Benjamin Graham's The intelligent Investor: Inflation and 100 Years of Stock Prices

Chapter 2 : Investment and Inflation

A Deep Dive into Corporate Profits, the Wealth of Things, and the Role of Bonds and Stocks

The complex relationship between inflationary times and changes in corporate earnings and stock prices.

Inflation, or periods of rising prices, and corporate earnings or stock prices don't always move in sync. A specific example of this is the period between 1966 and 1970, when the inflation rate reached a whopping 22%, but corporate earnings and stock prices actually declined, remaining at 1965 levels. This clearly shows that corporate earnings and stock prices are not always directly linked to the inflation rate.

The Complex Interaction Between Inflation and Earnings for Dow Companies

During the 20-year period from 1950 to 1970, the profits of the companies in the Dow grew quite strongly. These companies reinvested much of their profits, expanding the capital within their companies, which further increased their value.

However, during this same time period, from 1950 to 1970, inflation increased the costs of companies in the form of higher wages. These increased costs resulted in lower net profits, which in turn required companies to make more capital investments. These additional capital investments eroded companies' cash flow, which in turn was a major cause of declining sales.

Thus, we can see that inflation can have a negative impact on a company's revenue growth, and cost-increasing factors, such as rising wages, may be the most significant factor contributing to this negative impact.

This shows that the ability of a company's management to effectively manage cost growth and maximize profits through efficient operations plays a crucial role in the success of their investments. This provides a deeper understanding of the complex relationship between investment and inflation.

Real Assets and Inflation Protection

Investing in Gold: A Safe Haven Asset or Not?

Gold has traditionally been perceived as a safe haven asset, and many investors turn to it, especially during times of economic instability such as inflation. However, gold is not always a stable store of value.

1. Historical Trends in Gold Prices

In the 35 years from 1937 to 1972, the price of gold increased from $35 to $48 per ounce, a mere 35% increase. This is not much compared to the inflation rate, which averaged 3% per year. During this period, gold's price growth did not keep up with the inflation rate.

Additionally, from 1972 to 2020, the price of gold fluctuated wildly and was unstable. During this period, the price of gold spiked in the late 1970s and early 1980s, but then declined throughout the 1980s and most of the 1990s. In the 2000s, gold prices began to trend upward again, but this did not completely eliminate the instability.

2. The Complexity of Investing in Gold

The complexity of investing in gold is increased by a number of factors beyond these price fluctuations. For example, the price of gold is influenced by a number of factors, including global economic conditions, monetary policy, and geopolitical risks, which are difficult to predict, making the price of gold subject to uncertainty.

In addition, the supply and demand for gold also affects the price of gold. The demand for gold comes primarily from jewelry, financial investments, and industrial gold, and changes in these areas directly affect the price of gold. On the other hand, the supply of gold is determined by the amount of gold mined from mines, which can fluctuate due to unpredictable factors such as natural disasters and strikes by mine workers.

In conclusion, despite the common perception that investing in gold is a stable store of value, it is fraught with complexity and uncertainty due to a number of factors. Therefore, it is advisable to think of gold as one of the ways to diversify your overall investment portfolio. This will help to spread the risk of gold investing and create a more stable investment strategy.

Investing in Valuables: Why It's Not a Good Inflation Hedge

1. Instability in the Price of Valuables

   The first risk of investing in collectibles is the instability of the prices of collectibles. For example, in the early 1980s, the market for rare coins boomed. During this time, coin prices rose rapidly among coin collectors. However, as market conditions changed, the popularity of coins declined dramatically, resulting in large losses for many investors. As such, the price of valuables can be highly influenced by specific times or trends, and can fluctuate more dramatically than other investment assets such as stocks or real estate.

2. Low Liquidity of Valuables

   The second risk factor is the liquidity of the asset. Valuables are not easily bought and sold, and it takes time and effort to find the right buyer to sell at the right price, especially for expensive valuables. For example, Picasso's painting Son of Drama, which sold for $120 million at Vanessi Gallery in 2006, is one such example. Selling a high-priced valuable such as this painting requires a significant amount of time to find the right time and buyer, as well as consideration of commissions and associated costs.

