There are millions of books written about the stock markets, trading and investing. In this article, we look at five of the best books on stock markets and investing. I have read each of them and these books have elevated my knowledge on investing to a higher level. Hope you find them useful too.
If you are here, you love to read and have a hunger to consume knowledge.
Come to think of it, investing and books are quite intertwined. In books, lie a wealth of information on what makes the stock market ticks. And in those ticks, have many billions been won and many billions have been lost.
The list I have compiled below is a list of the best books on investing. Further, I have ordered it in sequential order of how it should be read. These five books will help you build the right knowledge and perspective on how to read stocks and how to invest.
The 5 Best Books on Stock Markets & Investing are –
- Extraordinary Popular Delusions and the Madness of Crowds
- The Intelligent Investors
- One Up on Wall Street
- Big Mistakes
- The Little Book That Beats the Market
What is covered in this article?
Extraordinary Popular Delusions and the Madness of Crowds
Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay was written in 1841. It continues to be relevant even after 179 years.
The book is a study on crowd psychology and seeks to understand how humans can be easily misled to embrace illogical concepts. This is especially true when popular opinion influences it. While there are three volumes of the book, if you are short of time the 1st volume is a must-read.
The central theme in Mackay’s book is the tendency of humans to develop a herd mentality. He examined many such instances over the years where the reactions of stimuli are very similar and predictable. The author refers to such a response as “madness” which leads to a downward spiral with negative effects.
One such instance in the book is what is popularly referred to as ‘Tulipmania’. In the Netherlands, the tulip bulb suddenly developed into a novelty item and a status symbol for the upper society. As a consequence, the value of tulip bulbs increased significantly by a factor of 1,000.
Such was the craze that investment & trade in tulips became the talk of the town. Per Mackay’s version, as much as 12 acres of land were being offered for a single bulb. Soon even the poor started to step in, often selling their houses in the hope of making a quick buck. It was not clear why the price for tulip bulbs was so high. When enough people had won & lost money, the price of the tulip bulbs fell back to its normal fundamental value.
Modern day versions of this tulipmania are seen in Applemania when people sleep outside an Apple store for days to buy the latest gadget. Why people do that is beyond belief and perhaps this is why the author refers to such behaviour as madness. The real estate bubble in the United States of 2007 also fits the bill. People were taking heavy loans to buy property under the assumption that housing prices will only go up. The crash that followed left many people homeless and brought the world economy to a standstill.
A second instance of madness in this book and my favourite is The South Sea Company. This company was a British company founded in 1711. The company was offered a monopoly to trade with the islands in the South America and Oceania regions (which were called the “South Seas” and hence the name of the company). However due to Britain’s war with Spain and Portugal, no trade could happen. As a consequence, the Company never made any significant profit from their business expeditions.
This did not stop it’s stock to rise greatly in value. It peaked in 1720 before collapsing suddenly and ruining thousands of investors. In these early three years, the founders of this company engaged in insider trading using their advanced knowledge of timings of national debt consolidations to make large profits by purchasing debt in advance. Politicians were bribed to support certain regulations which were necessary for the success of their nefarious scheme. Infact, the company’s money was used to deal in its own shares. And the expectation of profits from South American trade was amplified to encourage the public to purchase shares in the company from the promoters.
Charles Mackay in this book has put forward many good quotes. A couple of quotes which describe the madness of crowds are –
- “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”
- “We find that whole communities suddenly fix their minds upon one object, and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first.”
Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay is a hearty and excellent read. It helps us understand the patterns that lead to the creation of bubble. We have seen many in our times with the dot-com bubble of 2000 (led to a global recession), housing bubble of 2008 (led to the financial recession) and the Cryptocurrency bubble of 2016-2018. An understanding of history is important for us to avoid a repeat of the mistakes we made. This book is a big help to that.
The Intelligent Investor
This book should be a must read for every student of finance.
I first read The Intelligent Investor by Benjamin Graham in 2001 and must have read it a half-a-dozen times since then. There is always nothing new to understand and apply to investing in this all-time classic.
