Intelligent Investor

This chapter will outline the viewpoints that will be set forth in
the remainder of the book. In particular we wish to develop at the
outset our concept of appropriate portfolio policy for the individual,
nonprofessional investor.
Investment versus Speculation
What do we mean by “investor”? Throughout this book the
term will be used in contradistinction to “speculator.” As far back
as 1934, in our textbook Security Analysis,1 we attempted a precise
formulation of the difference between the two, as follows: “An
investment operation is one which, upon thorough analysis promises
safety of principal and an adequate return. Operations not
meeting these requirements are speculative.”


While we have clung tenaciously to this definition over the
ensuing 38 years, it is worthwhile noting the radical changes that
have occurred in the use of the term “investor” during this period.
After the great market decline of 1929–1932 all common stocks
were widely regarded as speculative by nature. (A leading authority
stated flatly that only bonds could be bought for investment.2)
Thus we had then to defend our definition against the charge that
it gave too wide scope to the concept of investment.
Now our concern is of the opposite sort. We must prevent our
readers from accepting the common jargon which applies the term
“investor” to anybody and everybody in the stock market. In our
last edition we cited the following headline of a front-page article
of our leading financial journal in June 1962:

SMALL INVESTORS BEARISH, THEY ARE SELLING ODD-LOTS SHORT
In October 1970 the same journal had an editorial critical of what it
called “reckless investors,” who this time were rushing in on the
buying side.

These quotations well illustrate the confusion that has been
dominant for many years in the use of the words investment and
speculation. Think of our suggested definition of investment given
above, and compare it with the sale of a few shares of stock by an
inexperienced member of the public, who does not even own what
he is selling, and has some largely emotional conviction that he
will be able to buy them back at a much lower price. (It is not irrelevant
to point out that when the 1962 article appeared the market
had already experienced a decline of major size, and was now getting
ready for an even greater upswing. It was about as poor a time
as possible for selling short.) In a more general sense, the later-used
phrase “reckless investors” could be regarded as a laughable contradiction
in terms—something like “spendthrift misers”—were
this misuse of language not so mischievous.
The newspaper employed the word “investor” in these
instances because, in the easy language of Wall Street, everyone
who buys or sells a security has become an investor, regardless of
what he buys, or for what purpose, or at what price, or whether for
cash or on margin. Compare this with the attitude of the public
toward common stocks in 1948, when over 90% of those queried
expressed themselves as opposed to the purchase of common
stocks.3 About half gave as their reason “not safe, a gamble,” and
about half, the reason “not familiar with.”* It is indeed ironical
Investment versus Speculation 19
* The survey Graham cites was conducted for the Fed by the University of
Michigan and was published in the Federal Reserve Bulletin, July, 1948.
People were asked, “Suppose a man decides not to spend his money. He
can either put it in a bank or in bonds or he can invest it. What do you think
would be the wisest thing for him to do with the money nowadays—put it in
the bank, buy savings bonds with it, invest it in real estate, or buy common
stock with it?” Only 4% thought common stock would offer a “satisfactory”
return; 26% considered it “not safe” or a “gamble.” From 1949 through
1958, the stock market earned one of its highest 10-year returns in history,
(though not surprising) that common-stock purchases of all kinds
were quite generally regarded as highly speculative or risky at a
time when they were selling on a most attractive basis, and due
soon to begin their greatest advance in history; conversely the very
fact they had advanced to what were undoubtedly dangerous levels
as judged by past experience later transformed them into “investments,”
and the entire stock-buying public into “investors.”

The distinction between investment and speculation in common
stocks has always been a useful one and its disappearance is a
cause for concern. We have often said that Wall Street as an institution
would be well advised to reinstate this distinction and to
emphasize it in all its dealings with the public. Otherwise the stock
exchanges may some day be blamed for heavy speculative losses,
which those who suffered them had not been properly warned
against. Ironically, once more, much of the recent financial embarrassment
of some stock-exchange firms seems to have come from
the inclusion of speculative common stocks in their own capital
funds. We trust that the reader of this book will gain a reasonably
clear idea of the risks that are inherent in common-stock commitments—
risks which are inseparable from the opportunities of
profit that they offer, and both of which must be allowed for in the
investor’s calculations.

What we have just said indicates that there may no longer be
such a thing as a simon-pure investment policy comprising representative
common stocks—in the sense that one can always wait to
buy them at a price that involves no risk of a market or “quotational”
loss large enough to be disquieting. In most periods the
investor must recognize the existence of a speculative factor in his
common-stock holdings. It is his task to keep this component
within minor limits, and to be prepared financially and psychologically
for adverse results that may be of short or long duration.
Two paragraphs should be added about stock speculation per
se, as distinguished from the speculative component now inherent
The Intelligent Investor
averaging 18.7% annually. In a fascinating echo of that early Fed survey, a
poll conducted by BusinessWeek at year-end 2002 found that only 24% of
investors were willing to invest more in their mutual funds or stock portfolios,
down from 47% just three years earlier.

in most representative common stocks. Outright speculation is
neither illegal, immoral, nor (for most people) fattening to the
pocketbook. More than that, some speculation is necessary and
unavoidable, for in many common-stock situations there are substantial
possibilities of both profit and loss, and the risks therein
must be assumed by someone.* There is intelligent speculation as
there is intelligent investing. But there are many ways in which
speculation may be unintelligent. Of these the foremost are: (1)
speculating when you think you are investing; (2) speculating seriously
instead of as a pastime, when you lack proper knowledge
and skill for it; and (3) risking more money in speculation than you
can afford to lose.

In our conservative view every nonprofessional who operates
on margin† should recognize that he is ipso facto speculating, and it
is his broker’s duty so to advise him. And everyone who buys a
so-called “hot” common-stock issue, or makes a purchase in any
way similar thereto, is either speculating or gambling. Speculation
is always fascinating, and it can be a lot of fun while you are ahead
of the game. If you want to try your luck at it, put aside a portion—
the smaller the better—of your capital in a separate fund for this
purpose. Never add more money to this account just because the
Investment versus Speculation

* Speculation is beneficial on two levels: First, without speculation, untested
new companies (like Amazon.com or, in earlier times, the Edison Electric
Light Co.) would never be able to raise the necessary capital for expansion.
The alluring, long-shot chance of a huge gain is the grease that lubricates
the machinery of innovation. Secondly, risk is exchanged (but never eliminated)
every time a stock is bought or sold. The buyer purchases the primary
risk that this stock may go down. Meanwhile, the seller still retains a residual
risk—the chance that the stock he just sold may go up!
† A margin account enables you to buy stocks using money you borrow
from the brokerage firm. By investing with borrowed money, you make more
when your stocks go up—but you can be wiped out when they go down. The
collateral for the loan is the value of the investments in your account—so you
must put up more money if that value falls below the amount you borrowed.
For more information about margin accounts, see www.sec.gov/investor/
pubs/margin.htm, www.sia.com/publications/pdf/MarginsA.pdf, and www.
nyse.com/pdfs/2001_factbook_09.pdf.
market has gone up and profits are rolling in. (That’s the time to
think of taking money out of your speculative fund.) Never mingle
your speculative and investment operations in the same account,
nor in any part of your thinking.

Results to Be Expected by the Defensive Investor
We have already defined the defensive investor as one interested
chiefly in safety plus freedom from bother. In general what
course should he follow and what return can he expect under
“average normal conditions”—if such conditions really exist? To
answer these questions we shall consider first what we wrote on
the subject seven years ago, next what significant changes have
occurred since then in the underlying factors governing the
investor’s expectable return, and finally what he should do and
what he should expect under present-day (early 1972) conditions.

1. What We Said Six Years Ago
We recommended that the investor divide his holdings between
high-grade bonds and leading common stocks; that the proportion
held in bonds be never less than 25% or more than 75%, with the
converse being necessarily true for the common-stock component;
that his simplest choice would be to maintain a 50–50 proportion
between the two, with adjustments to restore the equality when
market developments had disturbed it by as much as, say, 5%. As
an alternative policy he might choose to reduce his common-stock
component to 25% “if he felt the market was dangerously high,”
and conversely to advance it toward the maximum of 75% “if he
felt that a decline in stock prices was making them increasingly
attractive.”

In 1965 the investor could obtain about 41⁄2% on high-grade taxable
bonds and 31⁄4% on good tax-free bonds. The dividend return
on leading common stocks (with the DJIA at 892) was only about
3.2%. This fact, and others, suggested caution. We implied that “at
normal levels of the market” the investor should be able to obtain
an initial dividend return of between 31⁄2% and 41⁄2% on his stock
purchases, to which should be added a steady increase in underlying
value (and in the “normal market price”) of a representative
22 The Intelligent Investor
stock list of about the same amount, giving a return from dividends
and appreciation combined of about 71⁄2% per year. The half
and half division between bonds and stocks would yield about 6%
before income tax. We added that the stock component should
carry a fair degree of protection against a loss of purchasing power
caused by large-scale inflation.
It should be pointed out that the above arithmetic indicated
expectation of a much lower rate of advance in the stock market
than had been realized between 1949 and 1964. That rate had averaged
a good deal better than 10% for listed stocks as a whole, and it
was quite generally regarded as a sort of guarantee that similarly
satisfactory results could be counted on in the future. Few people
were willing to consider seriously the possibility that the high rate
of advance in the past means that stock prices are “now too high,”
and hence that “the wonderful results since 1949 would imply not
very good but bad results for the future.”4

2. What Has Happened Since 1964
The major change since 1964 has been the rise in interest rates on
first-grade bonds to record high levels, although there has since
been a considerable recovery from the lowest prices of 1970. The
obtainable return on good corporate issues is now about 71⁄2% and
even more against 41⁄2% in 1964. In the meantime the dividend
return on DJIA-type stocks had a fair advance also during the market
decline of 1969–70, but as we write (with “the Dow” at 900) it is
less than 3.5% against 3.2% at the end of 1964. The change in going
interest rates produced a maximum decline of about 38% in the
market price of medium-term (say 20-year) bonds during this
period.

