Edward Quince’s Wisdom Bites: Are You Intelligent? Chapter 13

If you’re going to invest in specific securities it is very likely that you will not simply examine a single security/company, but that you will want to understand how that security/company looks relative or in comparison to other securities/companies.  In this chapter, Graham compares four listed companies.  The companies themselves are irrelevant for our discussion, but what the chapter offers is an insight into how Graham thinks about analysis.

It’s a discussion Graham shares in the following chapters, but for now he focuses on profitability, stability (past declines in earnings), growth, financial position, dividends, and price history.  

Without getting into all of the details, what stands out to me is that Graham’s thinking shows that price matters, warning that “the careful investor wants to be reasonably sure in advance that he is not committing the typical Wall Street error of over enthusiasm for good performance in earnings and in the stock market.”

So what did Zweig take away from this chapter?

Commenting on Commentary on Chapter 13

Likely realizing the four companies that Graham discussed would feel irrelevant to the reader of the 2000’s, Zweig offers up analysis of 4 stocks using their 12/31/1999 numbers.  Like Graham he picked for companies starting with the letter “E”, Emerson Electric (the only stock from Graham’s original 1970 list), EMC Corp., Expeditors International of Washington and Exodus communications.

In case you’re curious about the journey of these companies and stocks over the last 25 years, here’s a quick summary:

Company	Trading Today?	What Happened?
Emerson Electric (EMR)	✅ Yes	Outstanding long-term compounder
EMC Corporation (EMC)	❌ No	Acquired by Dell in 2016
Expeditors International of Washington (EXPD)	✅ Yes	Exceptional compounder
Exodus Communications (EXDS)	❌ No	Bankrupt after the dot-com crash

It’s interesting that Emerson Electric was a stock that Graham was cautious about back in 1970, not because of the business, but because of the price the shares were trading at.

I won’t belabor the discussions around these companies, the point Zweig and Graham are both making is that a great company can still be a bad investment if purchased at too high a price.

The inverse can also hold true, seemingly boring companies can be excellent investments at the right price.

Just like in Graham’s era, Zweig’s writing highlights that investors fall into the one of the same behavioral traps time in memoriam.  We overpay for exciting narratives, we pay handsomely for the future in advance.

“In the Air Force we have a rule: check six. A guy is flying along, looking in all directions, and feeling very safe. Another guy flies up behind him (at “6 o’clock”) and shoots. Most airplanes are shot down that way. Thinking that you’re safe is very dangerous! Somewhere, there’s a weakness you’ve got to find. You must always check six o’clock.

-U.S. Air Force Gen. Donald Kutyna

 

Edward Quince’s Wisdom Bites: Are You Intelligent? Chapter 12

 After introducing the topic of ‘Security Analysis’, Graham moves towards a further examination of earnings. Remember there are really only three things that matter for the analyst, are there to be future earnings, when will they arrive, and how they should be capitalized.  Earnings are the lifeblood of the company and the lifeblood of an investors’ returns.  "The absolute most that the owners of a business, in aggregate, can get out of it in the end - between now and Judgment Day - is what that business earns over time."  The “in aggregate” part there is important, but I won’t harp on explaining it.

Graham has already spent plenty of time bemoaning simple extrapolations of the past and he extends that to his discourse on earnings per share, stating:”first, don’t take a single year’s earnings seriously. Second, is if you do pay attention to short-term earnings, look out for booby traps in the per-share figures. If our first warning were followed strictly, the second would be unnecessary.”

What are these “booby traps”? Graham lists a few such as: special charges, reduction in normal income tax due to past losses, the dilution factor implicit in convertibles and warrants/options, the method of depreciation, the treatment of R&D, the inventory method, etc.    Suffice to say, accounting can be tricky.

To avoid placing too much emphasis on the short-term and attempt to remove some of the noise of these “booby traps” Graham was a fan of looking at average returns over a long period of time and comparing recent earnings growth trends to the company’s previous growth trends, often 10 years earlier.  Something that is likely impossible to do for newer, early stage companies.

Zweig takes Graham’s “booby traps” and updates them for some of the traps investors face in the 21st century.

