Jul 12, 2022
Benjamin Graham, considered the father of security analysis and value investing, is one of the finest investors of the twentieth century. He is famed for his investing principles, which he put succinctly in his books, “The Intelligent Investor” and “Security Analysis.” He is also well known as one of the most impactful investors of our age, having mentored and indoctrinated the great Warren Buffet.
Graham is considered one of the greatest not just because of his published investing books but also by producing results that speak for themselves. His investment company consistently beat the market for two decades between 1936 to 1956. And as a result, the company’s financial statements recorded over 8% more than the market average.
Still abiding by his foundational investment principles, Warren Buffet formed his first partnership. He accomplished an annual return of 31.6% without incurring any loss.
As a believer in riding for the long haul, he had some tenets he strictly followed throughout his life. These principles have also been passed on to his protégés and many followers. They include:
Warren Buffet famously illustrated margin of safety as an investment strategy using an analogy.
He compared investing with a margin of safety to driving a 10,000-pound truck over a bridge with a 30,000-pound carrying capacity. This strategy is the notion of buying an asset at a considerable discount to its inherent value.
As a principle, Graham recommends buying dividend stock at a price lower than it is usually sold. If at all a poor decision is made or there is a market downtime, you will have incurred loss from a broader perspective.
Calculating the Real Worth of Stocks
Before buying any stock, Benjamin Graham would always calculate its intrinsic value using an old formula. It goes;
V = EPS x (8.5 + 2g)
V = Intrinsic value
EPS = Earnings per share
8.5 = price per earnings ratio of a zero growth stock
G = growth rate
After calculating the intrinsic value of the stock, he proceeds to determine the percentage of its margin of safety.
Ps: Every component of the equation can be derived from the financial statements of the company.
The stock market is volatile and prices are constantly fluctuating. Rather than fleeing the market during times of price volatility, Graham teaches staying put and expecting to profit from it. An astute investor utilizes price changes as an opportunity window for buying more assets at a bargain price.
Furthermore, market movements should not be reason enough to make emotional financial decisions. Instead, assess the business value, buy low, and sell high.
The detrimental consequences of market volatility can be alleviated in two ways.
Dollar-Cost Averaging: It is the act of purchasing an investment in an equal dollar amount at regular intervals. For example, investing $50 monthly in a particular stock until the desired price set is reached. It allows an investor to buy at different price points rather than at a particular peak price. It is the perfect answer to the question, “when to buy a stock?”
Portfolio Balancing: Graham believes it is essential to balance your portfolio between stocks and bonds to protect your money during times of market down times. His idea was to protect money first and then strive to develop it. As a rule, he believes 25% of your money should go into investing in stocks and bonds. However, this percentage may vary depending on market conditions.
Graham believes that you must be self-aware as an investor. So he created a contrast between categories of investors.
Enterprising and Defensive Investors: Graham famously categories every investor into two broad groups. According to him, everyone in the stock market falls into one of the two groups; the enterprising and the defensive investor. The enterprising investor is active and devotes a significant amount of time and effort to research. He attends the meetings, looks through the financial statements, etc., just to become skilled.
On the other hand, the defensive investor is passive and puts much less work into researching. As his standing principle, the more work you put into investing, the higher your projected return. He recommends that investing in indexes is the best way to make passive income from the stock market as a defensive investor.
Speculators versus Investors: An investor considers himself a part-owner of the business, while a speculator sees the stock market as another gambling opportunity.
It is imperative to distinguish a company’s stock price from its value. A stock price is volatile, and it fluctuates based on several factors. However, in reality, the actual underlying value of a business is mostly stable. Therefore, an intelligent investor must learn to take advantage of the price volatility and business stability.
Investing in a dividend stock or company you love is not enough. An investor must have a grasp of the company’s basics. Graham himself consistently applied this principle to his investments. Before buying any stock, he referenced it with a ten points checklist.
Graham’s investment principles, however relatively strict, produced consistent results in the stock market during his days. As old as it may seem, the principles of value investing still has its relevance in today’s market. Warren Buffet and countless other investors who follow his principles can boast of the Benjamin Graham way results.
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