There is a paradoxical aspect to these developments. In 1964 we
discussed at length the possibility that the price of stocks might be
too high and subject ultimately to a serious decline; but we did not
consider specifically the possibility that the same might happen to
the price of high-grade bonds. (Neither did anyone else that we
know of.) We did warn (on p. 90) that “a long-term bond may vary
widely in price in response to changes in interest rates.” In the light
of what has since happened we think that this warning—with
attendant examples—was insufficiently stressed. For the fact is that
Investment versus Speculation
if the investor had a given sum in the DJIA at its closing price of
874 in 1964 he would have had a small profit thereon in late 1971;
even at the lowest level (631) in 1970 his indicated loss would have
been less than that shown on good long-term bonds. On the other
hand, if he had confined his bond-type investments to U.S. savings
bonds, short-term corporate issues, or savings accounts, he would
have had no loss in market value of his principal during this period
and he would have enjoyed a higher income return than was
offered by good stocks. It turned out, therefore, that true “cash
equivalents” proved to be better investments in 1964 than common
stocks—in spite of the inflation experience that in theory should
have favored stocks over cash. The decline in quoted principal
value of good longer-term bonds was due to developments in the
money market, an abstruse area which ordinarily does not have an
important bearing on the investment policy of individuals.

This is just another of an endless series of experiences over time
that have demonstrated that the future of security prices is never
predictable.* Almost always bonds have fluctuated much less than
stock prices, and investors generally could buy good bonds of any
maturity without having to worry about changes in their market
value. There were a few exceptions to this rule, and the period after
1964 proved to be one of them. We shall have more to say about
change in bond prices in a later chapter.

3. Expectations and Policy in Late 1971 and Early 1972
Toward the end of 1971 it was possible to obtain 8% taxable
interest on good medium-term corporate bonds, and 5.7% tax-free
on good state or municipal securities. In the shorter-term field the
investor could realize about 6% on U.S. government issues due in
five years. In the latter case the buyer need not be concerned about
The Intelligent Investor
* Read Graham’s sentence again, and note what this greatest of investing
experts is saying: The future of security prices is never predictable. And as
you read ahead in the book, notice how everything else Graham tells you is
designed to help you grapple with that truth. Since you cannot predict the
behavior of the markets, you must learn how to predict and control your own
behavior.
a possible loss in market value, since he is sure of full repayment,
including the 6% interest return, at the end of a comparatively
short holding period. The DJIA at its recurrent price level of 900 in
1971 yields only 3.5%.

Let us assume that now, as in the past, the basic policy decision
to be made is how to divide the fund between high-grade bonds
(or other so-called “cash equivalents”) and leading DJIA-type
stocks. What course should the investor follow under present conditions,
if we have no strong reason to predict either a significant
upward or a significant downward movement for some time in the
future? First let us point out that if there is no serious adverse
change, the defensive investor should be able to count on the current
3.5% dividend return on his stocks and also on an average
annual appreciation of about 4%. As we shall explain later this
appreciation is based essentially on the reinvestment by the various
companies of a corresponding amount annually out of undistributed
profits. On a before-tax basis the combined return of his
stocks would then average, say, 7.5%, somewhat less than his interest
on high-grade bonds.* On an after-tax basis the average return
on stocks would work out at some 5.3%.5 This would be about the
same as is now obtainable on good tax-free medium-term bonds.
These expectations are much less favorable for stocks against
bonds than they were in our 1964 analysis. (That conclusion follows
inevitably from the basic fact that bond yields have gone up
much more than stock yields since 1964.) We must never lose sight
Investment versus Speculation

* How well did Graham’s forecast pan out? At first blush, it seems, very
well: From the beginning of 1972 through the end of 1981, stocks earned
an annual average return of 6.5%. (Graham did not specify the time period
for his forecast, but it’s plausible to assume that he was thinking of a 10-
year time horizon.) However, inflation raged at 8.6% annually over this
period, eating up the entire gain that stocks produced. In this section of his
chapter, Graham is summarizing what is known as the “Gordon equation,”
which essentially holds that the stock market’s future return is the sum of the
current dividend yield plus expected earnings growth. With a dividend yield
of just under 2% in early 2003, and long-term earnings growth of around
2%, plus inflation at a bit over 2%, a future average annual return of roughly
6% is plausible. (See the commentary on Chapter 3.)
of the fact that the interest and principal payments on good bonds
are much better protected and therefore more certain than the dividends
and price appreciation on stocks. Consequently we are
forced to the conclusion that now, toward the end of 1971, bond
investment appears clearly preferable to stock investment. If we
could be sure that this conclusion is right we would have to advise
the defensive investor to put all his money in bonds and none in
common stocks until the current yield relationship changes significantly
in favor of stocks.

But of course we cannot be certain that bonds will work out better
than stocks from today’s levels. The reader will immediately
think of the inflation factor as a potent reason on the other side. In
the next chapter we shall argue that our considerable experience
with inflation in the United States during this century would not
support the choice of stocks against bonds at present differentials
in yield. But there is always the possibility—though we consider it
remote—of an accelerating inflation, which in one way or another
would have to make stock equities preferable to bonds payable in a
fixed amount of dollars.* There is the alternative possibility—
which we also consider highly unlikely—that American business
will become so profitable, without stepped-up inflation, as to justify
a large increase in common-stock values in the next few years.
Finally, there is the more familiar possibility that we shall witness
another great speculative rise in the stock market without a real
justification in the underlying values. Any of these reasons, and
perhaps others we haven’t thought of, might cause the investor to
regret a 100% concentration on bonds even at their more favorable
yield levels.

Hence, after this foreshortened discussion of the major considerations,
we once again enunciate the same basic compromise policy
26 The Intelligent Investor
* Since 1997, when Treasury Inflation-Protected Securities (or TIPS) were
introduced, stocks have no longer been the automatically superior choice
for investors who expect inflation to increase. TIPS, unlike other bonds, rise
in value if the Consumer Price Index goes up, effectively immunizing the
investor against losing money after inflation. Stocks carry no such guarantee
and, in fact, are a relatively poor hedge against high rates of inflation. (For
more details, see the commentary to Chapter 2.)
for defensive investors—namely that at all times they have a significant
part of their funds in bond-type holdings and a significant
part also in equities. It is still true that they may choose between
maintaining a simple 50–50 division between the two components
or a ratio, dependent on their judgment, varying between a minimum
of 25% and a maximum of 75% of either. We shall give our
more detailed view of these alternative policies in a later chapter.
Since at present the overall return envisaged from common stocks
is nearly the same as that from bonds, the presently expectable
return (including growth of stock values) for the investor would
change little regardless of how he divides his fund between the
two components. As calculated above, the aggregate return from
both parts should be about 7.8% before taxes or 5.5% on a tax-free
(or estimated tax-paid) basis. A return of this order is appreciably
higher than that realized by the typical conservative investor over
most of the long-term past. It may not seem attractive in relation to
the 14%, or so, return shown by common stocks during the 20
years of the predominantly bull market after 1949. But it should be
remembered that between 1949 and 1969 the price of the DJIA had
advanced more than fivefold while its earnings and dividends had
about doubled. Hence the greater part of the impressive market
record for that period was based on a change in investors’ and
speculators’ attitudes rather than in underlying corporate values.
To that extent it might well be called a “bootstrap operation.”
In discussing the common-stock portfolio of the defensive
investor, we have spoken only of leading issues of the type
included in the 30 components of the Dow Jones Industrial Average.
We have done this for convenience, and not to imply that these
30 issues alone are suitable for purchase by him. Actually, there are
many other companies of quality equal to or excelling the average
of the Dow Jones list; these would include a host of public utilities
(which have a separate Dow Jones average to represent them).* But
Investment versus Speculation 27
* Today, the most widely available alternatives to the Dow Jones Industrial
Average are the Standard & Poor’s 500-stock index (the “S & P”) and the
Wilshire 5000 index. The S & P focuses on 500 large, well-known companies
that make up roughly 70% of the total value of the U.S. equity market.
The Wilshire 5000 follows the returns of nearly every significant, publicly
the major point here is that the defensive investor’s overall results
are not likely to be decisively different from one diversified or representative
list than from another, or—more accurately—that neither
he nor his advisers could predict with certainty whatever
differences would ultimately develop. It is true that the art of skillful
or shrewd investment is supposed to lie particularly in the
selection of issues that will give better results than the general market.
For reasons to be developed elsewhere we are skeptical of the
ability of defensive investors generally to get better than average
results—which in fact would mean to beat their own overall performance.*
(Our skepticism extends to the management of large
funds by experts.)
Let us illustrate our point by an example that at first may seem
to prove the opposite. Between December 1960 and December 1970
the DJIA advanced from 616 to 839, or 36%. But in the same period
the much larger Standard & Poor’s weighted index of 500 stocks
rose from 58.11 to 92.15, or 58%. Obviously the second group had
proved a better “buy” than the first. But who would have been so
rash as to predict in 1960 that what seemed like a miscellaneous
assortment of all sorts of common stocks would definitely outperform
the aristocratic “thirty tyrants” of the Dow? All this proves,
we insist, that only rarely can one make dependable predictions
about price changes, absolute or relative.
We shall repeat here without apology—for the warning cannot
be given too often—that the investor cannot hope for better than
average results by buying new offerings, or “hot” issues of any
sort, meaning thereby those recommended for a quick profit.† The
contrary is almost certain to be true in the long run. The defensive
investor must confine himself to the shares of important companies
with a long record of profitable operations and in strong financial
condition. (Any security analyst worth his salt could make up such
28 The Intelligent Investor
traded stock in America, roughly 6,700 in all; but, since the largest companies
account for most of the total value of the index, the return of the
Wilshire 5000 is usually quite similar to that of the S & P 500. Several lowcost
mutual funds enable investors to hold the stocks in these indexes as a
single, convenient portfolio.