Commenting on Commentary on Chapter 12

The biggest trap that Zweig highlights is the use of “pro forma” or “as is” earnings numbers.  These measures are simply the earnings that GAAP (accounting rules) proscribe with numerous adjustments.  The idea of pro forma numbers was to ‘help’ investors by removing the short-term, non-recurring, items that were otherwise making earnings noisy.  As occurs with many decent ideas, things can get taken too far.  Zweig describes pro forma earnings as: “enabling companies to show how well they might have done if they hadn’t done as badly as they did.”

Zweig explores a few cases of ‘abuses’ in accounting to make the point that “the intelligent investor should be sure to understand what, and why, a company capitalizes.” (capitalizes means the company spends money on something but doesn’t call that spending an expense)

The key takeaway for me in this chapter is that if you plan to invest in a given stock security on the basis of what would be necessary to call your investment ‘intelligent’ or ‘enterprising’ you’ll need to do a lot of reading up on the company’s financial statements, digging into the footnotes, understanding accounting policy elections and how they might be impacting earnings.  After all, if it was easy, everyone would be doing it.

“You can get ripped off easier by a dude with a pen than you can by a dude with a gun.” - Bo Diddley

Edward Quince’s Wisdom Bites: Are You Intelligent? Chapter 11

As we progress we move from topics like defining investing, to strategic asset allocation, and through the general topic of investment selection, deployment and investment advice. Against that backdrop Graham moves to the topic of “Security Analysis”, the “examination and evaluation of stocks and bonds.”  It is a movement in the discussion from the general to the specific and specifically what should the “lay investor” do when it comes to possibly selecting an individual stock or bond to include in their portfolio.

Graham has lofty standards when it comes to security selection and to scrutinize whether an investment is sound enough he believes you need a strong analysis of the past average earnings, the capital structure, asset values and of course the blanket “other matters.”  And as we’ve seen with most things that Graham has written in this book there is always the word of caution: “...we must point out a troublesome paradox here, which is that the mathematical valuations have become the most prevalent precisely in those areas where one might consider them least reliable.  For the more dependent the valuations become on anticipations of the future-and the less it is tied to a figure demonstrated by past performance-the more vulnerable it becomes to possible miscalculation and serious error.”

Graham’s protege, one Mr. Warren Buffett, simplifies all security analysis down to an application of Aesop’s fable about a bird in hand being worth two in the bush.  To value you any asset you must answer three questions:

1. How many birds are in the bush?

2. When will they come out? 

3. What is the risk-free rate?

It’s a question of the evaluation of the certainty of future profits, when they arrive and how to capitalize them (discount back to today) and whether that math is good enough for you to part with the cash you have today (the bird in hand).

Without getting into Discounted Cash Flows we’ll turn to what Zweig thinks about this chapter.

Commenting on Commentary on Chapter 11

So how do you attempt to answer the three questions posed above?  A logical starting point is to start thinking about the company’s long-term prospects and in doing so you need to try to get a fundamental understanding of what makes the company you are evaluating generate profits and grow.  Are the long term growth prospects reliant on debt or acquisitions, or do they come from things like a strong brand, a near monopoly in their industry, some other intangible source, etc.

If you can ferret out a solid understanding of the company, you realize its ability to maintain and sustain growth and profitability might be hindered or advanced by the quality of its management. Analyzing a management team can be tricky, but Zweig suggests evaluating factors like whether it seems like management is just out for maximizing their own compensation, whether they are true operators of the business or merely promoters.  Clearly there is some subjectivity here.

After covering growth and management the 3rd of Graham’s 5 factors in security analysis that Zweig discusses is “financial strength and capital structure”.  For Zweig this topic is somewhat simple, generate more cash than you use so owners have some earnings.  The complicating factors are sometimes determining what exactly is the appropriate measure of earnings and what exactly are the appropriate measures of how much cash is leftover for owners. Without getting into the nitty gritty, it’s thinking about things like funding depreciation and amortization and stock options and extraordinary items.  But no discussion of capital structure can be complete without a discussion around debt vs. equity.  For Zweig he recommends focusing on companies with long-term debt no greater than 50% of total capital.

