Cheat sheet

Finance on one page

The summary, key terms and the trap to avoid for every lesson, in order. Print it, or read it, cover it, and say it back.

Compound interest Mankiw ch. 14

Compounding: interest earns interest.
Future value = amount × (1 + r)ᴺ, with r as a decimal.
Simple interest only ever uses the original amount.
Rule of 70: doubling time ≈ 70 ÷ rate.
Small rate differences become large over long periods.

future value: what an amount grows to after interest
compounding: earning interest on earlier interest
simple interest: interest on the original amount only
rule of 70: doubling time ≈ 70 ÷ growth rate (%)

Watch out: Multiplying the rate by the number of years. "6% for 10 years is 60%" is simple interest. Compounding gives about 79% here, and the gap grows every year.

Present value Mankiw ch. 14

Money today is worth more than the same money later.
Present value = future amount ÷ (1 + r)ᴺ.
Higher interest rates mean lower present values.
Compare offers paid at different times by their present values.

present value: what a future amount is worth today
discounting: working out a present value
interest rate: the price of waiting; higher rates shrink present values

Watch out: Adding up future payments as if they were all paid today. A prize of 10,000 a year for 30 years is "300,000" on paper, but each later payment is worth less today, so its present value is well below 300,000.

Measuring inflation with a price index Mankiw ch. 11

Inflation is a rise in the general level of prices.
A price index tracks the cost of a basket over time; the basket is held fixed between updates.
Index = cost now ÷ cost in base year × 100.
Inflation is the percentage change between two index values.

consumer price index (CPI): cost of a basket of goods, held fixed between updates, compared with a base year
base year: the year the index is set to 100
inflation rate: percentage change in the price index from one period to the next

Watch out: Reading the index level as the inflation rate. An index of 106.25 does not mean prices rose 106%. It means prices are 6.25% above the base year. Inflation is always the change between two index numbers.

Real and nominal interest rates Mankiw ch. 11

Nominal: how fast the money grows. Real: how fast what it buys grows.
Real ≈ nominal − inflation.
If inflation beats your interest rate, you can buy less.
With deflation, the real rate is above the nominal rate.

nominal interest rate: the rate you are quoted, not corrected for inflation
real interest rate: the rate corrected for inflation: about nominal − inflation
purchasing power: how much your money can buy
deflation: falling prices

Watch out: Thinking you are richer because the balance went up. If inflation is higher than your interest rate, the balance rises while what it buys shrinks.

Investors as a group earn the market minus costs Costs and the market

Before costs, investors as a group earn the market return; trading among them moves money around but adds nothing.
After costs, the group must earn less, by exactly what it pays to brokers, managers, advisers and the tax collector.
Costs come every year and compound, like interest in reverse.
Judge a cost by what it takes over the whole time you hold something.

market return: the return of the whole market
zero-sum: one side's gain is another side's loss
index fund: a fund that simply holds all the shares in a market (or an index), in proportion, and keeps them
expense ratio: a fund's yearly running costs, as a % of what you hold
commission: a fee paid to a broker for each trade
Helpers: Bogle's name for brokers, managers and advisers paid by investors

Watch out: Thinking that because some investors beat others, investors as a group can beat the market. Every gain from a trade is another investor's loss. Only the Helpers are sure to come out ahead.

The balance sheet always balances Reading the accounts

Assets = liabilities + equity, always.
Every transaction changes two things, so the sheet still balances.
Swapping one asset for another leaves totals unchanged.
Profit raises equity; it is not the same as cash.

assets: what a business owns or controls
liabilities: what it owes others
equity: what belongs to the owners: money put in plus profits kept
balance sheet: a snapshot, on one date, of assets, liabilities and equity
statement of financial position: the name used in international accounting standards (and by ACCA) for the balance sheet
capital: another name for the owner's equity, used especially for small businesses; profit adds to it and drawings reduce it
drawings: money or goods the owner takes out of the business for personal use
current and non-current: assets and liabilities are split by whether they turn into cash, or fall due, within about a year

Watch out: Treating profit as cash. Profit raises equity; it does not always mean more cash. A sale on credit, for example, raises profit while the money is still owed by the customer.