To conclude this section, let us mention briefly three supplementary
concepts or practices for the defensive investor. The first is the
purchase of the shares of well-established investment funds as an
alternative to creating his own common-stock portfolio. He might
also utilize one of the “common trust funds,” or “commingled
funds,” operated by trust companies and banks in many states; or,
if his funds are substantial, use the services of a recognized investment-
counsel firm. This will give him professional administration
of his investment program along standard lines. The third is the
device of “dollar-cost averaging,” which means simply that the
practitioner invests in common stocks the same number of dollars
each month or each quarter. In this way he buys more shares when
the market is low than when it is high, and he is likely to end up
with a satisfactory overall price for all his holdings. Strictly speaking,
this method is an application of a broader approach known as
“formula investing.” The latter was already alluded to in our suggestion
that the investor may vary his holdings of common stocks
between the 25% minimum and the 75% maximum, in inverse relationship
to the action of the market. These ideas have merit for the
defensive investor, and they will be discussed more amply in later
chapters.*
Results to Be Expected by the Aggressive Investor
Our enterprising security buyer, of course, will desire and
expect to attain better overall results than his defensive or passive
companion. But first he must make sure that his results will not be
worse. It is no difficult trick to bring a great deal of energy, study,
and native ability into Wall Street and to end up with losses instead
of profits. These virtues, if channeled in the wrong directions,
become indistinguishable from handicaps. Thus it is most essential
that the enterprising investor start with a clear conception as to
Investment versus Speculation 29
* For more advice on “well-established investment funds,” see Chapter 9.
“Professional administration” by “a recognized investment-counsel firm” is
discussed in Chapter 10. “Dollar-cost averaging” is explained in Chapter 5.
which courses of action offer reasonable chances of success and
which do not.
First let us consider several ways in which investors and speculators
generally have endeavored to obtain better than average
results. These include:
1. Trading in the market. This usually means buying stocks
when the market has been advancing and selling them after it has
turned downward. The stocks selected are likely to be among those
which have been “behaving” better than the market average. A
small number of professionals frequently engage in short selling.
Here they will sell issues they do not own but borrow through the
established mechanism of the stock exchanges. Their object is to
benefit from a subsequent decline in the price of these issues, by
buying them back at a price lower than they sold them for. (As our
quotation from the Wall Street Journal on p. 19 indicates, even
“small investors”—perish the term!—sometimes try their unskilled
hand at short selling.)
2. Short-term selectivity. This means buying stocks of companies
which are reporting or expected to report increased earnings,
or for which some other favorable development is anticipated.
3. Long-term selectivity. Here the usual emphasis is on an
excellent record of past growth, which is considered likely to continue
in the future. In some cases also the “investor” may choose
companies which have not yet shown impressive results, but are
expected to establish a high earning power later. (Such companies
belong frequently in some technological area—e.g., computers,
drugs, electronics—and they often are developing new processes
or products that are deemed to be especially promising.)
We have already expressed a negative view about the investor’s
overall chances of success in these areas of activity. The first we
have ruled out, on both theoretical and realistic grounds, from the
domain of investment. Stock trading is not an operation “which, on
thorough analysis, offers safety of principal and a satisfactory
return.” More will be said on stock trading in a later chapter.*
30 The Intelligent Investor
* See Chapter 8.
In his endeavor to select the most promising stocks either for the
near term or the longer future, the investor faces obstacles of two
kinds—the first stemming from human fallibility and the second
from the nature of his competition. He may be wrong in his estimate
of the future; or even if he is right, the current market price
may already fully reflect what he is anticipating. In the area of
near-term selectivity, the current year’s results of the company are
generally common property on Wall Street; next year’s results, to
the extent they are predictable, are already being carefully considered.
Hence the investor who selects issues chiefly on the basis of
this year’s superior results, or on what he is told he may expect for
next year, is likely to find that others have done the same thing for
the same reason.
In choosing stocks for their long-term prospects, the investor’s
handicaps are basically the same. The possibility of outright error
in the prediction—which we illustrated by our airlines example on
p. 6—is no doubt greater than when dealing with near-term earnings.
Because the experts frequently go astray in such forecasts, it is
theoretically possible for an investor to benefit greatly by making
correct predictions when Wall Street as a whole is making incorrect
ones. But that is only theoretical. How many enterprising investors
could count on having the acumen or prophetic gift to beat the professional
analysts at their favorite game of estimating long-term
future earnings?
We are thus led to the following logical if disconcerting conclusion:
To enjoy a reasonable chance for continued better than average
results, the investor must follow policies which are (1) inherently
sound and promising, and (2) not popular on Wall Street.
Are there any such policies available for the enterprising
investor? In theory once again, the answer should be yes; and there
are broad reasons to think that the answer should be affirmative in
practice as well. Everyone knows that speculative stock movements
are carried too far in both directions, frequently in the general
market and at all times in at least some of the individual
issues. Furthermore, a common stock may be undervalued because
of lack of interest or unjustified popular prejudice. We can go further
and assert that in an astonishingly large proportion of the
trading in common stocks, those engaged therein don’t appear to
know—in polite terms—one part of their anatomy from another. In
this book we shall point out numerous examples of (past) dis-
Investment versus Speculation 31
crepancies between price and value. Thus it seems that any intelligent
person, with a good head for figures, should have a veritable
picnic on Wall Street, battening off other people’s foolishness. So it
seems, but somehow it doesn’t work out that simply. Buying a neglected
and therefore undervalued issue for profit generally proves
a protracted and patience-trying experience. And selling short a
too popular and therefore overvalued issue is apt to be a test not
only of one’s courage and stamina but also of the depth of one’s
pocketbook.* The principle is sound, its successful application is
not impossible, but it is distinctly not an easy art to master.
There is also a fairly wide group of “special situations,” which
over many years could be counted on to bring a nice annual return
of 20% or better, with a minimum of overall risk to those who knew
their way around in this field. They include intersecurity arbitrages,
payouts or workouts in liquidations, protected hedges of
certain kinds. The most typical case is a projected merger or acquisition
which offers a substantially higher value for certain shares
than their price on the date of the announcement. The number of
such deals increased greatly in recent years, and it should have
been a highly profitable period for the cognoscenti. But with the
multiplication of merger announcements came a multiplication of
obstacles to mergers and of deals that didn’t go through; quite a
few individual losses were thus realized in these once-reliable
operations. Perhaps, too, the overall rate of profit was diminished
by too much competition.†
32 The Intelligent Investor
* In “selling short” (or “shorting”) a stock, you make a bet that its share
price will go down, not up. Shorting is a three-step process: First, you borrow
shares from someone who owns them; then you immediately sell the
borrowed shares; finally, you replace them with shares you buy later. If the
stock drops, you will be able to buy your replacement shares at a lower
price. The difference between the price at which you sold your borrowed
shares and the price you paid for the replacement shares is your gross profit
(reduced by dividend or interest charges, along with brokerage costs). However,
if the stock goes up in price instead of down, your potential loss is
unlimited—making short sales unacceptably speculative for most individual
investors.
† In the late 1980s, as hostile corporate takeovers and leveraged buyouts
multiplied, Wall Street set up institutional arbitrage desks to profit from any
The lessened profitability of these special situations appears one
manifestation of a kind of self-destructive process—akin to the law
of diminishing returns—which has developed during the lifetime
of this book. In 1949 we could present a study of stock-market fluctuations
over the preceding 75 years, which supported a formula—
based on earnings and current interest rates—for determining a
level to buy the DJIA below its “central” or “intrinsic” value,
and to sell out above such value. It was an application of the governing
maxim of the Rothschilds: “Buy cheap and sell dear.”* And
it had the advantage of running directly counter to the ingrained
and pernicious maxim of Wall Street that stocks should be bought
because they have gone up and sold because they have gone down.
Alas, after 1949 this formula no longer worked. A second illustration
is provided by the famous “Dow Theory” of stock-market
movements, in a comparison of its indicated splendid results for
1897–1933 and its much more questionable performance since
1934.
A third and final example of the golden opportunities not
recently available: A good part of our own operations on Wall
Street had been concentrated on the purchase of bargain issues easily
identified as such by the fact that they were selling at less than
their share in the net current assets (working capital) alone, not
counting the plant account and other assets, and after deducting all
liabilities ahead of the stock. It is clear that these issues were selling
at a price well below the value of the enterprise as a private business.
No proprietor or majority holder would think of selling what
he owned at so ridiculously low a figure. Strangely enough, such
Investment versus Speculation 33
errors in pricing these complex deals. They became so good at it that the
easy profits disappeared and many of these desks have been closed down.
Although Graham does discuss it again (see pp. 174–175), this sort of trading
is no longer feasible or appropriate for most people, since only multimillion-
dollar trades are large enough to generate worthwhile profits.
Wealthy individuals and institutions can utilize this strategy through hedge
funds that specialize in merger or “event” arbitrage.
* The Rothschild family, led by Nathan Mayer Rothschild, was the dominant
power in European investment banking and brokerage in the nineteenth
century. For a brilliant history, see Niall Ferguson, The House of Rothschild:
Money’s Prophets, 1798–1848 (Viking, 1998).
anomalies were not hard to find. In 1957 a list was published showing
nearly 200 issues of this type available in the market. In various
ways practically all these bargain issues turned out to be profitable,
and the average annual result proved much more remunerative
than most other investments. But they too virtually disappeared
from the stock market in the next decade, and with them a dependable
area for shrewd and successful operation by the enterprising
investor. However, at the low prices of 1970 there again appeared a
considerable number of such “sub-working-capital” issues, and
despite the strong recovery of the market, enough of them
remained at the end of the year to make up a full-sized portfolio.
The enterprising investor under today’s conditions still has various
possibilities of achieving better than average results. The huge
list of marketable securities must include a fair number that can be
identified as undervalued by logical and reasonably dependable
standards. These should yield more satisfactory results on the
average than will the DJIA or any similarly representative list. In
our view the search for these would not be worth the investor’s
effort unless he could hope to add, say, 5% before taxes to the average
annual return from the stock portion of his portfolio. We shall
try to develop one or more such approaches to stock selection for
use by the active investor.

