Benjamin Graham

Who is Benjamin Graham?

Benjamin Graham was an influential investor whose securities research laid the foundation for in-depth fundamental valuation used in stock analysis by all market participants today. His famous book, The smart investor has been recognized as the foundational work of value investing.

Key points to remember

  • Benjamin Graham was an English-born investor and researcher whose work provided the framework for stock analysis.
  • Graham was earning around $500,000 a year by the age of 25, but lost almost all of his income and investments to the stock market crash of 1929.
  • The stock 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, known as the investor’s bible.
  • As an instructor at Columbia University, Graham trained and mentored now billionaire investor Warren Buffet.

Investopedia/Alex Dos Diaz


Understanding Benjamin Graham

Benjamin Graham was born in 1894 in London, UK. When he was still small, his family moved to America, where they lost their life savings during the Banking 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 age 25, he was already earning around $500,000 a year. The Stock market crash of 1929 Graham lost almost all of his investments and taught him valuable lessons about the world of investing. His post-crash observations inspired him to write a research book with David Dodd, titled Security analysis. Irving Kahn, one of America’s top investors, also contributed research content to the book.

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 the foundations for invest in valuewhich is to buy undervalued stocks with potential for growth over time. At a time when the stock market was known to be a speculative vehicle, the concept of intrinsic value and safety marginwhich were first introduced in Security analysispaved the way for a fundamental analysis of shares devoid of speculation.

Benjamin Graham and Value Investing

According to Graham and Dodd, value investing derives the intrinsic value of a common stock regardless of its market price. Using a company’s factors such as its assets, earnings and dividend payments, the intrinsic value of a stock can be found and compared to its market value. If the intrinsic value is higher than the current price, the investor should buy and hold until mean reversion occurs. A mean reversion is the theory that over time the market price and the intrinsic price will converge towards each other until the stock price reflects its true value. By buying an undervalued stock, the investor is actually paying less and should sell when the price is trading at its intrinsic value. This price convergence effect will only occur in a efficient market.

Graham was a strong proponent of efficient markets. If markets were not efficient, then the value of value investing would be useless because the fundamental principle of value investing is the ability of markets to eventually adjust to their intrinsic values. Common stocks won’t stay inflated or low indefinitely despite the investor irrationality on the market.

Benjamin Graham noted that due to investor irrationality, including other factors such as the inability to predict the future and stock market fluctuations, buying undervalued or disadvantaged stocks is sure to provide a margin of safety, that is, a margin for human error, for the investor. In addition, investors can obtain a margin of safety by buying shares of companies with high dividend yields and down debt ratiosand diversifying their portfolios. In the event of a company going bankrupt, the margin of safety would mitigate the losses that the investor would incur. Graham normally bought stocks trading at two-thirds of their net worth as its margin of safety.

Benjamin Graham’s original formula for finding the intrinsic value of a stock was:
















V


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where:














V


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intrinsic value














E

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end of 12 months

E

P

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the company














8

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P

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ratio of a zero growth stock



\begin{aligned}&V \=\ EPS \ \times\ (8.5\ +\ 2g)\\&\textbf{where:}\\& V\=\ \text{intrinsic value}\\&EPS\=\ \ text{Trailing 12-mth } EPS\text{ of the company}\\&8.5\ =\ P/E\text{ ratio of a zero-growth stock}\\&g\ =\ \text{long-term growth company rate}\end{aligned}


V = EPS × (8.5 + 2g)where:V = intrinsic valueEPS = end of 12 months EPS the company8.5 = P/E ratio of a zero growth stock

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

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4

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4



Yes




V=\frac{EPS\ \times\ (8.5\ +\ 2g)\ \times\ 4.4}{Y}


V=YesEPS × (8.5 + 2g) × 4.4

Benjamin Graham’s Intelligent Investor

In 1949 Graham wrote the acclaimed book The Intelligent Investor: The Definitive Book on Value Investing. The smart investor is widely regarded as the bible of value investing and features a character known as Mr. MarketGraham’s metaphor for the mechanics of market prices.

Mr. Market is the imaginary trading partner of an investor who tries daily to sell his shares to the investor or to buy the shares of the investor. Mr. Market is often irrational and shows up at the investor’s doorstep with different prices on different days depending on whether he is in an optimistic or pessimistic mood. Of course, the investor is not obliged to accept offers to buy or sell.

Graham points out that instead of relying on market sentiment which are driven by the investor’s emotions of greed and fear, the investor must make their own analysis of a stock’s value based on the company’s reports of its operations and financial condition. This analysis should strengthen the investor’s judgment when presented with an offer by Mr. Market.

According to Graham, the smart investor is one who sells to the optimists and buys from the pessimists. The investor should look for opportunities to buy low and sell high due to price discrepancies resulting from economic depressions, stock market crashes, one-time events, temporary negative publicity and human error . In the absence of such an opportunity, the investor should ignore the market noise.

While echoing the fundamentals introduced in Security analysis, The smart investor also provides key lessons for readers and investors advising investors not to follow herd or crowdhold a portfolio that is 50% stocks and 50% bonds or cash, be wary of transactions of the dayto take advantage of market fluctuations, not to buy stocks just because they are popular, to understand that Market volatility is a given and can be used for the benefit of an investor, and to research creative accounting techniques companies use to make their EPS value more attractive.

A notable disciple of Benjamin Graham is warren buffet, who was one of his students at Columbia University. After graduating, Buffett worked for Graham’s company, Graham-Newman Corporation, until Graham retired. Buffett, under Graham’s mentorship and principles of value investing, became one of the most successful investors of all time and, as of 2022, the seventh richest man in the world, valued at nearly $103 billion. Other notable investors who studied and worked under Graham’s tutelage 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 21st century by value investors and financial analysts who analyze the fundamentals of a company’s value and growth prospects.

What is the Dodd and Graham Prize?

The Graham and Dodd Award, in honor of former Columbia University professors of finance Benjamin Graham and David Dodd, recognizes individuals who excel in financial research and writing in the Financial Analysts Journal.

Why is Benjamin Graham famous?

Benjamin Graham was a renowned value investor, speaker, financial securities researcher and mentor to billionaire investor Warren Buffet. Known as the “father of investing”, Graham has written several books, including The smart investorwhich is widely regarded as the bible for value investors.

What are the three investment principles according to Benjamin Graham?

Conclusion

Benjamin Graham, dubbed the “Father of Value Investing”, is known for his investing style, literary contributions on investing, and research. Graham taught at his alma mater, Columbia University, and eventually became a professor of finance there. His mythical book, The smart investor, introduced value investing to the world of finance and investing. He also defined the investment principles embraced by some of the world’s most infamous investors.

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