While physicist Sir Isaac Newton is widely viewed as the leading authority on gravity and motion, economist Benjamin Graham (1894-1976) is lauded as a top guru of finance and investment. Known as "the father of value investing," Graham excelled at making money in the stock market without taking big risks, by evaluating companies with surgical precision. His principles of investing safely and successfully continue to influence investors today.
After graduating from Columbia University in 1914, Graham went to work on Wall Street, which enabled him to cultivate a sizable personal nest egg over the next 15 years. Sadly, Graham lost most of his money in the stock market crash of 1929 and the subsequent Great Depression.
Those experiences taught Graham lessons about minimizing downside risk 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, turning market fears to his advantage. These ideals inspired him to write "Security Analysis" (published in 1934), which chronicled his methods of analyzing securities.
"Mr. Market" and Margin of Safety
Graham stressed the importance of looking at the market in the same way one would regard a business partner who offers to buy you out or sell you his interest in a company. Graham referred to this imaginary person as "Mr. Market," who sometimes proposed prices that made sense, and who at other times proposed prices that were off the mark, given current economic realities.
As investors, we have the power to accept or reject Mr. Market's offers, on any given day, giving us a leg up over those who feel compelled to be invested at all times, regardless of the current valuation of securities.
Graham also stressed the importance of maintaining a margin of safety, which refers to the practice of buying into a stock at a price that’s well below a conservative valuation of the business. This allows for profit on the upside, as the market typically eventually recalibrates the stock to its fair value, while simultaneously offering downside protection in the event that a business falters or permanently shutters its doors.
The Intelligent Investor and Warren Buffett
Arguably Graham’s best-known book, "The Intelligent Investor" (1949), provided additional practical advice to the common investor. Legendary investor Warren Buffett, who Graham famously mentored, called this title "by far the best book on investing ever written.” In fact, after reading it at age 19, Buffett enrolled in Columbia Business School in order to study under Graham, with whom he developed a lifelong friendship. He later worked for Graham at his investment company, the Graham-Newman Corporation.
Buffett ultimately developed his own strategy, which differed from Graham's in that he stressed the importance of a business's quality, and he preached the virtue of holding stocks for the long haul. Even so, Buffett said that no one ever lost money by following Graham's methods.
The Bottom Line
Although details of Graham's specific investments aren’t readily available, he reportedly averaged an approximate 20% annual return over his many years managing money. His method of buying low-risk stocks with high return potential has made him a true pioneer in the financial analysis space.