NEW YORK (Money Magazine) -
Whenever Warren Buffett is asked to recommend a few good books about investing, America's greatest money manager begins with The Intelligent Investor by Benjamin Graham. (Among those who have picked up on Buffett's enthusiasm for the book is his good friend Bill Gates.)
In 1985, Buffett called it "by far the best book on investing ever written."
On one level, this is not surprising. Graham was Buffett's teacher, his boss, his friend and his intellectual hero.
But Graham came to Wall Street in 1914 and retired in 1956. He first wrote The Intelligent Investor in 1949, based on the ideas in his classic 1934 textbook, Security Analysis -- and last updated it in 1972.
At this point, isn't it just a golden oldie?
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Although I've read parts of The Intelligent Investor so many times that my copy of the book looks as if it has been run through a hay baler, I had last read it cover to cover in the early 1990s. (It was also the first book on investing I read when I became a financial journalist in 1987.)
So I had my doubts when HarperCollins, the book's publisher, approached me with a two-part plan: annotate Graham's original text with extensive footnotes, then write commentaries that would accompany each chapter and explain its relevance to today's investors. It seemed only fair to ask: Might the ideas Graham formed in the days of Calvin Coolidge and Herbert Hoover need, well, a heavy-duty Hoovering?
I soon found out how wrong I was. You might as well ask whether the Bible, some two millennia after it was written, is too passe to guide your soul. No matter how often or hugely the world changes, some truths endure as if they were engraved on granite with a diamond. And nearly 27 years after his death, Graham still speaks with the same present force as the biblical prophets.
Even after I tore every paragraph to bits, I could find only three or four significant points I disagreed with in Graham's 340 pages. Every basic principle was as valid as when he wrote it, if not more so.
Nearly all of Graham's warnings had come to pass -- as if, decades ago, he had gotten a sneak peek at today's headlines. Every aspect of his advice was as psychologically sound as it was financially sensible. And each of Graham's arguments was not just logical but contagiously logical, making me feel smarter just for having read it.
The more deeply I probed it for flaws, the more I realized that The Intelligent Investor is perfect for these times. If you understand Graham's message and take it to heart, nothing the markets throw at you can kill you.
Why listen to Ben? What makes Graham such a master? First, his indisputable brilliance: Before he even finished his senior year at Columbia College, Graham was offered teaching positions in three departments -- English, math and philosophy. He graduated second in his class. Not bad for a 20-year-old.
Second, his investing prowess: From 1936 to 1956, at his Graham-Newman mutual fund, he produced an average annual gain of more than 14.7 percent vs. 12.2 percent for the overall market -- one of the longest and widest margins of outperformance in Wall Street history.
Finally, his clear thinking: Like the ancient Greek philosophers he admired, Graham asks the most basic possible questions, then answers them in the clearest possible terms.
What is a stock? A stock is not a ticker symbol or a blip on a computer screen. Instead, a stock is an ownership stake in a business -- and in the long run it can go up in value only if that business grows and stays profitable.
In 1999 and early 2000, too many people fixated on the soaring prices of Internet stocks and ignored the ghastly unprofitability of Internet businesses. Graham saw traders make the same mistake with auto stocks in 1919, radio and utility stocks in 1929 and electronics stocks in the 1960s.
As the old saying goes, every time history repeats itself the price goes up.
What is the stock market? Some people say the stock market is a place where buyers and sellers meet, or a way for companies to raise capital. Graham, in a stroke of imaginative genius, says the stock market is a person. His name is Mr. Market, and all day long he asks you to trade with him. Mr. Market is generally stable and calm, but he often gets either manic or depressed.
When he's manic, he sets high prices -- and you should refuse to buy from him. When he's miserable, he sets low prices -- and you should refuse to sell to him. No matter what, you must not let Mr. Market's mood swings determine your own outlook.