Where stock returns come from Bogle ch. 2

Market return ≈ dividend yield + earnings growth + speculative return.
Speculative return per year = (P/E end ÷ P/E start)^(1/years) − 1.
Long run: the businesses dominate. Short run: P/E swings dominate.
Returns boosted by a rising P/E are a weak guide to the future.

dividend yield: yearly dividends as a % of the share price
earnings growth: how fast company profits grow each year
P/E ratio: share price ÷ earnings per share: what investors pay for each 1 of earnings
investment return: dividend yield + earnings growth
speculative return: the yearly effect of a change in the P/E ratio
reversion to the mean: the tendency of unusual results to move back toward the long-run average

Watch out: Treating a rising P/E as a lasting source of return. A P/E can't rise forever: if it went from 15 to 30 in one decade, that decade gained about 7% a year from mood alone, and a later fall back to 15 would take it away again. Bogle, like many others, calls this tendency to swing back reversion to the mean.

Owning the whole market Bogle ch. 3

An index fund holds all the shares of an index, in proportion, and keeps them.
Cap-weighted: weight = company value ÷ total value.
Price changes don't force trades; the fund stays in step automatically.
Bogle: the simplest way to own all of business (Occam's razor).

index: a list of shares with a rule for weighting them
index fund: a fund that holds the shares of an index in the same proportions
market capitalisation: share price × number of shares: a company's total market value
cap-weighted: each company counts in proportion to its market value
S&P 500: an index of about 500 large U.S. companies
Occam's razor: when several solutions work, choose the simplest

Watch out: Thinking an index fund must constantly rebalance as prices move. A cap-weighted fund rebalances itself; it trades mainly when companies join or leave the index, or when money comes in or goes out.

Fund returns versus investor returns Bogle ch. 5

Funds report time-weighted returns; investors earn dollar-weighted returns.
Money arriving after good years and leaving after bad ones makes investor returns lag.
Bogle's 1980–2005 estimate: about 2.7 points a year.
Recent estimates are smaller (Morningstar: about 1.2), and some researchers argue the true timing cost is much smaller still.

time-weighted return: the fund's return per share, as if no money came in or went out
dollar-weighted return: the return on the money investors actually had in, given when they added and withdrew it
investor return: another name for the dollar-weighted return of a fund's investors as a group
performance chasing: buying what has recently done well

Watch out: Assuming you earned the return in a fund's advert or fact sheet. That figure is for money that stayed put the whole time. If you added or withdrew money along the way, your own return can be quite different. Some brokers and fund companies show a personal (dollar-weighted) return on statements.

Taxes are costs too Bogle ch. 6

Selling at a profit realises gains, which may be taxed that year.
High turnover → more realised gains → bigger yearly tax bills.
Paying tax later lets the money keep compounding.
Rules depend on the country and account: this lesson teaches the idea, not any country's law.

capital gain: the profit when something is sold for more than it cost
realised gain: a gain that has been locked in by selling (often taxable)
turnover: how much of a fund's portfolio is traded in a year
tax-efficient: arranged so that as little tax as possible is due before you sell
taxable account: an account where gains and income are taxed as they arise

Watch out: Comparing funds only on their pre-tax returns when the money is in a taxable account. A fund that trades heavily can hand you a tax bill each year that its advertised return doesn't show. (Bogle also notes a twist: an index fund pays out more of its dividends, because its low costs eat less of them, so it can look less tax-efficient on dividends while being more tax-efficient overall.)

When future returns are lower Bogle ch. 7

Rough expected return ≈ dividend yield + earnings growth + P/E change per year.
Bogle's 2007 estimate: about 7%. The actual 2007–2016 return: about 6.9%, through a severe crash.
The same costs take a larger share of a lower return.
A forecast states assumptions; it is not a promise.

expected return: a reasoned estimate of a future average return, never a promise
assumption: an input you choose, such as the future P/E
sensitivity: how much the answer changes when an assumption changes
sequence: the order of good and bad years along the way

Watch out: Treating the past few decades' return as the expected future return. If part of a past return came from a rising P/E, it can't simply be repeated: the P/E would have to keep rising forever.

