Are the principles laid out by Benjamin Graham no longer of any use in today’s world?
There are some who believe this statement to be true. Indeed, there are few if any well-known investors who follow Graham’s net-nets investing rules today. The most prominent value investors such as Warren Buffett (Trades, Portfolio) and Seth Klarman (Trades, Portfolio) use intrinsic value calculations rather than a net-nets approach to find bargains in the market.
Deep value hunting even seems to have fallen out of fashion with smaller, more under-the-radar hedge funds. Few of the smaller hedge funds I have examined for ValueWalk’s Value Fund Interview series invest following deep value principles, and those that do layer deep value alongside another strategy.
Is Graham still relevant?
To truly be able to assess whether Graham is still relevant today, we need to look past his net-nets strategy and delve into his understanding of the markets. Most people mistakenly believe that Graham only invented value investing, but Graham also popularized the idea of reading financial statements; in effect, Graham actually created all types of fundamental investing. Prior to Graham’s writings on the subject of investing, most stocks were bought or sold by speculators betting on price movements – not investors buying a share of a company for the long term.
When Graham began writing about investing, he brought several new principles to the market. First, Graham made it known that buying a share in a company was more than just buying a lottery ticket; it was, in fact, buying a piece of the business and by acquiring the share, the owner became entitled to a proportionate share of the business’ profits with the ability to influence the direction of the company by voting at the annual general meeting. This first piece of advice ties in with what I believe is Graham’s second most important piece of guidance: investing for the long term.
If you own the business, say a cafe in the center of town, would you ask your accountant to value it every five minutes?
No, so why should you with a blue-chip business?
Investing is a long-term enterprise. If you invest in a stock, you own part of a business and should not expect to become a millionaire from the business overnight. Betting on price movements in the market is speculation, and an investor who is influenced by short-term market movements is at a disadvantage. As Graham’s now-famous quote summarizes:
“In the short run, the market is a voting machine, but in the long run it is a weighing machine.”
The margin of safety
Graham’s third most valuable lesson is the use and incorporation of the margin of safety principle in the investment process. The margin of safety is the difference between the intrinsic value of a stock and its market price. Once again, this concept is useless without the idea of fundamental analysis so the margin of safety and Graham’s introduction to the world of fundamental analysis go hand in hand.
Without incorporating a margin of safety into your investment decisions, you are opening yourself to a world of poor returns and likely capital impairment. The world isn’t perfect, and while you may be confident that your estimate of intrinsic value of a stock is correct, no one knows what the future holds, and there is no guarantee this intrinsic value will be realized. But if you buy at a deep enough discount to intrinsic value the chances of the market closing at least some of the discount are high so your chances of profit are greatly improved.
“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.
“On the other hand, investing is a unique kind of casino –Â one where you cannot lose in the end, so long as you play only by the rules that put the odds squarely in your favor.
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“You must thoroughly analyze a company, and the soundness of its underlying businesses, before you buy its stock; you must deliberately protect yourself against serious losses; you must aspire to 'adequate,' not extraordinary, performance.” – Benjamin Graham
Understand what kind of investor you are
Graham’s fourth lesson is to understand what sort of investor you are. Graham described two sorts of investors, the enterprising investor who is willing to spend time and effort selecting securities and the defensive investor who is more suited to a 60/40 portfolio of bonds and blue-chip stocks. The lesson here is to understand your own temperament as an investor and consider your investment goals. If you don’t have time to conduct detailed security analysis perhaps an active investment strategy isn’t for you.
The fifth and final lesson from Graham is the Mr. Market parable. Here's an excerpt from "The Intelligent Investor" by Benjamin Graham:
"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.
"If you are a prudent investor or a sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.
"The true investor is in that very position when he owns a listed common stock. He can take advantage of the daily market price or leave it alone, as dictated by his own judgment and inclination. He must take cognizance of important price movements, for otherwise his judgment will have nothing to work on. Conceivably they may give him a warning signal which he will do well to heed –Â this in plain English means that he is to sell his shares because the price has gone down, foreboding worse things to come. In our view such signals are misleading at least as often as they are helpful.
"Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies."
Conclusion
So to answer the question of whether Graham is still relevant today, yes he is. Graham’s investment principles are timeless, and even though value investing may not be what it used to be, the godfather of value investing's lessons for investors are still highly relevant, educational and valuable for those who follow them.
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