The bigger picture question you should consider asking is both whether and how the choice of capitalizing a company with debt and equity matters for the value of the firm?

After all in the words of the immortal philosopher Yogi Berra as retold by famed economist Merton Miller:

“It's after the ball game, and the pizza man comes up to Yogi Berra and he says, 'Yogi, how do you want me to cut this pizza, into quarters?' Yogi says, 'No, cut it into eight pieces, I'm feeling hungry tonight.' Now when I tell that story the usual reaction is, 'And you mean to say that they gave you a [Nobel] prize for that?'"

--Merton H. Miller, from his testimony in Glendale Federal Bank's lawsuit against the U.S. government, December 1997

You can also consult Howard Marks’ “Dynamite Equation” as a helpful aid. Hint: “levered portfolios face a downside risk to which there isn’t a corresponding upside: the risk of ruin. The most important adage regarding leverage reminds us to “never forget the six-foot-tall person who drowned crossing the stream that was five feet deep on average.” To survive, you have to get through the low points, and the more leverage you carry (everything else being equal), the less likely you are to do so. "

A lesson apparently that hedge fund ‘Situational Awareness’ and its founder Leopold Aschenbrenner apparently just learned the hard way.

I will skip Graham’s final two factors in security analysis that focus on dividends, but suffice to say ultimately you as an owner need some way for the company's earnings to come back to you, dividends and buybacks are two of those ways.

“Would you tell me, please, which way I ought to go from here?”  

“That depends a good deal on where you want to get to,” said the Cat

-Lewis Carroll, Alice’s Adventures in Wonderland

 

Edward Quince’s Wisdom Bites: Are You Intelligent? Chapter 10

The previous chapter largely was focused on investment managers, the people and entities that manage investment funds, the focus of this chapter moves to investment advice.  On this topic, Graham provides: 

“Our basic thesis is this: If the investor is to rely chiefly on the advice of others in handling his funds, then either he must limit himself and his advisers strictly to standard, conservative, and even unimaginative forms of investment, or he must have an unusually intimate and favorable knowledge of the person who is going to direct his funds into other channels.”

My read there is that either you find an advisor you really trust or you really put some strict guardrails around your advisor lest you risk potentially being taken advantage of.

The full read of Graham here is not anti the seeking of advice, but simply a reminder that the investor should be cognizant of their own frontier of knowledge and the incentives of those providing advice. Graham also seems to believe that “Perhaps the chief value [advisers offer] to their clients lies in shielding them from costly mistakes.

Commenting on Commentary on Chapter 10

Zweig outlines a number of reasons an investor may want or need to turn to a professional financial advisor for help.  Reasons range from gaining a better understanding of the rate of return needed to meet your goals, assistance with defining a savings rate, to simply having emotional support or someone else to blame.  He also provides some signposts of characteristics that you might want to consider a second opinion, that list includes: struggles with budgeting, experiences of big losses, portfolios constructed with no rhyme or reason, and major life changes.

Of course once you believe you want or need advice the question is how to find the right advisor for you.  Zweig’s advice is to do your homework, including reviewing information filed with the SEC such as form ADV and using BrokerCheck to search for disciplinary action.  He also provides the reader with a list of “words of warnings” to look out for when having a conversation with a prospective adviser, Zweig’s list is long, but the short version is to be wary of things that sound salesy and too good to be true.

A good adviser in any field should take the time to really get to know about their client’s goals and charge a fair fee for their work. 

I think I would summarize this chapter as when shopping for financial advice you are shopping for “trust”.  There are two major components of trust:

• Credibility - track record, credential, adherence to a code, brand

• Professionalism - values, competency, integrity

You should be looking for evidence of these and other traits and ensure that these traits are combined with a solid value proposition.  There is no sustainable trust without value.

