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Benjamin Graham
Benjamin Graham, who was of Jewish
descent and whose original last name was Grossbaum, was born in
London and moved to New York with his family when he was one
year old. Benjamin Graham's parents
 changed
the family name to Graham during World War I, when
German-sounding names were
regarded with suspicion. After the death of his father and
experiencing the humiliation of poverty, he became a model
student, graduating from Columbia, as salutatorian of his class,
at the age of 20. He received an invitation for employment as an
instructor in English, Mathematics, and Philosophy, but took a
job on Wall Street eventually starting the Graham-Newman
Partnership.
His book, Security Analysis, with David Dodd, was
published in 1934 and has been considered a bible for serious
investors since it was written. It and The Intelligent
Investor published in 1949 (4th revision, with Jason Zweig,
2003), are his two most widely acclaimed books. Warren Buffett
describes The Intelligent Investor as "the best book on
investing ever written."
Benjamin
Graham exhorted the stock market participant to first draw a
fundamental distinction between investment and speculation. In
Security Analysis, he proposed a clear definition of investment
that was distinguished from speculation. It read, "An investment
operation is one which, upon thorough analysis, promises safety
of principal and a satisfactory return. Operations not meeting
these requirements are speculative."
Benjamin
Graham wrote that the owner of equity stocks should regard them
first and foremost as conferring part ownership of a business.
With that perspective in mind, the stock owner should not be too
concerned with erratic fluctuations in stock prices, since in
the short term, the stock market behaves like a voting machine,
but in the long term it acts like a weighing machine (i.e. its
true value will in the long run be reflected in its stock
price).
Benjamin
Graham distinguished between the passive and the active
investor. The passive investor, often referred to as a defensive
investor, invests cautiously, looks for value stocks, and buys
for the long term. The active investor, on the other hand, is
one who has more time, interest, and possibly more specialized
knowledge to seek out exceptional buys in the market.
Benjamin
Graham recommended that investors spend time and effort to
analyze the financial state of companies. When a company is
available on the market at a price which is at a discount to its
intrinsic value, a "margin of safety" exists, which makes it
suitable for investment.
Benjamin
Graham wrote that investment is most intelligent when it is most
businesslike, a statement which Warren Buffett regarded as the
most important words about investment ever written. Graham said
that the stock investor is neither right nor wrong because
others agreed or disagreed with him; he is right because his
facts and analysis are right.
Benjamin
Graham's favorite allegory is that of Mr Market, a very obliging
fellow who turns up every day at the stock holder's door
offering to buy or sell his shares at a different price. Often,
the price quoted by Mr. Market seems plausible, but often 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 best off
concentrating on the real life performance of his companies and
receiving dividends, rather than being too concerned with Mr.
Market's often irrational behavior.
Benjamin
Graham was critical of the corporations of his day for
obfuscated and irregular financial reporting that made it
difficult for investors to discern the true state of the
business's finances. He was an advocate of dividend payments to
shareholders rather than businesses keeping all of their profits
as retained earnings. He also criticized those who advised that
some types of stocks were a good buy at any price, because of
the prospect of sustained stock price growth, without a good
analysis of the business's actual financial condition. These
observations remain extremely relevant today.
In recent years, Graham's "Mr. Market" approach has been
challenged by Modern Portfolio Theory, as advanced by such
proponents as William J. Bernstein, whose book The Intelligent
Asset Allocator is a direct challenge to Graham's The
Intelligent Investor. Modern Portfolio Theory posits that it is
generally impossible for any individual to outwit the market,
and is widely taught in American and British business schools.
Nevertheless, Graham's approach retains a widespread and
dedicated following. Indeed, numerous academic studies,
including "Contrarian Investment, Extrapolation, and Risk,"
"Good news for value stocks: Further evidence on market
efficiency," "The Cross Section of Expected Stock Returns," and
many others, have proven that value stocks outperform the market
over virtually all multi-year periods.
Benjamin
Graham put into practice a fundamental analytical process that
has been adopted by a generation of stellar money managers. By
using his methods, many of these managers have been able to
consistently beat the market averages. Graham influenced
investing superstars such as: Warren Buffett, Mario Gabelli,
Michael Price, John Bogle and John Neff. Simply put, Graham
turned speculating into investing. By devising sound principles
for analyzing a company's fundamentals and its future prospects,
he enabled stock pickers to be analysts - not gamblers. He
espoused many of these value-oriented principles in two timeless
investing books - Security Analysis and The Intelligent
Investor. These best-selling books explain how investors can
arrive at a stock or bond's true intrinsic value through
extensive fundamental research and financial statement analysis.
