We Study Billionaires - The Investor’s Podcast Network - TIP620: The Intelligent Investor by Benjamin Graham

Starting point is 00:00:00 You're listening to TIP. Welcome to the Investors Podcast. I'm your host, Clay Fink, and today I'm going to be sharing what I learned from reading The Intelligent Investor by Benjamin Graham. And more specifically, the two chapters that Warren Buffett highly recommends, which are chapters 8 and 20. Benjamin Graham is known as the father of value investing and the number one mentor to Warren Buffett in his own investing journey early on.

Starting point is 00:00:27 Buffett was a student of Graham's at Columbia University. and Buffett admired Graham so much and valued his insights that he offered to work for Graham for free. At the end of this episode, I'll also pull a couple of clips from my co-host William Green's conversation with Jason Zweig, who wrote the commentary on the most recent edition of The Intelligent Investor. Hope you enjoy it. Celebrating 10 years and more than 150 million downloads. You are listening to the Investors Podcast Network. Since 2014, we studied the financial markets and read the books that influence self-made

Starting point is 00:01:05 billionaires the most. We keep you informed and prepared for the unexpected. Now, for your host, Clay Fink. All right, so like I mentioned at the top, I picked up the Intelligent Investor by Benjamin Graham. I got the revised edition with new commentary from Jason's Weig. And the original text was published back in 1949, and this revised edition was published in 2006. So Zweig, he ended up preserving the integrity of Graham's original text and teachings, and then he tied in some of the things that are more relevant for today's market, and then drew

Starting point is 00:01:49 parallels between Graham's examples and the headlines of when Zweig wrote the book. My co-host William Green had Jason Zweig on the Richer Wiser Happier Podcast back on episode four, and this was just a phenomenal conversation, so I also wanted to link a couple of clips from that episode as well. So Warren Buffett picked up the intelligent investor all the way back in early 1950, and back then he believed it was the best book on investing ever written, and he still says that today. In the preface of the book, Buffett writes, I quote, To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights,

Starting point is 00:02:28 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 to the proper framework. You must supply the emotional discipline, end quote. And Buffett has talked about how chapters 8 and 20 alone will make you a far better investor, which is what I'm going to discuss in detail during this episode. Zweig has a section here on who Benjamin Graham was and why you should listen to him. He writes, I quote, 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

Starting point is 00:03:14 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, and the intelligent investor is the first book 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." Ben Graham was born in 1894 in London, and then he moved to New York when he was just one-year-old. When Graham graduated from Columbia, he tried his hand at Wall Street. He started out as a clerk at a bond trading firm and eventually made his way to running

Starting point is 00:03:59 his own investment partnership. Zweig describes how Graham became a master at researching stocks in microscopic, almost molecular detail. He would plow through reports and discover companies that traded at a market price below the cash value and the value of the high-quality bonds that the company held. He'd buy such companies and then go on to pester the management to start increasing the dividend to help boost the share prices. After learning some painful lessons in losing 70% of his money during the Great Depression, his returns from 1936 through 1956 were recorded to be at least 14.7% annually versus just 12.2% for the broader market. The intelligent investor dives into these core timeless investment principles. These include first, a stock is not just a ticker symbol or an electronic blip.

Starting point is 00:04:52 It is an ownership in a real business that has underlying value that does not depend on the share price. Second, the market is a pendulum that forever swings between unsustainable optimism and unjustified pessimism. The intelligent investor is a realist who sells to the optimist and buys from the pessimist. Third, the future value of every investment is a function of its present price. The higher prices you pay, the lower returns you will ultimately. receive. Fourth, no matter how careful you are, the one risk no investor can ever eliminate is the risk of being wrong. This is why Graham incorporates a margin of safety with his purchases. A margin of safety means that you're paying a price well below what you believe to be the underlying value

Starting point is 00:05:40 to help minimize losses in the case that you're wrong in your assessment. And finally, fifth, the secret to your financial success is inside yourself. So Igu writes, 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, end quote. So the book has Graham's original text, and then Zweig adds his own additional commentary after each chapter to help illustrate how relevant Graham's principles still are today.

Starting point is 00:06:27 So like I mentioned, Buffett said that the most important chapters are Chapter 8 and Chapter 20, so let's start there. Chapter 8 is titled The Investor in Market Fluctuations. So due to the involvement of humans, markets inevitably go through fluctuations. Markets always have and always will have a series of good years and a series of bad years. And as investors, we must be both financially and psychologically prepared for such fluctuations, and ideally, we want to take advantage of these fluctuations in the market. Think back to 2022.

