Investing Lessons From Graham and Buffett

A strategy both investors have used to learn about the market

Author's Avatar
Sep 16, 2021
Summary
  • Graham taught Buffett how to invest
  • The two investors used a similar approach
Article's Main Image

Benjamin Graham was widely considered to be one of the greatest investors of all time. He was also a great teacher and helped teach some of the best value investors of the last 100 years.

Graham's investing principles are still relevant today. His strategy of buying stocks at a discount to the value of their net assets may not be as relevant as it was when he first published "The Intelligent Investor," but his thoughts on the margin of safety and how to invest in a business, not a stock, are still very important in terms of making wise investment decisions.

Graham's most successful student is Warren Buffett (Trades, Portfolio). The Oracle of Omaha learned the ropes at Graham's hedge fund, the Graham-Newman Corporation, before moving back to Omaha when it closed.

In 1998, at the annual Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) meeting, Buffett talked a little about why he thought Graham was such a good teacher.

Lessons for investors

I wanted to highlight a couple of points from this discussion because I believe Buffett's insights can help any investor improve their process.

For example, the Oracle explained that one of Graham's teaching strategies was to get students to value different companies at different points in time, but there was often a trick:

"And he had various little games he would play with us. Sometimes he would have us evaluate company A and company B with a whole bunch of figures, and then we would find out that A and B were the same company at different points in its history, for example."

Graham's lecture notes from 1946 quite clearly illustrate this process in action. He liked to provide his students with different tables of numbers to help them design a valuation process. The teacher used this method frequently to show students how the same company could be worth more or less in its lifetime.

Interestingly, in 1994, Buffett stated that this is the approach he would use if he had to teach a course on investing:

"But I would, you know, if I were teaching a course on investments, there would be simply one valuation study after another with the students, trying to identify the key variables in that particular business, and evaluating how predictable they were first, because that is the first step. If something is not very predictable, forget it. You know, you don't have to be right about every company. You have to make a few good decisions in your lifetime. But then when you find — the important thing is to know when you find one where you really do know the key variables — which ones are important — and you do think you've got a fix on them."

Valuing a business is an imprecise art. It is not a science. There will never be any one set value for how much a business is worth. There are just too many variables and too many market participants to arrive at one value. That is why Buffett and Graham both use a range of values.

This may be the reason why Graham and then Buffett both advocated repeated valuation studies. These studies are never going to throw out the same answer, and that's why they can be helpful. They can teach investors the uncertainties of investing and the limits of valuations. They can also help investors refine and streamline their processes to concentrate on what they know best. This should help improve investment outcomes, as investors will not spend time chasing opportunities they do not understand.

The easiest way to reduce risk in an investment is with research. Getting the valuation right is part of that process, but getting an exactly accurate valuation is impossible. Valuing a business requires practice, and it is also something that needs to be practiced regularly, even on investments you have owned for a long time.

Disclosures

I am/ we are currently short the stocks mentioned. Click for the complete disclosure