Benjamin Graham, commonly known as father of value investing, is the author of The Intelligent Investor. This book is widely read all over the world and cited as a must read by many professional investors.
Benjamin Graham described the difference between the market price of a stock and the intrinsic value of the stock as the ‘margin of safety’. For example, if an investing company has a net asset value of 20p per share, but is available to buy at 15p, then the 5p difference is the margin of safety. This is because we would be able to buy the stock at a discount to its actual value. If the business shut up shop the next day, then surplus assets would be distributed to their owners – the shareholders.
Graham was a firm believer that investment is a business, rather than a game of speculation or betting. It involves a disciplined method that must be followed. The stock investor is not defined as right or wrong by the stock price, but by the facts and analysis.
Warren Buffett’s idea of the stock market being a place where everyday somebody turns up and offers a different price for your shares came from Graham.
Here are two pieces of wisdom from Benjamin Graham.
The intelligent investor is a realist who sells to optimists and buys from pessimists
The intelligent investor looks at every piece of the puzzle – they use all available information to come up with a fair value for a stock. If the current stock price is above this fair value, then the market is being optimistic. Graham would be interested in buying a stock that the market views optimistically.
Instead, he’d rely on there being a margin of safety, and buy a stock that the market is pessimistic about.
In the short run, the market is a voting machine but in the long run, it is a weighing machine
Graham believed that a proper investment decision is made on analysis of the financials and numbers alone. By focusing on what could be quantified, he did not take into account any exuberance or hatred of the stock, and went to work by focusing on what he knew best.
Graham understood that the market would change every day. He knew that people would always be buying and selling, and that this activity affects prices. But he also knew that ultimately the price would eventually reflect the valuation if he stuck around long enough and waited patiently.
He also knew that by ignoring the price action of a stock and focusing solely on the business, he would never succumb to the lure of a fast moving price.
It’s a lesson as relevant today as it was then. There’s always a reason to buy and sell every single day, as Mr Market turns up and offers us new prices on a daily basis. But just because there’s a reason, doesn’t mean that it’s a good one.