The Only Three Types of Investments You Need to Know 19Year A^ B
1 10% 25%
2 10% 15%
3 12% 15%
4 12% 15%At the end of year 4, $ 100 invested with A is worth $ 124.18 while
the same $ 100 invested with B is worth $ 114.06. Clearly this is a very
simple example and in no way is intended to imply that one inves-
tor is more skilled than the other, especially after only four years of
data. But the point is that a huge loss in one year can overshadow
magnifi cent results for quite some time. Investor B outperformed
A by a substantial margin in years 2 to 4, but Investor A had nearly
10 percent more in capital at the end. B ’ s annualized return was
around 3.4 percent while A delivered an annualized return of
approximately 5.6 percent.
Warren Buffett realized this signifi cance when, in 1961, he
wrote to his limited partners: “ I would consider a year in which we
decline 15% and the [Dow Jones] Average 30%, to be much supe-
rior to a year when both we and the Average advanced 20%. ”^4
Graham ’ s teachings relied more on the quantitative attributes of
a business than on the qualitative factors. He focused on analyzing
the balance sheet, income statement, and statement of cash fl ows
to get an idea of the quality of the business and of whether it was
worthy of investment. Today, this approach is commonly referred to
as fundamental analysis — aptly named, because it ’ s the fundamen-
tals of the business that count the most. Without understanding the
numbers, you cannot understand the business, no matter how well
you think you know it. You wouldn ’ t purchase a home without fi rst
knowing your mortgage payments, taxes, anticipated utilities, and
general cost of upkeep; similarly, never invest in a business without
understanding its fi nancial framework.CH002.indd 19CH002.indd 19 9/2/09 11:06:25 AM9/2/09 11:06:25 AM