Benjamin Graham: The Father of Value Investing
Benjamin Graham (1894 – 1976) was an American economist and a professional investor and is considered the “father of value investing”. Graham developed a track record of earning solid returns in the stock market for himself and his clients and for doing so without taking enormous risks. He began teaching this investment approach at Columbia Business School in 1928 and published several books (with David Dodd) on the subject, the best known of which were Security Analysis (1934) and The Intelligent Investor (1949). While Graham has many disciples, the best known may be Warren Buffet.
Graham’s Early Years
Born in London, Graham move to New York as a child and spent his early years living in poverty. A star student, Graham graduated from Columbia University and went right to work on Wall Street. Over the next 15 years, Graham began to develop his stock market savvy and grew a considerable sum of money for himself through his personal investments. His hardest lesson concerning risk came in 1929 when he lost it all in the stock market crash. His book Security Analysis (published in 1934) followed, focusing on new methods to analyze and value securities.
The Value Investing Approach
Through his writings, Graham began to draw distinctions between investing and speculating. His new approach to investing called for buying shares in companies whose market value was well below the company’s liquidation value. Graham encouraged investors to regard stock investing as it truly is- part ownership of a business and to not be overly concerned with short-term price fluctuations. With this view, the investor understands that the stock market behaves as a voting machine in the short-term and as a weighing machine in the long-term.
Intrinsic Value and a Margin of Safety
Under the value investing approach, the first step is to identify the “intrinsic” or true value of a company based on all of the aspects of the business. Value investors will only make a purchase decision when this intrinsic value is significantly greater than the current market price- the difference being the margin of safety. The greater the margin of safety, the lower the downside risk.
Intrinsic value is most often defined as the net present value of all of the expected future cash flows to the company. This value can be calculated through discounted cash flow analysis.
Graham’s Later Success as an Investor
It is believed that Graham averaged about a 20% annual return under the value investing approach. In recent years, Modern Portfolio Theory (which argues that it is normally not possible for an investor to outperform the market over the long-term) has challenged Graham’s theories. Even so, the value investing approach has been adopted by many successful investors.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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