Benjamin Graham was an influential investor whose research in securities laid the groundwork for in-depth fundamental valuation used in stock analysis today by all market participants. His famous book, The Intelligent Investor has gained recognition as the foundational work in value investing.
His Life
Graham was born in 1894 in London, UK. When he was still little, his family moved to America, where they lost their savings during the Bank Panic of 1907. Graham attended Columbia University on a scholarship and accepted a job offer after graduation on Wall Street.
The Stock Market Crash of 1929 lost Graham almost all his investments and taught him some valuable lessons about the investing world. His observations after the crash inspired him to write a research book with David Dodd, called Security Analysis.
Benjamin Graham is considered a founder of stock analysis and particularly value investing. According to Graham and Dodd, value investing is deriving the intrinsic value of a common stock independent of its market price. By using a company’s factors such as its assets, earnings, and dividend payouts, the intrinsic value of a stock can be found and compared to its market value. If the intrinsic value is more than the current price, the investor should buy and hold until a mean reversion occurs.
Graham was a strong proponent of efficient markets. If markets were not efficient, then the point of value investing will be pointless as the fundamental principle of value investments lies in the ability of the markets to eventually correct to their intrinsic values. Common stocks are not going to remain inflated or bottomed-out forever despite the irrationality of investors in the stock market.
Benjamin Graham noted that due to the irrationality of investors, including other factors such as the inability to predict the future and the fluctuations of the stock market, buying undervalued or out-of-favor stocks is sure to provide a margin of safety, i.e. room for human error, for the investor.
Also, investors can achieve a margin of safety by purchasing stocks in companies with high dividend yields and low debt-to-equity ratios, and diversifying their portfolios. In the event that a company goes bankrupt, the margin of safety would mitigate the losses that the investor would have. Graham normally bought stocks trading at two-thirds their net-net value as his margin of safety cushion.
Published Works
Security Analysis was first published in 1934 at the start of the Great Depression, while Graham was a lecturer at Columbia Business School. The book laid out the fundamental groundwork of value investing, which involves buying undervalued stocks with the potential to grow over time. At a time when the stock market was known to be a speculative vehicle, the notion of intrinsic value and margin of safety, which were first introduced in Security Analysis, paved the way for a fundamental analysis of stocks void of speculation.
In 1949, Graham wrote the acclaimed book The Intelligent Investor: The Definitive Book on Value Investing. The Intelligent Investor is widely considered the bible of value investing and features a character known as Mr. Market, Graham’s metaphor for the mechanics of market prices.
Mr. Market is an investor’s imaginary business partner who daily tries to either sell his shares to the investor or buy the shares from the investor. Mr. Market is often irrational and shows up at the investor’s door with different prices on different days depending on how optimistic or pessimistic his mood is. Of course, the investor is not obligated to accept any buy or sell offers.
Graham points out that instead of relying on daily market sentiments which are run by investor’s emotions of greed and fear, the investor should run his own analysis of a stock’s worth based on company’s reports of its operations and financial position. This analysis should strengthen the judgment of the investor when s/he’s made an offer by Mr. Market.
According to Graham, the intelligent investor is one who sells to optimists and buys from pessimists. The investor should look out for opportunities to buy low and sell high due to price-value discrepancies that arise from economic depressions, market crashes, one-time events, temporary negative publicity, and human errors. If no such opportunity is present, the investor should ignore the market noise.
While echoing the fundamentals introduced in Security Analysis, The Intelligent Investor also provides key lessons to readers and investors by advising investors to not follow the herd or crowd, to hold a portfolio of 50% stocks and 50% bonds or cash, to be wary of day trading, to take advantage of market fluctuations, to not buy stocks simply because it is liked, to understand that market volatility is a given and can be used to an investor’s advantage, and to look out for creative accounting techniques that companies use to make their EPS value more attractive.
Legacy
Benjamin Graham was a renowned value investor, lecturer, financial securities researcher, and mentor to many successful investors. He defined investment principles adopted by some of the world's most infamous investors. Known as the "father of investing," Graham wrote several books, including The Intelligent Investor, which is widely considered the value investor's bible.
The Graham and Dodd award, in honor of former Columbia University finance professors Benjamin Graham and David Dodd, acknowledges people who excel in research and financial writing in the Financial Analysts Journal.
Benjamin Graham's main investment principles are to:
- Invest with a margin of safety,
- Anticipate volatility and benefit from it, and
- Know what type of investing you are good at; in other words, know what type of investor you are.
Although Benjamin Graham died in 1976, his work lives on and is still widely used in the twenty-first century.