3. Subjectivity of Valuation

   The third risk factor is the subjectivity of valuation. The value of a diamond is determined by many factors, including color, clarity, cut, and carat weight, which are evaluated by each diamond appraiser. However, different appraisers have different criteria and interpretations, so the same diamond can be valued differently by different appraisers. This subjective valuation adds to the uncertainty of investing.

Diversify your portfolio with appreciation investments

As you can see, investing in valuables comes with a variety of risks. Because of this, it's best to build a portfolio with a variety of assets rather than relying solely on them as an inflation hedge. By diversifying your portfolio, you can spread out the risk of investing in appreciating assets and create a more stable investment strategy.

Real Estate Investing: Why It's Not a Good Inflation Hedge

Real estate investing is a long-term investment that is widely perceived as a defense against inflation. When inflation rises, real estate prices generally tend to rise as well. However, this type of investment comes with its own set of risks.

1. Price Fluctuations Due to Local Factors

   Real estate prices are heavily influenced by a variety of local factors, including the state of the economy in the region where the property is located, population movements, and national and local government policies. For example, if a development plan is announced for a new large shopping mall or park, real estate prices in the area may rise. On the other hand, unfavorable events such as factory closures or natural disasters can cause prices to decline. These local factors are difficult to predict, and the resulting price fluctuations can pose a significant risk to novice investors.

2. Price Fluctuations Due to Market and Economic Conditions

   Real estate prices are also affected by overall market conditions and the state of the economy. The 2008 financial crisis is a prime example of this, when the real estate market fell sharply across the globe, causing many investors to lose a lot of money. Similarly, the COVID-19 pandemic has negatively impacted office and retail real estate prices in some urban centers due to the spread of social distancing and telecommuting.

3. Subjective Evaluation of Real Estate Prices

   The value of a property is determined by many factors, including its location, size, and the condition of the building, which can be assessed differently by different investors or appraisers. This makes it very difficult to accurately determine the real value of a property.

Benjamin Graham's Value Investing Principles and Real Estate Investing

Benjamin Graham, known as the father of value investing, put forward "stability " as one of the important principles of investing: the price of an investment should be stable and its value should be easy to determine. However, real estate investing is difficult to follow this principle.

The value of real estate can be highly subjective, and it's difficult to determine exactly what it's worth. Real estate is also a relatively illiquid investment, meaning that it can be difficult for investors to cash out immediately when they need to. In these respects, real estate investing does not align with Benjamin Graham's value investing principles.

Understanding and Experience Required for Real Estate Investing

Therefore, real estate investing requires a deep understanding and sufficient experience. Especially for early investors, you need to fully understand the risks of real estate investing and have a strategy in place to manage those risks. This can only be done by taking into account the volatility, subjective valuation, and lack of liquidity of real estate investments. With this preparation and approach, real estate investing can be an effective defense against inflation.

An Uncertain Future and the Need for Different Investment Approaches

Investing is inherently a way of responding to an uncertain future. Benjamin Graham, the master of value investing, made a clear distinction between investing and speculation, explaining that investing is the pursuit of both stability and profitability, while speculation is the taking of risk for high returns.

Acknowledging Uncertainty and the Need for Diversified Investment Strategies

No investment of any kind can be guaranteed to be 100% successful, and according to Benjamin Graham's value investing principles, investors should recognize this uncertainty and manage it with a variety of investment methods. It is not advisable to invest all of your capital in just one asset, as this can lead to a lack of diversification and therefore increased investment risk.

In this regard, Nasim Taleb said:

"We live in a world of uncertainty. The future is always uncertain, and that uncertainty always exceeds our expectations."

This quote aligns with Graham's value investing principles and highlights the importance of recognizing uncertainty and managing it with a diversified investment strategy.

Investors should embrace an uncertain future and use a variety of investment strategies to deal with it, so that they can diversify their risk and achieve a stable return on their investments.