Why past winners rarely repeat Bogle ch. 8–9

Records that leave out closed funds look better than reality (survivorship bias).
Unusual results tend to fade (reversion to the mean).
A big gain followed by a big loss can leave almost nothing: 1.55 × 0.66 ≈ 1.02.
Current SPIVA data: most active funds trail their index over long periods, and top performers rarely stay on top.

survivorship bias: the distortion when failed funds drop out of the record
reversion to the mean: the tendency of unusual results to move back toward the average
persistence: whether a fund's good performance continues
star rating: a score based on a fund's past risk-adjusted returns

Watch out: Choosing a fund because it has the best record of the last few years. Bogle reports that a portfolio switching into Morningstar's 5-star funds earned 6.9% a year over 1994–2004, against 11.0% for the total stock market (a study by Mark Hulbert). Ratings describe what has happened; Bogle reports they were poor predictors over 1994–2004.

Is advice worth paying for? Costs and the market

Advisers can help with planning, taxes and behaviour; neither Bogle nor Graham expects them to beat the market reliably.
Commission and fee-only pay create different conflicts; both are costs.
A 1% yearly fee can take around 30% of 30 years' gains.
Help is most worth having after big losses, budget trouble, chaotic portfolios or big life changes. Trust, then verify.

commission: pay an adviser receives from a product provider for a sale
fee-only adviser: an adviser paid only by the client, not by product providers
conflict of interest: when an adviser's pay depends on what they recommend
advice fee: a yearly charge, often a % of the money advised on
investment counsel: a professional adviser paid a fee to manage or advise on investments
due diligence: checking someone's background before trusting them

Watch out: Treating a recommendation as free. If an adviser is paid by commission, the product price includes their pay; if fee-only, it's on your statement. Either way, ask how much it is in money per year, and what you get for it.

Costs go on forever Bogle ch. 11–12

Costs = expense ratio + trading costs, plus any sales charges.
Bogle's rule of thumb: trading costs ≈ 1% of the turnover rate.
Before costs, funds earn similar returns; after costs, cheap funds tend to come out ahead.
Costs are the one thing you can know in advance.

expense ratio: yearly running costs as a % of your money
sales charge (load): a one-off charge on buying or selling
trading costs: costs of the fund's own buying and selling, not in the expense ratio
turnover: how much of the portfolio is traded in a year
all-in cost: Bogle's term: expense ratio + trading costs (sales charges come on top)

Watch out: Looking only at the expense ratio. A fund with a low expense ratio but very high turnover, or a big sales charge, may not be cheap at all. Add up all three.

Bonds and money-market funds Bogle ch. 13

Bond and money-market returns come mainly from interest, set by the market.
Similar funds earn similar returns before costs; costs decide most of the difference after.
A fee takes a bigger share of a small yield: 1% of a 4% yield is a quarter of it.
Higher yield usually means more risk: longer maturities or weaker borrowers.

bond: a loan that pays interest and is repaid at maturity
maturity: the date a bond is repaid
yield: the yearly income from a bond or fund, as a % of its price
credit quality: how likely the borrower is to pay; lower quality pays more but risks default
money-market fund: a fund of very short-term, high-quality loans

Watch out: Choosing a bond fund for its higher yield without asking why it's higher. A higher yield often means longer bonds or weaker borrowers: more risk, not a better manager. Bogle also warns against sales charges on bond funds: a 5% charge can wipe out a whole year's interest.

New indexes and ETFs Bogle ch. 14–15

New "smart" indexes depart from the market portfolio, so Bogle treats them as active strategies.
Back-tests are chosen with hindsight and can mislead.
ETFs are a vehicle: broad and held can match a classic index fund; narrow and traded can't.
Researchers still debate whether factor tilts will keep paying.

ETF: exchange-traded fund: a fund whose shares trade on an exchange during the day
fundamental index: an index weighted by measures like sales or dividends, not market value
factor ("smart beta"): a trait such as value, size or momentum that a strategy tilts toward
back-test: applying a rule to past data to see how it would have done
data mining: searching past data until something looks good, which may not last

Watch out: Assuming "index" means "low cost and the whole market". An index can be narrow, frequently changed, or built to follow an active strategy. Check what it holds, how often it trades, and what it costs.

