01 -- Benjamin Graham -- Father of Value Investing
- CXOEditor
- Sep 21, 2024
- 4 min read
Updated: Oct 1, 2024
'Blessed is he who expecteth nothing, for he shall enjoy everything.' Benjamin Graham, The Intelligent Investor
Benjamin Graham, often hailed as the "father of value investing," was born in 1894 in London and moved to New York City as a young child. Graham graduated from Columbia University in 1914, founding the Graham-Newman Corp; which would ultimately propel him into a distinguished career in finance, blazing a legacy we still adhere to until this day.
Value Investing -- From the Very Beginning
To value invest is to invest in value -- it involves purchasing underpriced securities, including stock at discounts to book value. The value of a security -- intrinsic value as Graham calls it, is determined by fundamental analysis (with consideration of factors such as earnings, dividends, growth potential, etc.) rather than market price. As a result, there can often be a discrepancy between the intrinsic value of a security, and its market price -- the margin of safety.
"An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative."
Long-term vs Short-term Investing -- The Visionary Knows Best
Graham is an advocate of the long-term perspective, emphasising that short-term, erratic fluctuations in stock prices is often an inaccurate indicator of intrinsic value, much like a voting machine; emerging towards a focus in value towards the long-term, much like a weighing machine.
The Mr. Market philosophy was one of the pioneering philosophies put forward by Graham. Mr. Market is a caricature that also simultaneously represents the metaphorical stock market. He turns up at the investor's door each morning, offering to buy and sell his shares at a different price. Sometimes his words are plausible -- on other days, not so much. As such, investors need not pay attention to the chicanery of the figure, but more so, the underlying business itself. By the same token, investors should view market fluctuations as opportunities to buy low and sell high, rather than as threats.
The Defensive vs Enterprising Investor -- A Binary Split
Defensive investors prioritise safety and a passive approach, while enterprising investors actively seek to outperform the market through research and analysis. Graham devised numerous quantitative and qualitative methods for the enterprising and defensive investor to maximise their gains under their each, limited constraints and goals.
Eight Maxims for the Defensive Investor | Nine Maxims for the Enterprising Investor |
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Security Analysis (1934)
Security Analysis, co-authored by Benjamin Graham and David Dodd, is a seminal work that lays the foundation for value investing and provides a comprehensive framework for analysing securities. He devised the Benjamin Graham formula, providing a valuation metric for securities:
V = EPS x (8.5 + 2g)
V = the value expected from the growth formulas over the next 7 to 10 years
EPS = trailing twelve months earnings per share
8.5 = P/E base for a no-growth company
g = reasonably expected 7 to 10 year growth rate
The Intelligent Investor (1949)
'By far the best book on investing ever written,' commented Warren Buffett. The Intelligent Investor is a foundational text on value investing, authored by Benjamin Graham. It emphasises the importance of a disciplined, long-term investment strategy and the concept of "margin of safety" to protect investors from significant losses. It was also in this book where the concept of the Graham number was introduced.
The Graham Number:
The 22.5 figure is used in the calculation to reflect Graham's view that the price-to-earnings (P/E) ratio should not exceed 15 times, and the price-to-book ratio should not go beyond 1.5 times (hence, 15 multiplied by 1.5 equals 22.5). It would be considered a worthy investment if the market price of a stock is lower than the Graham Number.
Graham's Legacy -- A Post-Crisis Relevancy
Graham's theories came into light again during the 2008 Global Financial Crisis, as policymakers and economists explored alternatives to existing monetary systems to prevent future crises. Most notably, he proposed a new basis for both U.S. and global currency as an alternative to the gold standard. His currency theory was an opposition to the gold standard, introducing a currency backed by a diverse basket of stable commodities, such as wheat, cotton, and copper, which would provide a more balanced and resilient foundation. By using multiple commodities, the system aimed to reduce price volatility and better manage inflation, as fluctuations in individual commodity prices would be offset by the others.
"Wall Street people learn nothing and forget everything."
Graham's legacy, much like his investment philosophy, has proven to be a value that appreciates over time. His teachings, once considered contrarian, have now become gospel in the financial world. As we navigate the turbulent waters of modern finance, with its cryptocurrencies, meme stocks, and AI-driven trading algorithms, Graham's timeless wisdom serves as our North Star. He taught us to look beyond the noise, to seek intrinsic value, and to always maintain a margin of safety – advice that's as relevant in the boardroom as it is in a buffet line.
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