Graham's Investing philosophy
Benjamin
Graham argued that even with the best research, investors will
never know all there is to know about a company. They also cannot
predict the negative surprises that often send individual stocks
sharply lower. Therefore, investors should seek a "Margin of Safety."
Margin of Safety
One key concept taught by Benjamin Graham and still referred to today by
Warren Buffett, among others, is "Margin of Safety". The basic
meaning of this term is that investors should only purchase a
security when it is available at a discount to its underlying
intrinsic value: what the business would be worth if it were
sold today. In order to do this, of course, the investor must be
able to accurately estimate what the intrinsic value of any
given company might be. Along those lines, Benjamin Graham offered some
guidelines as to how to calculate this intrinsic value.
The key point for investors to remember is that they should only
invest in a company when its stock is trading below what the
firm would sell for in the open market. Those investors who
ignore valuation concerns and overpay for their investments are
operating with zero margin of safety. Even if their underlying
companies do well, these investors can still get burned.
Benjamin
Graham made his fortune by buying businesses that were so
battered and neglected that they sold for less than the value of
their working capital (calculated as current assets minus
current liabilities). He developed a Net Current Asset Value (NCAV)
model to determine if the company was worth its market price.
The NCAV formula subtracts all liabilities, including short-term
debt and preferred stock, from a company's current asset
balance. Graham's contention was that by buying stocks that were
trading below their NCAV, investors could manage to pay
essentially nothing for a firm's fixed assets.
Opt for Big Companies with Strong Sales
According to Benjamin Graham, larger firms pose much less risk. Graham's
rationale was that small companies have far more trouble dealing
with economic downturns, so it is best to invest in larger
companies.
Benjamin
Graham was an active investor during the Great Depression, where
he saw hundreds of once-thriving small firms go belly-up. Based
on his observations, he concluded that companies with more
diverse customer bases and greater revenues had a better chance
of surviving any sort of economic downturn.
Choose Companies that are Paying Dividends
Graham was adamant about investing in companies that pay
dividends. He believed that conservative investors should only
consider companies that have paid a dividend every year for at
least the last 20 years. He argued that dividends are a sign
that a company is profitable (dividends are paid from profits,
after all) and that they also offer investors a return even if
the company's stock does not perform well.
Seek Out Companies That Are in Strong Financial Shape
Always mindful of liquidity, Benjamin Graham looked for
companies whose current assets exceeded the sum of their current
and long-term debt. Companies with ample access to cash
(liquidity) are generally not as risky as those with low cash
balances and heavy debt loads.
Seek Companies with Sustainable Earnings Growth
Graham looked for companies with steady, rising earnings trends.
He believed that steadily improving earnings would lead to
improved share price performance.
Keep an Eye on Price Multiples
Benjamin
Graham sought companies with price/earnings ratios that were
below their historical average. He also took a careful look at
price/book values. In fact, he wouldn't purchase a stock unless
it was trading for less than 1.2 times its book value (total
assets minus total liabilities) per share. For example: A company
with $1 billion in assets and $700 million in debt has a book
value of $300 million. If the company has 10 million outstanding
shares of stock, then its per-share book value is $30. Graham
would not pay more than $36 per share (1.2 times the book value
per share) for this particular stock.
Benjamin Graham is considered by
many to be the father of financial analysis and value investing.
He revolutionized investment philosophy by introducing the
concept of security analysis, fundamental analysis and
value-investing theories. More than 20 years after his death, he
continues to have one of the largest and most loyal followings
of any investment philosopher.
According to Warren Buffett, Benjamin Graham said that he wished
every day to do something foolish, something creative, and
something generous. Warren Buffett said that Graham excelled
most at the last.
Publications
(1934) "Stabilized Reflation",
Economic Forum, Vol. 1, p.186-93.
(1934) Securities Analysis with David Dodd. New York:
McGraw-Hill.
(1937) The Interpretation of Financial Statements. with Spencer
B. Meredith, New York: Harper
(1937) Storage and Stability: A modern ever-normal granary. New
York: McGraw-Hill.
(1940) "Storage and Stability: A plan for monetizing the
commodity surplus", in A Forum on Finance, p.176-8.
(1943) "The Critique of Commodity Reserve Currency: A
point-by-point reply", Journal of Political Economy, Vol. 51
(1), p.66-9.
(1944) World Commodities and World Currency. New York:
McGraw-Hill.
(1947) "Money as Pure Commodity", American Economic Review, Vol.
37 (2), p.304-17.
(1947) "National Productivity: Its Relationship to
Unemployment-in-Prosperity", 1947, American Economic Review
(1949) The Intelligent Investor: A book of practical counsel.
New York: Harper Collins.
(1996) The Memoirs of the Dean of Wall Street. edited by Seymour
Chatman, New York: McGraw-Hill
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