Benjamin Graham is considered to be the father of value investing, and it can be argued that he has been instrumental in developing the idea of fundamental investing as a whole. His ideas contained in the book "Security Analysis" and later "The Intelligent Investor" taught generations of investors that stocks and shares are pieces of businesses, not just gambling chips to use to try and make money. This mentality has been influencing the way we invest ever since.
Graham’s style of investing, which has been named deep value investing, was constructed following his experience of the Great Depression. Equity investing was all about finding dividend stocks in the first couple of decades of the 1900s. Investors who weren’t bothered by dividends speculated on stocks going up and down. This was acceptable for the time because financial information was relatively challenging to get ahold of. I say relatively difficult, but actually, it was all but impossible for most.
When Graham tried to force one company to distribute more money to investors, he had to travel to Washington to uncover its paper annual report. The process took several days, and as many investors were not particularly financially savvy, this wouldn’t have made any sense for other shareholders.
Some of the few bits of information that were freely available and widely disseminated were company share prices and their dividends. So, this was the information most investors used.
When the Great Depression began, this information was almost pointless. Equity prices only reflect market sentiment, and as companies cut dividends, yields became irrelevant as well.
Graham developed a strategy based on finding companies that were solvent based on their financial situation and trading below the value of their assets. The mentality behind this approach was that if they collapsed, shareholders would still get some money back in the liquidation process.
This might seem strange today, but we need to remember that at the time, other investors weren’t valuing companies based on a ratio of earnings or book value because they didn’t have the information. Today we can say that a stock might look undervalued relative to its peers or its past trading history. Other investors didn’t have that information in the first couple of decades of the 1900s, so there was no point trying to discover these figures.
However, the world has changed significantly. It was even changing in the second half of Graham‘s life and his ideas became less relevant. His principles were based on the idea of preserving capital in an uncertain economic environment. As the financial world has developed and matured, these ideas have become out of date.
For example, in Graham's day, buying stocks below liquidation value was a good strategy because companies would almost certianly go bankrupt before the value of their assets deteriorated significantly. Nowadays, thanks to how indebted comapanies can become, it is commonplace for companies to dwindle their worth to nothing before finally being forced into Chapter 11, at which point investors are completely wiped out and not even bondholders are guaranteed anything.
As Munger once said:
"I don’t love Ben Graham and his ideas the way Warren does. You have to understand, to Warren — who discovered him at such a young age and then went to work for him — Ben Graham’s insights changed his whole life, and he spent much of his early years worshiping the master at close range. But I have to say, Ben Graham had a lot to learn as an investor. His ideas of how to value companies were all shaped by how the Great Crash and the Depression almost destroyed him, and he was always a little afraid of what the market can do. It left him with an aftermath of fear for the rest of his life, and all his methods were designed to keep that at bay."
There are a couple of takeaways from this. First of all, we need to appreciate that Graham‘s advice about investing is not as relevant today as it once was. Many of his principles and theories are still true, but his approach to investing is out of date. We need to acknowledge that the investing world does change, and even the best investors can be left behind. That is why we need to always keep learning.
