Investing Legends : Benjamin Graham

Benjamin Graham : The Father of Value Investing

“The individual investor should act consistently as an investor and not as a speculator. This means.....that he should be able to justify every purchase he makes and each price he pays by impersonal, objective reasoning that satisfies him that he is getting more than his money's worth for his purchase.” Ben Graham


“Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble... to give way to hope, fear and greed.” - Graham on Market Moods

"The one principal that applies to nearly all these so-called "technical approaches" is that one should buy because a stock or the market has gone up and one should sell because it has declined. This is the exact opposite of sound business sense everywhere else, and it is most unlikely that it can lead to lasting success in Wall Street. In our own stock-market experience and observation, extending over 50 years, we have not known a single person who has consistently or lastingly made money by thus "following the market." We do not hesitate to declare that this approach is as fallacious as it is popular." Graham on market Startegy


Yes, I know I made you wait a lot to put forward the second article in the series of knowing about legendary Investors and their investing styles. In this article we are going to discuss about none other than the Guru of the Gurus, "Benjamin Graham". Yes, We are talking about the man who taught Investing skills to the most well known Investment Guru "Warren Buffet".

Childhood Struggles and the Natural Investor
Benjamin Graham was born in London in 1894, the son of an importer. His family migrated to America when Ben was very young and opened an importing business. They did not do well, Graham’s father dying not long after moving to America and his mother losing the family savings in 1907 during an economic crisis.

Destiny had something else for this Genius
Graham was a star student. He managed to get to Columbia University and after graduation, offered a teaching post. However, destiny had somethign else in store for this genius and he took a job as a chalker on Wall Street with Newburger, Henderson and Loeb. It did not took him long when he began doing financial research for the firm and he became a partner in the firm.

Learning the hard way
In 1926, Graham formed an investment partnership with another broker called Jerome Newman. He also started lecturing at night on finance at Columbia, a relationship that was to continue until his retirement in 1956.

The Crash of 1929 almost wiped Graham out but the partnership survived with the assistance of friends and the sale of most of the partners’ personal assets. Graham’s wife was forced to return to work as a dance teacher. Graham was soon back on his feet but he had learned valuable lessons . These lessons build the edifice for the greatest book to be ever written on Investment.

The partnership between Graham and Newman continued until 1956 but never again lost money for its investors, earning an annual return of about 17 per cent.

Security Analysis
In 1934, Benjamin Graham together with David Dodd, another Columbia academic, published the classic Security Analysis which has never been out of print. Despite the crash, the book proposed that it was possible to successfully invest in common stocks as long as sound investment principles were applied. Graham and Dodd introduced the concept of ‘intrinsic value’ and the wisdom of buying stocks at a discount to that value. This books has been regarded as the "Bible " for the students of Investments for a decades. However this was just a beginning and the history had yet to unfold another gem written by benjamin.

The Intelligent Investor
The Intelligent Investor was published in 1949, is a widely acclaimed book on investing. Famous investor and billionaire Warren Buffet describes it as "by far the best book on investing ever written".

Ben Graham taught investments for 28 years at Columbia University, and perhaps his success as a professional investor is matched by his success as an academic, which is most unusual. His published works have instructed many thousands of students and, indeed, his strength as an academic is derived from his many years experience on Wall Street.

Understanding Ben Graham's Investment Philosophy

Margin of Safety
"To have a true investment, there must be a true margin of safety. And a true margin of safety is one that can be demonstrated by figures, by persuasive reasoning, and by reference to a body of actual experience" - Benjamin Graham

Graham looks for what he calls a "Margin of Safety" when investing in stocks. This is defined by how much a stock is trading below its intrinsic value which is what the business would be worth if it were sold today.

Graham was most insistent that any security purchased should represent good value. He felt stocks should be bought like groceries, not like perfume, and he distilled his investment philosophy down to just three words, "MARGIN OF SAFETY". By margin of safety, he meant that any stock bought should be worth considerably more than it costs. He sometimes suggested at least 50 percent more. Stocks bought with a margin of safety give some assurance that one has invested wisely. And stocks bought with a margin of safety should be low risk, high return investments.

Investment Versus Speculation
The distinction between investment and speculation is central to Graham's investment philosophy. He defined these terms thusly: "An investment operation is one which, upon thorough analysis promises safety of principal and adequate return. Operations not meeting these requirements are speculative.

Buying and Selling points - Mr. Market Theory
Stocks will fluctuate substantially in value. For a true investor, the only significant meaning of price fluctuations is that they offer ". . . an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal."

Using his famous Mr. Market parable, Graham suggests the attitude one should adopt toward fluctuations in prices.

Graham's favourite allegory is that of Mr. Market, an obliging fellow who turns up every day at the shareholder's door offering to buy or sell his shares at a different price. Often, the price quoted by Mr. Market seems plausible, but sometimes it is ridiculous. The investor is free to either agree with his quoted price and trade with him, or to ignore him completely. Mr. Market doesn't mind this, and will be back the following day to quote another price. The point is that the investor should not regard the whims of Mr. Market as determining the value of the shares that the investor owns. He should profit from market folly rather than participate in it. The investor is advised to concentrate on the real life performance of his companies and receiving dividends, rather than be too concerned with Mr. Market's often irrational behaviour.

