How to Think Like Benjamin Graham and Invest Like Warren Buffett (Paperback)

Both Graham and Buffett see buying stock as being the same as buying a whole company. The analytical methods involved are similar to those used by companies thinking about making an acquisition, except there is no need to consider what the joint operating benefits of the companies will be. The strength of this approach to stock investing is that if stock values for a company fall too low another company or group of cash-flow-oriented investors will acquire the whole company. In the long run, stocks should not fall too far below their intrinsic value (a Graham concept) as cash flow generators.

The book is organized into three sections. The first looks at whether the stock market is efficient or not. If it is, you cannot beat it. If it is not, you can beat it by investing where it is not efficient. The evidence here summarized estimates that the stock market is at least 20 percent inefficient and becoming more so. I am aware of a number of studies showing other kinds of inefficiency that Professor Cunningham does not cite. My own personal view is that the stock market is not very efficient at all, but is relatively predictable within a band of probability.

A particular strength of this section is in creating a summary of many of the arguments for stock market efficiency and inefficiency. Trust me. Unless you really love reading this kind of research (which I happen to), you will be better off reading the summaries here rather than the originals.

The second section discusses how to outperform the stock market. The best part of this section is an extremely well done parable about a man who wants to sell his apple tree. He is approached by many different types of potential purchasers, and they offer wildly varying prices. You get the interior logic of how each price is arrived at in a way that allows you to see the fundamental weaknesses and strengths of each approach. Nicely done!

The heart of this section emphasizes the familiar Graham and/or Buffett (their philosophies do not coincide, but rather partially overlap) concepts of sticking to what you know well, having a margin of safety, and doing your homework. I particularly liked the detailed description of how to determine where you have a knowledge edge that allows you to potentially have an advantage as a stock investor. The cautions against overestimating what you know are very well done.

The third section looks at the role of company management and boards of directors. It debunks a lot of the popular thinking about the importance of good governance. As Warren Buffett often emphasizes in his annual letters to shareholders, you should invest only with people you "like, trust, and admire." A CEO with a weakness (particularly a lack of integrity) can quickly tank your investment before you can do anything about it. Certainly, I have been sorry a number of times when I have not followed that rule. I certainly subscribe to it now. Every management will make mistakes. Only highly focused and capable ones will notice that they have and work on rectifying the errors rather than trying to explain why there really is no problem.

If you read this book carefully, it will convince you that outperforming the stock market is a pretty hard thing to do unless you have a great deal of knowledge about public companies and unusually good access to company managements. I think describing what needs to be done is the most eloquent argument that I have seen for why the average investor should be in indexed mutual funds for the stock portion of her or his portfolio. I suggest you already read John Bogle's Common Sense on Mutual Funds. I was pleased to see that this book raises an important question of valuation for when to commit to new purchases of indexed funds. People differ on this subject; but while the S&P 500's multiple is as high as sit is now and cash flow growth is so weak, many people may benefit from holding off or buying other indexes instead. Consider the small cap value indexes instead now, for instance.

I suspect that you can learn a lot by comparing your past stock investing with the patterns described here. Are you a great investor? Great investors have "independence of thought, . . . [and] utter and profound common sense . . . ." The challenge here is that "common sense is . . . it is so uncommon." On the other hand, "those who buy stocks outside their circle of competence are gamblers, speculators, or fools." Please wear the shoe that fits you.

The most accurate prediction of future stock market conditions is that they will fluctuate. Currently, the average stock varies by 50 percent in price each year. What method of stock investing will allow you to either ignore or best take advantage of that volatility? Be sure to consider your emotions at least as much as your intellect and available time in making this determination.

Get a great return on your time and on your investments!

But don't forget to (re)read "The Intelligent Investor (Graham)"

Happy investment....