Graham, the arithmetic, and a plan Bogle ch. 16–18

Graham: most investors should be defensive, simple and diversified.
Bogle's arithmetic: returns come from businesses; costs and behaviour decide what investors keep.
His plan: broad low-cost index funds, stay the course, at most a small "funny money" account.
The arithmetic applies to everyone; the plan is one investor's reasoned choice.

defensive investor: Graham's term for someone who invests simply and avoids speculation
the relentless rules of humble arithmetic: Bogle's phrase for: returns minus costs equals what investors keep
serious money / funny money: Bogle's split between long-term savings and a small amount for speculation
stay the course: keep to a sensible plan through good and bad markets
asset allocation: how money is divided between stocks, bonds and cash

Watch out: Treating any one investor's rule of thumb as a rule for you. "Bonds equal to your age" or "5% for fun" are Bogle's personal guides, offered with his own caveats. The arithmetic is general; the plan is personal.

Investment versus speculation Graham ch. 1

Investment = thorough analysis + safety of principal + adequate return.
Speculation isn't wrong in itself; it is unintelligent when mistaken for investing, done without skill, or done with money you can't afford to lose.
Defensive investor: avoid serious losses, minimise effort. Enterprising: put in time and care.
What you buy doesn't decide it; how you decide does.

investment operation: Graham: one that, on thorough analysis, promises safety of principal and an adequate return
speculation: any operation that fails Graham's test
defensive investor: aims to avoid serious losses and wants freedom from effort
enterprising investor: willing to put in time and care to find better-than-average opportunities
margin: buying with borrowed money; Graham counts it as speculation

Watch out: Calling anyone who buys shares an "investor". Graham complained that newspapers used the word for everyone in the market, even people making emotional short-term bets. The word should describe how you decide, not what you own.

Inflation and the investor Graham ch. 2

Inflation erodes fixed payments; stocks can keep up, but not reliably.
Graham, 1915–1970: stocks about 8% a year in all, no better than bonds paid in 1972.
Short term: no close link between inflation and stock prices.
Real return = (1 + return) ÷ (1 + inflation) − 1.

inflation: a general rise in prices, which shrinks what money buys
real return: the return after inflation: (1 + return) ÷ (1 + inflation) − 1
fixed income: payments set in money terms, like bond interest, which inflation erodes
inflation-protected bond: a government bond whose value is adjusted for inflation (Zweig discusses the U.S. version)

Watch out: Treating stocks as a perfect inflation shield. In Zweig's data, stocks did badly in years of very high inflation (and in deflation). Graham's advice is to expect inflation, but to protect against it with a mix, not with one asset.

A century of market history Graham ch. 3

Earnings yield = 1 ÷ P/E.
Graham compared stocks' yields with bond yields to judge whether the market was high.
In early 1972 he judged it no bargain; the 1973–74 fall followed.
Never assume past returns will simply continue: the price you pay changes what you can expect.

earnings yield: earnings ÷ price; the P/E ratio upside down
bond yield: the yearly return on a bond at its current price
bear market: a large, lasting fall in prices
extrapolation: assuming a past trend will simply continue

Watch out: "Stocks have returned 7% after inflation for two centuries, so I'll get 7% from here." Graham's point is that the price you pay changes the return you can expect: the same companies bought at a higher P/E leave less room for return, and for error.

The defensive investor's portfolio Graham ch. 4

Stocks between 25% and 75%; the simplest default is 50–50.
Graham: restore 50–50 when the mix drifts (his example: by about 5 points). Zweig: rebalance every six months.
Rebalancing sells some of what rose and buys what fell.
Graham ties return to effort, not risk; Zweig adds that circumstances matter more than age.

asset allocation: how money is split between stocks, bonds and cash
rebalancing: trading back to your target mix after prices have moved
high-grade bond: a bond from a very creditworthy borrower
defensive investor: Graham: wants safety and freedom from concern (a passive, low-effort approach)

Watch out: Letting the winners run until they dominate. After a long rise, an unrebalanced 50–50 portfolio can become 70–30 or more: much riskier than intended, often after prices have risen a long way. Rebalancing sells a little of what rose and buys what fell.

