Thursday, September 4, 2008

The Intelligent Investor: Chapter 3

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

In this chapter, Graham shows the major stock market swings between 1871 and 1972. There are nineteen bear- and bull-market cycles in that 100 year period. This is shown as evidence of the assertion in the introduction that the market always swings between unsustainable optimism (making stocks too expensive) and unjustified pessimism (which makes them too cheap).

Graham then looks at the stock market performance by decade for the same 100 year period to show that only two of the most recent nine decades show a decrease in performance and that no decade after 1900 shows a decrease in average dividends. In general, the market has experienced persistent growth. While the amount of growth has been variable, the fact that there has been near-persistent growth suggests that it is prudent to invest in common stocks.

With these two things established (the swing between bear and bull markets, and persistent growth), Graham is showing that, while it is important to hold common stocks as part of your portfolio, the intelligent investor will keep in mind that prices will fluctuate and so he will sell during bull markets and buy during bear markets. The intelligent investor never falls victim to the herd mentality by purchasing during a bull run only to suffer losses once the market turns. Instead, the intelligent investor uses the irrationality of the market to buy securities undervalued by irrational pessimism to then sell once overvalued by unbridled optimism.

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