"Benjamin Graham, Known as the 'Father'
of Value Investing Left a Legacy (Value Investing) For All Students of Stock Market Investing"

Introduction

Benjmin GrahamBenjamin Graham

Benjamin Graham was born in 1895.

By the age of 25 he had made $500,000 (in the early 1900s).  Around that time he formed a partnership with Jerome Newman.

He became a partner in the stock broking firm of Newburger Henderson and Lobe by the age of 30.

He made phenomenal amounts of money in the 30s, 40s, and 50s.  He taught security analysis at the University of Columbia and his tome: “Security Analysis” has sold nearly a million copies.  He also wrote a second book:  “The Intelligent Investor” which is still a best seller today.

He became known as: 'The Father of Value Investing'.

"Benjamin Graham's Methods"

'Here’s what Warren Buffett had to say about Benjamin Graham: 

“It is rare that a founder of a discipline does not find his work eclipsed in rather short order by successors.  But over forty years after publication of the book  ('The Intelligent Investor') that brought structure and logic to a disorderly and confused activity, it is difficult to think of possible candidates for even the runner up position in the field of security analysis.”

Graham came to be known for the expression “Value Investing.”  In fact, he was known as the "Father of Value Investing."

So what did he mean by the term 'Value Investing'? 

Graham wanted his investors to look for value in their investments with a significant 'Margin of Safety'.  Think of it as buying an asset for half of its saleable value or for half of its earnings’ power. 

Graham gradually tested his ideas and came up with some statistical criteria to measure when an investment was attractive or not.

Here are some of his value criteria:

1. Buy a stock for less than two-thirds of its net current assets

This is best described with an example.  Suppose a stock was selling at £6,66 and its net current assets were £10 per share, then, according to Graham you would have a stock that has value.

Graham back-tested this idea and found that if he had purchased stocks fitting this criteria, and then sold them once they had risen 50%, he would have produced a 19% per
annum compound rate of return.

This net asset value approach could be used as a market barometer.  Should there be a large number of stocks selling at less than two-thirds of net assets it would mean that the
overall market was cheap.  And the opposite would also be true. 

For example: in 1974 when the Bear Market was at its nadir, there were over 300 companies in the S&P guide that met the criteria.

Graham got a lot of his original ideas from the likes of Charles Dow, William Gann, and Richard Wyckoff.  

2. Buy a stock with a low P/E (Price to Earnings ratio) and with gearing of less than 100%

Graham based his definition of a low P/E on what the current Bond Yield happened to be.  He based his theory on the fact that a stock’s Earnings Yield should be not less than twice the yield on government bonds.

Here is a table of what Graham used as a guide:

   Yield on bonds            P/E must be under

          15%                              3,3
          14%                              3,5
          13%                              3,8
          12%                              4,2
          11%                              4,5
          10%                              5,0
            9%                              5,6
            8%                              6,3
            7%                              7,1
            6%                              8,3

3. The stock’s Dividend Yield should not be less than two-thirds of the Bond Yield

This means that, if the Bond Yield is 9% you should only buy stocks with a yield greater than 5.6%.

Graham back-tested everything that he did (and you should too).  In fact, his company Graham Newman, ran a value fund from 1930 to 1956 based entirely on his rules.  The
fund grew at a compound rate of 21% per annum and this was paid as a form of dividend each year to participating investors.


Sidebar:

Warren Buffett had this to say as a comment in “The Intelligent Investor”

“I have seen no trend toward value investing in the 35 years that I have practised it. There seems to be some perverse human characteristic that likes to make easy things difficult. 
The academic world, if anything, has actually backed away from the teaching  of value investing over the last 30 years.  It’s likely to continue that way. Ships will continue to sail
around the world but the Flat Earth Society will flourish.  There will continue to be widespread discrepancies between price and value.”


"Rules of Benjamin Graham"

Benjamin Graham took his methods a little further and expanded them into a set of rules.

However, our opinion of these rules is that they are fine as stand-alone rules but to find a stock that complies with all the rules may be extremely difficult in today's markets.

And that comment probably applies to most set of rules.

Depending on where you do your own research, you may find more than these 10 rules.