Inflation, and the fight against it, has been very much in the
public’s mind in recent years. The shrinkage in the purchasing
power of the dollar in the past, and particularly the fear (or hope
by speculators) of a serious further decline in the future, has
greatly influenced the thinking of Wall Street. It is clear that those
with a fixed dollar income will suffer when the cost of living
advances, and the same applies to a fixed amount of dollar principal.
Holders of stocks, on the other hand, have the possibility that a
loss of the dollar’s purchasing power may be offset by advances in
their dividends and the prices of their shares.

On the basis of these undeniable facts many financial authorities
have concluded that (1) bonds are an inherently undesirable form
of investment, and (2) consequently, common stocks are by their
very nature more desirable investments than bonds. We have
heard of charitable institutions being advised that their portfolios
should consist 100% of stocks and zero percent of bonds.* This is
quite a reversal from the earlier days when trust investments were
restricted by law to high-grade bonds (and a few choice preferred
stocks).

Our readers must have enough intelligence to recognize that
even high-quality stocks cannot be a better purchase than bonds
under all conditions—i.e., regardless of how high the stock market
may be and how low the current dividend return compared with
the rates available on bonds. A statement of this kind would be as
absurd as was the contrary one—too often heard years ago—that
any bond is safer than any stock. In this chapter we shall try to
apply various measurements to the inflation factor, in order to
reach some conclusions as to the extent to which the investor may
wisely be influenced by expectations regarding future rises in the
price level.

In this matter, as in so many others in finance, we must base our
views of future policy on a knowledge of past experience. Is inflation
something new for this country, at least in the serious form it
has taken since 1965? If we have seen comparable (or worse) inflations
in living experience, what lessons can be learned from them
in confronting the inflation of today? Let us start with Table 2-1, a
condensed historical tabulation that contains much information
about changes in the general price level and concomitant changes
in the earnings and market value of common stocks. Our figures
will begin with 1915, and thus cover 55 years, presented at fiveyear
intervals. (We use 1946 instead of 1945 to avoid the last year of
wartime price controls.)

The first thing we notice is that we have had inflation in the
past—lots of it. The largest five-year dose was between 1915 and
1920, when the cost of living nearly doubled. This compares with
the advance of 15% between 1965 and 1970. In between, we have
had three periods of declining prices and then six of advances at
varying rates, some rather small. On this showing, the investor
should clearly allow for the probability of continuing or recurrent
inflation to come.

Can we tell what the rate of inflation is likely to be? No clear
answer is suggested by our table; it shows variations of all sorts. It
would seem sensible, however, to take our cue from the rather consistent
record of the past 20 years. The average annual rise in the
consumer price level for this period has been 2.5%; that for
1965–1970 was 4.5%; that for 1970 alone was 5.4%. Official govern-
ment policy has been strongly against large-scale inflation, and
there are some reasons to believe that Federal policies will be more
effective in the future than in recent years.* We think it would be
reasonable for an investor at this point to base his thinking and
decisions on a probable (far from certain) rate of future inflation of,
say, 3% per annum. (This would compare with an annual rate of
about 21⁄2% for the entire period 1915–1970.)1
What would be the implications of such an advance? It would
eat up, in higher living costs, about one-half the income now
obtainable on good medium-term tax-free bonds (or our assumed
after-tax equivalent from high-grade corporate bonds). This would
be a serious shrinkage, but it should not be exaggerated. It would
not mean that the true value, or the purchasing power, of the
investor’s fortune need be reduced over the years. If he spent half
his interest income after taxes he would maintain this buying
power intact, even against a 3% annual inflation.
But the next question, naturally, is, “Can the investor be reasonably
sure of doing better by buying and holding other things than
high-grade bonds, even at the unprecedented rate of return offered
in 1970–1971?” Would not, for example, an all-stock program be
preferable to a part-bond, part-stock program? Do not common
stocks have a built-in protection against inflation, and are they not
almost certain to give a better return over the years than will
bonds? Have not in fact stocks treated the investor far better than
have bonds over the 55-year period of our study?
The answer to these questions is somewhat complicated. Common
stocks have indeed done better than bonds over a long period
of time in the past. The rise of the DJIA from an average of 77 in
1915 to an average of 753 in 1970 works out at an annual compounded
rate of just about 4%, to which we may add another 4%
for average dividend return. (The corresponding figures for the
S & P composite are about the same.) These combined figures of 8%
per year are of course much better than the return enjoyed from
bonds over the same 55-year period. But they do not exceed that
now offered by high-grade bonds. This brings us to the next logical
question: Is there a persuasive reason to believe that common
stocks are likely to do much better in future years than they have in
the last five and one-half decades?
Our answer to this crucial question must be a flat no. Common
stocks may do better in the future than in the past, but they are far
from certain to do so. We must deal here with two different time
elements in investment results. The first covers what is likely to
occur over the long-term future—say, the next 25 years. The second
applies to what is likely to happen to the investor—both financially
and psychologically—over short or intermediate periods, say five
years or less. His frame of mind, his hopes and apprehensions, his
satisfaction or discontent with what he has done, above all his decisions
what to do next, are all determined not in the retrospect of
a lifetime of investment but rather by his experience from year
to year.

On this point we can be categorical. There is no close time connection
between inflationary (or deflationary) conditions and the
movement of common-stock earnings and prices. The obvious
example is the recent period, 1966–1970. The rise in the cost of living
was 22%, the largest in a five-year period since 1946–1950. But
both stock earnings and stock prices as a whole have declined since
1965. There are similar contradictions in both directions in the
record of previous five-year periods.

Inflation and Corporate Earnings
Another and highly important approach to the subject is by a
study of the earnings rate on capital shown by American business.
This has fluctuated, of course, with the general rate of economic
activity, but it has shown no general tendency to advance with
wholesale prices or the cost of living. Actually this rate has fallen
rather markedly in the past twenty years in spite of the inflation of
the period. (To some degree the decline was due to the charging of
more liberal depreciation rates. See Table 2-2.) Our extended studies
have led to the conclusion that the investor cannot count on
much above the recent five-year rate earned on the DJIA group—
The Investor and Inflation 51
about 10% on net tangible assets (book value) behind the shares.2
Since the market value of these issues is well above their book
value—say, 900 market vs. 560 book in mid-1971—the earnings on
current market price work out only at some 61⁄4%. (This relationship
is generally expressed in the reverse, or “times earnings,”
manner—e.g., that the DJIA price of 900 equals 18 times the actual
earnings for the 12 months ended June 1971.)

Our figures gear in directly with the suggestion in the previous
chapter* that the investor may assume an average dividend return
of about 3.5% on the market value of his stocks, plus an appreciation
of, say, 4% annually resulting from reinvested profits. (Note
that each dollar added to book value is here assumed to increase
the market price by about $1.60.)
The reader will object that in the end our calculations make no
allowance for an increase in common-stock earnings and values to
result from our projected 3% annual inflation. Our justification is
the absence of any sign that the inflation of a comparable amount
in the past has had any direct effect on reported per-share earnings.
The cold figures demonstrate that all the large gain in the earnings
of the DJIA unit in the past 20 years was due to a proportionately
large growth of invested capital coming from reinvested profits. If
inflation had operated as a separate favorable factor, its effect
would have been to increase the “value” of previously existing
capital; this in turn should increase the rate of earnings on such old
capital and therefore on the old and new capital combined. But
nothing of the kind actually happened in the past 20 years, during
which the wholesale price level has advanced nearly 40%. (Business
earnings should be influenced more by wholesale prices than
by “consumer prices.”) The only way that inflation can add to
common stock values is by raising the rate of earnings on capital
investment. On the basis of the past record this has not been
the case.

In the economic cycles of the past, good business was accompanied
by a rising price level and poor business by falling prices. It
was generally felt that “a little inflation” was helpful to business
profits. This view is not contradicted by the history of 1950–1970,
52 The Intelligent Investor
* See p. 25.
which reveals a combination of generally continued prosperity and
generally rising prices. But the figures indicate that the effect of all
this on the earning power of common-stock capital (“equity capital”)
has been quite limited; in fact it has not even served to maintain the
rate of earnings on the investment. Clearly there have been important
offsetting influences which have prevented any increase in the
real profitability of American corporations as a whole. Perhaps the
most important of these have been (1) a rise in wage rates exceeding
the gains in productivity, and (2) the need for huge amounts
of new capital, thus holding down the ratio of sales to capital
employed.

Our figures in Table 2-2 indicate that so far from inflation having
benefited our corporations and their shareholders, its effect has
been quite the opposite. The most striking figures in our table are
those for the growth of corporate debt between 1950 and 1969. It is
surprising how little attention has been paid by economists and by
Wall Street to this development. The debt of corporations has
expanded nearly fivefold while their profits before taxes a little
more than doubled. With the great rise in interest rates during this
period, it is evident that the aggregate corporate debt is now an
The Investor and Inflation
adverse economic factor of some magnitude and a real problem for
many individual enterprises. (Note that in 1950 net earnings after
interest but before income tax were about 30% of corporate debt,
while in 1969 they were only 13.2% of debt. The 1970 ratio must
have been even less satisfactory.) In sum it appears that a significant
part of the 11% being earned on corporate equities as a whole
is accomplished by the use of a large amount of new debt costing
4% or less after tax credit. If our corporations had maintained the
debt ratio of 1950, their earnings rate on stock capital would have
fallen still lower, in spite of the inflation.

