas, this one is based on sleight of hand. How, exactly, would you (or anyone) figure out which days will be the worst days—before they arrive? On January 7, 1973, the New York Times featured an interview with one of the nation’s top financial forecasters, who urged investors to buy stocks without hesitation: “It’s very rare that you can be as unqualifiedly bullish as you can now.” That forecaster was named Alan Greenspan, and it’s very rare that anyone has ever been so unqualifiedly wrong as the future Federal Reserve chairman was that day: 1973 and 1974 turned out to be the worst years for economic growth and the stock market since the Great Depression.2 Can professionals time the market any better than Alan Green-span? “I see no reason not to think the majority of the decline is behind us,” declared Kate Leary Lee, president of the market-timing firm of R. M. Leary & Co., on December 3, 2001. “This is when you want to be in the market,” she added, predicting that stocks “look good” for the first quarter of 2002.3 Over the next three months, stocks earned a measly 0.28% return, underperforming cash by 1.5 percentage points. Leary is not alone. A study by two finance professors at Duke University found that if you had followed the recommendations of the best 10% of all market-timing newsletters, you would have earned a 12.6% annualized return from 1991 through 1995. But if you had ignored them and kept your money in a stock index fund, you would have earned 16.4%.

We define a bargain issue as one which, on the basis of facts established by analysis, appears to be worth considerably more than it is selling for. The genus includes bonds and preferred stocks selling well under par, as well as common stocks. To be as concrete as possible, let us suggest that an issue is not a true “bargain” unless the indicated value is at least 50% more than the price. What kind of facts would warrant the conclusion that so great a discrepancy exists? How do bargains come into existence, and how does the investor profit from them? There are two tests by which a bargain common stock is detected. The first is by the method of appraisal. This relies largely on estimating future earnings and then multiplying these by a factor appropriate to the particular issue. If the resultant value is sufficiently above the market price—and if the investor has confidence in the technique employed—he can tag the stock as a bargain. The second test is the value of the business to a private owner. This value also is often determined chiefly by expected future earnings—in which case the result may be identical with the first. But in the second test more attention is likely to be paid to the realizable value of the assets, with particular emphasis on the net current assets or working capital. At low points in the general market a large proportion of common stocks are bargain issues, as measured by these standards. (A typical example was General Motors when it sold at less than 30 in 1941, equivalent to only 5 for the 1971 shares. It had been earning in excess of $4 and paying $3.50, or more, in dividends.) It is true that current earnings and the immediate prospects may both be poor, but a levelheaded appraisal of average future conditions would indicate values far above ruling prices. Thus the wisdom of having courage in depressed markets is vindicated not only by the voice of experience but also by application of plausible techniques of value analysis.

WHY DIVERSIFY? During the bull market of the 1990s, one of the most common criticisms of diversification was that it lowers your potential for high returns. After all, if you could identify the next Microsoft, wouldn’t it make sense for you to put all your eggs into that one basket? Well, sure. As the humorist Will Rogers once said, “Don’t gamble. Take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.” However, as Rogers knew, 20/20 foresight is not a gift granted to most investors. No matter how confident we feel, there’s no way to find out whether a stock will go up until after we buy it. Therefore, the stock you think is “the next Microsoft” may well turn out to be the next MicroStrategy instead. (That former market star went from $3,130 per share in March 2000 to $15.10 at year-end 2002, an apocalyptic loss of 99.5%).1 Keeping your money spread across many stocks and industries is the only reliable insurance against the risk of being wrong. But diversification doesn’t just minimize your odds of being wrong. It also maximizes your chances of being right. Over long periods of time, a handful of stocks turn into “superstocks” that go up 10,000% or more. Money Magazine identified the 30 best-performing stocks over the 30 years ending in 2002—and, even with 20/20 hindsight, the list is startlingly unpredictable. Rather than lots of technology or health-care stocks, it includes Southwest Airlines, Worthington Steel, Dollar General discount stores, and snuff-tobacco maker UST Inc.2 If you think you would have been willing to bet big on any of those stocks back in 1972, you are kidding yourself. Think of it this way: In the huge market haystack, only a few needles ever go on to generate truly gigantic gains. The more of the haystack you own, the higher the odds go that you will end up finding at least one of those needles. By owning the entire haystack (ideally through an index fund that tracks the total U.S. stock market) you can be sure to find every needle, thus capturing the returns of all the superstocks. Especially if you are a defensive investor, why look for the needles when you can own the whole haystack?

BARGAIN-ISSUE PATTERN IN SECONDARY COMPANIES. We have defined a secondary company as one that is not a leader in a fairly important industry. Thus it is usually one of the smaller concerns in its field, but it may equally well be the chief unit in an unimportant line. By way of exception, any company that has established itself as a growth stock is not ordinarily considered “secondary.” In the great bull market of the 1920s relatively little distinction was drawn between industry leaders and other listed issues, provided the latter were of respectable size. The public felt that a middle-sized company was strong enough to weather storms and that it had a better chance for really spectacular expansion than one that was already of major dimensions. The depression years 1931–32, however, had a particularly devastating impact on the companies below the first rank either in size or in inherent stability. As a result of that experience investors have since developed a pronounced preference for industry leaders and a corresponding lack of interest most of the time in the ordinary company of secondary importance. This has meant that the latter group have usually sold at much lower prices in relation to earnings and assets than have the former. It has meant further that in many instances the price has fallen so low as to establish the issue in the bargain class. When investors rejected the stocks of secondary companies, even though these sold at relatively low prices, they were expressing a belief or fear that such companies faced a dismal future. In fact, at least subconsciously, they calculated that any price was too high for them because they were heading for extinction—just as in 1929 the companion theory for the “blue chips” was that no price was too high for them because their future possibilities were limitless. Both of these views were exaggerations and were productive of serious investment errors. Actually, the typical middle-sized listed company is a large one when compared with the average privately owned business. There is no sound reason why such companies should not continue indefinitely in operation, undergoing the vicissitudes characteristic of our economy but earning on the whole a fair return on their invested capital.