For ourselves, 10 rules are more than enough.  Better still, we think they need to be refined a little. But for completeness, here are Benjamin Graham's original 10 rule criteria for trading in stocks:

  1. An Earnings to Price Yield of twice the AAA bond rate. If the AAA Bond Yield is 6% then the required Bond Yield is 12%.  In reciprocol form, that's a Price Earnings Ratio of 8.33

  2. A Price Earnings Ratio less than 40% of the highest P/E Ratio the stock has had over the past 5 years

  3. A Dividend Yield of at least two-thirds the AAA Bond Yield.  If the AAA Bond Yield is 3%, then the Dividend Yield must be at least 2%

  4. A stock price below two-thirds of the tangible Book Value per share 

  5. A stock price that is below two-thirds of of Net Current Asset Value or Net Quick Liquidation Value.  This figure is defined as current assets less total debt.  Fixed assets are not included

  6. Total debt must be less than tangible Book Value

  7. The Current Ratio (current assets divided by current liabilities) must be greater than 2 or more

  8. Total debt is less than twice the Net Current Asset Value

  9. The average compounded Earnings Growth of the previous 10 years to be at least 7% annually 

  10. Stability of Earnings Growth - to be defined as no more than 2 declines of 5% or more in year-end earnings (relative to the previou year) in the prior 10 years

But ... and it's a big but, the above rules can be whittled down to 4 simple rules:

  • An Earnings to Price Yield of at least twice the AAA Bond Rate

  • A P/E Ratio (excluding extraordinary items) of less than 40% of the highest P/E Ratio the stock has had over the previous 5 years

  • Total debt less than Book Value

  • Current Ratio greater than 2

"Other BIG Ideas By Benjamin Graham"

One of Benjamin Graham's criteria for investing in a stock was that the stock should have a 'Margin of Safety.'

Great title.  But what the heck does 'Margin of Safety' actually mean?

Best explained with a very simple example.  If you were to buy a stock for 90p that has  100p worth of assets, then you have a 10p 'Margin of Safety'.

Graham wanted the stock that he bought to have as large a 'Margin of Safety' as possible.

David Dodd, Graham's partner put it very well.  He said: "You don't try to buy something for $80 million that you think is worth $83,400,000.  You build a bridge that 30,000 pound trucks can go across, and then you drive 10,000 pound trucks across it.  That is the way I like to go across bridges."

Graham's focus was on two variables:  price and value.  He said he liked: "Buying a pound for 60 pence."

He reckoned that you could measure the attractiveness of a stock to its Book Value or its historic Return on Equity.  In the 1950s the U.S. Stock Market sold on a Price to Book Ratio of around 1.5

Historically, the return on Book Value averaged about 12-13% thus making the yield on equity around 8% (13/1.5).  This was considerably higher than the Bond Yield of around 3-4%

In the 1950s the Stock Market yielded about 18.9%

Come 1972 and the Price/Book Value Ratio had risen to 2.0.

Therefore, at any given time, equities were more attractive than bonds, and other times bonds were more attractive than equities. 

"So, How Do You Go About Finding Bargain Shares That Comply With Graham's Criteria?"

We're not professional financial researchers.  But we have distilled Graham's criteria down into simplified terms.

Using your 'Stock Trading Software' of choice, search for shares that have Price Earnings Ratio (PER) less than 6% and high yields.

It's amazing that discrepancies occur in the market.  But they do.

At the risk of repeating ourselves, Benjamin Graham simplified his own criteria for identifying value stocks, for completeness, these yardsticks are listed below:

Yardstick #1:  Use a rating agency (Standard and Poor's, Moody's, or Fitch Group) to rate the quality of a company.  The S&P, for example, has ratings of D to A+  For our valuations we could stipulate a rating of A- or better.

Yardstick #2:  Graham advised only buying companies with a Total Debt to Current Asset Ratio of less than 1.1  Better still, look for companies with no debt at all.

Yardstick #3:  A company's Current Ratio i.e. its current assets divided by its current liabilities, should be in excess of 1.5 and preferably greater than 2.

Yardstick #4: This is clear-cut.  Only invest in companies with a record over at least the past 5 years (better still,10 years) of Earnings Per Share growth.  Stay clear of companies that have had declining earnings over any of those years.

Yardstick #5:  Only consider companies with a Price Earnings Ratios (PER) of 9 or under. 

Yardstick #6:  Dig out companies with Price to Book Value Ratios (P/BV) of less than 1.2

Yardstick#7:  Buy into companies that are currently paying dividends and have consistently upped their dividend over the years.  The further you go back, the better.