Select Low Price/Book Value Stocks
Graham felt rather strongly that an investor should not pay much more than book value for a stock. In his word, "Strangely enough we shall suggest as one of our chief requirements . . . that our readers limit themselves to issues selling not far above their tangible-asset value."

Selecting Unpopular Stocks If an investor is to do better than average, Graham argued that his or her investment policies should not be popular. He believed that most Wall Street professionals tend to seek out stocks with the best growth prospects and to ignore other stocks. This bias causes unpopular stocks to become undervalued and good buys.

Benjamin Graham’s investment principles

Know the business
The investor needs to become knowledgeable about the business or businesses carried on by the company in which they propose to invest – what it sells, how it operates, what is the competitive environment, what are the threats and opportunities, the strengths and weaknesses.
An investor who bought a fruit shop, or a shoe factory, without investigating these things, and knowing them, would be foolish. The same applies to share investment. An investor who does not understand the business should not be investing in it.


Know who runs the business
An investor who cannot operate the business for himself or herself, needs a manager. This is the position of the average share investor, who owns a share of an enterprise that is run by others.
The owner of a business in this position would want a manager who will manage the business competently, efficiently and honestly. The share investor should not be satisfied with less. Unless the investor believes, through sound research, that the company is managed efficiently, competently and honestly, in the best interests of the shareholders, the investment should not be made.


Invest for profits
An investor would not normally buy a business that did not, on proper research, appear to have reasonable expectations of producing good profits over time. Share investors should take the same approach and buy, as Graham says, "not on optimism, but on arithmetic".


Have confidence
Graham encourages investors to properly research their investments and, if they believe their investment judgment to be sound, to act on it. He cautions investors in this position against listening to others.

"You are neither right nor wrong because the crowd disagrees with you. You are right [or wrong] because your data and reasoning are right [or wrong]."

Let's Salute the wisdom of this Investing legend who has been referred to as "Father of Value Investing" for propogating the Investment wisdoms through his everlasting writings.

13 comments:

Manish said...

Dear Sir,
IS it the right time to buy Infosys. The stock is current price at 1990. Please advice.

Thanks
Manish

Anonymous said...

Hi rajesh,
Thanks for this excellent write-up. It is quite informative. However..i have one question rajesh...how to determine value stocks in current market ? It is difficult to find stocks qouting at a price lesser than their book value or at the book value. So how relevant is value investing ? please provide your valuable comments and advice.

KK

Anonymous said...

Hi Rajesh...what's your view on sensex levels for the month of april ? people are talking about 10000 levels by may . please guide.

many thanks
guarav

MARKETMAN said...

MARKETS ARE SET FOR A BIG FALL ...GET OUT OF THE MARKETS AND ENTER AT 10000 LEVELS.

Anonymous said...

Hi Marketman..what is the basis of your prediction ? given the corporate earning season starting in april things are expected to be better rather than worse !

Abhay

Abhi said...

Dear Rajesh,
I am tracking Gitanjali gems for a month but I have not seen a definite trend in the stock during this period. I see that you have put this stock in your favourite recommendations...what is the target for 1 year on Gitanjali? I am a big fan of your blog and your advice is valued very highly.

thanks
Abhishek

Anonymous said...

Hi Rajesh
Markets are falling like anything...what should be the strategy now?

contact said...
This comment has been removed by the author.
contact said...

Thank you for your post on Ben Graham's methodology. My site www.investinvalue.com is one more site about this great investor ! Sorry for that ... but I would be glad to have your point of view on it ! For the moment, there is no indian stock on it but I'm planning to...

bhavik said...

it was good to read abt benjamin graham.can u put some articles on value investing style suggested by Philip Phiser,who was an inspiration to Warren Buffet.

Anonymous said...

You can get a bio of benjamin graham at http://www.benjamingraham.info if you want to find out a little more about him

Bud said...

I think you might like my new self-published book. My book, "The Four Filters Invention of Warren Buffett and Charlie Munger" examines each of the basic steps they perform in framing and making an investment decision. Here is a 10 min. audio book summary: http://www.frips.com/4fsummary.mp3

Here is the review that George at valueinvestingnews.com and fatpitchfinancial.com did on my book. http://www.valueinvestingnews.com/four-filters-invention-warren-buffett-ch-0

As for my own views, “The Four Filters Invention of Warren Buffett and Charlie Munger” at http://www.frips.com is designed to be the next “Intelligent Investor.” It is a small book at 98 pages, and it concentrates mainly on the sequential process outlined by Warren Buffett. How do the best “frame” their investing decisions? The Four Filters cluster around the important business variables of Products, Customer-Sustainablility, Managers, and Price/Value.

The book also strives to prove that Buffett and Munger invented a Behavioral Finance Formula composed of three qualitative steps and one quantitative step, that is underappreciated by the
business and academic communities. In that respect, Buffett and Munger will have a greater long term impact on academics than the Efficient Market Hypothesis.

While my book is concentrated on Munger and Buffett’s approach to framing, this book contains the best of Graham, Carret, Fisher, Buffett and Munger. Read the summary a few times, and you will be motivated and hypnotized into thinking about ways you “frame” your important decisions. This is a subtle peek into sensible and optimal thinking within Behavioral Finance.

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