- Caution and cynicism that may have held you back elsewhere will keep you safe in the stock market, and that very safety is the key to investment success.
- True intelligence is the ability to recognize patterns, and to determine the best course of action given past events. This includes being able to tell when there is no pattern.
- Value Investing acknowledges the stock market's randomness and irrationality, and uses them to the investor's advantage; consistently outperforming more impressive looking strategies that stand on less tenable foundations.
Benjamin Graham — also known as The Dean of Wall Street and The Father of Value Investing — was a scholar and financial analyst who mentored legendary investors such as Warren Buffett, William J. Ruane, Irving Kahn and Walter J. Schloss.
In the past, we have seen how Value Investing as taught by Graham is an elaborate framework that includes extensive checks for Quality and Growth; and some of the wrong interpretations of Graham's methods that have resulted in Value Investing being mistaken for bargain hunting.
A Perfect Field For The Cynical
Buffett describes Graham's book The Intelligent Investor (in its preface) as:
"By far the best book about investing ever written."
Warren Buffett, Preface (1986): The Intelligent Investor (by Benjamin Graham).
One of the first lines that grabs one's attention in The Intelligent Investor is from the Introduction:
"While enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster."
Benjamin Graham, Introduction, The Intelligent Investor.
The book continues this line of thought all through, in some of its most important chapters:
"You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right."
Benjamin Graham, Chapter 20: “Margin of Safety” as the Central Concept of Investment, The Intelligent Investor.
"Operations for profit should be based not on optimism but on arithmetic."
Benjamin Graham, Chapter 20: “Margin of Safety” as the Central Concept of Investment, The Intelligent Investor.
We see also similar ideas expressed in Warren Buffett's letters and interviews, but in a lighter vein, e.g.:
"It's only when the tide goes out that you learn who's been swimming naked."
Warren Buffett, Berkshire Hathaway: Letter to Shareholders (1992).
The Tragedy Of The Commons
We are often told that to succeed, one needs to be confident and even aggressive. In almost every facet of our lives — from driving in traffic to promotions at work — being sincere, cautious and diligent usually results in getting left behind.
One doesn't even need to get into more complex issues such as dating and elections. Even at something as commonplace as an ATM, others enjoy the benefits of your integrity and intelligence. You pay the price for their lack of it. This phenomenon is known in Economics as the Tragedy Of The Commons.
Then from a place one would least expect — the supposed capital of refined aggression, the stock market — comes someone who tells us that everything that held us back thus far is, in fact, the key to success here.
"To distill the secret of sound investment into three words, we venture the motto - Margin of Safety."
Benjamin Graham, Chapter 20: “Margin of Safety” as the Central Concept of Investment, The Intelligent Investor.
"Rule #1: Never lose money. Rule #2: Never forget rule #1."
Warren Buffett, Adam Smith’s Money World: How to Pick Stocks & Get Rich, PBS (1985).
Ignoring Social Cues
Suddenly, one no longer needs to be able to talk charmingly or "network", or "take the initiative", or worry about "it's not what you know, it's who you know".
In fact, most of these mind numbing exercises actually prove detrimental in the stock market. All one needs to be able to do well, is one's due diligence.
For anyone to whom life has started to seem like a unending sequel to H. G. Wells' Country of the Blind — and headed toward a similarly dismal end — Value Investing comes as a second lease of life. You begin to realize that the stock market is the probably the only place where it pays to be right when everyone else is wrong; and that it pays extremely well.
While pick-up artists and politicians use systemic inefficiencies to their benefit too, Value Investing allows one to do so without compromising on one's integrity.
The stock market is, when approached correctly, the true intellectual's dream come true — an application of pure intelligence to making money.
"I develop my financial IQ because I want to participate in the fastest game and biggest game in the world. And in my own small way, I would like to be part of this unprecedented evolution of humanity, the era where humans work purely with their minds and not with their bodies."
Robert T. Kiyosaki, Chapter Five: Lesson 5, Rich Dad Poor Dad (1997).
But What Is Intelligence?
Intelligence is often confused with knowledge. So people with impressive degrees or large vocabularies are often considered intelligent as a matter of course.
But real intelligence is the ability to think, not just read. This is why we often hear of college dropouts clearing Mensa or doing great at business, when many of their more educated counterparts fail at these endeavors. Beyond a certain point, education and intelligence have little to do with one another.
One of the tests Mensa uses to measure intelligence is known as the Raven's progressive matrices test. The test is unique because it's completely visual; no written questions whatsoever. The test simply checks the individual's ability to predict a fifth pattern when shown four progressive ones, over an increasingly complex series of patterns.
In very basic terms, that's all intelligence is — the ability to recognize patterns; the ability to determine the best future course of action, given past events.
But correct pattern recognition also includes being able to tell when a sequence of events is random. Some people see patterns where there actually are none, or do not recognize randomness correctly when they see it.