Bonds, Stocks, and Inflation

While bonds offer relatively stable returns, stocks have the potential for higher returns. While bonds may offer better protection against inflation than stocks, stocks generally offer better protection against inflation than bonds. The reason we have so many different investment options is to prepare for an uncertain future.

In this regard, Warren Buffett once said:

"Stocks are the best way to beat inflation over the long term."

This quote from Warren Buffett suggests that stocks are a great defense against inflation over the long term, emphasizing the importance of investing in stocks.

Therefore, investors should invest in a variety of assets, understand the characteristics of each asset, and develop an investment strategy to prepare for an uncertain future. This will help diversify investment risk and provide a stable return on investment.

The Importance of Value Investing Principles: Dealing with an Uncertain Future

The principle of value investing, emphasized by Benjamin Graham, is to seek stable returns while managing investment risk. This principle is central to an investor's strategy for dealing with an uncertain future.

To prepare for an uncertain future, investors should consider a prudent investment approach and a variety of investment vehicles. Following Graham's principles of value investing can help investors effectively manage future uncertainty and pursue stable returns.

In the world of investing, there are no certainties. Volatility and risk are part of investing, and the ability to manage and respond to them determines the success of an investment. Graham's Value Investing Principles provide an effective way to respond to this uncertainty.

As such, investors should keep in mind that when creating their own investment strategy, they must be prepared and prepared for an uncertain future.

A good investment strategy is to follow Graham's principles of value investing, consider a variety of assets and investment approaches, and make investment decisions carefully. This approach will allow investors to earn a stable return from their investments despite an uncertain future.

Chapter 3: Stock Price Movements over the Past 100 Years and Current Stock Price Levels

One of the keys to investing success is to have a deep understanding of the history of the stock market and the complex interrelationships between stock prices, earnings, and dividends within it. This allows you to properly evaluate the attractiveness and risk of stocks at different points in time and make strategic investment decisions accordingly. Since we are in 1971, the year of Benjamin Graham, we analyzed the 100 years of stock price history to determine whether we are currently in a bear or bull market.

Average Change in Stock Price, Earnings, and Dividends from 1871 to 1971

When we examine the average of stock prices, earnings, and dividends over the 100-year period from 1871 to 1971, we see that these numbers tend to rise.

Aspect	Description
Declining Stock Prices and Profits (1871 - 1880)	Only two instances of declining stock prices and profits Linked to specific economic conditions Shows how economic volatility affects stock market
Dividend Stability Since 1900	No instance of dividend decline since 1900 Average level of dividends returned to shareholders has never declined Positive indicator of steady market growth and shareholder returns
Volatility and Investment Philosophy	Considerable volatility in stock price, earnings, and dividend growth Highlights uncertainty in investing Emphasizes the need for a consistent investment strategy and philosophy

Analyzing Stock Price Levels at the End of 1971

Aspect	Description
Stock Price Levels at End of 1971	PER (Price-to-Earnings Ratio) on a downward trend Stock price relatively low compared to company's profits Expected stable stock price in 1972 similar to 1965
Investor Reaction	Not good news for defensive investors seeking stable returns Heavy losses suffered from overinvestment in non-blue-chip and new stocks (high-risk stocks)
Investment Environment in 1971	Investors expected to avoid high-risk stocks Yield on high-quality bonds: 7.57% Stocks relatively less attractive compared to stable returns of bonds

Benjamin Graham's Investment Philosophy

Benjamin Graham's investment philosophy emphasizes fundamental analysis and caution against expensive valuations when making investment decisions. His approach reflects the following key factors:

Key Factors	Description
Consideration of Multiple Metrics	Average earnings over the last three years Current dividends Yields on high-quality bonds Dividend yields This allows assessment of a company's financial stability and growth potential.
Determining Market Strength and Weakness	Bullish market: stock prices trending upward Bearish market: stock prices trending downward These judgments help investors determine their investment strategy.

The Importance of Graham's Philosophy

Graham's philosophy teaches investors that they should understand the intrinsic value of their investments and make investment decisions centered around the fundamental value of a company. His philosophy guides investors to focus on long-term value and not be swayed by the short-term volatility of the market.