Benjamin Graham was an influential investor whose research in securities laid the groundwork for in-depth fundamental valuation used in stock analysis today by all market participants. His famous book, The Intelligent Investor has gained recognition as the foundational work in value investing.
- Benjamin Graham was an English-born investor and researcher whose work provided the framework for stock analysis.
- Graham earned approximately $500,000 per year by age 25 but lost nearly all of his earnings and investments from the stock market crash of 1929.
- The market crash of 1929 inspired Benjamin Graham to co-write a research book titled Security Analysis.
- In 1949, Graham published The Intelligent Investor: The Definitive Book on Value Investing, which is known as the investor's bible.
- As an instructor at Columbia University, Graham instructed and mentored now-billionaire investor Warren Buffet.
Early Life and Education
Benjamin Graham was born in 1894 in London, UK. When he was still little, his family moved to America, where they lost their savings during the Bank Panic of 1907. Graham attended Columbia University on a scholarship and accepted a job offer after graduation on Wall Street with Newburger, Henderson, and Loeb.
By the age of 25, he was already earning about $500,000 annually. The Stock Market Crash of 1929 lost Graham almost all his investments and taught him some valuable lessons about the investing world. His observations after the crash inspired him to write a research book with David Dodd, called Security Analysis. Irving Kahn, one of the greatest American investors, also contributed to the research content of the book.
Benjamin Graham is considered a founder of stock analysis and particularly value investing. According to Graham and Dodd, value investing is deriving the intrinsic value of a common stock independent of its market price. By using a company’s factors such as its assets, earnings, and dividend payouts, the intrinsic value of a stock can be found and compared to its market value. If the intrinsic value is more than the current price, the investor should buy and hold until a mean reversion occurs.
A mean reversion is the theory that over time, the market price and intrinsic price will converge towards each other until the stock price reflects its true value. By buying an undervalued stock, the investor is, in effect, paying less for it and should sell when the price is trading at its intrinsic worth. This effect of price convergence is only bound to happen in an efficient market.
What is Value Investing?
Graham was a strong proponent of efficient markets. If markets were not efficient, then the point of value investing will be pointless as the fundamental principle of value investments lies in the ability of the markets to eventually correct to their intrinsic values. Common stocks are not going to remain inflated or bottomed-out forever despite the irrationality of investors in the market.
Benjamin Graham noted that due to the irrationality of investors, including other factors such as the inability to predict the future and the fluctuations of the stock market, buying undervalued or out-of-favor stocks is sure to provide a margin of safety, i.e. room for human error, for the investor.
Also, investors can achieve a margin of safety by purchasing stocks in companies with high dividend yields and low debt-to-equity ratios, and diversifying their portfolios. In the event that a company goes bankrupt, the margin of safety would mitigate the losses that the investor would have. Graham normally bought stocks trading at two-thirds their net-net value as his margin of safety cushion.
The original Benjamin Graham Formula for finding the intrinsic value of a stock was:
V = EPS × (8.5 + 2g)where:V = intrinsic valueEPS = trailing 12-mth EPS of the company8.5 = P/E ratio of a zero-growth stockg = long-term growth rate of the company
In 1974, the formula was revised to include both a risk-free rate of 4.4% which was the average yield of high grade corporate bonds in 1962 and the current yield on AAA corporate bonds represented by the letter Y:
V=YEPS × (8.5 + 2g) × 4.4
Security Analysis was first published in 1934 at the start of the Great Depression, while Graham was a lecturer at Columbia Business School. The book laid out the fundamental groundwork of value investing, which involves buying undervalued stocks with the potential to grow over time. At a time when the stock market was known to be a speculative vehicle, the notion of intrinsic value and margin of safety, which were first introduced in Security Analysis, paved the way for a fundamental analysis of stocks void of speculation..
In 1949, Graham wrote the acclaimed book The Intelligent Investor: The Definitive Book on Value Investing. The Intelligent Investor is widely considered the bible of value investing and features a character known as Mr. Market, Graham’s metaphor for the mechanics of market prices.
Mr. Market is an investor’s imaginary business partner who daily tries to either sell his shares to the investor or buy the shares from the investor. Mr. Market is often irrational and shows up at the investor’s door with different prices on different days depending on how optimistic or pessimistic his mood is. Of course, the investor is not obligated to accept any buy or sell offers.
Graham points out that instead of relying on daily market sentiments which are run by investor’s emotions of greed and fear, the investor should run his own analysis of a stock’s worth based on company’s reports of its operations and financial position. This analysis should strengthen the judgment of the investor when s/he’s made an offer by Mr. Market.
According to Graham, the intelligent investor is one who sells to optimists and buys from pessimists. The investor should look out for opportunities to buy low and sell high due to price-value discrepancies that arise from economic depressions, market crashes, one-time events, temporary negative publicity, and human errors. If no such opportunity is present, the investor should ignore the market noise.
While echoing the fundamentals introduced in Security Analysis, The Intelligent Investor also provides key lessons to readers and investors by advising investors to not follow the herd or crowd, to hold a portfolio of 50% stocks and 50% bonds or cash, to be wary of day trading, to take advantage of market fluctuations, to not buy stocks simply because it is liked, to understand that market volatility is a given and can be used to an investor’s advantage, and to look out for creative accounting techniques that companies use to make their EPS value more attractive.
One notable disciple of Benjamin Graham is Warren Buffett, who was one of his students at Columbia University. After graduation, Buffett worked for Graham’s company, Graham-Newman Corporation, until Graham retired. Buffett, under the mentorship of Graham and value investing principles, went on to become one of the most successful investors of all time and as of 2022, the seventh wealthiest man in the world valued at almost $103 billion. Other notable investors who studied and worked under the tutelage of Graham include Irving Kahn, Christopher Browne, and Walter Schloss.
Although Benjamin Graham died in 1976, his work lives on and is still widely used in the twenty-first century by value investors and financial analysts running fundamentals on a company’s prospect for value and growth.
What Is the Dodd and Graham Award?
The Graham and Dodd award, in honor of former Columbia University finance professors Benjamin Graham and David Dodd, acknowledges people who excel in research and financial writing in the Financial Analysts Journal.
What Is Benjamin Graham Known for?
Benjamin Graham was a renowned value investor, lecturer, financial securities researcher, and mentor to billionaire investor Warren Buffet. Known as the "father of investing," Graham wrote several books, including The Intelligent Investor, which is widely considered the value investor's bible.
What Are the Three Principles of Investment According to Benjamin Graham?
Benjamin Graham's main investment principles are to:
- Invest with a margin of safety,
- Anticipate volatility and benefit from it, and
- Know what type of investing you are good at; in other words, know what type of investor you are.
The Bottom Line
Benjamin Graham, dubbed the "father of value investing," is known for his investing style, literary contributions on investing, and research. Graham lectured at his alma mater, Columbia University, and eventually became a professor of finance there. His legendary book, The Intelligent Investor, introduced value investing to the financial and investing world. He also defined investment principles adopted by some of the world's most infamous investors.