Recently, the Wall Street Journal published some notes from a lecture by Benjamin Graham that occured in 1963. In there, as usual, the brilliant insight of Mr. Graham shines across the lecture. Since it is a large document, I decided to share and comment some of the most important points from my point of view.
“The argument that common stocks are and always will be attractive, including the present time, because of their excellent record since 1949- involves in those terms a very fundamental and important fallacy. This is the idea that the better the past record of the stock market as such, the more certain it is that common stocks are sound investments for the future… As I see it, the real truth is exactly the opposite, for the higher the stock market advances the more reason there is to mistrust its future action if you are going to consider only the market’s internal behavior. “
Here is one of the most important premises for value investors. As Klarman puts it, we don’t root for bad economic times; however, for the real value investor, investing becomes easier and more naturally when prices are down in a general sense. After some years of uninterrupted bull-market, we are starting to hear comments from value investors across the world which mention the lack of really attractive opportunities and the shift to cash in the wait of better, more attractive times to allocate capital.
“My basic conclusion is that investors as well as speculators must be prepared in their thinking and in their policy for wide price movements in either direction. They should not be taken in by soothing statements that a real investor doesn’t have to worry about the fluctuations of the stock market.”
One of my favorite quotes from Ben Graham is “The correct attitude of the security analyst toward the stock market might well be that of a man toward his wife. He shouldn’t pay too much attention to what the lady says, but he can’t afford to ignore it entirely.” I find this to be very true, given that the market is throwing prices at us daily and sometimes, it will throw attractive figures to both get in and out of positions. As Warren Buffett (Trades, Portfolio) mentioned, the market is there to serve us, not guide us.
“For obvious reasons it is impossible for investors as a whole, and therefore for the average investor or speculator, to do better than the general market. The reason is that you are the general market and you can’t do better than yourselves.”
This is an incredibly profound statement. There is no possibility of beating the market by doing the same thing as it is doing. Obviously, being closer to the crowd feels warmer, but it also dampens our results. As Howard Marks (Trades, Portfolio) mentions, we need to think different and be right in those thoughts to add some value over a given benchmark.
“I do believe it is possible for a minority of investors to get significantly better results than the average. Two conditions are necessary for that. One is that they must follow some sound principles of selection which are related to the value of the securities and not to their market price action. The other is that their method of operation must be basically different than that of the majority of security buyers. They have to cut themselves off the general public and put themselves into a special category. The investor needs common stocks in his portfolio; but these introduce hazards of wide fluctuations which he cannot expect to avoid more successfully than others unless perhaps he thinks independently from the crowd, that is unless he is constitutionally different from the average.”
The two conditions Graham mentions are very important: sound principles, basically to have a system in place and to think independently. As Pabrai mentions, the use of checklists, two-track analysis by Munger, and ask the same fundamental questions for different ideas is always relevant and vital to minimize errors and dig deeper to better understand a company.
“What investment policy to follow under the conditions discussed? My views thereon are definite and strong. In my nearly fifty years experience in Wall Street I’ve found that I know less and less about what the market is going to do but I know more and more about what investors ought to do; and that’s a pretty vital change in attitude.”
We don’t know where the market will go today, tomorrow or in the following month. However, sound investment principles that take into account a significant margin of safety lets us navigate through different economic environments. While minimizing the importance we place in figuring out what the market will do, we maximize the importance of our independent research and thinking, which leaves us better prepared to outperform the market.
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