Defensive investors and stocks Graham ch. 5

Four rules: 10–30 companies; large, prominent, conservatively financed; long dividend record; price limits (25× seven-year average earnings, 20× last year's).
The price rule excludes most growth stocks.
Dollar-cost averaging: same amount, regular intervals; average cost below average price.
Zweig: a broad index fund can now do much of this work with less effort.

diversification: spreading money across many holdings
growth stock: a company expected to grow earnings much faster than average
dollar-cost averaging: investing a fixed amount at regular intervals
earnings multiplier: another name for the P/E ratio
conservatively financed: not heavily in debt

Watch out: Treating a famous, fast-growing company as safe. Growth that's already in the price leaves no room for disappointment. Graham notes that some authorities define a "true growth stock" as one expected to at least double its earnings in ten years (a compounded rate of over 7.1% a year), and that growth stocks were the favourites of speculators and big institutions alike in his day.

What the enterprising investor avoids Graham ch. 6

Graham's enterprising "don'ts": high-grade preferreds (leave to companies), second-grade bonds and preferreds unless at bargain prices (for high-coupon issues, 30%+ below par), foreign government bonds, new issues.
New issues come with salesmanship and are sold when conditions favour sellers.
Zweig: IPO booms repeat, and buyers usually pay too much.
Don't buy anything only for its yield.

par: a bond's face value, the amount repaid at maturity
preferred stock: shares that pay a fixed dividend before ordinary shareholders get anything
second-grade (junk) bond: a bond from a borrower with weaker credit, paying more interest
new issue / IPO: shares or bonds sold to the public for the first time (IPO: initial public offering)

Watch out: Buying a bond or preferred stock only for its high yield. Zweig puts it bluntly: when the yield dries up, there's nothing else there. A higher yield usually means a higher risk that the payments stop.

What the enterprising investor does Graham ch. 7

Enterprising options: unpopular large companies, bargain issues, special situations.
Bargain = worth at least 50% more than the price (price ≤ about two-thirds of value).
Net current asset value = current assets − all liabilities (incl. preferred), per share.
Buy bargains as a diversified group; any single one can fail.

net current asset value: current assets minus all liabilities (including preferred stock)
working capital: current assets minus current liabilities; Graham's "net working capital" here deducts all liabilities, including long-term debt and preferred stock
bargain issue: Graham: worth at least 50% more than its price
special situation: a share whose price depends on a specific event, such as a takeover
unpopular large company: a big company temporarily out of favour with the market

Watch out: Treating "cheap" as "safe" for one company. Graham's evidence is for groups of bargain stocks. A single company priced below its working capital may be losing money fast, so the working capital shrinks before the market recovers.

Mr. Market Graham ch. 8

Mr. Market quotes a price daily; you can trade with him or ignore him.
Prices are offers, not verdicts on value.
Timing (forecasting) leads to speculation; pricing (value versus price) is the investor's approach.
Watch the businesses, and use extreme prices when they come.

Mr. Market: Graham's moody partner who quotes a price every day
timing: trying to forecast market moves and act ahead of them
pricing: buying below fair value, selling above it, or at least never overpaying
fair value: what a business is worth, judged from its earnings and assets

Watch out: Letting the daily price tell you how to feel. Zweig points out that the average contribution to U.S. workplace retirement (401(k)) plans fell from 8.6% of pay in 1999, when stocks were soaring, to 7% in 2002, after three years of falling prices: the cheaper stocks got, the less eager people were to buy them.

Living with fluctuations Graham ch. 8

Even safe bonds change price when interest rates change; longer bonds change more.
A shareholder is both a part-owner and the holder of a tradable share.
Graham: being stampeded by falls turns your advantage into a disadvantage.
Zweig: control your costs, expectations, risk, taxes and above all your behaviour.

interest-rate risk: the chance that rising rates lower a bond's market price
maturity: when a bond is repaid; longer maturity means bigger price swings
present value: what future payments are worth today at a given rate
behaviour: the control Zweig stresses "most of all"

Watch out: Treating a fall in price as a loss you have to act on. Unless you need to sell, a lower price changes what Mr. Market offers. If the business or the borrower hasn't deteriorated, it doesn't change what you're paid; Graham says to check that first.