The stock market has considered that the public-utility enterprises
have been a chief victim of inflation, being caught between a
great advance in the cost of borrowed money and the difficulty of
raising the rates charged under the regulatory process. But this
may be the place to remark that the very fact that the unit costs of
electricity, gas, and telephone services have advanced so much less
than the general price index puts these companies in a strong
strategic position for the future.3 They are entitled by law to charge
rates sufficient for an adequate return on their invested capital, and
this will probably protect their shareholders in the future as it has
in the inflations of the past.

All of the above brings us back to our conclusion that the
investor has no sound basis for expecting more than an average
overall return of, say, 8% on a portfolio of DJIA-type common
stocks purchased at the late 1971 price level. But even if these
expectations should prove to be understated by a substantial
amount, the case would not be made for an all-stock investment
program. If there is one thing guaranteed for the future, it is that
the earnings and average annual market value of a stock portfolio
will not grow at the uniform rate of 4%, or any other figure. In the
memorable words of the elder J. P. Morgan, “They will fluctuate.”*
This means, first, that the common-stock buyer at today’s prices—
54 The Intelligent Investor
* John Pierpont Morgan was the most powerful financier of the late nineteenth
and early twentieth centuries. Because of his vast influence, he was
constantly asked what the stock market would do next. Morgan developed a
mercifully short and unfailingly accurate answer: “It will fluctuate.” See Jean
Strouse, Morgan: American Financier (Random House, 1999), p. 11.
or tomorrow’s—will be running a real risk of having unsatisfactory
results therefrom over a period of years. It took 25 years for General
Electric (and the DJIA itself) to recover the ground lost in the
1929–1932 debacle. Besides that, if the investor concentrates his
portfolio on common stocks he is very likely to be led astray either
by exhilarating advances or by distressing declines. This is particularly
true if his reasoning is geared closely to expectations of further
inflation. For then, if another bull market comes along, he will
take the big rise not as a danger signal of an inevitable fall, not as a
chance to cash in on his handsome profits, but rather as a vindication
of the inflation hypothesis and as a reason to keep on buying
common stocks no matter how high the market level nor how low
the dividend return. That way lies sorrow.

Alternatives to Common Stocks as Inflation Hedges
The standard policy of people all over the world who mistrust
their currency has been to buy and hold gold. This has been against
the law for American citizens since 1935—luckily for them. In the
past 35 years the price of gold in the open market has advanced
from $35 per ounce to $48 in early 1972—a rise of only 35%. But
during all this time the holder of gold has received no income
return on his capital, and instead has incurred some annual
expense for storage. Obviously, he would have done much better
with his money at interest in a savings bank, in spite of the rise in
the general price level.
The near-complete failure of gold to protect against a loss in the
purchasing power of the dollar must cast grave doubt on the ability
of the ordinary investor to protect himself against inflation by
putting his money in “things.”* Quite a few categories of valuable
The Investor and Inflation 55
* The investment philosopher Peter L. Bernstein feels that Graham was
“dead wrong” about precious metals, particularly gold, which (at least in the
years after Graham wrote this chapter) has shown a robust ability to outpace
inflation. Financial adviser William Bernstein agrees, pointing out that a
tiny allocation to a precious-metals fund (say, 2% of your total assets) is too
small to hurt your overall returns when gold does poorly. But, when gold
does well, its returns are often so spectacular—sometimes exceeding 100%
objects have had striking advances in market value over the
years—such as diamonds, paintings by masters, first editions of
books, rare stamps and coins, etc. But in many, perhaps most, of
these cases there seems to be an element of the artificial or the precarious
or even the unreal about the quoted prices. Somehow it is
hard to think of paying $67,500 for a U.S. silver dollar dated 1804
(but not even minted that year) as an “investment operation.”4 We
acknowledge we are out of our depth in this area. Very few of our
readers will find the swimming safe and easy there.
The outright ownership of real estate has long been considered
as a sound long-term investment, carrying with it a goodly amount
of protection against inflation. Unfortunately, real-estate values are
also subject to wide fluctuations; serious errors can be made in
location, price paid, etc.; there are pitfalls in salesmen’s wiles.
Finally, diversification is not practical for the investor of moderate
means, except by various types of participations with others and
with the special hazards that attach to new flotations—not too different
from common-stock ownership. This too is not our field. All
we should say to the investor is, “Be sure it’s yours before you go
into it.”
Conclusion
Naturally, we return to the policy recommended in our previous
chapter. Just because of the uncertainties of the future the investor
cannot afford to put all his funds into one basket—neither in the
bond basket, despite the unprecedentedly high returns that bonds
have recently offered; nor in the stock basket, despite the prospect
of continuing inflation.
The more the investor depends on his portfolio and the income
therefrom, the more necessary it is for him to guard against the
56 The Intelligent Investor
in a year—that it can, all by itself, set an otherwise lackluster portfolio glittering.
However, the intelligent investor avoids investing in gold directly, with its
high storage and insurance costs; instead, seek out a well-diversified mutual
fund specializing in the stocks of precious-metal companies and charging
below 1% in annual expenses. Limit your stake to 2% of your total financial
assets (or perhaps 5% if you are over the age of 65).
unexpected and the disconcerting in this part of his life. It is
axiomatic that the conservative investor should seek to minimize
his risks. We think strongly that the risks involved in buying, say, a
telephone-company bond at yields of nearly 71⁄2% are much less
than those involved in buying the DJIA at 900 (or any stock list
equivalent thereto). But the possibility of large-scale inflation
remains, and the investor must carry some insurance against it.
There is no certainty that a stock component will insure adequately
against such inflation, but it should carry more protection than the
bond component.

This is what we said on the subject in our 1965 edition (p. 97),
and we would write the same today:
It must be evident to the reader that we have no enthusiasm for
common stocks at these levels (892 for the DJIA). For reasons
already given we feel that the defensive investor cannot afford to
be without an appreciable proportion of common stocks in his
portfolio, even if we regard them as the lesser of two evils—the
greater being the risks in an all-bond holding.

The investor’s portfolio of common stocks will represent a small
cross-section of that immense and formidable institution known as
the stock market. Prudence suggests that he have an adequate idea
of stock-market history, in terms particularly of the major fluctuations
in its price level and of the varying relationships between
stock prices as a whole and their earnings and dividends. With this
background he may be in a position to form some worthwhile
judgment of the attractiveness or dangers of the level of the market
as it presents itself at different times. By a coincidence, useful statistical
data on prices, earnings, and dividends go back just 100
years, to 1871. (The material is not nearly as full or dependable in
the first half-period as in the second, but it will serve.) In this chapter
we shall present the figures, in highly condensed form, with
two objects in view. The first is to show the general manner in
which stocks have made their underlying advance through the
many cycles of the past century. The second is to view the picture
in terms of successive ten-year averages, not only of stock prices
but of earnings and dividends as well, to bring out the varying
relationship between the three important factors. With this wealth
of material as a background we shall pass to a consideration of the
level of stock prices at the beginning of 1972.

The investor’s portfolio of common stocks will represent a small
cross-section of that immense and formidable institution known as
the stock market. Prudence suggests that he have an adequate idea
of stock-market history, in terms particularly of the major fluctuations
in its price level and of the varying relationships between
stock prices as a whole and their earnings and dividends. With this
background he may be in a position to form some worthwhile
judgment of the attractiveness or dangers of the level of the market
as it presents itself at different times. By a coincidence, useful statistical
data on prices, earnings, and dividends go back just 100
years, to 1871. (The material is not nearly as full or dependable in
the first half-period as in the second, but it will serve.) In this chapter
we shall present the figures, in highly condensed form, with
two objects in view. The first is to show the general manner in
which stocks have made their underlying advance through the
many cycles of the past century. The second is to view the picture
in terms of successive ten-year averages, not only of stock prices
but of earnings and dividends as well, to bring out the varying
relationship between the three important factors. With this wealth
of material as a background we shall pass to a consideration of the
level of stock prices at the beginning of 1972.

The long-term history of the stock market is summarized in two
tables and a chart. Table 3-1 sets forth the low and high points of
nineteen bear- and bull-market cycles in the past 100 years. We
have used two indexes here. The first represents a combination of
an early study by the Cowles Commission going back to 1870,
which has been spliced on to and continued to date in the well.


on Wall Street with such fine achievements, and a quite illogical and
dangerous conviction that equally marvelous results could be
expected for common stocks in the future. Few people seem to have
been bothered by the thought that the very extent of the rise might
indicate that it had been overdone. The subsequent decline from the
1968 high to the 1970 low was 36% for the Standard & Poor’s composite
(and 37% for the DJIA), the largest since the 44% suffered in
1939–1942, which had reflected the perils and uncertainties after
Pearl Harbor. In the dramatic manner so characteristic of Wall
Street, the low level of May 1970 was followed by a massive and
speedy recovery of both averages, and the establishment of a new
all-time high for the Standard & Poor’s industrials in early 1972.

The annual rate of price advance between 1949 and 1970 works out
at about 9% for the S & P composite (or the industrial index), using
the average figures for both years. That rate of climb was, of course,
much greater than for any similar period before 1950. (But in the last
decade the rate of advance was much lower—51⁄4% for the S & P
composite index and only the once familiar 3% for the DJIA.)

The record of price movements should be supplemented by corresponding
figures for earnings and dividends, in order to provide
an overall view of what has happened to our share economy over
the ten decades. We present a conspectus of this kind in our Table
3-2 (p. 71). It is a good deal to expect from the reader that he study
all these figures with care, but for some we hope they will be interesting
and instructive.

