Now let’s answer a vitally important question. What exactly does Graham mean by an “intelligent” investor? Back in the first edition of this book, Graham defines the term—and he makes it clear that this kind of intelligence has nothing to do with IQ or SAT scores. It simply means being patient, disciplined, and eager to learn; you must also be able to harness your emotions and think for yourself. This kind of intelligence, explains Graham, “is a trait more of the character than of the brain.” There’s proof that high IQ and higher education are not enough to make an investor intelligent. In 1998, Long-Term Capital Management L.P., a hedge fund run by a battalion of mathematicians, computer
scientists, and two Nobel Prize–winning economists, lost more than $2 billion in a matter of weeks on a huge bet that the bond market would return to “normal.” But the bond market kept right on becoming more and more abnormal—and LTCM had borrowed so much money that its collapse nearly capsized the global financial system. 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. Sir Isaac Newton was one of the most intelligent people who ever lived, as most of us would define intelligence. But, in Graham’s terms, Newton was far from an intelligent investor. By letting the roar of the crowd override his own judgment, the world’s greatest scientist acted
like a fool.
In short, if you’ve failed at investing so far, it’s not because you’re stupid. It’s because, like Sir Isaac Newton, you haven’t developed the emotional discipline that successful investing requires. Graham describes how to enhance your intelligence by harnessing your emotions and refusing to stoop to the market’s level of irrationality. There you can master his lesson that being an intelligent investor is more a matter of “character” than “brain.”
A CHRONICLE OF CALAMITY
Now let’s take a moment to look at some of the major financial developments of the past few years:
The worst market crash since the Great Depression, with U.S. stocks losing 50.2% of their value—or $7.4 trillion—between March 2000 and October 2002.
Far deeper drops in the share prices of the hottest companies of the 1990s, including AOL, Cisco, JDS Uniphase, Lucent, and Qualcomm—plus the utter destruction of hundreds of Internet stocks.
Accusations of massive financial fraud at some of the largest and most respected corporations in America, including Enron, Tyco, and Xerox.
The bankruptcies of such once-glistening companies as Conseco, Global Crossing, and WorldCom.
Allegations that accounting firms cooked the books, and even destroyed records, to help their clients mislead the investing public.
Charges that top executives at leading companies siphoned off
hundreds of millions of dollars for their own personal gain.
Proof that security analysts on Wall Street praised stocks publicly
but admitted privately that they were garbage.
A stock market that, even after its bloodcurdling decline, seems
overvalued by historical measures, suggesting to many experts
that stocks have further yet to fall.
A relentless decline in interest rates that has left investors with no attractive alternative to stocks.
An investing environment bristling with the unpredictable menace of global terrorism and war in the Middle East.
Much of this damage could have been (and was!) avoided by investors who learned and lived by Graham’s principles. As Graham puts it, “while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster.”
By letting themselves get carried away—on Internet stocks, on big “growth” stocks, on stocks as a whole—many people made the same stupid mistakes as Sir Isaac Newton. They let other investors’ judgments determine their own. They ignored Graham’s warning that “the really dreadful losses” always occur after “the buyer forgot to ask ‘How much?’ ” Most painfully of all, by losing their self-control just when they needed it the most, these people proved Graham’s assertion that “the investor’s chief problem—and even his worst enemy—is
likely to be himself.”
THE SURE THING THAT WASN’T
Many of those people got especially carried away on technology and Internet stocks, believing the high-tech hype that this industry would keep outgrowing every other for years to come, if not forever:
In mid-1999, after earning a 117.3% return in just the first five months of the year, Monument Internet Fund portfolio manager Alexander Cheung predicted that his fund would gain 50% a year over the next three to five years and an annual average of 35% “over the next 20 years.” 5
After his Amerindo Technology Fund rose an incredible 248.9% in 1999, portfolio manager Alberto Vilar ridiculed anyone who dared to doubt that the Internet was a perpetual moneymaking machine: “If you’re out of this sector, you’re going to underperform. You’re in a horse and buggy, and I’m in a Porsche. You don’t like tenfold growth opportunities? Then go with someone
else.”
In February 2000, hedge-fund manager James J. Cramer proclaimed that Internet-related companies “are the only ones worth owning right now.” These “winners of the new world,” as he called them, “are the only ones that are going higher consistently in good days and bad.” Cramer even took a potshot at Graham: “You have to throw out all of the matrices and formulas and texts that
existed before the Web. . . . If we used any of what Graham and Dodd teach us, we wouldn’t have a dime under management.” All these so-called experts ignored Graham’s sober words of warning: “Obvious prospects for physical growth in a business do not translate into obvious profits for investors.” While it seems easy to foresee which industry will grow the fastest, that foresight has no real value if most other investors are already expecting the same thing. By the time everyone decides that a given industry is “obviously” the best one to invest in, the prices of its stocks have been bid up so high that its future returns have nowhere to go but down.
