Ben Graham: Investment Legend.
Ben Graham is widely acknowledged as the Dean of Value Investing. His disciplined approach to investing has impacted generations of investors. His best-selling book, The Intelligent Investor has become a blueprint for investment success for generations of high profile Money Managers including
- Warren Buffett,
- Seth Klarman,
- Leon Cooperman,
- and Mario Gabelli.
In this article, I will review the books Ben Graham wrote as well as the basics of his life and investing style. The more knowledge we can acquire from Benjamin Graham and Warren Buffett, the better our investing success will be.
*Affiliate Disclosure: This post contains affiliate links. Business partners may compensate me for inclusion on this blog, but I strive to only partner with quality businesses and the reader pays nothing.
Who Was Ben Graham:
“The intelligent investor is a realist who sells to optimists and buys from pessimists.”
― Benjamin Graham, The Intelligent Investor
Benjamin Graham: Known as “the father of value investing” and the “dean of Wall Street,” excelled at making money in the stock market for himself and his clients without taking big risks.
Graham created and taught many principles of investing safely and successfully that modern investors continue to use today’s stock market.
The Intelligent Investor:
“By far the best book on investing ever written.” — Warren E. Buffett
Graham’s second book is much more user-friendly for the average investor. If you want to become a really good investor, this book is a great place to start. It is well worth the time and money. “The Intelligent Investor,”
This is the book I re-read during the 2008 Financial Crisis. And it helped me tremendously. You may want to read my post, Lessons Learned from the 2008 Financial Crisis.
“The best known and most likely to make you money is The Intelligent Investor.” — Andrew Tobias
“Graham ranks as this century’s (and perhaps history’s) most important thinker on applied portfolio investment.” — John Train, author of The Money Masters
More on the Intelligent Investor here.
1929 Crash and Great Depression:
Value investing is about minimizing risk.
Graham’s painful losses in the 1929 crash and Great Depression led him to hone his investment techniques. These techniques sought to profit in stocks while minimizing downside risk. He did this by investing in companies whose shares traded far below the companies’ liquidation value.
In simple terms, his goal was to buy a dollar’s worth of assets for $0.50. To do this, he utilized market psychology, using the fear and greed of the market to his advantage, and invested by the numbers.
Graham also stressed the importance of always having a margin of safety in one’s investments. This meant only buying into a stock at a price that is well below a conservative valuation of the business.
This is important because it allows profit on the upside as the market eventually revalues the stock to its fair value, and it also gives some protection on the downside if things don’t work out as planned.
Ben Graham & Value Investing
How do we apply his investment criteria to make money today. Many value managers use the following criteria to screen and filter for stocks that are worth much more than their current share price.
I use Graham’s investing criteria to find undervalued stocks.
See my investing articles on Signet or Ralph Lauren, the most undervalued brand in the world, as examples.
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Investment Criteria:
Size: Sales $500 million ($100m originally, but adjusted for inflation since the time of Graham’s writing). Smaller companies are generally subject to wider fluctuations in earnings.
- For industrial companies, Graham used annual sales as a proxy for company size but, for utilities, he used $50m of assets instead ($250m inflation adjusted).
Strong Financial Condition, Current Ratio: Greater than 2.0
A current ratio above 2 means that the cash and liquid assets of the company are more than twice the Total Debts.
This is a strong financial condition. And it was the painful lessons of the Great Depression that led Graham to be strict in terms of only selecting the companies with a strong financial condition.
Long Term debt: Low Debt Long term debt should not exceed the working capital or net current assets.
Earnings Stability: EPS for the last 10 Years on the basis that companies that have maintained at least some level of earnings are more likely to be stable going forward.
Dividend track record over a 20 year period – not as relevant today as few companies pass this test as nowadays, companies are more inclined to use excess cash to buy back their shares.
Earnings growth = 3% on average over last 10 years. Graham wanted to see defensive companies grow their EPS by at least one third over the last 10 years, implying this minimum compound growth rate.
Price Earnings Ratio 15, using an average of EPS for the last three years. This is to account for special charges and to overcome the impact of cyclical business.
Price to Book 1.5. Graham recommended that the current price should not be more than 1.5x the book value last reported.
Warren Buffett:
After reading “The Intelligent Investor” at age 19, Buffett enrolled in Columbia Business School in order to study under Graham, and they subsequently developed a lifelong friendship.