Let us comment on them as follows: The full decade figures
smooth out the year-to-year fluctuations and leave a general picture
of persistent growth. Only two of the nine decades after the
first show a decrease in earnings and average prices (in 1891–1900
and 1931–1940), and no decade after 1900 shows a decrease in average
dividends. But the rates of growth in all three categories are
quite variable. In general the performance since World War II has
been superior to that of earlier decades, but the advance in the
1960s was less pronounced than that of the 1950s. Today’s investor
A Century of Stock-Market History 69
Record, 1926–65,” The Journal of Business, vol. XLI, no. 3 (July, 1968),
pp. 291–316. For a summary of the study’s wide influence, see http://
library.dfaus.com/reprints/work_of_art/.
cannot tell from this record what percentage gain in earnings dividends
and prices he may expect in the next ten years, but it does
supply all the encouragement he needs for a consistent policy of
common-stock investment.

However, a point should be made here that is not disclosed in
our table. The year 1970 was marked by a definite deterioration in
the overall earnings posture of our corporations. The rate of profit
on invested capital fell to the lowest percentage since the World
War years. Equally striking is the fact that a considerable number
of companies reported net losses for the year; many became “financially
troubled,” and for the first time in three decades there were
quite a few important bankruptcy proceedings. These facts as
much as any others have prompted the statement made above*
that the great boom era may have come to an end in 1969–1970.
A striking feature of Table 3-2 is the change in the price/earnings
ratios since World War II.† In June 1949 the S & P composite
index sold at only 6.3 times the applicable earnings of the past 12
months; in March 1961 the ratio was 22.9 times. Similarly, the dividend
yield on the S & P index had fallen from over 7% in 1949 to
only 3.0% in 1961, a contrast heightened by the fact that interest
rates on high-grade bonds had meanwhile risen from 2.60% to
4.50%. This is certainly the most remarkable turnabout in the
public’s attitude in all stock-market history.

To people of long experience and innate caution the passage
from one extreme to another carried a strong warning of trouble
ahead. They could not help thinking apprehensively of the
1926–1929 bull market and its tragic aftermath. But these fears have
not been confirmed by the event. True, the closing price of the DJIA
70 The Intelligent Investor

The following data based largely on figures appearing in N. Molodovsky’s article, “Stock Values and Stock Prices,” Financial Analysts Journal,
May 1960. These, in turn, are taken from the Cowles Commission book Common Stock Indexes for years before 1926 and from the spliced-on
Standard & Poor’s 500-stock composite index for 1926 to date.
b The annual growth-rate figures are Molodovsky compilations covering successive 21-year periods ending in 1890, 1900, etc.

c Growth rate for 1968–1970 vs. 1958–1960.
d These growth-rate figures are for 1954–1956 vs. 1947–1949, 1961–1963 vs. 1954–1956, and for 1968–1970 vs. 1958–1960.

in 1970 was the same as it was 61⁄2 years earlier, and the much heralded
“Soaring Sixties” proved to be mainly a march up a series of
high hills and then down again. But nothing has happened either
to business or to stock prices that can compare with the bear market
and depression of 1929–1932.

The Stock-Market Level in Early 1972
With a century-long conspectus of stock, prices, earnings, and
dividends before our eyes, let us try to draw some conclusions
about the level of 900 for the DJIA and 100 for the S & P composite
index in January 1972.

In each of our former editions we have discussed the level of the
stock market at the time of writing, and endeavored to answer the
question whether it was too high for conservative purchase. The
reader may find it informing to review the conclusions we reached
on these earlier occasions. This is not entirely an exercise in selfpunishment.
It will supply a sort of connecting tissue that links the
various stages of the stock market in the past twenty years and also
a taken-from-life picture of the difficulties facing anyone who tries
to reach an informed and critical judgment of current market levels.
Let us, first, reproduce the summary of the 1948, 1953, and 1959
analyses that we gave in the 1965 edition:

In 1948 we applied conservative standards to the Dow Jones
level of 180, and found no difficulty in reaching the conclusion that
“it was not too high in relation to underlying values.” When we
approached this problem in 1953 the average market level for that
year had reached 275, a gain of over 50% in five years. We asked
ourselves the same question—namely, “whether in our opinion the
level of 275 for the Dow Jones Industrials was or was not too high
for sound investment.” In the light of the subsequent spectacular
advance, it may seem strange to have to report that it was by no
means easy for us to reach a definitive conclusion as to the attractiveness
of the 1953 level. We did say, positively enough, that
“from the standpoint of value indications—our chief investment
guide—the conclusion about 1953 stock prices must be favorable.”
But we were concerned about the fact that in 1953, the averages
had advanced for a longer period than in most bull markets of the
72 The Intelligent Investor
past, and that its absolute level was historically high. Setting these
factors against our favorable value judgment, we advised a cautious
or compromise policy. As it turned out, this was not a particularly
brilliant counsel. A good prophet would have foreseen that
the market level was due to advance an additional 100% in the
next five years. Perhaps we should add in self-defense that few if
any of those whose business was stock-market forecasting—as
ours was not—had any better inkling than we did of what lay
ahead.

At the beginning of 1959 we found the DJIA at an all-time high
of 584. Our lengthy analysis made from all points of view may be
summarized in the following (from page 59 of the 1959 edition):
“In sum, we feel compelled to express the conclusion that the present
level of stock prices is a dangerous one. It may well be perilous
because prices are already far too high. But even if this is not the
case the market’s momentum is such as inevitably to carry it to
unjustifiable heights. Frankly, we cannot imagine a market of the
future in which there will never be any serious losses, and in
which, every tyro will be guaranteed a large profit on his stock
purchases.”

The caution we expressed in 1959 was somewhat better justified
by the sequel than was our corresponding attitude in 1954. Yet
it was far from fully vindicated. The DJIA advanced to 685 in 1961;
then fell a little below our 584 level (to 566) later in the year;
advanced again to 735 in late 1961; and then declined in near panic
to 536 in May 1962, showing a loss of 27% within the brief period
of six months. At the same time there was a far more serious
shrinkage in the most popular “growth stocks”—as evidenced by
the striking fall of the indisputable leader, International Business
Machines, from a high of 607 in December 1961 to a low of 300 in
June 1962.

This period saw a complete debacle in a host of newly launched
common stocks of small enterprises—the so-called hot issues—
which had been offered to the public at ridiculously high prices
and then had been further pushed up by needless speculation to
levels little short of insane. Many of these lost 90% and more of the
quotations in just a few months.

The collapse in the first half of 1962 was disconcerting, if not
disastrous, to many self-acknowledged speculators and perhaps
A Century of Stock-Market History 73
to many more imprudent people who called themselves “investors.”
But the turnabout that came later that year was equally
unsuspected by the financial community. The stock-market averages
resumed their upward course, producing the following
sequence:
Standard & Poor’s
DJIA 500-Stock Composite
December 1961 735 72.64
June 1962 536 52.32
November 1964 892 86.28

The recovery and new ascent of common-stock prices was
indeed remarkable and created a corresponding revision of Wall
Street sentiment. At the low level of June 1962 predictions had
appeared predominantly bearish, and after the partial recovery to
the end of that year they were mixed, leaning to the skeptical side.
But at the outset of 1964 the natural optimism of brokerage firms
was again manifest; nearly all the forecasts were on the bullish
side, and they so continued through the 1964 advance.

We then approached the task of appraising the November 1964
levels of the stock market (892 for the DJIA). After discussing
it learnedly from numerous angles we reached three main conclusions.
The first was that “old standards (of valuation) appear
inapplicable; new standards have not yet been tested by time.”
The second was that the investor “must base his policy on the
existence of major uncertainties. The possibilities compass the
extremes, on the one hand, of a protracted and further advance in
the market’s level—say by 50%, or to 1350 for the DJIA; or, on the
other hand, of a largely unheralded collapse of the same magnitude,
bringing the average in the neighborhood of, say, 450"
(p. 63). The third was expressed in much more definite terms. We
said: “Speaking bluntly, if the 1964 price level is not too high how
could we say that any price level is too high?” And the chapter
closed as follows:
74 The Intelligent Investor

WHAT COURSE TO FOLLOW
Investors should not conclude that the 1964 market level is dangerous
merely because they read it in this book. They must weigh
our reasoning against the contrary reasoning they will hear from
most competent and experienced people on Wall Street. In the end
each one must make his own decision and accept responsibility
therefor. We suggest, however, that if the investor is in doubt as to
which course to pursue he should choose the path of caution. The
principles of investment, as set forth herein, would call for the following
policy under 1964 conditions, in order of urgency:
1. No borrowing to buy or hold securities.
2. No increase in the proportion of funds held in common stocks.
3. A reduction in common-stock holdings where needed to bring
it down to a maximum of 50 per cent of the total portfolio. The
capital-gains tax must be paid with as good grace as possible,
and the proceeds invested in first-quality bonds or held as a
savings deposit.

Investors who for some time have been following a bona fide
dollar-cost averaging plan can in logic elect either to continue their
periodic purchases unchanged or to suspend them until they feel
the market level is no longer dangerous. We should advise rather
strongly against the initiation of a new dollar-averaging plan at the
late 1964 levels, since many investors would not have the stamina
to pursue such a scheme if the results soon after initiation should
appear highly unfavorable.

This time we can say that our caution was vindicated. The DJIA
advanced about 11% further, to 995, but then fell irregularly to a
low of 632 in 1970, and finished that year at 839. The same kind of
debacle took place in the price of “hot issues”—i.e., with declines
running as much as 90%—as had happened in the 1961–62 setback.
And, as pointed out in the Introduction, the whole financial picture
appeared to have changed in the direction of less enthusiasm and
greater doubts. A single fact may summarize the story: The DJIA
closed 1970 at a level lower than six years before—the first time
such a thing had happened since 1944.