Finally, we used to get confused.  When we found suitable companies that met all of our criteria we asked ourselves: "Why is this company undervalued?"

Was it because the company was badly managed?

Was it because the company was operating in a fading business?

Was it because the company had been "hit" by some extraordinary problem?

Or having satisfied yourself that the company is just plain undervalued by the market, and the company is in rude health, then have the courage of your conviction and sit and wait for that right time to buy.  It could be weeks. It could be months.  It might even be years. 

But put that company on your watchlist and monitor it closely.  Your patience will be rewarded.

"Warren Buffett Wasn't The Only Successful
Student of Benjamin Graham"

A guy called Bill Ruane was also extremely successful.  He ran the Sequoia Fund which averaged over 18% annual compound growth.

Here's how his Sequoia Fund performed from 1970 to 1983:

Year                                           % Growth                                          S&P % Growth

1970                                          12.1                                                   20.6
1971                                          13.5                                                   14.3
1972                                            3.7                                                   18.9
1973                                          (24.0)                                                (14.8)
1974                                          (15.7)                                                (26.4)
1975                                           60.5                                                  37.2
1976                                           72.3                                                  23.6
1977                                           19.9                                                  (7.4)
1978                                           23.9                                                    6.4
1979                                           12.1                                                  18.2
1980                                           12.6                                                  32.3
1981                                           21.5                                                   (5.0)
1982                                           31.2                                                   21.4
1983                                           27.3                                                   22.4

Compound annual rate:           +18.2                                                 +10.0

Not bad going for a student!

And another successful student, Rick Guerin also had similar returns.

"Books By and About Benjamin Graham"

Benjamin Graham's two books - 'The Intelligent Investor' and 'Security Analysis' should belong on any serious investor's bookshelf. 

Books by other authors about the 'Father of Value Investing' are also a good investment in your education.  In many cases they simplify the writings of Graham and put into layman's terms what this genius had to say about investing.

The Intelligent InvestorThe Intelligent Investor

The Intelligent Investor by Benjamin Graham

This is where Benjamin Graham revolutionised investing by 'discovering' his 'Value Investing' theory. 

He had a star pupil in Warren Buffett who we know has gone on to become one of the world's richest people - all through Value Investing. Phenomenal!

Being honest, this is a 'heavy' read, but a useful one.  Our copy serves as a great reference. You can obtain your copy right here:

Intelligent Investor: The Definitive Book on Value Investing - A Book of Practical Counsel

Summary of The Intelligent Investor  published by Business News Publishing

We love summary books.  We don't read them instead of the full work but in addition to.

The Summary adequately covers Graham's 6 principles of Value Investing and although only 40 pages in total it will:

  • Save you time
  • You will grasp all the key concepts and
  • It will give you a better understanding

We just love the work that Benjamin Graham put into this volume.  Any work by him is worth consuming and this is one of his best.  You can get it right here:

Summary: The Intelligent Investor: Review and Analysis of Graham's Book

Security Analysis by Benjamin Graham and David Dodd

Now in its 6th edition, Security Analysis was first published in 1934 and the contents are as relevant today as they were over 75 years ago.

This new edition has over 200 pages of additional content with entries from some of Wall Street's leading experts and a foreword by none other than Warren Buffett.

We admit that this book is somewhat of a "tome" but the words of wisdom within make it the firsst work any investor should possess for reference.

Access Graham's masterpiece right here:

Security Analysis: Sixth Edition, Foreword by Warren Buffett (Security Analysis Prior Editions)

Applied Value Investing by Joseph Calandro

There hve been many books published about Benjamin Graham's approach to investing i.e. Value Investing, but 'Applied Value Investing' is right up there with the best of them.

This book takes a similar path as 'Security Analysis' did.  Nothing beats Graham and dodd's tome, but 'Applied Value Investing' offers something more.  The book covers several cas studies which are always relateable.

One such case study details the acquisitions, by Warren Buffett, of GEICO and General Reinsurance.  The book contains many other case studies.

You can get your copy right here:

Applied Value Investing: The Practical Application of Benjamin Graham and Warren Buffett's Valuation Principles to Acquisitions, Catastrophe Pricing ... Execution (McGraw-Hill Finance & Investing)

The Einstein of Money by Joe Carlen

Benjamin Graham, as well as being given the title 'The Father of Value Investing' was also given the title 'Dean of Wall Street'.