“I feel grateful to the Milesian wench who, seeing the philosopher Thales continually spending his time in contemplation of the heavenly vault and always keeping his eyes raised upward, put something in his way to make him stumble, to warn him that it would be time to amuse his thoughts with things in the clouds when he had seen to those at his feet. Indeed she gave him good counsel, to look rather to himself than to the sky.” - Michel de Montaigne

Edward Quince’s Wisdom Bites: Are You Intelligent? Chapter 9

 After delivering the parable of Mr. Market, Graham moves to a chapter titled ‘Investing in Investment Funds’.  At first blush it seems like an odd jump to go from a chapter dealing with market fluctuations and volatility to a discussion of open and closed-end funds, but there is actually a deep connection which I think is best made through this sentence in the chapter: 

“We cannot help thinking, too, that the average individual who opens a brokerage account with the idea of making conservative common-stock investments is likely to find himself beset by untoward influences in the direction of speculation and speculative losses; these temptations should be much less for the mutual-fund buyer.”

Do you see the connection there?  Mr. Market shows up not only in the form of the stock market ticker but he’s also the financial industry salesman who is pitching you products. That salesman could be your financial advisor or an advertisement for a triple-leveraged ETF or to make a parlay bet, you get the picture. As Graham warns, “Bright, energetic people - usually quite young - have promised to perform miracles with ‘other people’s money’ since time immemorial.”

The lesson is the same just because Mr. Market shows up doesn’t mean you have to pay attention to him.

Commenting on Commentary on Chapter 9

Zweig starts by offering up the merits of investing in mutual funds, mind you this was just near the advent of ETFs, calling these products “almost perfect”, with a key emphasis on the “almost”.  The “almost” is the source of caution for the investor.

The caution is against things like developing a belief that past fund/manager performance should be extrapolated into the future, that the costs the funds charge doesn’t matter, that product design doesn’t matter (for example - do you really know how an inverse ETF works?).  

If you’ve followed along through the last 8 chapters it should come as no surprise to find Zweig’s antidote to potentially high cost and poor performing funds to be owing index funds.  Writing in 2002, Zweig reminds readers of a fact that still holds true 20+ years later,  that very few actively managed funds beat the S&P 500 over a horizon of 10-years or greater. Is it possible to find funds that outperform in the short-run, absolutely, do you think you can consistently find them and then switch to the next out-performing fund at the right time to consistently outperform the market index over time? Probably not. 

Once you realize that all of the active trading in the market is actually the market, someone’s wins are another participant's losses.  As a collective group active managers cannot outperform, it’s a zero sum game, but a game that has frictional costs paid to intermediaries, which actually makes the game ‘negative sum’.  The central idea of index investing was born out of the “Cost Matters Hypothesis”, a central idea that rather than try to beat the market just buy/own everything in the market as cheaply as possible because just as returns compound, costs compound.

I will leave you with this to ponder, why do so many of the world’s best investors consistently state that: “Most people would be better off with an index fund”?  And is this advice worth ignoring?

And feel free to add your comments about how passive, index investing destroys market efficiency -  that’s always a fun topic.  

“The schoolteacher asks Billy Bob: “If you have twelve sheep and one jumps over the fence, how many sheep do you have left?  Billy Bob answers, “None.”  “Well,” says the teacher, “you sure don’t know your subtraction.”  “Maybe not,” Billy Bob replies, “but I darn sure know my sheep.” - an old Texas joke.

Edward Quince’s Wisdom Bites: Are You Intelligent? Chapter 8

 Back in August 2024 famed investor Howard Marks wrote a memo titled “Mr. Market Miscalculates”.  The Mr. Market referred to by Marks’ is the one Ben Graham made famous in the Chapter 8 we are discussing today.  Mr. Market is the central character in a parable that I’ll paraphrase here:

“Ben Graham and Warren Buffett have talked about a charming, seductive manic-depressive gentleman named Mr. Market. Every day he shows up on your doorstep offering to do business with you. When he's manic, he'll offer to buy your stocks or sell you his for absurdly inflated prices. When he's depressed, his prices go ridiculously low. The mistake most people make is answering the door just because Mr. Market knocks. You don't have to let him in. Why should you buy just because he's excited? Why should you sell just because he's down in the dumps? A long-term investor shouldn't care about market prices.” - Charles D. Ellis

The parable of Mr. Market is a lesson, not so much to ignore the daily market madness of the ticker, but to only engage with it when you are using it to serve your own interests.  Inherent in that is that you have to know what your interests are and you have to be willing and able to ignore everything else that Mr. Market will bring your way.  Further Graham says that “A serious investor is not likely to believe that the day-to-day or even month-to-month fluctuations of the stock market make him richer or poorer.”

