The Intelligent Investor: Chapter 6

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.

As discussed in earlier chapters, the difference between defensive and enterprising investors is small. The enterprising (or aggressive) investor should still divide his portfolio between high-grade bonds and high-grade common stocks. The difference between these two investor personas is that the enterprising investor will be willing to purchase securities that do not fall within these categories so long as there is a well-reasoned justification for doing so. Again, as discussed in earlier chapters, the risk does not increase, because the enterprising investor has more time to research and analyze these departures.

So, what should the enterprising investor look at? Well, Graham starts first with what the enterprising investor should NOT do. The enterprising investor should NOT:

• Invest in high-grade preferred stocks (for the reasons outlined in earlier chapters - namely, these are worst-of-both-worlds investments)
• Invest in junk bonds unless they can be bought at bargain levels (30% under par for high-coupon issues)
• Invest in foreign-government bond issues, even though the yield would be attractive
• Invest in new issues (see note below)
• Invest in convertible bonds and preferred stocks
• Invest in common stocks with excellent earnings confined to the recent past

Graham warns against buying bonds or preferred shares which lack adequate safety (i.e. are not high grade) only because the yield is attractive. Don’t fall prey to the siren call of yield. Failing to heed this warning may leave you highly susceptible in poor economic times, when interest or dividends are suspended. Graham refers to this as the Businessman’s Investment Fallacy - It is wrong to accept greater odds of a loss of principal in exchange for a 1 - 2% gain in annual income.

Zweig points out that in Graham’s day, this was a concern, whereas today investors can easily and inexpensively diversify away the risks associated with junk bonds. However, most of the funds that invest in junk bonds charge high fees that eliminate the benefit of investing in junk bonds.

Remember: “Buying a bond only for its yield is like getting married only for the sex. If the thing that attracted you in the first place dries up, you’ll find yourself realizing there is nothing left”

Investing in New Issues
Graham recommends that all investors be wary of new issues. New issues require more examination and must meet a higher threshold than the securities of well-established companies. Two reasons:

1. New Issues come with a certain salesmanship that requires significant resistance. Underwriters make significantly more money on new issues, and so they work significantly harder to sell these.
2. Most new issues are sold in market conditions favourable to the seller, not the buyer. Corporations often choose to issue an IPO at the market peak, and so often these issues are overvalued.