The Intelligent Investor

Zweig provides examples of companies from the 1990s to bolster Graham’s advice concerning financial statements and the importance of accurate and reliable information in making investment decisions. He discusses the term “pro forma,” which refers to the presentation of financial information that excludes certain items or non-recurring events to present a more favorable picture of a company’s financial performance. According to Zweig, “pro forma earnings enable companies to show what they might have done if they hadn’t done as badly as they did” (323). This practice of presenting pro forma earnings—figures that do not follow generally accepted accounting principles (GAAP)—alongside standard GAAP earnings became increasingly common among companies in the decades following Graham’s original publication.

Zweig provides the example of Qwest Communications, a telecommunications company that used pro forma earnings to inflate its valuation. In 1999, the company decided to count revenue from sales of ad space in its telephone books as soon as they were published, even though this money would be received in monthly installments. This increased its reported income by $240 million, making it appear more profitable than it was. The company later acknowledged it had inflated these numbers, eventually admitting that its revenues for 2000 and 2001 were reported as being $2.2 billion higher than they were.

Zweig advises investors to read financial statements from back to front to focus first on the information that companies intentionally bury in the final pages. He also recommends that they pay close attention to footnotes, looking for disclosures about potential risk factors.

Graham compares four companies listed near each other on the New York Stock Exchange list: ELTRA Corp., Emerson Electric Co., Emery Air Freight, and Emhart Corp. He examines these four companies according to their profitability, stability, growth, financial position, dividends, and price history. In terms of profitability, Graham determines that Emerson and Emery Air Freight have consistently shown higher profits compared to ELTRA Corp. and Emhart Corp. He also examines their stability by looking at the worst-performing year for each company. He concludes that ELTA’s and Emhart’s worst years only saw moderate declines. Regarding growth, he sees ELTA as especially impressive. Graham believes all four companies are in sound financial positions. In terms of dividends, Emhart has the strongest record of consistent payments. Lastly, Graham deems the price history impressive for all four companies.

Overall, Graham sees Emerson as possessing huge market value. He calls it a “good-will giant” (335), referring to the company’s strong reputation and brand recognition in the market. He categorizes Emery as “the most promising of the four companies in terms of future growth” (335). Graham notes that the company has experienced consistent growth in earnings and offers a solid dividend history, making it an attractive investment option. Regarding ELTRA and Emhart, Graham acknowledges that neither of the companies is seen as glamorous by the market, but they are still solid investments. While they may not attract investors because of their lack of allure, Graham believes they have the potential for steady and reliable returns.

Graham believes that even though Emery and Emerson may be more appealing to investors according to the principles of conservative investing, both ELTRA and Emhart should not be overlooked. They offer a good investment for reasonable prices.

Zweig emulates Graham’s analysis exercise by comparing four modern companies. Similar to Graham, he selects four companies listed near each other on the NYSE list, including the only company (Emerson) that remains from Graham’s original four. Aside from Emerson, the group includes EMC Corp., Expeditors International of Washington Inc., and Exodus Communications Inc.

He characterizes Emerson’s performance through the 1990s as reliable: “never flashy […] and showed no sign of overheating” (341). And, during the dot-com bust of the early 2000s, it fared well compared to other companies. By contrast, EMC experienced astronomical growth in the 1990s (more than 81,000%), but it never paid a dividend to its shareholders and did not seem to manage its money well. It finished 2001 with a net loss of $508 million.

Zweig regards Expeditors as a fast-growing, excellent company that was largely ignored by Wall Street. Unlike the other companies in the group, Expeditors continued to grow even through the bear market of the early 2000s. Lastly, Exodus grew extremely fast in the 1990s but filed for bankruptcy in the 2000s. Zweig describes Exodus as a cautionary tale of the dangers of investing in companies experiencing rapid growth without considering the fundamentals of the business.

Graham discusses techniques for selecting stocks as part of the defensive investor’s portfolio. He gives two options for selection: choosing a portfolio that mirrors the overall market and choosing individual stocks that meet specific criteria for valuation and safety. Graham presents seven criteria that he believes will help the intelligent investor select value stocks from the market.

First, Graham suggests that the investor should focus on companies that are large and well-established with a proven track record of financial stability. These companies are more likely to weather economic downturns and offer a sense of security for the investor. Second, he advises the defensive investor to examine the financial condition of the companies they are considering. He recommends that current assets should be at least twice as large as current liabilities, indicating a strong financial position.

Third, Graham emphasizes the importance of earnings stability. Investors should look for companies that have demonstrated consistent and reliable earnings over several years. Fourth, he underscores the importance of a company’s dividend record. Investors should look for companies that have a history of paying uninterrupted dividends to their shareholders.

Fifth, Graham recommends looking at earnings growth. Investors should seek companies that have a consistent and positive trend of earnings growth over time as it indicates long-term profitability and potential for future returns. Sixth, he addresses the price/earnings ratio. Graham suggests that investors should consider the current price of a stock in relation to its earnings, advising that a stock’s price should be no more than 15 times the company’s per-share earnings.

Seventh, Graham advises investors to assess the price of a stock in relation to its assets, suggesting that the price should not be significantly higher than the company’s book value. He believes that these criteria are suitable for the defensive investor as they exclude many companies that may be overvalued or risky.

Graham preempts the argument that armed with these criteria and a suitable advisor, investors may be able to obtain returns that are better than the market average. Graham counters this argument by explaining that the intelligent investor should not strive to beat the market but rather focus on achieving satisfactory returns with a margin of safety.

He describes two ways in which investors approach the future: “the way of prediction and the way of protection” (364). According to Graham, the way of prediction involves trying to forecast future market movements and individual stock prices, which he deems unreliable and speculative. On the other hand, the way of protection involves adopting a defensive investment approach by selecting stocks that meet the aforementioned criteria and provide a margin of safety. He espouses the second approach, saying that, by adhering to these criteria, the intelligent investor can protect themselves from volatility and increase their chances of achieving satisfactory returns.

Zweig reviews Graham’s criteria for investment selection and discusses whether and how certain criteria should be updated to reflect the present market conditions. The only criterion he modifies concerns the definition of a “large” company. He advises that investors avoid companies with market values of less than $2 billion as that would be the approximate threshold for defining a large company today.