Starting point is 00:07:01 Many people were scared because markets were falling and everyone feared a severe market crash. Looking back, many people, including myself, were fairly pessimistic on where things were heading. And now with the benefit of hindsight, things were just taken too far, and the market swiftly rebound founded in 2023. This is an example of using market drawdowns as an opportunity to capitalize on investors thinking too short term and being too pessimistic. In an ideal world, Graham explains how the intelligent investor is able to capitalize by buying near the lows of a bear market and selling near the highs of a bull market. He explains that there are two ways to

Starting point is 00:07:42 profit from the mood swings of the market. The first is by the way of market timing, and the second way is by the way of pricing. By market timing, he essentially means anticipating the price action of the stock market, especially in the short run. In other words, buying when you believe markets are going to go up and selling when you believe markets are going to decline. Benefitting through the means of pricing is simply comparing the market price to what you deem the underlying business to be worth or what Buffett would just call the intrinsic value. So comparing the price that the market is offering you relative to what you consider to be the intrinsic value. So when the price is trading below the intrinsic value, you buy, and when it

Starting point is 00:08:23 trades far above the intrinsic value, you sell. Graham believes that if you're an investor who primarily relies on market timing, then he believes that you're a speculator, and you end up with a speculator's financial results. And it's funny how closely Graham's words align with Buffett's with regards to market forecasting. He writes, the farther one gets from Wall Street, the more skepticism one will find, we believe, as to the pretensions of stock market forecasting or timing, the investor can scarcely take seriously the innumerable predictions, which appear almost daily and are his for the asking. Yet in many cases, he pays attention to them and even acts on them. Why? Because he has been persuaded that it is important for him to form some

Starting point is 00:09:10 opinion of the future course of the stock market. And because he feels that the brokerage or service forecast is at least more dependable than his own." So despite decades of market forecasts being close to useless, we continue to be fooled by them. But he does admit that there are actually a few people out there who are able to make money with forecasting, but more broadly, he thinks that the general public will never be able to invest successfully based on predicting where the market's short-term price movements will go. One critical difference between a speculator and an investor is that a speculator puts a heavy emphasis on the timing. The idea of waiting one year before his stock goes up is a foreign idea to him. The speculator wants to make

Starting point is 00:09:55 returns now, but the intelligent investor has no issue with waiting because he knows eventually the market is a weighing machine and reflects the true underlying value of the business. While the intelligent investor can't predict the short-term mood swings of the market, what they can't do is take action after such swings have taken place. Graham saw that markets frequently went through its periods of ups and downs, the bull markets, the bear markets. Bull markets were characterized by historically high prices, high PE ratios, low dividend yields against bond yields, and much speculation on margin, and many IPOs of poor quality. So when looking at these signs, an investor can recognize where the market's mood is at and adjust their portfolio and strategy,

Starting point is 00:10:42 accordingly. But simply the process of buying low and selling high definitely is not easy, because sometimes bull markets go on for much longer than one might expect, and bare markets may be very short-lived before the next bull market comes around. So what's high can always go higher, and what's low can always go lower. The intelligent investor also recognizes that the day-to-day and month-to-month fluctuations in the prices of stocks he owns doesn't make him richer or poorer. The market brings us a flurry of emotions inside of us, especially when things are quite volatile. When stocks advance significantly, we should keep ourselves from becoming too infected with the overconfidence and enthusiasm that the broader public falls prey to.

Starting point is 00:11:28 Graham writes, the intelligent investor is likely to need considerable willpower to keep from following the crowd, end quote. And then he discusses one of the key central ideas of his teachings, and that is understanding the difference between price and value. The value in owning a common stock is that you've become a part owner of an actual business. The results as an owner of a business are entirely dependent on the profits of the enterprise or on a change in the underlying value of the assets that the business holds. Owning a stock is different from owning a share of a private business because we're able to sell our shares in the company in a matter of minutes, depending on the price the market is giving us, you know, which changes by the minute.

Starting point is 00:12:12 At times, the market price can become far removed from what a sensible person would pay to have a part ownership of that business and a private transaction. This is a critical insight because your typical investor today judges the performance of a company, oftentimes based on how the stock price has moved, with making no consideration of the underlying business's actual performance. The stock is not the business, and the business is not. the stock. However, over the long run, you should expect the performance of the stock to follow the performance of the business and not the other way around. In determining the value of a business,

Starting point is 00:12:50 Graham puts a really heavy emphasis on the balance sheet and what sort of assets the business owns. Typically, higher quality companies trade well below the company's book value, and it's more difficult to accurately assess what the intrinsic value of such a company is, which is why during that time, Graham focused really heavily on companies that were trading below their liquidation value. The problem with this is that these types of investments have really become easy picking for computer algorithms or these really smart people on Wall Street. So you typically aren't able to find these at least as often as Graham did back when he was an investor. So Graham illustrates the example of A&P. A&P was an American chain of grocery stores and was the largest grocery retailer in

Starting point is 00:13:36 the U.S. from 1915 through 1975. And during 1929, the stock sold for as high as $494, and by 1932, it had declined to $104. So up from $494 at the top, all the way down to $104 in 1932. By 1938, the share price fell down to a new low of $36. That was a 92% decline from the 1929 high. So the market price of A&P was $126 million in total, and the company had just reported that it held $85 million in cash and had $134 million in working capital. For many years, A&P delivered strong earnings as the largest retail enterprise in the United States, but the market decided that it should be worth less than its current assets alone for three reasons. The first reason was that there were threats of special taxes on chain stores.

Starting point is 00:14:36 The second reason was that net profits had fallen from the previous year. And the third reason was that the general market was as depressed as it's ever been. So the first reason in Graham's view was an exaggeration and eventually was based on groundless fear. And the other two reasons were temporary. So fast forward from 1938 to 1961, the shares had advanced from the low of $366,000, to a high of $705 after adjusting for stock splits. So that's nearly a 20 times increase in the stock, as the stock went from 12 times earnings to 30 times earnings.

