Shortly before he died, Benjamin Graham was interviewed by the "Financial Analyst Journal," where he spoke about his life and investing career. Published in 1976, the interview was called "A Conversation with Benjamin Graham." Today, his advice is still highly relevant and informative.
Below, I have provided some extracts from the interview. Specifically, these extracts focus on Graham's advice for the average investor when creating a portfolio. Graham recommends two approaches for the average investor, both of which revolve around the idea of buying undervalued stocks and attractive prices.
Question:Â : "Can you indicate concretely how an individual investor should create and maintain his common stock portfolio?"
Graham:Â "I can give two examples of my suggested approach to this problem. One appears severely limited in its application, but we found it almost unfailingly dependable and satisfactory in 30-odd years of managing moderate-sized investment funds. The second represents a great deal of new thinking and research on our part in recent years. It is much wider in its application than the first one, but it combines the three virtues of sound logic, simplicity of application, and an extraordinarily good performance record, assuming--contrary to fact--that it had actually been followed as now formulated over the past 50 years--from 1925 to 1975."
The first technique is Graham's well-known net-nets strategy, buying equities that are currently trading at a deep discount to the value of their working capital or net current asset value. Graham used this approach for many years successfully while running the Graham Newman Corp., but its effectiveness is limited in bull markets, which means you have to be extremely patient if you want to adopt the strategy.
Question:Â "Some details, please, on your two recommended approaches."
Graham: "My first, more limited, technique confines itself to the purchase of common stocks at less than their working-capital value, or net-current-asset value, giving no weight to the plant and other fixed assets, and deducting all liabilities in full from the current assets. We used this approach extensively in managing investment funds, and over a 30-odd year period we must have earned an average of some 20 per cent per year from this source. For a while, however, after the mid-1950's, this brand of buying opportunity became very scarce because of the pervasive bull market. But it has returned in quantity since the 1973-74 decline. In January 1976 we counted over 300 such issues in the Standard & Poor's Stock Guide--about 10 per cent of the total. I consider it a foolproof method of systematic investment--once again, not on the basis of individual results but in terms of the expectable group outcome."
The other approach is a simple low valuation approach. Buying stocks trading at a historic price-earnings ratio of less than seven. This requires much less effort than the first approach, but as Graham notes, his studies indicate this strategy still yields impressive mid-teens returns over the long term, which still seems a good trade-off considering the vast amount of extra effort required in the first approach.
Question: "Finally, what is your other approach?"
Graham:Â "This is similar to the first in its underlying philosophy. It consists of buying groups of stocks at less than their current or intrinsic value as indicated by one or more simple criteria. The criterion I prefer is seven times the reported earnings for the past 12 months. You can use others--such as a current dividend return above seven per cent or book value more than 120 percent of price, etc. We are just finishing a performance study of these approaches over the past half-century--1925-1975. They consistently show results of 15 per cent or better per annum, or twice the record of the DJIA for this long period. I have every confidence in the threefold merit of this general method based on (a) sound logic, (b) simplicity of application, and (c) an excellent supporting record. At bottom it is a technique by which true investors can exploit the recurrent excessive optimism and excessive apprehension of the speculative public."