So what did Zweig have to say about this chapter?

Commenting on Commentary on Chapter 8

To Zweig this is somewhat simple, just because Mr. Market shows you prices everyday, “You do not have to trade with him just because he constantly begs you to.”  The goal is to turn Mr. Market into someone who serves your interests, which could simply be buying at fair prices and selling at euphoric prices when offered, and it could be accomplished in ways like automating decisions to buy and rebalance.  Those aren’t necessarily the only ways to make the market serve your interest, but serve as good examples.

It’s a lesson about moving from a mindset of anticipating and predicting the market (the hallmarks of speculation) to one focusing on controlling what you can control.  Zweig lists several things an intelligent investor can control:

• Your brokerage costs

• Your ownership costs, through expense ratios

• Your expectations for future returns

• Your risk, through asset allocation and any associated rebalancing

• Your tax bill, by not churning your account

Zweig reminds us that investing is not a competition, it’s about reaching your goals as it relates to your own financial needs, but cautions that getting caught up in comparison games is human nature. It is easy to say that the daily market fluctuations won’t matter over a 10 or 20 or longer year investment horizon because they won’t, but to actually act accordingly is a different matter.  We crave control and acting gives us a sense of control.

For Zweig the remedy to our biological instincts is to “dollar-cost average, rebalance, and sign an investment contract.” with an end towards reaching your long-term financial goals without getting caught up in the arms of the manic depressive Mr. Market.

“The happiness of those who want to be popular depends on others; the happiness of those who seek pleasure fluctuates with moods outside their control; but the happiness of the wise grows out of their own free acts.” - Marcus Aurelius

Edward Quince’s Wisdom Bites: Are You Intelligent? Chapter 7

 Can you beat the market?  Chapter 7 of The Intelligent Investor is geared towards those “enterprising investors” who believe they can potentially do better than the market. Before proceeding, it is worth a reminder that Graham defines “investing” as very specifically those endeavors that embody thorough analysis, provide protection from serious losses and offer adequate returns for their effort.  Like all eras our current “investing” climate offers many ways to invest that are likely to fail meeting Graham’s definition at the personal level, because most of us are not willing or capable to put in the work.  Nevertheless, Graham believed it was possible to do better than the average investor, while recognizing that to do so you would have to be willing and able to hold a portfolio of investments that was different from most other investors and speculators.  

Graham concludes this chapter with a warning: “..the majority of security owners should elect the defensive classification.  They do not have the time, or the determination, or the mental equipment to embark upon investing as a quasi-business.” and  “..the investor’s choice as between the defensive or aggressive status is of major consequence to him, and should not allow himself to be confused or compromised in this basic decision.”

Fast forward to today, many investors have heeded Graham’s advice, so much so in fact that a current market debate is whether there is so much passive, index investing that markets are no longer efficient in providing price discovery.  I don’t have the answers to this question, but a recent research article by Owen Lamont (behind a paywall) posits the following:
“Has the rise of passive investing broken the stock market? Is the level of passive ownership too high? No. There is no strong reason to believe that higher indexing degrades market efficiency. What matters are the non-passive investors: Are there enough of them, do they have the right incentives, are they able to express their views via trading? What does not matter are the passive investors: They are like the audience in a play; they just watch the activity on stage. There is no level of passive ownership, other than 100%, that obviously causes the market to be dysfunctional.”

Anyway, what does Zweig have to say about trying to beat the market?

Commenting on Commentary on Chapter 7

While the chapter was focused on “positive” things investors could do to try to do better than average, Zweig focuses again on things investors should generally not do: 

• Don’t try to time the market. Calling market timing a “practical and emotional impossibility.” 

• Don’t pay too much for a growth stock.  He reminds investors of a cardinal rule, that no company is a great investment at “any price”, you’re always investing against what’s already priced in.  Meaning even if a company is going to grow gangbusters if that growth is already priced in, you probably don’t have the upside you think in terms of investment gains.