And don’t take just my word for it. The book is regarded by Warren Buffett as the best book about investing ever written. Buffett goes on to say that chapter 8 and chapter 20 are a must-read so it is only fair that we start with these chapters.
It is also worthy to note that when Benjamin Graham wrote this book, his ideas were contrary to the general public’s perception towards investing. Graham advocated the use of numbers and investing rules in a time when almost everyone looked at stocks as speculative and driven by brokers & manipulators. No one understood why stocks go up and down in value or how to price an investment in equities.
Graham established through his book that investment returns were not based on luck. He fought to advocate that your returns were based on the price that one bought a company relative to it’s true value. This was 1949 and surely there were many detractors from that thought process.
Benjamin Graham introduced the concept of Mr. Market in Chapter 8 of this book. Mr. Market is an imaginary figure who arrives every day. He will yell out a price for a stock much like a persistent salesperson. Somedays Mr. Market will be in a very buoyant mood and offer a stock at a very high price that imitates his optimism. On other days, Mr. Market will be in a dull mood and quote a very low price in line with his pessimism. Graham says that, as an investor, you can pick any price that he is ready offer at (high or low) or can choose to ignore Mr. Market complete. The point is – Mr. Market is a personification of the stock market as a whole with people throwing all kinds of prices.
The book helps us understand that the purpose of intelligent investing is not to look at prices but to have a way of finding the intrinsic value of the stock. Mr. Market is there to help us pick this stock at a delicious bargain price. He is there to serve us. Unfortunately, many people think exactly the opposite and work on the whims and fancies of Mr. Market, often succumbing to it’s frailties.
In Chapter 20 of the Intelligent Investor, we are introduced to the concept of Margin of Safety.
Benjamin Graham uses the concept of a bridge saying if you had trucks weighing 5,000 kilograms to go over a bridge, you would not make a bridge that supports only 5,000 kilograms. You would certainly want to give extra support to ensure the bridge can be reliable in case bigger trucks were to pass through it. Graham says this same safety is important in investing aswell. More specifically, he suggests buying stocks at 50% lower than what you have calculated as the intrinsic value.
He gives specific formulae for this margin of safety. Here’s one – buy only if the price of stock is 66% or lower of the net current asset value per share. Net current asset value is the difference between current assets minus current liabilities. The reason, Graham suggest a margin of safety is to account for any errors you might have made in the calculations. Afterall, investment is a predictive activity and because you totally rely on financial statements prepared by the same company that you are evaluating (companies then were not heavily audited as todays). The larger the margin of safety, higher is the chance of making profits on your investments.
Graham shares some important investment rules in the Intelligent Investor aimed at defensive investors. These include :
- Achieve a portfolio diversification of between 10 to 30 stocks
- Choose stocks in companies which have large sales numbers of atleast $1 billion
- Prefer companies which manage conservatively. Such as having a current ratio of 2 i.e. the current assets in the company’s books are twice the current liabilities which indicates that the company can pay its short term liabilities with no trouble.
- The company must have paid dividends for at least 20 years without having missed a single dividend payment
- No single year of decreasing earnings over the past 10 years
- The earnings must have grown by atleast 3% annually during those same 10 years
- The price earnings ratio should be 15 or lower
- The difference between assets and liabilities in the business should be atleast 1.5 times of the market capitalization of the company
Seems a little strict, doesn’t it?
Benjamin Graham lived in a different time to what we live in now. So it is OK to disagree with some of these tenets. I too don’t agree with some points here but we can’t help appreciate the author’s sincere plea to investors to start looking at investing as an analytical exercise and not a speculative one.
Graham, in the book, also created a checklist for the more enterprising investors where some of these criteria have been relaxed. However, he asks of the common investor to stick to the defensive style. Thats because most investors are likely to not have the necessary experience nor the time to research and follow the guidelines.