A Century of Stock-Market History 75
Such were our efforts to evaluate former stock-market levels. Is
there anything we and our readers can learn from them? We considered
the market level favorable for investment in 1948 and 1953
(but too cautiously in the latter year), “dangerous” in 1959 (at 584
for DJIA), and “too high” (at 892) in 1964. All of these judgments
could be defended even today by adroit arguments. But it is doubtful
if they have been as useful as our more pedestrian counsels—in
favor of a consistent and controlled common-stock policy on the
one hand, and discouraging endeavors to “beat the market” or to
“pick the winners” on the other.

Nonetheless we think our readers may derive some benefit from
a renewed consideration of the level of the stock market—this time
as of late 1971—even if what we have to say will prove more interesting
than practically useful, or more indicative than conclusive.
There is a fine passage near the beginning of Aristotle’s Ethics that
goes: “It is the mark of an educated mind to expect that amount of
exactness which the nature of the particular subject admits. It is
equally unreasonable to accept merely probable conclusions from a
mathematician and to demand strict demonstration from an orator.”
The work of a financial analyst falls somewhere in the middle
between that of a mathematician and of an orator.

At various times in 1971 the Dow Jones Industrial Average stood
at the 892 level of November 1964 that we considered in our previous
edition. But in the present statistical study we have decided to
use the price level and the related data for the Standard & Poor’s
composite index (or S & P 500), because it is more comprehensive
and representative of the general market than the 30-stock DJIA.
We shall concentrate on a comparison of this material near the four
dates of our former editions—namely the year-ends of 1948, 1953,
1958 and 1963—plus 1968; for the current price level we shall take
the convenient figure of 100, which was registered at various times
in 1971 and in early 1972. The salient data are set forth in Table 3-3.
For our earnings figures we present both the last year’s showing
and the average of three calendar years; for 1971 dividends we use
the last twelve months’ figures; and for 1971 bond interest and
wholesale prices those of August 1971.

The 3-year price/earnings ratio for the market was lower in
October 1971 than at year-end 1963 and 1968. It was about the same
as in 1958, but much higher than in the early years of the long bull
76 The Intelligent Investor.

This important indicator, taken by itself, could not be construed
to indicate that the market was especially high in January
1972. But when the interest yield on high-grade bonds is brought
into the picture, the implications become much less favorable. The
reader will note from our table that the ratio of stock returns (earnings/
price) to bond returns has grown worse during the entire
period, so that the January 1972 figure was less favorable to stocks,
by this criterion, than in any of the previous years examined. When
dividend yields are compared with bond yields we find that the
relationship was completely reversed between 1948 and 1972. In
the early year stocks yielded twice as much as bonds; now bonds
yield twice as much, and more, than stocks.

Our final judgment is that the adverse change in the bondyield/
stock-yield ratio fully offsets the better price/earnings ratio
for late 1971, based on the 3-year earnings figures. Hence our view
of the early 1972 market level would tend to be the same as it was
some 7 years ago—i.e., that it is an unattractive one from the standpoint
of conservative investment. (This would apply to most of the
1971 price range of the DJIA: between, say, 800 and 950.)
In terms of historical market swings the 1971 picture would still
appear to be one of irregular recovery from the bad setback suffered
in 1969–1970. In the past such recoveries have ushered in a
new stage of the recurrent and persistent bull market that began in
1949. (This was the expectation of Wall Street generally during
1971.) After the terrible experience suffered by the public buyers of
low-grade common-stock offerings in the 1968–1970 cycle, it is too
early (in 1971) for another twirl of the new-issue merry-go-round.
Hence that dependable sign of imminent danger in the market is
lacking now, as it was at the 892 level of the DJIA in November
1964, considered in our previous edition. Technically, then, the outlook
would appear to favor another substantial rise far beyond the
900 DJIA level before the next serious setback or collapse. But we
cannot quite leave the matter there, as perhaps we should. To us,
the early-1971-market’s disregard of the harrowing experiences of
less than a year before is a disquieting sign. Can such heedlessness
go unpunished? We think the investor must be prepared for difficult
times ahead—perhaps in the form of a fairly quick replay of
the the 1969–1970 decline, or perhaps in the form of another bullmarket
fling, to be followed by a more catastrophic collapse.3


The long-term history of the stock market is summarized in two
tables and a chart. Table 3-1 sets forth the low and high points of
nineteen bear- and bull-market cycles in the past 100 years. We
have used two indexes here. The first represents a combination of
an early study by the Cowles Commission going back to 1870,
which has been spliced on to and continued to date in the well.


on Wall Street with such fine achievements, and a quite illogical and
dangerous conviction that equally marvelous results could be
expected for common stocks in the future. Few people seem to have
been bothered by the thought that the very extent of the rise might
indicate that it had been overdone. The subsequent decline from the
1968 high to the 1970 low was 36% for the Standard & Poor’s composite
(and 37% for the DJIA), the largest since the 44% suffered in
1939–1942, which had reflected the perils and uncertainties after
Pearl Harbor. In the dramatic manner so characteristic of Wall
Street, the low level of May 1970 was followed by a massive and
speedy recovery of both averages, and the establishment of a new
all-time high for the Standard & Poor’s industrials in early 1972.

The annual rate of price advance between 1949 and 1970 works out
at about 9% for the S & P composite (or the industrial index), using
the average figures for both years. That rate of climb was, of course,
much greater than for any similar period before 1950. (But in the last
decade the rate of advance was much lower—51⁄4% for the S & P
composite index and only the once familiar 3% for the DJIA.)

The record of price movements should be supplemented by corresponding
figures for earnings and dividends, in order to provide
an overall view of what has happened to our share economy over
the ten decades. We present a conspectus of this kind in our Table
3-2 (p. 71). It is a good deal to expect from the reader that he study
all these figures with care, but for some we hope they will be interesting
and instructive.

Let us comment on them as follows: The full decade figures
smooth out the year-to-year fluctuations and leave a general picture
of persistent growth. Only two of the nine decades after the
first show a decrease in earnings and average prices (in 1891–1900
and 1931–1940), and no decade after 1900 shows a decrease in average
dividends. But the rates of growth in all three categories are
quite variable. In general the performance since World War II has
been superior to that of earlier decades, but the advance in the
1960s was less pronounced than that of the 1950s. Today’s investor
A Century of Stock-Market History 69
Record, 1926–65,” The Journal of Business, vol. XLI, no. 3 (July, 1968),
pp. 291–316. For a summary of the study’s wide influence, see http://
library.dfaus.com/reprints/work_of_art/.
cannot tell from this record what percentage gain in earnings dividends
and prices he may expect in the next ten years, but it does
supply all the encouragement he needs for a consistent policy of
common-stock investment.

However, a point should be made here that is not disclosed in
our table. The year 1970 was marked by a definite deterioration in
the overall earnings posture of our corporations. The rate of profit
on invested capital fell to the lowest percentage since the World
War years. Equally striking is the fact that a considerable number
of companies reported net losses for the year; many became “financially
troubled,” and for the first time in three decades there were
quite a few important bankruptcy proceedings. These facts as
much as any others have prompted the statement made above*
that the great boom era may have come to an end in 1969–1970.
A striking feature of Table 3-2 is the change in the price/earnings
ratios since World War II.† In June 1949 the S & P composite
index sold at only 6.3 times the applicable earnings of the past 12
months; in March 1961 the ratio was 22.9 times. Similarly, the dividend
yield on the S & P index had fallen from over 7% in 1949 to
only 3.0% in 1961, a contrast heightened by the fact that interest
rates on high-grade bonds had meanwhile risen from 2.60% to
4.50%. This is certainly the most remarkable turnabout in the
public’s attitude in all stock-market history.

To people of long experience and innate caution the passage
from one extreme to another carried a strong warning of trouble
ahead. They could not help thinking apprehensively of the
1926–1929 bull market and its tragic aftermath. But these fears have
not been confirmed by the event. True, the closing price of the DJIA
70 The Intelligent Investor

The following data based largely on figures appearing in N. Molodovsky’s article, “Stock Values and Stock Prices,” Financial Analysts Journal,
May 1960. These, in turn, are taken from the Cowles Commission book Common Stock Indexes for years before 1926 and from the spliced-on
Standard & Poor’s 500-stock composite index for 1926 to date.
b The annual growth-rate figures are Molodovsky compilations covering successive 21-year periods ending in 1890, 1900, etc.

c Growth rate for 1968–1970 vs. 1958–1960.
d These growth-rate figures are for 1954–1956 vs. 1947–1949, 1961–1963 vs. 1954–1956, and for 1968–1970 vs. 1958–1960.

in 1970 was the same as it was 61⁄2 years earlier, and the much heralded
“Soaring Sixties” proved to be mainly a march up a series of
high hills and then down again. But nothing has happened either
to business or to stock prices that can compare with the bear market
and depression of 1929–1932.

The Stock-Market Level in Early 1972
With a century-long conspectus of stock, prices, earnings, and
dividends before our eyes, let us try to draw some conclusions
about the level of 900 for the DJIA and 100 for the S & P composite
index in January 1972.

