Benjamin Graham is widely considered to be the father of value investing. He wrote the first widely-acclaimed book on finding undervalued stocks and using fundamental analysis to choose investments. He developed an investment strategy based on finding stocks that looked cheap compared to the value of the company's assets.
While this strategy might not be the same today as it was when Graham was practicing his art in the early 1900s, some of the principles laid out in Graham's works remain relevant to this day.
Investment vs speculation
"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."
The Graham principle above is fundamentally important. Investing is all about putting money to work with the goal of achieving a positive return. One must seek to avoid a permanent capital loss at all costs.
Graham understood this, which is why he focused exclusively on deeply undervalued securities. He believed that by focusing on deeply undervalued companies, he could improve his odds of achieving a positive investment result while minimizing the risk of taking a loss.
This does not mean one has to buy deep value stocks. It is applicable to any type of investment—properties, private businesses, antiques or growth stocks. The primary aim of investing money is to achieve a positive return, and the only way to be sure one can achieve a positive return is to do your research.
"The stock investor is neither right or wrong because others agreed or disagreed with him; he is right because his facts and analysis are right."
If there's no research involved, the activity is speculative. There's nothing morally wrong with speculating with financial assets. Some traders have even made a lot of money doing this. However, confusing speculation for investment can lead to devastating results, so investors should always be aware of the path that they are taking.
Investment psychology
The second Graham principle that I want to highlight is this:
"The investor's chief problem - and even his worst enemy - is likely to be himself."
Controlling one's emotions is a vital part of investing. This is something even the most experienced investors can slip up with.
Bill Ackman (Trades, Portfolio) is a good example. His emotional involvement in pharmaceutical giant Valeant Pharmaceuticals (BHC, Financial) ultimately led him to ignore the warning signs of a business and hold onto the stock, as well as support the faltering management for longer than was sensible. Ultimately, this mistake cost the hedge fund manager and his investors more than $4 billion.
Controlling one's emotions and remaining rational is essential for making evidence-based investment decisions. The overriding goal of investing is to achieve a positive return on money deployed. This is only possible through a thorough analysis of the investment opportunity. If one does not remain rational, it becomes difficult to conduct a comprehensive analysis of the asset. An investor might become sidetracked by market sentiment or other factors. This may result in a decision that's not entirely backed up by research.
When that happens, the trade is no longer an investment. Instead, it becomes a speculative bet on the direction of a price. Again, if an investor does not know they are now speculating rather than investing, that's when problems will emerge.
The investment world has changed significantly since Graham published his books on value investing. However, the principles outlined above are just as important today as they were in the first half of the 1900s. Every investor can benefit from following Graham's advice.
Disclosure: The author owns no share mentioned.
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