• Don’t put all your eggs in one basket. While acknowledging that really big fortunes are made from concentrated holdings of common stock, Zweig looks at the negatives of concentrated positions, noting that “concentration also makes most of the great failures of life.”

• Don’t think all cheap, “cigar butt” companies are great investments just because they’re cheap.  Some items are on sale for a reason.

• Don’t keep all your money invested at home.  Learn the lessons of Japan’s lost decade and at least own something that diversifies away home country risk. Many multinational companies likely meet this criteria.

So there you have it, Zweig offers us no concrete ways to beat the market, it seems like a theme here, but why? 

We start to get some answers in the next Chapter, which is one of the greatest chapters in investing literature, as we introduce market volatility to the discussion.

As Morgan Housel says, volatility in the price of admission to investing and earning returns.

“It requires a great deal of boldness and a great deal of caution to make a great fortune; and when you have got it, it requires ten times as much wit to keep it.” - Nathan Mayer Rothschild

Edward Quince’s Wisdom Bites: Are You Intelligent? Chapter 6

The year is 2026, you as an investor have lived through recent things like memecoins, SPACs, amongst other market phenomena of the recent past and now you’ve witnessed the largest IPO in history with SpaceX’s recent offering.  And while that has all been very exciting, you still have the possibilities of Anthropic and OpenAI IPOs on the horizon, both of which are poised to exceed SpaceX’s record raise. But, assuming an investor can buy these new issuances, should they?

In Chapter 6, Ben Graham shares his thoughts on “new issues” both generally and in common stocks, cautioning: “be wary of new issues…new issues have special salesmanship behind them..[and] most new issues are sold under “favorable market conditions” which means favorable for the seller and consequently less favorable for the buyer.”  

And if that warning wasn’t enough, Graham goes on: “Bull-market periods are usually characterized by the transformation of a large number of privately owned businesses into companies with quoted shares.” and “One fairly dependable sign of the approaching end of a bull swing is the fact that new common stocks of small and nondescript companies are offered at prices somewhat higher than the current level for many medium sized companies with a long market history.”  Time will tell whether 2026 will be a year where Graham can say “told you so.”

The whole chapter is a lesson in via negativa, it’s an ode to knowing what not to do, it’s a list of “don’ts” for more “aggressive” investors.

Commenting on Commentary on Chapter 6

After discourse on how “permanent autopilot” might be the best approach for the building an investment portfolio for the “defensive investor”, in Chapter 6, Zweig, via his commentary on Graham, tackles what Graham calls the “Negative Approach” to portfolio policy.  The attention turns to “Enterprising Investors” but the starting point for general asset allocation remains the same as that of the defensive investor (consider your risk tolerance).  As mentioned above, it’s a list of things that most investors should likely say “no” to when it comes to inclusion in their portfolio. 

So here we go:

• Junk Bonds - while largely a flat no for Graham given very high expenses of buying these bonds at the time. Zweig gives this a moderate no, citing some benefits of junk bonds for certain investors, but ultimately concluding that these are “only a minor option” for the intelligent investor
  
  

• Foreign Bonds - again Graham was largely a flat no, while Zweig cites some benefits of EM Bonds as a diversification tool while stating “no sane investor would put more than 10% of a total bond portfolio in spicy holdings like these."
  
  

• Day Trading - a no as “the cost of trading wear away your returns like so many swipes of sandpaper…and taxes”
  
  

• IPOs - while picking the right IPO can be a bonanza, we likely overestimate the frequency with which IPOs actually work out for investors.  For every Microsoft there are countless Pets.com….it really to say most IPOs tend to be overpriced.  The intelligent investor might characterize IPO as meaning: “It’s probably overpriced”, “Imaginary profits only.”, “Insiders Private Opportunity.”, or “Idiotic, Preposterous, and Outrageous.”

If you’ve been following along the list above should really come as no surprise given Graham’s definition of intelligent investing…feel free to read the previous post for a refresher.

Now that Zweig has told you what not to do with your portfolio, the next chapter moves to what types of investments an enterprising investor should consider if they want a chance of doing better than “run of the mill investment results.”

Until then:

“The punches you miss are the ones that wear you out.” - Boxing trainer Angelo Dundee