Starting point is 00:15:13 In 1938, the general population had been far too pessimistic in the pricing of these quality businesses. And by 1961, the market had become far too optimistic on the pricing of the shares of A&P, as it had dismal performance in the years following. So the lofty multiple of 30 wasn't justified if you looked at the underlying business performance and also considered that the broader market traded at 23 times earnings. In 1962, share prices of A&P had fallen by 50%. Graham writes, I quote,

Starting point is 00:15:48 In 1938, the business was really being given away, with no takers. And in 1961, the public was clamoring for the shares at a ridiculously high price, end quote. The two lessons are as follows. First, the stock market often prices things far wrong, and the patient and advantageous investor can take advantage of such mispricings. The second lesson is that most businesses change in character and quality over the years, sometimes for the better, and perhaps more often than not for the worse. I quote, the investor need not watch his company's performance like a hawk, but he should give it a good, hard look from time to time, end quote.

Starting point is 00:16:33 Graham also emphasizes that the intelligent investor is not worried about unjustified declines in his holdings. The advantage of the intelligent investor is that he isn't ever forced to sell his shares. Just because other market participants want to sell down the share price far below the underlying value doesn't mean that you should too. Doing so turns your basic advantage into a basic disadvantage. Graham writes, that man would be better off if his stocks had no market quotation at all. For he would be spared the mental anguish caused him by other person's mistakes of judgment, end quote.

Starting point is 00:17:14 Buffett has often used the story of Mr. Market knocking on your door and offering to buy your home. So if you buy your home for, say, $200,000 and you thought that was a fair price, You wouldn't care if someone knocked on your door and offered to buy it for a $100,000. But when it comes to stocks, this freaks people out. He got this idea from Graham in this chapter. I'll read those last few paragraphs directly from Graham here. Let us close this section with something in the nature of a parable. Imagine that in some private business, you own a small share that cost you $1,000.

Starting point is 00:17:51 One of your partners, named Mr. Market, is very very important. Very obliging indeed. Every day, he tells you what he thinks your interest is worth in the business, and furthermore offers either to buy you out or sell to you an additional interest on that basis. Sometimes his idea of value appears plausible and justified based on the underlying business and the prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with them. And the value he proposes seems to you a little short of the business. silly. If you are a prudent investor or a sensible businessman, will you let Mr. Markets' daily communication determine your view of the value of the interest in the enterprise, only in case you

Starting point is 00:18:36 agree with him or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when the price is absurdly low. But the rest of the time, you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position. The true investor is in that very position when he owns a listed common stock. He can take advantage of the daily market price or leave it alone as dictated by his own judgment and inclination. He must take cognizant of important price movements, for otherwise his judgment will have

Starting point is 00:19:17 nothing to work on. Conceivably, they may give him a warning signal, which he will do well to heed. This in plain English means that he is to sell his shares because the price has gone down for boating worse things to come. In our view, such signals are misleading, at least as often as they are helpful. Basically, price fluctuations have only one significant meaning for the true investor. They provide him with the opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market. and pays attention to his dividend returns and to the operating results of his companies."

Starting point is 00:19:59 Then in the ending commentary, Zweig explains that most of the time, the market is fairly accurate in the pricing of stocks. But sometimes the market gets things very wrong, which makes Graham's metaphor of Mr. Market incredibly useful. When stocks go up, people are naturally prone to want to buy them, and when stocks fall, are naturally prone to want to sell them. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every

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Starting point is 00:24:31 All right. Back to the show. Dwight illustrates the example of Ink Tomi during the tech bubble. Inc. tome was the fast-growing tech company whose stock had risen by 1,900% from June of 1998 through March of 2000. In just a few weeks leading up to March 17th of 2000, the stock had tripled. Investors saw that Ink Toomey was an internet company, and in the last quarter of 1999, they had $36 million in revenue, which was more than they had done in revenue all of the previous year. But Mr. Market was overlooking a very critical aspect of their business.

Starting point is 00:25:12 They were not only losing money, but losing lots of money. Despite losing $24 million in the trailing 12 months, the market put a value on this business on March 17, 2000, at $25 billion. That's with the B. The stock at the time was trading at $231, and if we fast forward two and a half years later, Inc. tome stock, from that previous high of $231, it closed at 25 cents, bringing the total market value from its high of $25 billion down to less than $40 million. So while the business was still generating $113 million in revenues, Mr. Markets' mood on the stock had changed

Starting point is 00:25:57 substantially. The funny thing is that this stock traded on both extremes of extreme optimism and extreme pessimism. Later in 2002, Yahoo would buy Ink Tomi for $1.65 per share. This was seven times the stock price of what had been a few months earlier. With the benefit of hindsight, we would find that Yahoo actually got a bargain on that purchase as well. This is why critical thinking and the ability to think for yourself is just so, so important. If you can think for yourself, you can find these sort of obvious situations where the market is just incredibly irrational and the odds are heavily stacked in our favor. So in this case of Ink-Tomi, all these tech companies were bid up to extreme levels.

