A while ago we wrote an article on the 5 principles of value investing. It complements this one and goes into a bit more detail, and I recommend it.
These days, when we talk about Graham, the next person who comes to mind is the investor Warren Buffett, since he is Ben Graham’s star pupil, and probably one of the few (though not the only one) who applied Graham’s teachings to the letter.
Every great businessperson or investor starts from a set of principles that explain their success, so many people may wonder what principles Graham started from, and, more importantly, whether that long-term view of investing, which many believe is now finished, still applies today.
First, let’s remember that both now and in Graham’s heyday, there were plenty of investment “gurus” who said that the most profitable thing was to speculate: buy and sell, but never hold. As soon as it goes up, sell. As soon as it goes down, cut your losses. And of course trading already existed, although doing it without today’s technology was rather more of an embarrassment.
Value investing is criticised today, and it was already criticised in Graham’s day
We’ll use an extract from Graham’s own book, The Intelligent Investor, to get at the principles he started from in order to succeed as an investor, and to try to understand the stock market the same way Graham understood it.
During the 1929–1932 crash, markets lost almost 70%, and that is when Benjamin Graham thrived, looking for opportunities in the middle of the worst stock market disaster seen up to that time.
It’s said that there are no exact records of the returns Graham made, but from 1936 until he retired in 1956, his fund, Graham-Newman Corp., gained at least 14.7% a year, compared with 12.2% for the stock market as a whole, which makes it one of the best track records in Wall Street history.
If we look at the data on the historical returns of the world’s best investors, where we used figures provided by Forbes, Graham’s average annual return over 30 years was 17%, according to that publication.
How did Graham do it?
By combining his extraordinary intellect with deep common sense and wide experience.
What were Benjamin Graham’s principles for investing in the stock market, and why do they still hold today?
1. A share is not just a symbol on a price board
Shares are real stakes in the ownership of a real business, with an underlying value that doesn’t depend on the share price.
This may well be the point investors forget most. You’re not buying pieces of paper. You’re becoming a part-owner of a business, and that business will share its profits with you in the form of dividends.
As we’ve explained before, if you want to own part of Inditex, buy Inditex shares, and Amancio Ortega will share its profits or losses with you.
2. The market is a swinging pendulum
It swings constantly between unsustainable optimism (which makes shares too expensive) and unjustified pessimism (which makes them too cheap).
See also: Which companies NOT to invest in, according to value investing
The intelligent investor is the one who sells to the optimists and buys from the pessimists. And that is undoubtedly the most profitable approach in the stock market.
(Read: how Warren Buffett analyses a company’s shares before investing)
3. The future value of any investment depends on its price today: the more you pay, the lower your return
Clearly, if you believe something is worth 100, the cheaper you buy it, the more you’ll make when “it” reaches 100.
4. However careful you are, the one risk no investor can ever fully eliminate is the risk of being wrong
That’s why Graham came up with what he called the “margin of safety”, which basically means never paying too much, however attractive an investment may look. That way we can minimise (but never eliminate) the odds of making a mistake.
5. The secret of financial success lies within the person
If you become a critical thinker who doesn’t accept any stock market “fact” as an article of faith, and if you invest with patient confidence, you can do well consistently, even in the worst bear markets.
By developing discipline and personal courage, you can stop other people’s (other investors’) mood swings from ruling your financial destiny. In the end, how a person’s investments behave matters far less than how that person behaves.
See also: How to protect yourself from common stock market investing mistakes
(Read: the secret of Warren Buffett’s financial success)
As we’ve shown before, investors, being human, are subject to certain biases that affect how we invest.
The best investors usually aren’t the best because of their knowledge of finance, but because of a solid psychology when it comes to investing.
This article is based on an extract from The Intelligent Investor by Benjamin Graham, adapted and extensively modified.
Further reading
- 19 investing secrets everyone should know before they invest
- 5 books on investing and the stock market to read this summer
- The most profitable investment is this asset Warren Buffett says everyone should invest in
Featured image: Tengo las llaves, CC BY-SA 4.0, via Wikimedia Commons.
