The Intelligent Investor

Zweig warns that “for most investors, selecting individual stocks is unnecessary—if not inadvisable” (397). He believes that most people would be better off investing in a diversified portfolio of stocks and bonds, rather than trying to pick individual stocks. He specifically recommends index funds as a low-cost and diversified approach to investing.

If an investor wants to try picking stocks for themselves, Zweig recommends they follow Graham’s advice to practice first. He suggests that investors begin spending a year tracking a hypothetical portfolio, making buy and sell decisions as if they were investing real money. Then, they should compare their results to the performance of a well-diversified index fund. If the returns are good, then the investor can consider investing with real money, limiting such stocks to only 10% of their portfolio and keeping the remainder in an index fund.

Zweig advises investors to pay attention to the managers of any companies they invest in, looking for communicative and trustworthy individuals who have a proven track record of success. He recommends examining financial statements and determining whether they are easily readable and transparent or whether they include complicated jargon and hidden information like unexplained recurring charges.

Graham discusses whether convertible issues serve as viable investment opportunities and how they can affect the common stocks of companies that issue them. He says that convertible issues are a financing vehicle that supposedly benefits both buyers and issuers. The investor benefits from the protection against poor performance, as they do not lose more than the face value of the debt while also having the opportunity to reap the benefits of a firm performing well through the option to convert the bonds into common stock. On the other hand, issuers can raise capital at a lower cost compared to issuing straight equity or traditional bonds.

However, Graham points out that there will always be a trade-off between the attractiveness of the convertible issue to the investor and the cost to the issuer. Even when a profit can be made from the conversion option, the company may call the bonds to retire them before conversion, minimizing the potential gain for investors. Graham cites an old maxim, “Never convert a convertible bond” (409). He advises investors to be wary of the potential risks and considerations when investing in convertible bonds, especially when considering newer issues.

Graham also discusses how convertible issues can affect common stock. They can have a dilutive effect on existing shareholders if the conversion of bonds into stock increases the number of shares outstanding. This dilution can lead to a decrease in earnings per share and a decrease in the market value of the existing stock. He goes on to explain stock-option warrants, which are essentially additional securities attached to a bond or preferred stock that give holders the right to purchase more shares of common stock at a specified price for a specific period. Graham points out that they can lead to confusion and complexity for investors. They separate the rights that would normally be included with the purchase of common stock.

Zweig expands on Graham’s discussion of convertible bonds, describing them as a confusing type of security: “Although convertible bonds are called ‘bonds,’ they behave like stocks, work like options, and are cloaked in obscurity” (418). He acknowledges that they are now less risky than they were in the past and that the convertible bond market has “blossomed since Graham’s day” (419). Nevertheless, he argues that these securities are expensive to trade and therefore not worthwhile for most investors. Instead of buying a convertible bond, Zweig recommends simply maintaining a diversified portfolio of stocks, bonds, and cash.

Graham next focuses on four case studies: Penn Central (Railroad) Co., Ling-Temco-Vought Inc., NVF Corp., and AAA Enterprises.

In the case of Penn Central, the country’s biggest railroad, which went into bankruptcy in 1970, Graham concludes that “the application of the simplest rules of security analysis and the simplest standards of sound investment would have revealed the fundamental weakness” of the company “long before its bankruptcy” (423). Among other signs of trouble, Graham notes suspicious transactions and accounting methods as well as the fact that the company did not pay income taxes over a significant period.

Graham characterizes Ling-Temco-Vought as a high-growth company that plunged into debt. Despite its initial success, the company’s aggressive acquisition strategy and heavy borrowing eventually led to its downfall. Graham then describes the takeover of Sharon Steel by NVF. Out of all the takeovers that took place in 1969, he characterizes it as “no doubt the most extreme in its financial disproportions” (430). NVF was much smaller than the company it acquired. He also notes fraudulent accounting practices used by NVF to inflate its earnings. In the case of AAA Enterprises, Graham notes that it was a heavily leveraged company that relied on the success of several subsidiaries to generate profits.

Zweig provides updated versions of Graham’s case studies, mapping companies from the 1990s and 2000s onto Graham’s examples. He provides Lucent Technologies Inc. as an example of a company with a huge and undeserved valuation (438). Zweig also examines the serial acquirer Tyco International Ltd. As a case study of a small company acquiring a big one, he discusses the merging of AOL and Time Warner. And as an example of a “basically worthless company,” he discusses eToys Inc. (438).