Investing in funds Graham ch. 9

Open-end funds trade at NAV; closed-end funds trade on an exchange, often at a discount.
Graham: funds were useful, but no better than the market, and may have cost more.
His rule: discounted closed-end funds gave about one-fifth more for the money than mutual funds bought with a 9% charge.
Zweig: start with low cost and good stewardship; treat past returns as the weakest reason to buy, and look at them last.

net asset value (NAV): the value of a fund's holdings per share
open-end (mutual) fund: issues and redeems shares at NAV
closed-end fund: has a fixed number of shares that trade on an exchange, often at a discount or premium to NAV
sales charge (load): a fee paid when buying (or selling) some funds
discount: a closed-end fund's price below its NAV

Watch out: Buying a fund because it was last year's top performer. In Zweig's account, a fund at the top often attracts a flood of new money, swells in size, loses its manager to a rival, or simply had luck that runs out. A good past return is the weakest reason to buy.

Security analysis for the lay investor Graham ch. 11

Bond safety: interest coverage, averaged over years; Graham's minimums vary by type of company (industrials: 7× average or 5× in the worst year, before tax).
Graham's growth formula: value ≈ earnings × (8.5 + 2g): a shortcut, not a precise truth.
Work backwards from the price to see what growth it assumes.
Zweig: watch for serial acquisitions, reliance on outside money and dependence on one customer; look for moats and steady growth.

interest coverage: earnings ÷ interest charges: how many times the company can pay its interest
investment-grade: judged safe enough for a conservative investor
capitalisation rate (multiplier): the number earnings are multiplied by to estimate value
implied growth: the growth rate a price assumes, worked backwards
moat: the term Zweig uses for a lasting competitive advantage

Watch out: Trusting a precise-looking valuation. Every formula depends on the growth figure you put in, and growth forecasts are where analysts are most often wrong. Zweig warns that a growth rate of around 10% a year before tax may be sustainable for a long time, but that companies promising much more, or showing a sudden burst, usually fade.

Per-share earnings and their traps Graham ch. 12

Don't judge a company on one year's earnings.
Watch for special charges and dilution; fully diluted EPS allows for new shares.
Graham: average earnings over 7–10 years, including special items.
Growth: compare the last three years' average with the same three years a decade earlier.
Zweig: ignore "pro forma" earnings.

earnings per share (EPS): net profit ÷ number of shares
special charge: a cost reported as unusual or one-off
dilution: earnings spread over more shares, from conversions or warrants
fully diluted EPS: earnings per share allowing for all possible new shares
pro forma earnings: a company's figure for what it "would have" earned without certain costs

Watch out: Taking the headline figure. Zweig adds a modern version: "pro forma" earnings, in which a company shows what it would have earned if certain costs hadn't happened. His advice for the intelligent investor: ignore them.

Comparing four companies Graham ch. 13

Compare companies on profitability, stability, growth, financial position, dividends and price history.
Graham's 1970 four: P/E ratios varied far more than business results.
High valuations entail high risks.
Rising prices ("market action") aren't a reason for a conservative investor to buy.

book value: a company's net assets per share, from its balance sheet
return on book value: earnings ÷ book value
current ratio: current assets ÷ current liabilities
dividend yield: dividend per share ÷ share price
price/book ratio: share price ÷ book value per share

Watch out: Choosing the company with the more exciting share price. Graham notes that many analysts preferred the two dear companies mainly for their "market action" (rising prices), which he calls something for speculators, not a valid reason for a conservative investor.

The defensive investor's screen Graham ch. 14

Seven tests: size, financial strength, ten years of earnings, 20 years of dividends, one-third EPS growth, P/E ≤ 15, price ≤ 1.5 × book or P/E × P/B ≤ 22.5.
They exclude weak companies and expensive popular ones.
They are minimums, not a buy list; the 1972 size figure needs updating.
Zweig: an index fund now does much of the defensive job.

current ratio: current assets ÷ current liabilities
net current assets: current assets minus current liabilities (working capital)
book value: net assets per share, from the balance sheet
22.5 rule: P/E × price-to-book should not exceed 22.5 (15 × 1.5)
screen: a set of tests used to rule shares in or out

Watch out: Treating the screen as a list of things to buy. Graham's tests are minimums to exclude risky or expensive shares; a company that passes still needs diversification around it, and the 1972 size figure needs updating for inflation.