Starting point is 00:26:44 And really the entire sector was just multiples of where they were months earlier. And then on the opposite end, when a stock or an industry like this is witnessing these force-sellings by institutions, that's the times where investors should probably start getting interested, I'm brought to mind of what happened in March 2020, where just everything was getting crushed and there was a lot of forced selling at play. Zweig explains how he views we should utilize Mr. Marcus' offerings to us, I quote. The intelligent investor shouldn't ignore Mr. Market entirely. Instead, you should do business with him, but only to the extent that it serves your interests. Mr. Marcus's job is to provide you with prices. Your job is to decide whether it is

Starting point is 00:27:29 your advantage to act on them. You do not have to trade with him just because he constantly begs you to. By refusing to let Mr. Market be your master, you transform him into your servant, end quote. So Graham talked about how those who get persuaded by Mr. Market have transformed their basic advantage into a basic disadvantage. Zweig explains what he believes Graham meant by this. The intelligent investor has the full freedom to choose whether or not to find. follow Mr. Market. You have the luxury of being able to think for yourself. Many investment professionals really don't have this luxury. Many of them manage billions of dollars and they're forced to hold really big companies. Many investors pour into these funds during the good years and take

Starting point is 00:28:17 their money out during the bad years. This means that professionals aren't able to take full advantage of market drops. Many portfolio managers get bonuses for beating the market. So instead of optimizing for long term, they may try and optimize for the next three or the next six months and not stray too far from the index. Zweig argues that because many institutional investors can't truly think for themselves and have a full level of independence, then there's no reason for us individual investors to think we can't do as well as the pros. The intelligent investor focuses their attention on things they can control. You can look at your costs or fees, using realistic expectations in your forecasts, deciding your level of risk through portfolio concentration,

Starting point is 00:29:04 when you sell and incur taxes, and most important of all is your behavior. Zweig also explains that we shouldn't judge our financial success by how other people are doing. He writes, you're not one penny poorer if someone in Dallas or Denver beats the S&P 500 and you don't. No one's gravestone reads, he beat the market, end quote. More important, important than beating the market is achieving your financial goals and having enough money to cover the things that are most important to you. There's always going to be someone out there who achieves higher returns than you. And that shouldn't sway you to do irrational things like ignoring the price of the investments you're paying for or forgetting about your core investment principles.

Starting point is 00:29:48 What is amazing is that we're all susceptible to falling prey to Mr. Market. Zweig explains that we're actually hardwired to get into investing trouble because humans are pattern-seeking animals. Even if you were to tell people that numbers shown on a screen are entirely random, people will still insist on trying to guess what's going to come next. If you believe a stock will go up and your prediction is correct, your brain releases dopamine. That's the feel-good hormone. And this is what we always want more of. Dopamine can make us addicted to our own predictions in the midst of all this randomness.

Starting point is 00:30:27 On the flip side, when a stock drops, our brain processes fear and anxiety. And this generates a fight or flight response within us. It's totally natural to feel fearful when stocks are falling because we're literally hardwired for it, just as if we're hardwired to avoid a rattlesnake or have a rising heart rate when a fire alarm goes off. The other irony is that falling stock prices for long-term investors is actually good news, not bad. Falling stock prices means better bargains are available, and the lower prices fall, the higher

Starting point is 00:31:00 your expected returns are. If you're a long-term investor and you won't need to sell any stocks in the near term, then you should be welcoming falling stock prices. So that concludes Chapter 8. Let's jump to Chapter 20 here. Chapter 20 is titled, Margin of Safety, as the central concept of. investment. Graham argues that a margin of safety is essential for sound investments in bonds and stocks. Now the way Graham argues the definition of a margin of safety is by comparing the

Starting point is 00:31:30 yield you get on stocks relative to that of bonds. During the Benjamin Graham era of investing, your typical stock was selling at around 11 times earnings. So your earnings yield on that just dividing 1 divided by 11 was 9%. And then the typical rate on bonds was around 4% so it didn't seem too difficult to get a better earnings yield on stocks relative to bonds. A more relevant definition of the margin of safety is a favorable difference between the price you pay and the intrinsic value of the underlying asset. So the difficulty in stock picking is forecasting the future because the future has been and always will be fundamentally uncertain.

Starting point is 00:32:11 When you purchase with a large margin of safety, you help remove the need to know how the future is going to play out. Buffett's number one rule is not to lose money. In utilizing a margin of safety approach not only limits your downside risk, but it also gives you more upside opportunity as you're buying at more opportune prices. Graham writes, I quote, if such a margin is present in each of a diversified list of 20 more stocks, the probability of a favorable result under fairly normal conditions becomes very large. That is why the policy of investing in representative common stocks does not require high, qualities of insight and foresight to work out successfully. The danger to investors lies in concentrating their purchases in the upper levels of the market, or in buying non-representative common stocks that

Starting point is 00:33:00 carry more than average risk of diminished earnings power." Graham is, of course, well known for diving into the land of cigar butts and looking for these opportunities, and part of the reason he found it so attractive is because cigar butts are the companies in which the market has no real enthusiasm about the company's prospects. If the sentiment is so bad that no investor wants to touch that stock no matter the price, this is what gets him interested because the company is priced at such a level that even very conservative forecasts will lead to highly satisfactory returns. Plus, if you buy with an appropriate margin of safety and the company ends up underperforming your expectations, the margin of safety may still prevent you from losing money or earning an

