Benjamin Graham, an American-British economist, professor, and investor. Born on May 9, 1894, in London, UK a died in 1976 in France at the age of 81 tears old.
In 1949 he published “The intelligent investor” one of his most successful works that made him inspire a lot of people worldwide with his philosophy of “value investing”. Graham was teacher and mentor for some of the most fulfilling investors like Warren Buffett, William Ruan, and Charles Brandes.
Meet Mr. Market:
The writer likens the market to a real person who visits you multiple times a day trying to convince you to sell or buy bonds/stocks. Mr. Market is too sensitive to news, he straightforwardly becomes too optimistic or too pessimistic which makes his offers untrustable and very often misleading.
According to Graham, investors should focus on the real-life performance of a company in order to not get misled by Mr. Market’s changing moods, because the underlying value of a business can differ from the price the market gives it, it frequently is over-priced or under-priced as the market easily reacts to the news.
A stock is not just a tricker combined with a price tag, it’s an ownership interest in a business. Graham advises you to invest only if you feel comfortable holding the stock in the future without seeing the fluctuating prices the market presents you with.
The margin of safety:
Risk is inevitable in the stock market, but we can, however, minimize it through methods like “the margin of safety”.
The margin of safety is a core principle in Graham’s investing approach, according to which an investor should only purchase securities when their market price is significantly lower than their estimated intrinsic value.
The difference between the price and the intrinsic value is called “the margin of safety”.
Investors use different qualitative and quantitative methods to estimate the intrinsic value and then use the market price as a comparison point.
Those methods used to estimate the value of a stock are what Graham calls “security analysis”. He actually devoted a whole book to this subject: Security Analysis by Benjamin Graham ( Classic version).
All of the above leads us to the value investing paradigm, one of the most famous investment approaches attributed to Benjamin Graham, also known as “the father of value investing”, this paradigm involves choosing stocks that appear to be trading for less than their intrinsic or book value, in other words, picking stocks that we believe are underestimated by the market. Believers in this model recommend investing in companies that show strong earning potential and growth aptitude in the long term.
Value investors ignore the market trends since these do not reflect the firm’s long-term fundamentals.
Defensive Investors vs Enterprising Investors:
Graham makes the distinction between defensive and enterprising (offensive) investors
- Defensive investor: this is a risk-averse investor whose primary goal is the preservation of principal. According to this investment approach, the investor should have an adequate diversification in issues (stocks and bonds) as well as a diversification across sectors and countries. A defensive investor is looking for protection in the first place and then comes a modest growth. This strategy involves regular portfolio rebalancing to restore an intended asset allocation
When choosing stocks, as a defensive investor, Graham recommends considering a few things about each company:
- How large is the enterprise? Choose larger and less volatile companies.
- Assets should be at least 2x liabilities, and long-term debt should be less than net current assets.
- Positive earnings should be recorded for the past ten years.
- Dividends should have been paid out without interruption for the past 20 years.
- The per-share earnings should have a minimum increase of at least one-third over the past ten years.
- The price-to-earnings ratio should be no more than 15 times the average earnings of the past three years.
- The ratio of price to assets should not be more than 1.5 times the book value last reported. Plus, the PE ratio x PB Ratio should not be more than 22.5.
- Offensive investor: an offensive investor (or enterprising investor) puts more time, effort, and experience into investing in order to broaden his possible opportunities beyond conservative investing. It’s an active process that requires constant attention and monitoring.
Graham recommends different considerations for enterprising investors looking into companies:
- The company’s current assets should be at least 1.5 times current liabilities. They should not have debt that is more than 110% of net current assets.
- There should be no earning deficit in the last five years.
- There should be a dividend.
- Last year’s earnings should be more than those of the year before.
- The price of the stock should be less than 120% of net tangible assets.
The Intelligent Investor: The Definitive Book on Value Investing is, with no doubt, one of the greatest books ever written on finance and investing. Graham succeeded in inspiring millions of people to follow his investment approach and became a true role model even for the most successful investors like Warren Buffett who described as “by far the best book on investing ever written”