Benjamin Graham is widely considered to be the godfather of value investing, but while his teachings have inspired a generation of value investors who have revolutionized the way we think about investing today, Graham's primary contribution to the world of investing was his teaching.
He taught not only value investors how to invest in undervalued stocks, but also offered advice on how to select growth investments and manage portfolios.
Reading through his historical lecture notes, books and interviews, it is clear that Graham wasn't entirely against growth stocks. Instead, it seems that he believed it was easier to estimate the intrinsic worth of value stocks as their earnings revenues tend to be more predictable.
How to pick growth stocks
According to a transcript of one of Graham's lectures titled Current Problems in Security Analysis, given in 1947, Graham believed that the successful purchase of growth stocks requires two "rather obvious conditions:"
"First, that their prospect of growth be realized; and, second, that the market has not already pretty well discounted these growth prospects."
He went on to explain why he believed it is so difficult to identify companies that meet both of these conditions:
"These conditions do obtain with regard to some growth stocks, as they are identified by analysts; and highly satisfactory profits are made from that work. But the results vary a great deal with the skill of the selector, and perhaps with "the luck of the draw." It is quite questionable to my mind whether you can establish a technique of a communicable sort -- that a good instructor can pass on to his pupil -- by which you will be enabled to identify those stocks not only which have good prospects of growth but which have not already discounted pretty much those prospects in the market."
Graham wasn't saying it is impossible to be a successful growth stock investor, but he did seem to believe that most analysts just don't have the right qualities:
"Let us put it in this way: I think at bottom success in the identification of growth stocks comes from being smart or shrewd, but I do not consider it a standard quality of good security analysis to be smart or shrewd. Not that I have any objection to that, but it just doesn't seem to me to fit into the general pattern or canon of security analysis to require those rather rare qualities."
A teacher of investing
Graham's primary goal as a teacher was to develop an investment strategy that was easy for all investors to follow and make money from. As the quotes above explain, he believed that it was impossible to teach growth investing because there are so many variables that analysts have to consider when analyzing growth stocks.
That's why the dean of value investing concentrated his time and efforts developing a strategy for finding undervalued equities, rather than trying to come up with a template for finding growth stocks. Growth stocks are so much more unpredictable and difficult to value.
This viewpoint is just as relevant today as it was back in 1947. The very nature of growth stocks makes them challenging to understand. Many companies will be breaking into a new industry, or create a new sector altogether and trying to assess how big this market could eventually become, and whether or not the company has what it takes to grab significant market share, is virtually impossible to compute.
Even industry experts (if there are any) may find it almost impossible to work out if a company is succeeding in a new industry.
Investing is hard enough, so why add another layer of complexity?Â
Disclosure: The author owns no share mentioned.
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