Starting point is 00:33:44 unsatisfactory return. In this case, the margin of safety would have served its purpose. Graham also touches on the topic of investing versus speculation. Because of the world is fundamentally uncertain, and we don't know the true probabilities of what's going to happen, it makes it pretty difficult at times to distinguish between an investment and a speculation. One man's investment may be another man's speculation. Graham proposes that the margin of safety concept can be used as a tool to distinguish between the two. In investing, we want to stack the odds of earning a satisfactory return in our favor. Using arithmetic reasoning and practical investment experience, in a true investment, there must be present

Starting point is 00:34:27 a true margin of safety. And he concludes, I quote, a true margin of safety is one that can be demonstrated by figures, by persuasive reasoning, and by reference to a body of actual experience, end quote. Graham also believes that there's no such thing as a good stock or a bad stock, only cheap stocks and expensive stocks. The best companies can be poor investments if you're paying a price too high, and the worst companies can be great investments if the price is too low. Then Graham has a section at the end of the chapter that starts with the quote that I really like, investment is most intelligent when it's most business-like. This is why value investors repeatedly say that buying the stock is the same as taking ownership in a real business.

Starting point is 00:35:12 And this is also why we should view ourselves as business analysts and not stock analysts. And then he concludes with four principles that we can use to invest in such a manner. The first principle he lists is to know what you're doing and to know your business. Second, do not let anyone else run your business unless you can supervise his performance with adequate care and comprehension, or you have an unusually strong. reasons for placing implicit confidence in his integrity and ability. Third, do not enter upon an operation unless a reliable calculation shows that it has a fair chance to yield a reasonable profit.

Starting point is 00:35:50 In other words, avoid opportunities that present little to gain, but much to lose. And fourth, I quote, have the courage of your knowledge and experience. If you have formed a conclusion from the facts, and if you know your judgment is sound, act on it, even though others may hesitate or differ. He writes, you are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right. This takes us to the commentary on Zweig for this chapter. He proposes the question, what is risk? Well, in 1999, risk was making less money than your friends or less money than your coworkers during the tech boom. In 2003, risk had come to mean that the stock market wouldn't

Starting point is 00:36:34 quit falling and the remainder of your wealth would evaporate. Dwight shares the wise words, the people who take the biggest gambles and make the biggest gains in a bull market are almost always the ones who get hurt the worst in the bear market. Being quote-unquote right makes speculators even more eager to take extra risk, as their confidence catches fire, end quote. He then explains that losing some money is an inevitable part of investing, and there's nothing you can do to prevent But to be an intelligent investor, you must take responsibility for ensuring that you never lose most or all of your money. Survival is everything.

Starting point is 00:37:15 The margin of safety concept ensures that you don't pay too much for an investment and you minimize the chances that your wealth will be destroyed. I'm also reminded of the lessons that Poulac Prasad shared in his book, what I learned about investing from Darwin. He shared six types of companies that he tends to avoid as a permanent owner. of high-quality businesses to help eliminate the risk of ruin. These include one, avoiding companies that are run by criminals, crooks, and cheats. Two, avoiding turnaround situations because turn-around seldom turn. Three, only invest in companies with little to no debt,

Starting point is 00:37:52 as companies with too much debt are the most likely ones to go bankrupt during a downturn. 4. Stay away from what he calls M&A junkies, as most acquisitions are not value-accretive to shareholders. Five, stay away from fast-changing in hot industries, as they are highly disruptive and unpredictable. And finally, six, only invests with companies whose managers are well aligned with their shareholder base. My co-host, Kyle Greve, did an entire review of this book on Episode 597, which I highly recommend. If you want to find the most extreme examples of what it looks like to overpay, look no further than the 1999 tech bubble. Over one year, JDS Uniface Corp generated $673 million in sales. It lost $313 million and it had tangible assets totaling $1.5 billion.

Starting point is 00:38:46 On March 7th of 2000, Mr. Market quoted a market value of $143 billion for the. entire business. The peak of the hype, shares traded at $153 per share, and it ended up cratering to $2.47 cents at the end of 2002. Just to get back to the $153 price level, you would need 43 years of 10% compounding just to get back to even. So if the stock price increased by a very high percentage, say 20% a year, then you'd still need to wait 22 years. The lesson is that overpaying is painful because to break even after losing a substantial amount of your capital is very hard to do. Zweig also explains that much of the risk in investing can actually lie within ourselves. Many people are naturally overconfident in their ability to select stocks and how you will react

Starting point is 00:39:43 when your analysis turns out to be wrong. He shares a quote from Paul Slavic, I quote, risk is brewed from an equal dose of two ingredients, probabilities and consequences, end quote. Before we invest, we have to realistically assess the probability of being right and how we will react to the consequences of being wrong. There's also a great quote from Peter Bernstein that is just absolutely wonderful. In making decisions under conditions of uncertainty, the consequences must dominate the probabilities. We never know the future. I'll repeat that for you.