For instance, in the short term, the stock market is completely random. But many people still try to predict the market and profit from it.
Value Investing, however, acknowledges the stock market's randomness and irrationality, and uses them to the investor's advantage. This is why Graham's Value Investing framework consistently outperforms more impressive looking strategies that are based on the less tenable premise that the stock market can be predicted.
While it looks simple on the surface, Value Investing is a creation of pure genius. It's not for nothing that — in the preface to The Intelligent Investor — Buffett writes about Graham:
"Certainly I have never met anyone with a mind of similar scope."
Warren Buffett, Preface (1986): The Intelligent Investor (by Benjamin Graham).
Graham's Value Investing framework was developed over a period of nearly 50 years. Like Einstein's E=mc2, it looks childishly simple on the surface but derives from concepts that only a handful of people on the planet can probably understand.
One doesn't need to be able to understand the derivation to apply the end result though. One just needs to understand its significance, and the genius behind its external simplicity.
"It’s what is in your head that determines what is in your hands. Money is only an idea. There is a great book called Think and Grow Rich. The title is not Work Hard and Grow Rich. Learn to have money work hard for you, and your life will be easier and happier."
Robert T. Kiyosaki, Final Thoughts: Using Financial Intelligence, Rich Dad Poor Dad (1997).
The Obstacle For Investors Today
Graham's framework itself has been spelled out quite clearly, and software such as GrahamValue's now automate the required statistical work.
The obstacle today is mostly in misunderstandings about the principles themselves. For many people, the very simplicity of Value Investing's premise is what makes it incomprehensible to them.
But like Einsten's equation, Value Investing too has proven itself over and over for decades in both domestic and international markets.
"The four most dangerous words in investing are: 'this time it's different'."
Sir John Templeton, Franklin Templeton Investments: 16 Rules For Investment Success (1993).
To quote Buffett again from the preface to The Intelligent Investor:
"To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. This book precisely and clearly prescribes the proper framework. You must supply the emotional discipline."
Warren Buffett, Preface (1986): The Intelligent Investor (by Benjamin Graham).
Buffett's concluded his article The Superinvestors of Graham-and-Doddsville, writing:
"Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper."
Warren Buffett, Columbia Business School: The Superinvestors of Graham-and-Doddsville (1984) [PDF].
GrahamValue provides two web-based stock screeners:
1. A free Classic Graham screener that lets you screen 5000+ NYSE and NASDAQ stocks by a strict 17-point Benjamin Graham Value Investing assessment.
2. An Advanced Graham screener that lets you screen the same 5000+ stocks by customized combinations of the Graham Number and Graham's 15 other Value Investing rules.
Watch Videos
Warren Buffett
Only a small percentage of the population seem to be able to see Value Investing for what it is, and take advantage of it. What's even stranger is that the determining factor does not even appear to be intelligence or IQ in the traditional sense.
In his 1984 article, The Superinvestors of Graham-and-Doddsville, Buffett says:
"It is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately to people or it doesn’t take at all. It’s like an inoculation. If it doesn’t grab a person right away, I find that you can talk to him for years and show him records, and it doesn’t make any difference. They just don’t seem able to grasp the concept, simple as it is... I’ve never seen anyone who became a gradual convert over a ten-year period to this approach. It doesn’t seem to be a matter of IQ or academic training. It’s instant recognition, or it is nothing."
Warren Buffett, Columbia Business School: The Superinvestors of Graham-and-Doddsville (1984).
The following is Buffett's first National Television appearance, and aired in 1985 on PBS. Buffett talks about the role of ignoring social cues in investing.
The interview also covers other topics such as the role of stock prices, the role of thinking and intelligence, the problems with academic finance, and the idea of there being no called strikes in investing.
Seth Klarman
In his 2008 Preface to the sixth edition of Graham's book, Security Analysis, Seth Klarman writes:
"While it might seem that anyone can be a value investor, the essential characteristics of this type of investor—patience, discipline, and risk aversion—may well be genetically determined. When you first learn of the value approach, it either resonates with you or it doesn’t."
Seth Klarman, Preface (2008): Security Analysis (by Benjamin Graham).
In the following video, Seth Klarman explains how he borrowed the title for his own book Margin of Safety from Graham's book Security Analysis — the latest of edition of which he wrote the above Preface for — and how Value Investing characteristics may be genetic.
Peter Thiel
As Peter Thiel explains in the video below, wealth creation often requires being immune to social cues. This is especially true of Value Investing, which almost always requires going against the grain.
For those with strong technical skills — and possibly poor soft skills — Value Investing as taught by Benjamin Graham provides a most direct way of generating wealth from IQ.
"There's this really odd phenomenon in Silicon Valley where a lot of the great businesses seem to be run by people who suffer from a mild form of Asperger's."
Peter Thiel, Live Talks Los Angeles.