The enterprising investor's screen Graham ch. 15

Graham: beating the averages is hard, even for professionals; look where others don't.
His enterprising screen: P/E of 9 or less, current ratio 1.5, debt ≤ 110% of net current assets, five years without a loss, some dividend, earnings above four years earlier, price below 120% of net tangible assets.
Random stocks fell 22%; good-will giants did best, but Graham kept his preference for asset value.
Bargain issues need diversification and patience; workouts are for professionals.
Practise on paper for a year (Graham's advice, via Zweig); Zweig limits stock picking to 10% of the portfolio.

net tangible assets: net assets excluding intangibles such as goodwill
bargain issue: a stock priced below its net current asset value
workout: a holding whose profit depends on a merger, liquidation or similar deal going through
good-will component: the part of a share price above book value
52-week low: the lowest price of the past year

Watch out: Reading the "good-will giants" result as Graham's advice to buy popular, expensive companies. He reports the finding because it was true over that period, says momentum may carry such stocks along, and still prefers stocks with substantial asset value behind the price.

Convertibles and warrants Graham ch. 16

A convertible's conversion value is shares × price; its premium is how far its price is above that.
Graham: the buyer pays for conversion with quality or yield; new convertibles cluster late in bull markets and fall hard afterwards.
"Never convert a convertible bond": Eversharp holders who did lost three-quarters.
Warrants reduce the value of the common; add their market value when judging the price.
Zweig (2003): convertibles act like stocks, are safer than in Graham's day, and are best held through a low-cost fund.

convertible: a bond or preferred share the holder can exchange for common shares
conversion ratio: the number of shares received for one convertible
conversion value: conversion ratio × share price
conversion premium: how far a convertible's price is above its conversion value
warrant: a long-term right to buy new shares from the company at a set price
call: the company paying off a bond early

Watch out: Buying a new convertible because it "can't lose much and might gain a lot". Graham's records show new convertibles doing worse than straight issues in falling markets, because they are often issued by weaker companies near market tops. The convertible form alone makes an issue neither good nor bad; the facts of each issue decide.

Four extreme case histories Graham ch. 17

Four patterns: the tottering giant, empire building on debt, the small firm swallowing a big one, the hot new issue.
Each showed a simple warning sign in the published figures: coverage, debt, taxes paid, price against earnings.
Graham faulted the lenders and questioned the sponsors, not only the buyers.
Zweig (2003): Lucent, Tyco, AOL–Time Warner and eToys repeat the patterns.

interest coverage: earnings before interest and tax ÷ interest charges
conglomerate: a company built by buying businesses in many unrelated fields
hot issue: a new share issue whose price jumps soon after sale
non-recurring charge: a cost reported as a one-off, outside normal earnings
tangible equity: shareholders' equity minus goodwill and other intangibles

Watch out: Treating size, a famous name or a respected sponsor as proof of safety. Penn Central was the country's largest railroad, and AAA's shares were sold by a leading firm. Graham's point is that the figures decide, whoever stands behind the company.

Eight pairs of companies Graham ch. 18

Graham's method: set two companies' figures side by side and ask which gives more per dollar of price.
Whiting vs Willcox & Gibbs and Blue Bell vs Block: the bigger, better-backed business was the cheaper stock.
Popular, fast-growing companies can be fine businesses and still overpriced.
The analyst should look for the minority of cases where price is clearly below value.
Zweig: there are no good stocks, only good prices.

price / book: share price ÷ net assets per share (book value)
tangible assets: assets other than intangibles such as goodwill
dividend yield: yearly dividend ÷ share price
current ratio: current assets ÷ current liabilities
overvalued: priced above what the facts reasonably support

Watch out: Judging the company instead of the price. Graham calls Block an "excellent business". The question he asks is whether 300 million dollars for it already paid for everything it might reasonably achieve. A fine company at too high a price can be a worse holding than an ordinary company at a low one.