Starting point is 00:40:20 In making decisions under conditions of uncertainty, the consequences must dominate the probabilities. We never know the future. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance,

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Starting point is 00:44:04 single stock picker or active investor is going to have at least one mistake during his investing career. That's a near certainty. And we don't have control over that. What we do have control over is the consequences when we are wrong. There was a survey that was done that showed that 10% out of 1,300 investors surveyed had put at least 85% of their money in tech stocks in 1999. Based on that statistic, 10% of investors ignored the potential consequences of being wrong and ignored the margin of safety concept. So they did nothing to protect themselves against the serious consequences of being wrong. Zweig writes, simply by keeping your holdings permanently diversified and refusing to fling

Starting point is 00:44:51 money at Mr. Market's latest, craziest fashions, you can ensure that the consequences of your mistakes will never be catastrophic. No matter what Mr. Market throws at you, you will always be able to say with a quiet confidence, this two shall pass away, end quote. Next, I wanted a turn to play a couple of clips from William Green's interview with Jason's Wig. That was released on the Richer Wiser Happier Podcast back in April of 2022. That was episode four, which you can find on our website or on the feed you're listening to now. And I'll be sure to get that linked in the show notes as well. The first clip is Jason's Wyck talking about Graham's emphasis on survival, and adhering

Starting point is 00:45:31 so strongly to the principle of the margin of safety. Some people could argue that he is too pessimistic in his view of the world, so I thought it would be an interesting one to play here in this context. Here's the clip of William and Jason discussing why he was shaped to view the world in this way. There are other fascinating things about Graham that I wanted to run by you. One of them, I wrote about Graham and Richard Wieser, a happier about. about his early life, which is kind of fascinating, like that he came from this prosperous

Starting point is 00:46:00 family that I think imported porcelain from Europe. And then his father died at the age of about 35, and the mother was widowed and left with three kids to bring up. And the business collapsed, and she ends up turning their home into a boarding house, which failed. Then she borrows money, gets wiped out in the panic of 1907. And then Graham grows up, instead of growing up with a cook and a maid and a governess, which he'd always had when they were this prosperous family, when his dad was alive, sees the family

Starting point is 00:46:28 actually forced to sell its possessions in a public auction and never really recovered from that kind of public disgrace. And then lives through World War I, the Great Depression, the crash of 29, where I think from 1929 to 32, he lost like 70% of his money and then lives through World War II. And he's from a Jewish family. He was born Benjamin Grossman, as you know, and had come from Poland, same sort of area that you're from family of mine had come from as you can't use. And what's fascinating to me is that his entire investment credo is built on this idea of the margin of safety.

Starting point is 00:47:05 And here's a guy whose youth is in a sense the epitome of chaos. That even as a Jewish guy coming from Poland, he's seen, I mean, I think his, if I remember rightly, I think his grandfather may have been the chief rabbi of Warsaw. And so this is kind of fascinating to me because my background is similar. your background is similar, right? My family came from Russia, Poland, and Ukraine. Yours, I think, came from Ukraine. I remember your grandfather was from Ukraine. And I'm wondering if you could talk about that connection, the link between this kind of personal chaos and his sense that you have to find a way of investing that protects you against chaos.

Starting point is 00:47:44 Yeah, that's a, that's such a good observation, William. You know, the anecdote that stands out for me from Graham's life story is when he was a very small child, this was after his dad had died. His mother had to cash a check at the bank. And I think she asked Graham to take it to the bank. And was it that she had to cash a check? No, she had to, I forget whether to cash a check or make a withdrawal. But in any case, Graham had to go to the teller. And the teller said out loud, sort of to the bank floor, is Mrs. Graham good for this amount?

Starting point is 00:48:25 And it just stuck with him. It was maybe $5 or something like that, which, of course, in those days was a lot more than it is today, but it still wasn't much. And I think he was, Graham was traumatized by loss. And, you know, in several of his books and articles, he has this expression. He says the future is, something to be guarded against. And I think this is the, you know, this is the biggest knock on Graham. It's the criticism so many people make of him today and have been making for 20 years. And I think it's valid. Charlie Munger makes the same point. The first, you know, one of the first times I interviewed Munger, he said to me, Graham was afraid that the depression would repeat. And he always saw another depression around the corner. And all he cared about was surviving that. And in the intelligent investor, he talks about the difference between protection and projection.

Starting point is 00:49:25 And effectively, growth stocks, growth investors are in the projection business. They're trying to extrapolate a, you know, a fabulous line of growth into the future. They're projecting it. And Graham cares about protecting. He's worried about the downside. And that's because he really suffered it. And he really felt it. And, you know, both Buffett and Munger went through the Great Depression, but they were much younger than Graham.