What is an investor? Graham warns that most people who think they are investing are, in fact, speculating. Speculators, he says, base their "standards of value upon the market price," while investors judge "the market price by established standards of value." A speculator likes a stock if its price has gone up. An investor likes a stock if it sells for less than the value of its underlying business.
An investor, adds Graham, uses "thorough analysis" to test whether a stock or bond or fund "promises safety of principal and a satisfactory return." That's an and, not an or, definition: You must study an investment thoroughly, and it must have minimal risk of massive loss, and its potential return must be realistic. Without all three of those elements, you are speculating.
Are you an intelligent investor? The Wall Street propaganda machine -- and the daily bloodshed of the markets -- reinforce the message that investing is not for amateurs. Without expert guidance, many pundits say, you'll end up as roadkill on your own path to prosperity.
Nonsense, says Graham. A retail investor can do at least as well as a professional money manager. To be an intelligent investor, you don't need an M.B.A. or an IQ of 180. Instead of being "smart," you need only be wise. That means being able to harness your emotions, accept the limits of your knowledge, be patient and think independently.
Most big money managers, meanwhile, are stuck buying the largest, most popular stocks. Nearly every growth fund owns GE and Microsoft and Pfizer and Wal-Mart, often in nearly identical proportions. The fund industry often resembles a huge herd of fat sheep, all plodding in the same direction, all saying "Baaaa" at the same time.
While the "experts" charge annual management fees of up to 1.5 percent and can incur trading costs at least that high, the intelligent individual investor can get expenses down close to zero by buying patiently and selling rarely. Plus you get to control when you take your own taxable gains.
Are you defensive or enterprising? It's become conventional wisdom that investors fall into two camps: conservative and aggressive. The first group, afraid of losing money, puts safety foremost -- preferring bonds over stocks and current income over future gains.
The second group likes taking lots of risk in hopes of getting high returns. But that's not how investing life really works. Until we lose money, we think it will be much less painful than it is. After we lose money, we shun risk even more than we should. So why are investors grouped by "risk tolerance" when we all have such a poor grasp on how much risk is right for us?
Graham has a better idea. He thinks what kind of investor you are depends on how hard you are willing to work at it. If you enjoy the intellectual challenge of studying stocks or funds in detail, then he calls you "enterprising." You can put in the time and effort required to build a portfolio piece by piece. But if you don't enjoy the nitty-gritty of financial analysis, Graham considers you a "defensive" investor. You will do just fine buying an index fund and holding it forever.
What are your rights? Today's investors put most of their effort into buying a stock, a little into selling it -- but none into owning it. As soon as they buy one stock, most individual and institutional investors promptly turn their attention to the next one. However, Graham reminds us, "there is just as much reason to exercise care and judgment in being as in becoming a stockholder."
Graham wants you to realize something simple but incredibly profound: Once you buy a stock, you are an owner of the company. Its managers, all the way up to the CEO, work for you.
Its board of directors must answer to you. Its cash and its businesses belong to you. If you don't like the way your company is being managed, you have the right to demand that the managers be fired, the directors be replaced or the property be sold.
So how can you become an intelligent owner? Ask searching questions like these.
Is the company sitting on billions of dollars in cash while refusing to pay a dividend? Do the bosses keep buying other companies instead of investing in their own? Do they pay themselves hundred-million-dollar stock-option windfalls regardless of performance? Do "nonrecurring" accounting charges keep recurring?
If so, your rights are being trampled on. Visit chat rooms devoted to your company at websites like Yahoo Finance or Morningstar.com, and band together with fellow shareholders. Study the annual proxy statement. Write to the board of directors. Go to the annual meeting and grab the microphone. Vote against the incumbent directors and every proposal by management.
Maybe corporate America would never have gotten into the mess it's in today if the investing public had heeded Graham's clarion call: "Stockholders should wake up."
On this issue, as he so often does, Graham comes across as a prophet who saw it all coming long ago -- from Enron to Tyco to WorldCom. Here, as always, listening to Graham's luminous words can make every investor a more intelligent investor.
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