Later, he worked for Graham at his company, the Graham-Newman Corporation, which was similar to a closed-end mutual fund. Buffett worked there for two years until Graham decided to close the business and retire.
Security Analysis: In 1928 he began teaching investment classes at Columbia University.
Over time, working with former student David Dodd, the lessons of his classes were gathered into his first book, titled “Security Analysis,” which was published in 1934. More about Security Analysis here.
Security Analysis by Graham and Dodd is a lengthy and serious study of security analysis.
This book is for the knowledgeable and serious investor.
The book has sold over a million copies.
Warren Buffett says he’s read it at least four times.
Buffett Investing Strategy: Warren Buffett went on to develop his own strategy, which differed from Graham’s in that he stressed the importance of a business’ brand equity and of holding investments indefinitely.
Graham would typically invest based purely on the numbers of a company, and he would sell an investment at a predetermined value.
Even so, Buffett could not have achieved his incredible success if Benjamin Graham had not taught him the way.
One of the best in-depth profiles of Warren Buffett was done by Roger Lowenstein, a Wall Street Journal reporter.
Buffett: Making of an American Capitalist here.
Benjamin Graham: Legacy of Creating Incredible Value Investors:
- Investors like Warren Buffett and Charlie Munger refined the principles by applying additional factors – such as franchise value, management quality and capital allocation – in the assessment of intrinsic value.
- Those who applied Graham’s ideas to new situations: Investors like John Templeton showed how well value investing could work in international stocks, including emerging markets.
- Others, like Joel Greenblatt, known for The Little Book that Beats the Market and Seth Klarman, applied the principles to special situations, such as bankruptcy securities, spinoffs, and complex structures.
Hedge Fund Titans Leon Cooperman & Mario Gabelli:
While a student at Columbia University’s business school, famed investor Leon Cooperman used to carpool to class with Mario Gabelli, CEO of GAMCO Investors. The two studied security analysis under Roger Murray, a noted value investing professor and co-author of the fifth edition of Graham’s Security Analysis, the bible of modern day value investing.
“Value investing became very appealing to me,” says Cooperman. “Why wouldn’t anyone want to get more for less?”
Cooperman, who was the head of research and a top strategist at Goldman, Sachs before launching Omega Advisors in 1991, says he shuns the risks of momentum investing, believing that a better long-term strategy is to know that he is making investments in stocks that are fundamentally mispriced.
The Sequoia Fund:
If there was ever a legendary fund, it’s Sequoia SYMBOL: (SEQUX), managed by New York-based Ruane, Cunniff & Goldfarb. This mutual fund was co-founded by Richard Cunniff and William Ruane, Buffett’s stockbroker, in 1970. It got a boost right from the beginning because Buffett, who was liquidating his own investment partnership, advised his clients to take their cash to Sequoia.
Ruane and Cunniff shared the Graham-inspired value underpinnings with Buffett and over the years developed a reputation for focusing on long-term growth of capital. The fund looks for undervalued companies with potential for growth and, like Buffett’s Berkshire Hathaway, is willing to hold positions for many years, even decades.
Seth Klarman:
Klarman’s fund has reportedly generated annual returns of 16.4 percent and $22.6 billion in net profit for his clients since inception more than three decades ago through 2015. Baupost generated a “high single-digit” return in 2016, according to an investor letter.
Investing Tips from Seth Klarman, author of Margin of Safety: (via FT)
- Value investing works. Buy bargains.
- Quality matters, in businesses and in people. Better-quality businesses are more likely to grow and compound cash flow; low-quality businesses often erode and even superior managers, who are difficult to identify, attract, and retain, may not be enough to save them. Always partner with highly capable managers whose interests are aligned with yours.
- There is no need to overly diversify. Invest like you have a single, lifetime “punch card” with only 20 punches, so make each one count. Look broadly for opportunity, which can be found globally and in unexpected industries and structures.
- Consistency and patience are crucial. Most investors are their own worst enemies. Endurance enables compounding.
Legacy: Ben Graham’s disciplined approach to investing has impacted generations of investors. His best-selling book, The Intelligent Investor and Security Analysis have become a blueprint for investment success for generations of high profile Money Managers including Warren Buffett, Seth Klarman, Mario Gabelli, and Leon Cooperman.
These books still deliver value to new investors today. If you want to become a great investor there is no better place to begin.