What is the most significant lesson ever taught by Benjamin Graham, the "father of value investing"?
Graham's writings contain hundreds of nuggets of advice for aspiring and existing value investors. Trying to pick just one lesson is not easy.
When it comes to Warren Buffett (Trades, Portfolio), I believe it is easy to conclude his most significant lesson is that to be a successful investor, you have to minimize the risk of total loss. You should aim to never lose money investing, and over time your returns will compound to produce a favorable result.
This is not the only advice Buffett has ever issued, but it lays the foundation for the rest of his wisdom. If you do not understand this simple concept first, you could find yourself in an irrecoverable position. Buffett's strategy of only investing in the highest-quality businesses, with the most extensive moats and best balance sheets, builds on this initial concept.
The key to investing
When I first read Graham's book, "The Intelligent Investor," it was an eye-opener, not because of the writer's love of value, but because the book made it clear that under every stock was a business. As such, analysis of each business' fundamentals was vital if you wanted to be a successful investor.
Once you have this basic understanding of how shares and companies interact, it becomes easier to understand the market, what market moves mean and how to value businesses. Value investing as a whole would not make much sense if this distinction were not made clear at the beginning.
Even though Graham has made countless other contributions to the world of investing, I believe this is possibly his most significant piece of advice.
Look past the stock price
Valuing the business, not the stock, opens up a whole world of fundamental analysis that goes way beyond value investing. It can be applied to almost any investment style. Indeed, growth stocks like Amazon (AMZN, Financial) and Netflix (NFLX, Financial) trade more on the fundamental prowess of their management than the actual valuation of the stock and business (I include analysis of intangible assets such as management and brand power in my example of fundamental analysis).
Once you know and understand that a stock price does not reflect the state of the underlying business at all times, it is a lot easier to develop an understanding of market moves, what makes the market tick and how you can profit from taking advantage of Mr. Market. In fact, even if you have a relatively rudimentary grasp of finance, accounting or fundamental analysis, it is possible to take this advice and run with it, buying the market at a low price-earnings (P/E) ratio and selling at the highs.
The fact so many investors are still not able to grasp the concept of what a share represents presents a vast opportunity for those who do. Despite the fact Graham’s works have been around now for nearly 100 years, investors (both private and institutional) continue to chase momentum. Yes, this strategy can be profitable, but it ignores Graham’s key lesson.
Start at the beginning
If you are new to investing, you cannot go wrong with reading Graham’s books and establishing, first and foremost, it is the business’ fundamentals that are the most important quality, not the share price.
After this, Buffett’s advice not to lose money is a great way to build onto your education. These two tips are closely linked. If you want to avoid losing money, it is important to know everything about the underlying business. Valuation comes after. You can buy high-priced shares and still avoid losing money (permanent loss of capital) as long as the underlying fundamentals remain intact.
Overall, Graham’s most significant lesson to investors is the crucial difference between the stock and underlying business. Understanding this concept is key to being a successful investor. With that in mind, you can build out your strategy.
Disclosure: The author owns no stocks mentioned.