The book takes about 10 hours to read cover-to-cover and is highly recommended
One Up on Wall Street
Peter Lynch is counted among the legends of Wall Street. In 1977 he took over Fidelity’s Magellan mutual fund and delivered enviable annual returns of 29.2% over the next thirteen years until he retired in 1990.
That incredible run perches Peter Lynch as the mutual fund manager with the best run of more than ten years ever.
One Up on Wall Street by Peter Lynch was published in 1989 and I first read the book in 2006. I found it to be a perfect introduction to investing for people who are beginners at it. It was the great writing ability with a simple overlay of investing knowledge that made this book a real joy to read and learn.
The book focuses on the idea that daily observations can help you identify promising stocks. And one does not need to bank up analysts and statisticians who come up with complicated formulae and daily commentary on stocks. Let’s look at my quick summary on this investing classic.
Peter Lynch starts off with every investor’s dilemma – “Is it even possible for a beginner investor to outperform professionals in the stock market?”. According to Lynch, the assumption that analysts will always perform better than the average you-me investor is wrong. Infact, he sticks his head out to say that individuals have a better chance of beating the pros
In the book, Lynch goes on to explain why professionals are at many disadvantages compared to amateurs. These include –
- A successful fund manager attracts a lot of capital which means less opportunity. E.g. A $10 billion fund will not (no can not) invest in companies with a market cap of $10 million as it won’t have a meaningful impact on the portfolio. So, mediocrity becomes the default play.
- Fund managers spend over a quarter of their time on wasteful activities like explaining to stakeholders why they made certain decisions.
- The capital at the fund manager’s disposal is dependent on the clients. These clients are not savvy investors and pull out their money during crisis times. This means, the fund manager has a lot of money when the market is expensive and has much less to invest in when the markets are cheap. Such is the fund manager’s dilemma.
My next takeaway from the book is that – “all investment opportunities are not created equal”. Infact, Peter Lynch says that there are six categories of stock investments which are –
- Slow growers – These are large companies operating in mature industries growing a low single digit percentage. You invest mainly for dividends and should not expect big stock price appreciation.
- Stalwarts – Somewhere between the hair and the tortoise companies. These companies have an earnings growth rate of 10-12% per year. You might want to sell these off if they make a quick 30-50% gain.
- Fast growers – Aggressive enterprises growing at 20% or more per year. These can be great investments if one can conclude that the growth will continue for several years.
- Cyclicals – These are companies whose sales & profits rise and fall in business cycles. If you can identify early signs of a booming or busting cycle, you’ll have the advantage.
- Turnarounds – Companies with declining earnings and problematic balance sheets. This is a risky strategy but potentially very rewarding. The chances of success improve when you can identify a temporary bad reputation scenario. More often than not, it usually becomes a profitable turnaround case.
- Asset plays – These are situations where the value of the company indicates that the stock market players have missed out on something valuable that the company owns. These can be real estate, patents, natural resources, subscribers, tax set-offs from previous year losses etc.
Recall from our review of the Intelligent Investor, it’s author Benjamin Graham was a strong advocate of the asset play approach. Graham looked for companies where the value of the assets was atleast 50% higher than the market capitalization.
The above six categories are explained in greater details in the book. Do remember – a company can belong to more than one of them at once .. and companies don’t stay in the same category forever. McDonald’s is a good example. It moved from being a fast grower to a stalwart to an asset play to a slow grower.
The fourth takeaway was Peter Lynch’s 10 traits of the tenbagger. Hmm .. who wouldn’t want to read more about this? ?
A ten-bagger (or multibagger) is used by Lynch to describe a stock which has appreciated to ten times your purchase price. Here are 10 positive signs for such a stock –
- The company name is dull bordering on ridiculous. These are the companies that are overlooked
- The company does something dull
- Better still, the company does something disagreeable
- Institutions don’t own it, and it’s not followed by any analysts
- There’s something depressing about it
- The company’s industry isn’t growing. (stalling industries are not prone to competition)
- It’s got a niche (important to have; these are the moats that investors like Warren Buffett are looking for)
- It has recurring revenues (it is a subscription or customers are forced to return for more of it)
- Insiders are buying
- The company is buying back shares.