In each of our former editions we have discussed the level of the
stock market at the time of writing, and endeavored to answer the
question whether it was too high for conservative purchase. The
reader may find it informing to review the conclusions we reached
on these earlier occasions. This is not entirely an exercise in selfpunishment.
It will supply a sort of connecting tissue that links the
various stages of the stock market in the past twenty years and also
a taken-from-life picture of the difficulties facing anyone who tries
to reach an informed and critical judgment of current market levels.
Let us, first, reproduce the summary of the 1948, 1953, and 1959
analyses that we gave in the 1965 edition:

In 1948 we applied conservative standards to the Dow Jones
level of 180, and found no difficulty in reaching the conclusion that
“it was not too high in relation to underlying values.” When we
approached this problem in 1953 the average market level for that
year had reached 275, a gain of over 50% in five years. We asked
ourselves the same question—namely, “whether in our opinion the
level of 275 for the Dow Jones Industrials was or was not too high
for sound investment.” In the light of the subsequent spectacular
advance, it may seem strange to have to report that it was by no
means easy for us to reach a definitive conclusion as to the attractiveness
of the 1953 level. We did say, positively enough, that
“from the standpoint of value indications—our chief investment
guide—the conclusion about 1953 stock prices must be favorable.”
But we were concerned about the fact that in 1953, the averages
had advanced for a longer period than in most bull markets of the
72 The Intelligent Investor
past, and that its absolute level was historically high. Setting these
factors against our favorable value judgment, we advised a cautious
or compromise policy. As it turned out, this was not a particularly
brilliant counsel. A good prophet would have foreseen that
the market level was due to advance an additional 100% in the
next five years. Perhaps we should add in self-defense that few if
any of those whose business was stock-market forecasting—as
ours was not—had any better inkling than we did of what lay
ahead.

At the beginning of 1959 we found the DJIA at an all-time high
of 584. Our lengthy analysis made from all points of view may be
summarized in the following (from page 59 of the 1959 edition):
“In sum, we feel compelled to express the conclusion that the present
level of stock prices is a dangerous one. It may well be perilous
because prices are already far too high. But even if this is not the
case the market’s momentum is such as inevitably to carry it to
unjustifiable heights. Frankly, we cannot imagine a market of the
future in which there will never be any serious losses, and in
which, every tyro will be guaranteed a large profit on his stock
purchases.”

The caution we expressed in 1959 was somewhat better justified
by the sequel than was our corresponding attitude in 1954. Yet
it was far from fully vindicated. The DJIA advanced to 685 in 1961;
then fell a little below our 584 level (to 566) later in the year;
advanced again to 735 in late 1961; and then declined in near panic
to 536 in May 1962, showing a loss of 27% within the brief period
of six months. At the same time there was a far more serious
shrinkage in the most popular “growth stocks”—as evidenced by
the striking fall of the indisputable leader, International Business
Machines, from a high of 607 in December 1961 to a low of 300 in
June 1962.

This period saw a complete debacle in a host of newly launched
common stocks of small enterprises—the so-called hot issues—
which had been offered to the public at ridiculously high prices
and then had been further pushed up by needless speculation to
levels little short of insane. Many of these lost 90% and more of the
quotations in just a few months.

The collapse in the first half of 1962 was disconcerting, if not
disastrous, to many self-acknowledged speculators and perhaps
A Century of Stock-Market History 73
to many more imprudent people who called themselves “investors.”
But the turnabout that came later that year was equally
unsuspected by the financial community. The stock-market averages
resumed their upward course, producing the following
sequence:
Standard & Poor’s
DJIA 500-Stock Composite
December 1961 735 72.64
June 1962 536 52.32
November 1964 892 86.28

The recovery and new ascent of common-stock prices was
indeed remarkable and created a corresponding revision of Wall
Street sentiment. At the low level of June 1962 predictions had
appeared predominantly bearish, and after the partial recovery to
the end of that year they were mixed, leaning to the skeptical side.
But at the outset of 1964 the natural optimism of brokerage firms
was again manifest; nearly all the forecasts were on the bullish
side, and they so continued through the 1964 advance.

We then approached the task of appraising the November 1964
levels of the stock market (892 for the DJIA). After discussing
it learnedly from numerous angles we reached three main conclusions.
The first was that “old standards (of valuation) appear
inapplicable; new standards have not yet been tested by time.”
The second was that the investor “must base his policy on the
existence of major uncertainties. The possibilities compass the
extremes, on the one hand, of a protracted and further advance in
the market’s level—say by 50%, or to 1350 for the DJIA; or, on the
other hand, of a largely unheralded collapse of the same magnitude,
bringing the average in the neighborhood of, say, 450"
(p. 63). The third was expressed in much more definite terms. We
said: “Speaking bluntly, if the 1964 price level is not too high how
could we say that any price level is too high?” And the chapter
closed as follows:
74 The Intelligent Investor

WHAT COURSE TO FOLLOW
Investors should not conclude that the 1964 market level is dangerous
merely because they read it in this book. They must weigh
our reasoning against the contrary reasoning they will hear from
most competent and experienced people on Wall Street. In the end
each one must make his own decision and accept responsibility
therefor. We suggest, however, that if the investor is in doubt as to
which course to pursue he should choose the path of caution. The
principles of investment, as set forth herein, would call for the following
policy under 1964 conditions, in order of urgency:
1. No borrowing to buy or hold securities.
2. No increase in the proportion of funds held in common stocks.
3. A reduction in common-stock holdings where needed to bring
it down to a maximum of 50 per cent of the total portfolio. The
capital-gains tax must be paid with as good grace as possible,
and the proceeds invested in first-quality bonds or held as a
savings deposit.

Investors who for some time have been following a bona fide
dollar-cost averaging plan can in logic elect either to continue their
periodic purchases unchanged or to suspend them until they feel
the market level is no longer dangerous. We should advise rather
strongly against the initiation of a new dollar-averaging plan at the
late 1964 levels, since many investors would not have the stamina
to pursue such a scheme if the results soon after initiation should
appear highly unfavorable.

This time we can say that our caution was vindicated. The DJIA
advanced about 11% further, to 995, but then fell irregularly to a
low of 632 in 1970, and finished that year at 839. The same kind of
debacle took place in the price of “hot issues”—i.e., with declines
running as much as 90%—as had happened in the 1961–62 setback.
And, as pointed out in the Introduction, the whole financial picture
appeared to have changed in the direction of less enthusiasm and
greater doubts. A single fact may summarize the story: The DJIA
closed 1970 at a level lower than six years before—the first time
such a thing had happened since 1944.

A Century of Stock-Market History 75
Such were our efforts to evaluate former stock-market levels. Is
there anything we and our readers can learn from them? We considered
the market level favorable for investment in 1948 and 1953
(but too cautiously in the latter year), “dangerous” in 1959 (at 584
for DJIA), and “too high” (at 892) in 1964. All of these judgments
could be defended even today by adroit arguments. But it is doubtful
if they have been as useful as our more pedestrian counsels—in
favor of a consistent and controlled common-stock policy on the
one hand, and discouraging endeavors to “beat the market” or to
“pick the winners” on the other.

Nonetheless we think our readers may derive some benefit from
a renewed consideration of the level of the stock market—this time
as of late 1971—even if what we have to say will prove more interesting
than practically useful, or more indicative than conclusive.
There is a fine passage near the beginning of Aristotle’s Ethics that
goes: “It is the mark of an educated mind to expect that amount of
exactness which the nature of the particular subject admits. It is
equally unreasonable to accept merely probable conclusions from a
mathematician and to demand strict demonstration from an orator.”
The work of a financial analyst falls somewhere in the middle
between that of a mathematician and of an orator.

At various times in 1971 the Dow Jones Industrial Average stood
at the 892 level of November 1964 that we considered in our previous
edition. But in the present statistical study we have decided to
use the price level and the related data for the Standard & Poor’s
composite index (or S & P 500), because it is more comprehensive
and representative of the general market than the 30-stock DJIA.
We shall concentrate on a comparison of this material near the four
dates of our former editions—namely the year-ends of 1948, 1953,
1958 and 1963—plus 1968; for the current price level we shall take
the convenient figure of 100, which was registered at various times
in 1971 and in early 1972. The salient data are set forth in Table 3-3.
For our earnings figures we present both the last year’s showing
and the average of three calendar years; for 1971 dividends we use
the last twelve months’ figures; and for 1971 bond interest and
wholesale prices those of August 1971.

The 3-year price/earnings ratio for the market was lower in
October 1971 than at year-end 1963 and 1968. It was about the same
as in 1958, but much higher than in the early years of the long bull
76 The Intelligent Investor.

This important indicator, taken by itself, could not be construed
to indicate that the market was especially high in January
1972. But when the interest yield on high-grade bonds is brought
into the picture, the implications become much less favorable. The
reader will note from our table that the ratio of stock returns (earnings/
price) to bond returns has grown worse during the entire
period, so that the January 1972 figure was less favorable to stocks,
by this criterion, than in any of the previous years examined. When
dividend yields are compared with bond yields we find that the
relationship was completely reversed between 1948 and 1972. In
the early year stocks yielded twice as much as bonds; now bonds
yield twice as much, and more, than stocks.

Our final judgment is that the adverse change in the bondyield/
stock-yield ratio fully offsets the better price/earnings ratio
for late 1971, based on the 3-year earnings figures. Hence our view
of the early 1972 market level would tend to be the same as it was
some 7 years ago—i.e., that it is an unattractive one from the standpoint
of conservative investment. (This would apply to most of the
1971 price range of the DJIA: between, say, 800 and 950.)
In terms of historical market swings the 1971 picture would still
appear to be one of irregular recovery from the bad setback suffered
in 1969–1970. In the past such recoveries have ushered in a
new stage of the recurrent and persistent bull market that began in
1949. (This was the expectation of Wall Street generally during
1971.) After the terrible experience suffered by the public buyers of
low-grade common-stock offerings in the 1968–1970 cycle, it is too
early (in 1971) for another twirl of the new-issue merry-go-round.
Hence that dependable sign of imminent danger in the market is
lacking now, as it was at the 892 level of the DJIA in November
1964, considered in our previous edition. Technically, then, the outlook
would appear to favor another substantial rise far beyond the
900 DJIA level before the next serious setback or collapse. But we
cannot quite leave the matter there, as perhaps we should. To us,
the early-1971-market’s disregard of the harrowing experiences of
less than a year before is a disquieting sign. Can such heedlessness
go unpunished? We think the investor must be prepared for difficult
times ahead—perhaps in the form of a fairly quick replay of
the the 1969–1970 decline, or perhaps in the form of another bullmarket
fling, to be followed by a more catastrophic collapse.