Starting point is 00:49:57 And they saw the country come roaring back. To Graham, you know, he had been through many more severe cycles. And of course, he, you know, he was only, you know, he was a young adult when the Federal Reserve was created. So he had lived through the panic of 1907 when there was no longer. lender of last resort. And it wasn't clear if the financial system would survive. So he was obsessed with the downside and protecting against it. And, you know, if I were revising the book today, that would be the main issue that I would be struggling with, which is how do we reconcile the need for protection with the importance of projection? I mean, we're not investing for today. We're

Starting point is 00:50:45 investing for tomorrow. And if you don't project, if all you do is protect, then how will you prosper tomorrow? And I think that's the, that's a valid criticism of Graham's approach. It's a profound conundrum. I remember having a revelation at one point when Howard Marks, who's great at articulating these conundrums, said at a certain point, risk avoidance becomes return avoidance. And I have that kind of fearfulness and anxiety about the future that I suspect to some degree is an inherited thing from our families having gone through the trauma of having fled from Russia and Poland and the Holocaust and the like. And I don't, I remember talking to Chuck Akrae about this at one point saying that I'm kind of a pessimist and

Starting point is 00:51:31 he's like, good luck with that. You know, he was like, look, as an investor in stocks, you need to be an optimist. Yeah. Do you think that's true that there is a, I mean, I see you conflicted about this as well, right? Because you've written, I think, that uncertainty is the the most fundamental fact about human life and economic activity. So I think you temperamentally in some ways are on my side and Ben Graham's side more than on Chuck Akre's side temperamentally. Yeah, I mean, sure, I'm a worrier. But, you know, I also am an optimist. I mean, I've seen too many good things happen in my own life and frankly in the world's life to be a pessimist. I mean, I think it was, I forget who it was.

Starting point is 00:52:18 An Israeli prime minister, naturally, said to be a realist, you have to believe in miracles. I think it might have been Ben-Gurion. Yeah, either Van Gereon or Golda Mayer, one of those two. Yeah. And it's kind of true. I mean, you think back a decade ago, you know, who would have expected, well, a little more than a decade, but who would have expected, you know, cloud computing and fracking? the U.S. is energy independent. That seemed impossible 15 years ago.

Starting point is 00:52:52 And, you know, progress doesn't stop as negative and horrible as a lot of the headlines are. And as worried as I am, as I think any thinking person has to be about the polarization in our society and the rising resentment and distrust of expertise. and the anger across the political spectrum at the other side. I don't know how you can really be a pessimist. Yeah, I tend to feel, having talked to a lot of great investors who are smarter about this stuff than I am, that it's a kind of general upward trajectory that's interrupted by these periods of tremendous disruption. But I think that that was Ray Dalio's view when I interviewed him recently.

Starting point is 00:53:39 That if you look at the very long-term picture of productivity, longevity, you know, human lifespan, quality of life. It's hard not to be optimistic, but there are these periods of disruption. And so it seems to me that part of the key to investing well is to set yourself up for survival. And I remember you having a great interview with Peter Bernstein, where he talked about just this recognition of just how badly things can get wrong when you asked him about the biggest mistake that you can make investing. So when Jason tells the story of Graham being at the bank and the teller asking if they are good for the $5.

Starting point is 00:54:18 I really can't help but compare that to my own life experiences. I grew up in a family where we were generally pretty well off. And whenever I needed the basic necessities, they were always provided to me. I had a stable family. My parents had great jobs and I had a good support system around me. And I can clearly see that partially because of that, I have an optimistic view of the world and that things tend to remain stable or tend to continually get better over time. I haven't lived through a Great Depression-type scenario, and

Starting point is 00:54:50 whenever financial markets go sort of haywire, the Fed tends to swoop in, support markets, support asset prices, and the environment for businesses is largely accommodative. And I think this is a reminder that we shouldn't rely on things always being so good. Having some protection against calamity can be very wise, whether that means having more cash in an emergency fund than I I probably otherwise would, or maybe having some physical gold as a safe haven, or buying more safe blue chip companies or index funds. I'm not one to say what that additional cushion might be for the listener, but those are just some ideas that I can come up with for myself.

Starting point is 00:55:30 I think we can still have an optimistic view of the economy and an optimistic view of the world, but still know that bad and unexpected things are bound to happen at some point in our lives that we can just never see coming. Morgan Housel wisely said that the biggest risk over the next 10 years is one that we can't foresee coming. And we really can't even fathom. I love how they also mentioned that the conundrum of needing to balance survival with capital appreciation. If you focus solely on capital appreciation, you're going to find out the hard way that you need to balance it with some of these survival characteristics, such as not growing too fast, having a strong, healthy balance sheet, growing thoughtfully and strategically,

Starting point is 00:56:16 thinking long term, etc. And if you focus too much on capital preservation, then you may come to find that your returns aren't enough to reach your financial goals. So you need to find that healthy balance between the two that suits your temperament and suit your skill set. Next, I wanted to share one more clip here on Jason's Weig's thoughts on diversification versus concentration. This is an area where Graham actually differed from Buffen Munger. For example, Charlie Munger, he feels that when he's nearly certain on a bet, he's more than willing to put 30% of his portfolio in that bet. Graham liked to be much, much more diversified. So here's the next clip from Jason and William.

Starting point is 00:56:58 And you've said that I think the phrase you used at one point was that a diversified portfolio is the closest thing to a sure thing in all of finance. That ultimately the best insurance policy other than not investing, which doesn't lead to a great outcome either with inflation and the like. The best insurance policy is to diversify. Is that also one of the one of just the most simple and basic but timeless lessons that we get from someone like Graham, who was probably much more diversified than Buffett chose to? Yeah. Yeah, correct.