For now at least, no one has the gall to try claiming that technology will still be the world’s greatest growth industry. 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.
scientists, and two Nobel Prize–winning economists, lost more than $2 billion in a matter of weeks on a huge bet that the bond market would return to “normal.” But the bond market kept right on becoming more and more abnormal—and LTCM had borrowed so much money that its collapse nearly capsized the global financial system. 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. Sir Isaac Newton was one of the most intelligent people who ever lived, as most of us would define intelligence. But, in Graham’s terms, Newton was far from an intelligent investor. By letting the roar of the crowd override his own judgment, the world’s greatest scientist acted
like a fool.
In short, if you’ve failed at investing so far, it’s not because you’re stupid. It’s because, like Sir Isaac Newton, you haven’t developed the emotional discipline that successful investing requires. Graham describes how to enhance your intelligence by harnessing your emotions and refusing to stoop to the market’s level of irrationality. There you can master his lesson that being an intelligent investor is more a matter of “character” than “brain.”
A CHRONICLE OF CALAMITY
Now let’s take a moment to look at some of the major financial developments of the past few years:
The worst market crash since the Great Depression, with U.S. stocks losing 50.2% of their value—or $7.4 trillion—between March 2000 and October 2002.
Far deeper drops in the share prices of the hottest companies of the 1990s, including AOL, Cisco, JDS Uniphase, Lucent, and Qualcomm—plus the utter destruction of hundreds of Internet stocks.
Accusations of massive financial fraud at some of the largest and most respected corporations in America, including Enron, Tyco, and Xerox.
The bankruptcies of such once-glistening companies as Conseco, Global Crossing, and WorldCom.
Allegations that accounting firms cooked the books, and even destroyed records, to help their clients mislead the investing public.
Charges that top executives at leading companies siphoned off
hundreds of millions of dollars for their own personal gain.
Proof that security analysts on Wall Street praised stocks publicly
but admitted privately that they were garbage.
A stock market that, even after its bloodcurdling decline, seems
overvalued by historical measures, suggesting to many experts
that stocks have further yet to fall.
A relentless decline in interest rates that has left investors with no attractive alternative to stocks.
An investing environment bristling with the unpredictable menace of global terrorism and war in the Middle East.
Much of this damage could have been (and was!) avoided by investors who learned and lived by Graham’s principles. As Graham puts it, “while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster.”
By letting themselves get carried away—on Internet stocks, on big “growth” stocks, on stocks as a whole—many people made the same stupid mistakes as Sir Isaac Newton. They let other investors’ judgments determine their own. They ignored Graham’s warning that “the really dreadful losses” always occur after “the buyer forgot to ask ‘How much?’ ” Most painfully of all, by losing their self-control just when they needed it the most, these people proved Graham’s assertion that “the investor’s chief problem—and even his worst enemy—is
likely to be himself.”
THE SURE THING THAT WASN’T
Many of those people got especially carried away on technology and Internet stocks, believing the high-tech hype that this industry would keep outgrowing every other for years to come, if not forever:
In mid-1999, after earning a 117.3% return in just the first five months of the year, Monument Internet Fund portfolio manager Alexander Cheung predicted that his fund would gain 50% a year over the next three to five years and an annual average of 35% “over the next 20 years.” 5
After his Amerindo Technology Fund rose an incredible 248.9% in 1999, portfolio manager Alberto Vilar ridiculed anyone who dared to doubt that the Internet was a perpetual moneymaking machine: “If you’re out of this sector, you’re going to underperform. You’re in a horse and buggy, and I’m in a Porsche. You don’t like tenfold growth opportunities? Then go with someone
else.”
In February 2000, hedge-fund manager James J. Cramer proclaimed that Internet-related companies “are the only ones worth owning right now.” These “winners of the new world,” as he called them, “are the only ones that are going higher consistently in good days and bad.” Cramer even took a potshot at Graham: “You have to throw out all of the matrices and formulas and texts that
existed before the Web. . . . If we used any of what Graham and Dodd teach us, we wouldn’t have a dime under management.” All these so-called experts ignored Graham’s sober words of warning: “Obvious prospects for physical growth in a business do not translate into obvious profits for investors.” While it seems easy to foresee which industry will grow the fastest, that foresight has no real value if most other investors are already expecting the same thing. By the time everyone decides that a given industry is “obviously” the best one to invest in, the prices of its stocks have been bid up so high that its future returns have nowhere to go but down.
For now at least, no one has the gall to try claiming that technology will still be the world’s greatest growth industry. 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.
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