Benjamin Graham: The father of value investing
Graham became a partner at a Wall Street firm just six years after graduating college. For 30 years, from 1926 to 1956, he lectured on a range of financial matters at Columbia University. After suffering great losses in the crash of 1929, Benjamin Graham learned his lessons and described them in his seminal books, Security Analysis in 1934 and The Intelligent Investor in 1949. In Security Analysis, Graham defined the difference between investments and speculations as, "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."
Graham's notions of careful selection of stocks for a portfolio paved the way for fundamental analysis, the attempt to determine a company's intrinsic value, or what a company is actually worth, by studying the business's underlying quantitative and qualitative factors.
Investment track record: After the publication of Security Analysis in 1934, the Graham-Newsome Corporation averaged 17% annual returns until 1956 when the company was terminated. During this time, Graham outperformed the market average by at least 2.5% annually.
Though normally widely diversified by investing in stocks across a number of different sectors, Graham once invested more than 20% of his portfolio to acquire GEICO, the property and casualty insurance company. While they held it, the value of the holding increased an incredible 200 times, from about $700,000 to more than $1 billion!
Important lesson: I believe the most valuable lesson to take away from Graham is that the market is not always efficient, meaning that stocks often sell below their intrinsic value, what a stock is actually worth. In Intelligent Investor, Graham wrote:
"Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly."
Graham developed the notion of the margin of safety, the gap between the stock's intrinsic value and current market price. The further the market price was below the intrinsic value, the more likely it is that investors will score a winning investment. This stands in stark contrast to the efficient market hypothesis, which states that all information is factored into a stock's market price. The implication of this theory being that "beating the market" is a matter of chance, not skill and hard work.
Graham's track record is a testament, however, to the belief that waiting for Mr. Market to irrationally offer investors great entry points for stocks is a proven way to beat the market.
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