Benjamin Graham – Valuable Investing Lessons From the Father of Value Investing

Often known as the father of value investing, Benjamin Graham was also Warren Buffett’s mentor. The author of two investments classics, Graham was one of the first true proponents of Fundamental Analysis — the science of evaluating companies based on their financial performance or fundamentals.

We can glean some valuable investing lessons by taking a look at Graham’s early life, investing career, and the investing principles he developed during his lifetime.

Early Life
Ben Graham was born Benjamin Grossbaum in on May 9, 1894, in London. His father was a dealer in china dishes and figurines. The family migrated to the United States when Graham was only one.

At first, the family lived in the lap of luxury on upper Fifth Avenue. But in 1903, Graham’s father passed away. The porcelain business stumbled, and the family’s financial health steadily declined. Graham’s mother turned their house into a boardinghouse to make money. She also borrowed money to trade stocks “on margin.” This proved to be a costly mistake – she was wiped out in the crash of 1907.

Graham’s teenage years were filled with financial humiliation. Fortunately, Graham won a scholarship to Columbia, where he shone brilliantly. He graduated second in his class in 1914. So remarkable were his academic achievements, that by the time he graduated, three departments – English, Philosophy, and Mathematics – asked him to join the faculty. Graham was only 20 years old.

Graham’s Investment Career
Graham chose Wall Street over academia. He started as a clerk in a bond-trading firm, quickly progressing to analyst, then partner, and shortly after that he started his own investment partnership.

Graham pioneered the science of investing as against speculation. Quite shockingly, trading of stocks was largely a speculative exercise in those days and hardly any attention was paid to the fundamentals of a company.

Graham became an expert in researching stocks in painstaking detail. In 1925, for example, in the course of his research, he came across some interesting findings…. Northern Pipe Line Co. held at least $80 a share in high-quality bonds. Northern Pipe Line’s stock price at that time? $65 a share. Graham exploited this discrepancy by buying the stock and persuading the management to raise the dividend. Three years later, he walked away with $110 a share – a return of almost 70%.

Graham was not always successful, though, in those days. During the great crash of 1929-32, he lost 70% of his portfolio. But despite this steep decline, he was able to apply his methods and scoop up stunning bargains when the rest of the market was deeply pessimistic. From 1936 until his retirement in 1956, Graham-Newman Corp., the partnership he created with Jerome Newman, gained almost 20% annually (14.7% after accounting for fees), while the rest of the market was up 12.2%. This enviable performance is one of the best Wall Street has ever seen.

Graham’s Investment Principles
Two of the books that Graham authored have stood the test of time to achieve classic status – The Intelligent Investor, and Security Analysis. The following investment principles can be distilled from these masterpieces:

  • Buying stock in a company is like buying the business – This falls under Graham’s recommendation to invest rather than speculate. Buying stock in a company should involve research and analysis along the same lines as buying a business.
  • Know your investing style – Graham talks about two types of investors: “defensive” and “enterprising”. A defensive investor is a passive investor who does not spend much time analyzing companies and picking his investment opportunities. Graham’s recommendation for the defensive investor would be, in today’s terminology, to stick to index funds. A defensive investor should expect average returns. An enterprising investor, on the other hand, is one who is seriously committed to researching and analyzing companies to invest in. Graham believed that the more work you put into your investments, the higher the return you could expect.
  • Use market fluctuations to your advantage – The market usually is fairly accurate in pricing stocks. However, sometimes, emotions get the better of investors. At times like this stocks can be mispriced. What advice does Graham have for the intelligent investor in such conditions? Never sell in panic just because the market is under-valuing your stock. In most cases, this is only temporary. In fact, times of maximum pessimism like these are when the best bargains are to be had. Graham recommends buying meaningful amount of stock at huge discounts in companies that you’ve researched. What about the other extreme – overvaluing? If you find the stock price of companies you’ve invested in way above what you’ve valued them, this might be a good time to sell. Sooner or later the market will correct itself and it’s best to lock in your gains before that happens.
  • Always use a margin of safety – Graham called this the central concept of investment. When asked to distill the “secret” of sound investment, margin of safety was the motto he offered. But first, what exactly does this mean? When conducting a valuation on a company, the intrinsic value we come up with is based on our best prediction of the future. Like any prediction, there is a probability that things won’t go as planned. In order to insulate ourselves from such uncertainties, we need to add a safety factor to our calculations. This is your safety margin. So how much of a margin do we need? Depends on our measure of uncertainty of the future. Companies that are more stable and have a proven track record of great financial performance will demand less margin. Anywhere between 25-50% off our calculated value would be a good starting point.

The Mr. Market Parable
In the Intelligent Investor, Ben Graham uses a very powerful parable to illustrate market fluctuation. In Graham’s own words….

“Imagine you had a partner in a private business named Mr. Market. Mr. Market, the obliging fellow that he is, shows up daily to tell you what he thinks your interest in the business is worth.

On most days, the price he quotes is reasonable and justified by the business’s prospects. However, Mr. Market suffers from some rather incurable emotional problems; you see, he is very temperamental. When Mr. Market is overcome by boundless optimism or bottomless pessimism, he will quote you a price that seems to you a little short of silly. As an intelligent investor, you should not fall under Mr. Market’s influence, but rather you should learn to take advantage of him.

The value of your interest should be determined by rationally appraising the business’s prospects, and you can happily sell when Mr. Market quotes you a ridiculously high price and buy when he quotes you an absurdly low price. The best part of your association with Mr. Market is that he does not care how many times you take advantage of him. No matter how many times you saddle him with losses or rob him of gains, he will arrive the next day ready to do business with you again.”

Summing Up
Benjamin Graham was undoubtedly one of the most profound financial thinkers. His contribution to the field is invaluable. A good testimony to his achievements is the outstandingly successful group of disciples he spawned…. Warren Buffett, Jean-Marie Eveillard, William J. Ruane, Irving Kahn, Hani M. Anklis, and Walter J. Schloss.

Graham’s investment principles are easy to understand, but sometimes difficult to put into practice. For instance, it takes a great deal of courage to invest when everyone else is panicking. But if you pick your companies based on sound analysis of the fundamentals, there is a high probability that you will profit handsomely when the market eventually corrects itself.