We must recognize the psychology of the speculator militates strongly against the speculator. For by relation of cause and effect, he is most optimistic when prices are highest and most despondent when they are at bottom. Hence, in the nature of things, only the exceptional speculator can prove successful, and no one has a logical right to believe that he will succeed where most of his companions must fail.
– Benjamin Graham adn David L. Dodd, 1934
Who was Benjamin Graham, and why is he worth listening to?
Graham was not just one of the best investors of all time; he remains far and away the greatest thinker about investing who ever lived. As a money manager and a finance professor at Columbia Business School, Graham was a teacher, mentor and hero to such investing giants as Sir John Templeton, William Ruane of the Sequoia Fund, and Charles Munger and Warren Buffett of Berkshire Hathaway. Buffett has said: “Ben had more influence on me than any person except my father…. Graham was the smartest man I ever knew.”
What accounts for Graham’s influence and innovation? Put simply, by any measure he was one of the most brilliant men of the 20th century. Graham’s genius manifested itself on at least five fronts:
• as an intellectual
• as a financier
• as a psychologist
• as an historian
• as a writer
As an intellectual, Graham graduated second in his class at Columbia and, before the end of his senior year, was offered faculty positions in three different departments: English, Greek and Latin, and mathematics. (He was all of 20 years old.) Later, Graham came up with several of the key ideas behind the Bretton Woods agreement that modernized the global financial system. He also patented an improved slide rule, wrote a Broadway play and taught himself Spanish so he could translate a major Uruguayan novel, Mario Benedetti’s The Truce, into English. (By the end of his life, Graham knew at least seven languages.) But Graham was not just smart: he was wise. His book-learning and quantitative genius were always tempered by prudence and common sense.
As a financier, Graham amassed one of the best track records in the history of investing, outperforming the Standard & Poor’s 500-stock index by at least 2.5 percentage points annually for a period of more than 20 years. Graham survived the Great Crash of 1929 and, for the rest of his career, issued timely warnings about overvalued markets (including the severe collapse in 1973-1974). He also helped restructure GEICO Corp. and was a fearless advocate for better corporate governance, going so far as to take on the Rockefeller family by shaking up their sheltered interest in the Northern Pipe Line Co.
As a psychologist, Graham cast a bright spotlight on human behavior, revealing subtleties and contradictions that anticipated the findings of Nobel Laureate Daniel Kahneman. Throughout his writings, Graham is not concerned with how people ought to act; instead, he focuses on how they actually behave in the real world. All his recommendations are based not just on what people should do, but on what they can do. Graham knew that self-control and self-knowledge are the keys to successful investing. In his words, “The investor’s chief problem — and even his worst enemy — is likely to be himself.” If you read nothing but Chapters 1, 8, and 20 of The Intelligent Investor, you can get off the self-destructive path that sends so many people astray in their financial lives.
As a historian, Graham had a mastery of the facts about everything and everyone that had come before him. The razor of his logic, sharpened by repeated readings of Aristotle and Plato, made mincemeat out of contemporaries who argued that “valuations don’t matter” or that “you can’t overpay for a great stock.” History taught Graham that the financial markets obey fundamental laws as irrevocable as Newton’s laws of thermodynamics. Throughout his books, Graham shows that regression to the mean — what goes up must come down, and what goes way up must come down even harder — is the first law of financial physics. Graham’s commanding knowledge of history made him a formidable prophet, since the best way to predict the financial future is simply to understand the past. To avoid disastrous losses in the 2000-2002 bear market, you needed only to have read and understood Graham’s warnings about past bubbles. And there’s no better way to brace yourself against the booms and busts of the future than by learning what Graham has to say.
As a writer, Graham was a master of formal but clear and classic prose. Large parts of The Intelligent Investor are set up as compare-and-contrast exercises. The distinctions that Graham draws between stocks and companies, price and value, investment and speculation, “projection” and “protection,” show how to think about the big picture. And his pairing of stocks — one glamorous and overpriced, the other stodgy and cheap — show how to analyze individual investments. Finally, Graham’s imaginative brilliance shines forth in his metaphor of “Mr. Market,” the manic-depressive neighbor who remains the single best image ever devised for explaining how the stock market really works.
Although Graham was born in 1894 and died in 1976, the proofs continue to pile up with the passage of the years: Graham was not just the greatest investing mind of his time, but he remains the greatest investing mind of all time. Every investor, no matter how much or little you know, can benefit from Graham’s ideas and from what Warren Buffett calls “the best book about investing ever written.”
<< Benjamin Graham >> – Jason Zweig
“Common stocks have one important investment characteristic and one important speculative characteristic. Their investment value and average market price tend to increase irregularly but persistently over the decades, as their net worth builds up through the reinvestment of undistributed earnings. However, 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”.
- Benjamin Graham
It is difficult to encapsulate Benjamin Graham’s investing style in a few sentences or paragraphs. Readers are strongly urged to refer to his “The Intelligent Investor” to obtain a more thorough understanding of his investment principles.
In brief, the essence of Graham’s value investing is that any investment should be worth substantially more than an investor has to pay for it. He believed in thorough analysis, which we would call fundamental analysis. He sought out companies with strong balance sheets, or those with little debt, above-average profit margins, and ample cash flow. (For more insight, see Introduction To Fundamental Analysis and Testing Balance Sheet Strength.)
He coined the phrase “margin of safety” to explain his common-sense formula that seeks out undervalued companies whose stock prices are temporarily down, but whose fundamentals, for the long run, are sound. The margin of safety on any investment is the difference between its purchase price and its intrinsic value. The larger this difference is (purchase price below intrinsic), the more attractive the investment – both from a safety and return perspective – becomes. The investment community commonly refers to these circumstances as low value multiple stocks (P/E, P/B, P/S).
Graham also believed that market valuations (stock prices) are often wrong. He used his famous “Mr. Market” parable to highlight a simple truth: stock prices will fluctuate substantially in value. His philosophy was that this feature of the market offers smart investors “an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.”
Quotes
“To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.”
” Most of the time 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.”
“Even the intelligent investor is likely to need considerable willpower to keep from following the crowd.”
“It is absurd to think that the general public can ever make money out of market forecasts.”
Benjamin Graham’s Criteria for the Defensive Investor
Benjamin Graham’s Criteria for the Defensive Investor:
P/E Ratio less than 15.
P/Book Ratio less than 1.5.
Book Value over 0.
Current Ratio over 2.
Earnings growth of 33% over 10 years.
Uninterrupted dividends over 20 years.
Some earnings in each of the past 10 years.
Annual revenue of more than $100 Million (1950).