And finally, these are the 5 anti-multibaggers by Peter Lynch –
- It’s in a hot industry.
- It’s “the next” something.
- The company is diworseifying (Peter Lynch likes to refer to it as diworseification rather than diversification i.e. the art of acquiring other companies in unrelated industries)
- It’s dependent on a single customer.
- It’s a whisper stock (i.e. these are long shots like on the brink of doing something miraculous like curing every type of cancer)
One Up on Wall Street is a book made for individual investors with practical tips and insights that lead them to beating the pros at their own game. In other words, Peter Lynch is saying the game is actually rigged in favour of the amateur.
Everyone makes mistakes.
You, me and even the world’s biggest and best investors.
It is always good to learn from the mistakes made by others so that you don’t have to repeat their follies. And this is why I recommend any budding investor to read this book by Michael Batnick.
Big Mistakes is a compilation of lessons learned through failure by legendary investors that in turn, propelled them to the top. The book looks at investing stories from Warren Buffett, Jack Bogle, Bill Ackman, John Maynard Keynes and many such illustrious investors who at times, overlooked deep-rooted investment principles. In these misplaced moments, they garnered millions and billions in losses but came out with much more wisdom and gumption. If failure is the biggest teacher then this book is the headmaster.
Here are my top takeaways from this book.
The Availability Heuristic – In 1991, Warren Buffett acquired the shoe company H.H. Brown through his investment vehicle, Berkshire Hathaway. H.H. Brown proved to be a tremendous investing success. He then bought Lowell Shoe which too was a runaway success. So, it didn’t come as a surprise when Buffett announced the acquisition of a third shoe company Dexter shoe.
The only problem was that Dexter Shoe wasn’t a H.H. Brown or Lowell Shoe. It just appeared to be a similar situation and Warren Buffett made a mental map of it. It’s a bit like attaching a previous experience to a current situation like Venezuela is going through it’s own Arab Spring or Jeff Bezos is the modern-day Sam Walton etc. In reality, Dexter Shoe did not have the same type of moat around it’s business. The company steadily got crushed by low-priced competitors from China. Berkshire Hathaway had to write down all of the goodwill from the Dexter Shoe acquisition. In other words, the business was deemed worthless.
The big mistake made by Buffett was to fall into a human bias called the availability heuristic. This is a mental shortcut that relies on immediate examples to come to a given person’s mind when evaluating a specific topic, concept, method or decision. The lesson to be learnt here is to be extra careful when you invest in a company that appears to be similar to a previously successful investment.
The Law of Holes is another interesting story in the book about Mark Twain.
Mark Twain, the author of books like The Adventures of Tom Sawyer and The Adventures of Huckleberry Finn, invested in a typesetting machine. The venture quickly turned south but Mark Twain kept pouring money into it. This is the law of holes – a situation where you keep on putting things into the hole even when the chance of recovery is poor or none.
Another famous investor, David Einhorn, says this about the law of holes: “What do we call a stock that is down 90%? A stock that was down 80%, and then got cut in half!”
Just because a stock is getting cheaper it doesn’t rule out the possibility that it can get even more cheap in the future. The difficulty lies in being able to admit defeat before it is too late. The lesson to be drawn from this is you must decide beforehand how much you are willing to lose for every stock purchase that you make. This way it is easier to quit digging that hole before burning all your money.
The Ego and Bill Ackman
This was more of a crusade that Bill Ackman ran against Herbalife by claiming that the company was basically a pyramid scheme. He sold the company short, betting that the stock would crash to zero and his hedge fund will make a lot of money for its investors.