Starting point is 00:57:29 I mean, it's kind of interesting. This is another area where Buffett and Munger really diverged from Graham. Graham invested in categories of securities. You know, if railroad stocks were cheap, he would just buy every railroad stock that was cheap. He wouldn't buy one. He would buy dozens. Maybe he thought utilities were cheap. He would buy every utility he could find that was cheap.

Starting point is 00:57:55 Graham was a huge believer in diversification. And Buffett and Munger are not. And, you know, I think the right way to think about it is that diversification, you know, The justification is inverse to the likelihood that you have superior knowledge and you're actually right. So the more sure you are that you know what you're doing, that you're doing something that not everybody else is, and that there's an asymmetry between the downside and the upside, the more you should put in that asset. And, you know, great investors will tend to be under-diversified, great active investors, because they feel or their experience tells them that they should concentrate. The problem with that is that people aren't very good at assessing how valid their signals of confidence are. And, you know, it's part of normal human behavior to be overconfident.

Starting point is 00:58:58 And if you're overconfident about the things you're over concentrating in, the result is not likely to be very accretive in the long run. Yeah, I remember once saying to Bill Miller when he was, I think he had bought 15% of Amazon. This is back in 2000, 2001. And everything was going to hell in the market after 9-11. And he was, I was with him while he was investing hundreds of millions of dollars. And I said to him at one point, God, you've got to have so much balls to do what you do. He said, yeah, I've also got to be right.

Starting point is 00:59:29 And it was one of those moments where you were like, oh, yeah, it's like so many of the, the truths that you hear in investing are so simple. You know, there's this emphasis on survival, this emphasis on diversification, this emphasis on being right. Like this emphasis on being long term patient. They're all so platitudinous that our eyes kind of glaze over and we don't take them seriously. But it's like, yeah, if you're going to, if you're going to, if you're going to, If you're going to concentrate really heavily in a few positions, you better be really smart and right. Yeah. And William, and it's worth emphasizing for people the sequel, right?

Starting point is 01:00:03 Because Bill was almost looking forward in a way. He was almost looking ahead because he did the same thing seven or eight years later with financials. And he wasn't right. And then the sequel to the sequel, which is then he did the same thing with Bitcoin and Amazon. And he was right. And was right. So I think to some extent when I look at these great investors, I was thinking about this recently with Bill Ackman as well, where I was reading in the journal the other day

Starting point is 01:00:32 about how he just made $4 billion during the financial crisis. Sorry, during the COVID meltdown and then the recovery. I was just thinking one of the keys is just to be true to themselves. Like you have to kind of embrace your own form of craziness to some extent to be extraordinary at anything. You have to play the game in a way that suits your particular form of brilliance and craziness. Does that resonate for you? Yeah, it does.

Starting point is 01:00:59 And I think, you know, I think the challenge all great professionals face is this push and pull between the sense you have that you are exerting actual skill and the need for humility. I mean, whenever I hear anyone talk about being humble, I just, I mean, I want to throw up. I mean, it's like if you're talking about your own humility, then you don't have any. I literally, Jason, had a conversation a few years ago where I was talking with a guy I was friends with who I was helping with a memoir that hasn't been published, who's multi-billionaire art collector. And I was talking about, you know, someone had said something about humility and vanity and the like. And he said, no one is more humble than I am. And I sort of burst out watching and I thought he was joking. And then I realized, no, no, he's totally serious.

Starting point is 01:01:54 Here is this multi-billionaire saying nobody is more humble than I am. Right. Mostly that is the reality. It's wonderful. I'm the best at being humble. Look at me. Yeah. Yeah.

Starting point is 01:02:04 I mean, it's a, I think the key is that combination of you can't be good at something if you don't think you're good at it. And if you've been a professional investor for years and you have a successful track record, it's sort of inconceivable that you would, you don't come into the office each day and saying, oh, God, what am I going to screw up next? You come in, you have a sense of exerting your skill and demonstrating your power and your facility and your knowledge. And without that, you'd be lost. On the other hand, you can't let it go to your head.

Starting point is 01:02:42 And, you know, there's ultimately, I think, humility, the only way to resolve it is with paradox, right? I mean, there's a wonderful expression, I think it's somewhere in the Talmud, actually, that says, the truly healthy man has a soul without knowing it. And it's something like that. It's that you want to be humble and you seek to be humble, but you don't really expect to achieve it because if you did, if you did expect it, you would end up sounding like the person you were just describing. So as William said to Bill Miller,

Starting point is 01:03:23 you've got to have a lot of guts to concentrate so heavily. And he also made the point that you really need to be right when you concentrate. Remember what I said earlier that you need to consider the consequences of when you're wrong and the consequences cut really heavily when you're wrong after you concentrate like that. So concentration in a way is,

Starting point is 01:03:42 like leverage in that it's a knife that cuts both ways. When you're right, it can be tremendously profitable, but when you're wrong, it can definitely work against you really strongly. So that wraps up today's episode on The Intelligent Investor. I really hope you enjoyed it. If you'd like to check out that full interview with Jason Zweig and William Green, Jason did the commentary on the most recent edition of The Intelligent Investor. I'll be sure to get that episode linked in the show notes and I'll get the book linked as well. So thanks a lot for tune and in and I hope to see you again next time. Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes.

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