Shareholders, managements and dividends Graham ch. 19

Graham: shareholders should act as owners; in practice, takeovers did more to change poor managements.
Dividend test: about two-thirds paid out, or proof that retained earnings raised earnings per share.
Zweig: read the proxy statement; dividends discipline managers; buybacks are good only at sensible prices; vote against option plans over 3% of shares.

payout ratio: dividends ÷ earnings
retained earnings: earnings kept in the business instead of paid out
buyback: a company buying its own shares, reducing the number outstanding
proxy statement: the document sent to shareholders before the annual meeting, covering votes, pay and insider dealings
stock option: a right given to employees to buy shares at a set price

Watch out: Assuming a buyback always benefits shareholders. A buyback reduces the number of shares, so earnings per share rise. But if the company pays more than the shares are worth, or is mainly buying back shares it just issued to executives cheaply, the remaining owners lose.

Margin of safety (1): the idea Graham ch. 20

Margin of safety: the cushion between price and value, or earnings and charges, that absorbs error.
Bonds: earnings well above interest, or value well above debt.
Stocks: earnings yield well above the bond rate; Graham's typical ten-year excess was about 50% of the price.
It always depends on the price; growth estimates must be conservative.
Bargains: price two-thirds of value or less.

margin of safety: the cushion between price and value, or earnings and charges, that absorbs error
earning power: what a company can be expected to earn year after year under normal conditions
earnings yield: earnings per share ÷ price (the inverse of the P/E)
enterprise value: here, the total fair value of a business, against which its debt is compared
bargain issue: a security priced well below its appraised value

Watch out: Treating a margin of safety as a guarantee. Graham says the margin gives a better chance of profit than of loss, not certainty: any single holding can still go wrong. That is why he pairs it with diversification (the next lesson).

Margin of safety (2): in practice Graham ch. 20

A margin of safety improves the odds; diversification makes an overall gain more and more likely.
Graham's test of investment: a margin shown by figures, reasoning and experience.
A low enough price can make even a mediocre security an investment, for an informed, diversified buyer.
Four principles: know your business, supervise anyone who runs it, use arithmetic not optimism, have the courage of your knowledge.
Zweig: avoid big losses (a 50% loss needs a 100% gain to recover).

diversification: spreading money over many holdings so no single one decides the result
negative margin of safety: odds or prices set against you, as in a casino game
speculation: buying on judgement or hope without a margin of safety shown by figures
well-calibrated confidence: being as sure as the evidence justifies, no more
Pascal's wager: Bernstein's point that consequences should outweigh probabilities under uncertainty

Watch out: Thinking diversification can fix a bad bet. Graham's roulette example shows the reverse: spreading money over many bets with a negative margin only makes the loss more certain. Diversification helps only when each holding has a margin in your favour.

The superinvestors of Graham-and-Doddsville Graham appendix 1

Buffett's coin contest: chance alone creates impressive winners.
His case: winners concentrated in one method, named in advance, audited, with little overlap.
In value investing, a lower price means less risk and more reward.
Cautions: a small chosen sample, survivorship, a value premium that has varied, and shrinking edges with size.

efficient market: the view that prices already reflect all available information, so beating the market is luck
survivorship bias: judging from the records that survived and are known, while failures drop out of sight
value investing: buying a business, or shares in it, for clearly less than it is worth
value premium: the extra return, if any, of value stocks over other stocks
pre-identified: named in advance, before the results were known

Watch out: Concluding from a few famous winners that anyone who follows a method will win, or, the other way round, dismissing every long record as luck. Buffett's test is whether success is concentrated among people named in advance who share a method; the counter-arguments are about how strong that evidence can be.

Graham today Graham postscript

Graham's postscript: one well-prepared decision (GEICO) outweighed 20 years of careful work; luck and shrewdness are hard to tell apart.
Zweig: Graham's risk was small because of the asset value behind the price; most of us should diversify.
What holds up: investment versus speculation, Mr. Market, the margin of safety, simple defensive plans, elementary checks.
What has dated: the 1972 figures, some instruments, some of Graham's own views.

postscript: Graham's closing story about one decisive investment
preparation: the knowledge, standing and means that let a person act on an opportunity
concentration: putting a large share of money into one holding
earnings yield: earnings per share ÷ price

Watch out: Taking the GEICO story as permission to concentrate everything in one idea. Graham himself does not know whether it was luck or shrewdness, and Zweig draws the opposite lesson for most investors: diversify.