Ackman was so convinced that he went on Bloomberg television in 2013 and stated that his short position around $400 million in the red but will hold on until the company folded. This did not happen and Ackman finally exited his bet against Herbalife in 2018 at an undisclosed loss
Bill Ackman’s mistake was of carrying very strong opinions about Herbalife that it became increasingly difficult for him to back down. This was inspite of evidence pouring in that was contradicting Ackman’s contention.
There is a documentary on this entire episode titled Betting on Zero which is highly recommended. The pic investigates the allegation that Herbalife is a pyramid scheme and follows Bill Ackman’s billion dollar bet that the company is about to collapse.
The lesson here is that investors should never forget the purpose of investing – which is to make money and it is not about being proven right. One should not let emotions and ego take over the investing principles as it more often than not leads to monetary disaster.
The book gives many more examples of lessons learnt by investors such as even the great Benjamin Graham (who wrote the Intelligent Investor that we reviewed earlier). Mistakes are a part of investing but it is not necessary that everyone needs to continue making them. We can learn from these big mistakes others have made and put our energies on being better investors.
I thoroughly enjoyed reading Michael Batnick’s book. It’s not as much an investing how-to book as it is about the psychology of investing.
The Little Book That Beats the Market
The Little Book That Beats the Market is written by Joel Greenblatt.
Joel Greenblatt started a hedge fund, Gotham Capital, in 1985 and delivered an annualized return of 30% (net of all fees) from 1985 to 1994. He did this by investing in special situations like spinoffs and other corporate restructurings.
Since 1996, Joel Greenblatt teaches Value Investing at Columbia University’s Graduate School of Business.
In his book, Joel Greenblatt says that everyone has many options with his or her money. You can leave it the way it is, give it to a bank (term deposits), spend it or invest it. On investing it in the stock markets, he adds: “Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but just still an idiot”
Purchasing stocks using the price earning ratio or PE Ratio is very common. As a thumb rule, investors say low PE ratio is good while high PE ratio is bad. However, Greenblatt says that even buying at a low PE ratio can result in a disastrous investment especially if the earnings part is not growing. And hence it is important to buy a good business.
This is where the author introduces the use of ROA or Return on Assets. The higher the ROA, the better it is. The metric represents the efficiency with which the company’s assets are churning out profits of the business and ultimately the shareholders. The companies with the highest ROAs often have the better moat i.e. protection for shareholder’s capital.
Joel Grenblatt’s Magic Formula is tempered around buying good companies (high ROA) at low prices (low PE Ratio). If you do this, you will end up with buying underpriced quality businesses.
The Magic Formula is actually a system. The system involves the ranking of companies according to their combined score of a) quality and b) price of business.
During the 17 year period that Joel Greenblatt evaluated the magic formula, it outperformed the overall market by about 18%. The Magic Formula system returned 30.8% annual returns in 17 years. The S&P 500 which performed at 12.3% per year during the same period. In other words, $10,000 invested in the system would have turned to almost $1,000,000 in 17 years. The same investment in the broader stock market index would have yielded a modest returns of $70,000.
Since this is a system, there will be some companies that will turn out to be crappy investments with this formula. I have personally tried and found that not all investments are golden. But on an average, it does work better than a lot of other speculative systems like just picking low PE ratios or stocks which are on 52-week lows etc.
Unlike what we learnt in other books, the Magic Formula is not based on the buy-and-hold system. On the other hand, the formula requires investors to buy 5-7 stocks every two to three months until you have a portfolio of 20-30 stocks. You are required to hold these stocks for an year post which you need to sell them. Remember to hold the winners for a little over an year and losers for a little under – to take advantage of tax rules. You can continue this process for many years.
If you are a bit confused between using a dumbed-down system or an intellectual value investor style read-the-balance-sheet approach .. then you can always use the Magic Formula as a screener for you for stocks which can warrant further investigation.
Overall, Joel Greenblatt’s “The Little Book That Beats the Market” does provide a handy time-testing system on how to identify worthy stocks and apply it to a system that can provide market beating returns. The PE ratio and ROA are two important quantitative factors that should be considered when buying stocks. Remember – low PE and high ROA.