Einstein Money gives readers a look into Graham's wealth creation concepts and tells the story of his amazing business career and investment systems that worked. 

They worked for him and they can work for you too.  Grab this book right here:

The Einstein of Money: The Life and Timeless Financial Wisdom of Benjamin Graham

Benjamin Graham - The Father of Value Investing by John Dave

A great testimony to what Graham has left to the world of investment is the outstanding students that he helped. Guys like: Warren Buffett, William Ruane, Rick Guerin, Irving Kahn, Walter Schloss.

This book contains 14 chapters jam-packed with nuggets of gold. From why he was successful to how he became successful.

A fascinating read.  If you want to really study the mind and works of Benjami Graham then this is the resource for you.  Get it here:

Benjamin Graham: The Father of Value Investing

Benjamin Graham - The Memoirs of the 'Dean of Wall Street' by Benjamin Graham

The great man was 82 years of age when he pased away.

His memoirs recount his life from humble beginnings through public school, on to uni at Columbia, surviving the great crash of 1929, and the depression of the early 1930s.

Maybe that background is what helped him through those depressing times and it taught him dicipline.  And it was discipline that played such a large part in his success at trading. 

He re-kindled a technique that we must all be grateful for - Value Investing.  There will probably never be another equal. Get Graham's memoirs here:

Benjamin Graham: The Memoirs of the Dean of Wall Street

Benjamin Graham - Lessons from Graham That Will Make You Become The Greatest Investor by John Dave

Graham maintained that when an investor bought a stake in a company that person should view his stake as if he were buying into a partnership. 

The book's 8 chapters covers topics such as: his main strategy, his first, second and third principles which are respectively:

  1. Invest with a Margin of Safety
  2. Expect and profit from volatility
  3. Know yourself

The remainder of the book covered lessons that his students learned.

You can pick up this book by clicking on the link below:

Benjamin Graham: Lessons from Graham That Will Make You Become The Greatest Investor

Benjamin Graham and The Power of Growth Stocks by Frederick Martin

Graham of course made Value Investing popular and as a result of it "discovered" a share's Intrinsic Value'.

The author, Fred Martin, himself a long-term investor shows ho to use value investing principles to find growth stocks.

Finding growth stocks is Warren Buffett's second favourite pastime (next to Value Investing).  It must have been Benjamin Graham that convinced him (although Buffett gives credit to his Growth Investing enthusiasm to Philip Fisher). 

This book will show you how Graham uses his valuation formula to:

a) Build a 7 year forecast for your company under cosideration
b) Estimate  the company's future value in 4 easy steps
c) Promise long-term profits

Another Graham bookyou should add to your library.  Get it here:

Benjamin Graham and the Power of Growth Stocks: Lost Growth Stock Strategies from the Father of Value Investing

Value Investing Made Easy by Janet Lowe

This is a paperback version of a classic work on Value Investing.

For over 60 years Graham's secrets were restricted to a chosen few - the Warren Buffett's of this world.

Janet Lowe has whittled Graham's technique down to a trading strategy that every investor can make use of.  Get this inexpensive book now:

Value Investing Made Easy: Benjamin Graham's Classic Investment Strategy Explained for Everyone

Security Analysis Summary by Preston Pysh and Stig Brodersen

Security Analysis: 100 Page Summary

The Intelligent Investor Summary by Preston Pysh and Stig Brodersen

The Intelligent Investor (100 Page Summaries) by Preston Pysh Stig Brodersen(2014-02-19)

Conclusion

Benjamin Graham was undoubtedly the man who started it all off (i.e. Value Investing), or at least popularised it.

It stands to reason that if you buy an undervalued stock, sooner or later, that stock is going to outperform.

Good software with a stock screener will help you pick out such stocks.  Otherwise, just monitor your chosen stocks in a spreadsheet.

Some of Benjamin Graham's books are not an easy read, but they are informative. We find that obtaining a summary guide is a good introduction to such books and have recommended a few above.  Get them and consume them. 

Benjamin Graham laid the foundation for modern day 'Fundamental Analysis'.  His original books may be a difficult read but there are many who have tried to simplify his works (see list above).

And of course ...

... another route to studying Benjamin Graham is to follow the teachings of Warren Buffett and Charlie Munger.  That's why we here at Common Sense Retirement Investing are avid Buffettologists - it's all common sense.

Enjoy your journey!

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