Who is Benjamin Graham?

Benjamin Graham is most famous for being the teacher of investment legend Warren Buffett. Graham is widely recognized as being the father of value investing. He transformed the investment world from speculators gambling on the market into investors profiting off investments. Graham wrote two books that are now famous in the finance world the first was “Security Analysis” (1934) and the second is “The Intelligent Investor” (1949). The Intelligent Investor is still a must in any investor’s library.

How Does He Do It?

Graham is very detail oriented. He is one of the first investor’s to use financial calculations to determine stock picks. He helped write two federal laws that require businesses to release financial statements regularly, which made his life as an investor much easier. He lost most of his money in the stock market crash of 1929, which led him to redefine his investment style. He learned how to invest in low risk companies that were trading under their true value. He would try to buy companies for 50% of what they were really worth. He was really good at this.

Graham’s Investment Philosophy

Graham came up with two method’s to acheive his goal of buying companies for half their value. The first one was to use market psychology and the other was to crunch the financial numbers.

Market Psychology

Before the great depression, economic recessions were referred to as panics. This is because investors panic as the market starts to fall and sell their shares resulting in a free fall of the market. Because, the investor’s are panicing, one can imply that some of this panic may be irrational. This is where Graham would make millions. He had a philosophy that investor’s should invest when others were panicing and foolisly selling their stocks and be fearfull and cautious when others are buying, buying.

Warren Buffett adopted this principle adametly. He is famously quoted as saying “We simply attempy to be fearful when others are greedy and to be greedy when others are fearful.”

Basic Principles

1. Look for a margin of Safety

During the stock crash of 1929, Benjamin Graham lost most of his money. As the coming great depression ensued he began to think how investors could lower risk yet still profit off investments. The Margin of safety allows investors to do both. Graham determined that if investors purchase a stock well under it’s intrinsic value, they could then make large profits as the stock’s value increased and the level of valitility would be low since the stock was already under priced.

Often times Graham would attempt to buy companies that had assets that valued more than a company’s market cap which, he concluded was, essentially, buying a company for nothing. He had a formula he would use, where he subtracted total liabilities from a company’s total assets he called this the Net Current Asset Value oR NCAV. If the NCAV is less than a company’s market cap, the virtual price tag of a company, then investors can make a steal buying that company’s stock. In fact, he would never purchase a stock, unless it was trading for 1.2 times less than it’s NCAV. So if a company’s assets minus liabilites equaled 100 million dollars, then Graham would only consider the stock if the market cap was 120 million dollars or less.

2. Invest In Large Successful Companies with Strong Sales.

Similarly to the margin of safety, this principle decreases risk for an investor. Large Companies with proven sales are far less risky than small growing companies. Large Companies can weather the storm of a serious economic recession. Graham came to this conclusion while inveting in the Great Depression, where he saw this first hand.

3. Understand the Market Will Go Down and Use This to Your Advantage.

This Principle follows the Grahamatic wisdom that one should be fearful when others are greedy and greedy when others are fearful. Graham knew that the market would take occasional downturns. Often times, during these economic slips, the market falls farther than it really should. In terms of Graham’s philosophy this means that the intrinsic value of many strong companies will be under-priced. Thus, there is an enormous margin of profitability during this economic climate.

Smart investors don’t follow the crowd. They won’t sell their stocks in panic when most other investors do. The smart investor will buy up all the cheap stocks that other panicked investors leave behind. This leads to enormous profit margins.

4. Be wary of Debt.

Like most other sucessful investors, Benjamin Graham found debt to be an investor’s enemy. Graham always tried to find companies whose assets valued higher than the sum of their debts. He also liked companies with cash available. He believed that companies with high liquidity were less risky than other companies.

5. Sustainable Earnings Growth.

Graham prefered companies with a strong earnings growth. He particularly fancied companies whose earning trends were steadily increasing. He concluded that companies with this kind of earning behavior would be increasingly profitable for investors.

Profitable Investing

If you can hone the skills that Benjamin Graham taught to his students, you are well on your way to becoming an experienced and successful investor. Graham placed a lot of stress on the value of a company and this aspect of his investment strategy is most important. Graham himself earned an annual average return of 20%, which includes the tumultuous Great Depression and more importantly he went on to become perhaps the best investment teacher in history. His principles are still used today by the most successful investors on wall street. If you would like to learn more about Benjamin Graham’s investment philosophy his books Security Analysis and, especially, “The Intelligent Investor” are great buys and a must for any serious investor.