Often referred to as the father of value investing, Benjamin Graham was also Warren Buffett’s mentor. Graham, the author of two investment classics, was one of the first true advocates of fundamental analysis, the science of evaluating companies based on their financial performance or fundamentals.

We can glean some valuable investment lessons from Graham’s early life, his investment career, and the investment principles he developed during his lifetime.

Early life

Ben Graham was born as Benjamin Grossbaum on May 9, 1894, in London. His father was a merchant of porcelain plates and figurines. The family immigrated to the United States when Graham was just one year old.

At first, the family lived in the lap of luxury on upper Fifth Avenue. But in 1903, Graham’s father passed away. The china business faltered, and the family’s financial health steadily declined. Graham’s mother turned her house into a boarding house to earn money. She also borrowed money to trade stocks “on margin.” This turned out to be a costly mistake: she was wiped out in the 1907 crash.

Graham’s teenage years were filled with financial humiliation. Fortunately, Graham won a scholarship to Columbia, where he shone brilliantly. He graduated second in his class in 1914. His academic achievements were so remarkable that when he graduated, three departments (English, Philosophy, and Mathematics) asked him to join the faculty. Graham was only 20 years old.

Graham’s investment career

Graham Wall Street thing about academia. He started out as an employee at a bond trading firm, quickly rose to analyst, then partner, and soon after started his own investment firm.

Graham pioneered the science of investing versus speculation. Surprisingly, stock trading was very much a speculative exercise in those days and almost no attention was paid to the fundamentals of a company.

Graham became an expert in stock research in great detail. In 1925, for example, in the course of researching him, he came across some interesting findings… Northern Pipe Line Co. had at least $80 a share in high-quality bonds. Northern Pipe Line stock price at that time? $65 per share. Graham took advantage of this discrepancy by buying shares and persuading management to increase the dividend. Three years later, he walked away with $110 a share, a return of nearly 70%.

However, Graham was not always successful in those days. During the great crisis of 1929-32, he lost 70% of his portfolio. But despite this sharp decline, he was able to apply his methods and get amazing bargains when the rest of the market was deeply bearish. From 1936 until his retirement in 1956, Graham-Newman Corp., the partnership he created with Jerome Newman, earned nearly 20% a year (14.7% after taking into account fees), while the rest of the market rose. 12.2%. This enviable performance is one of the best Wall Street has ever seen.

Graham’s Investment Principles

Two of the books Graham wrote have stood the test of time to achieve the status of classics: The smart investorY Security analysis. The following investment principles can be distilled from these masterpieces:

• Buying shares in a company is like buying the business: this falls within Graham’s recommendation to invest rather than speculate. Buying stock in a company should involve research and analysis along the same lines as buying a business.
• Know Your Investing Style: Graham talks about two types of investors: “defensive” and “entrepreneurs.” A defensive investor is a passive investor who does not spend a lot of time analyzing companies and choosing their investment opportunities. Graham’s recommendation for the defensive investor would be, in today’s terminology, to stick with index funds. A defensive investor should expect average returns. An enterprising investor, on the other hand, is one who is seriously committed to researching and analyzing companies to invest in. Graham believed that the more work he put into his investments, the greater the return he could expect.
• Use market fluctuations to your advantage: The market is usually pretty accurate when pricing stocks. However, sometimes emotions get the best of investors. At times like this, stocks can be mispriced. What advice does Graham have for the savvy investor in such conditions? He will never panic sell just because the market is undervaluing his stock. In most cases, this is only temporary. In fact, it is in moments of maximum pessimism like these that the best bargains are found. Graham recommends buying a significant number of shares at deep discounts in companies he has researched. What about the other extreme: overvaluation? If he finds that the price of the shares of the companies he has invested in is well above what he has valued them, this might be a good time to sell. Sooner or later the market will correct itself and it is better to lock in your profits before that happens.
• Always use a safety margin – Graham called this the core concept Investing When asked to distill the “secret” of a good investment, the margin of safety was the motto he offered. But first, what exactly does this mean? When conducting a valuation of a company, the intrinsic value we come up with is based on our best prediction of the future. Like any prediction, there is a chance that things will not go as planned. To insulate ourselves from such uncertainties, we need to add a factor of safety to our calculations. This is your margin of safety. So how much margin do we need? It depends on our measure of uncertainty of the future. Companies that are more stable and have a proven track record of excellent financial performance will require less margin. Anywhere between 25-50% of our calculated value would be a good starting point.

The parable of Mr. Mercado

In The Intelligent Investor, Ben Graham uses a very powerful parable to illustrate market fluctuation. In Graham’s own words…

“Imagine you have a partner in a private business named Mr. Market. Mr. Market, the accommodating fellow that he is, shows up every day to tell you how much he thinks your interest in the business is worth.

Most days, the price quoted is reasonable and justified by the prospects for the business. However, Mr. Market suffers from some pretty incurable emotional problems; You see, he is very temperamental. When Mr. Market is overwhelmed by boundless optimism or bottomless pessimism, he will quote you a price that seems a bit silly to you. As a smart investor, you must not fall under the influence of Mr. Market, but must learn to take advantage of him.

The value of your interest must be determined by rationally evaluating the prospects of the business, and you can happily sell when Mr. Market quotes you a ridiculously high price and buy when he quotes you an absurdly low price. The best part of his association with Mr. Mercado is that he doesn’t care how many times you take advantage of him. No matter how many times you charge it with a loss or steal its profit, it will arrive the next day ready to do business with you again.”

summarizing

Benjamin Graham was undoubtedly one of the deepest financial thinkers. His contribution to the field is invaluable. A good testament to his accomplishments is the extraordinarily successful group of disciples he spawned…Warren Buffett, Jean-Marie Eveillard, William J. Ruane, Irving Kahn, Hani M. Anklis, and Walter J. Schloss.

Graham’s investment principles are easy to understand, but sometimes difficult to put into practice. For example, it takes a lot of courage to invest when everyone else is panicking. But if you choose your companies based on sound fundamental analysis, there’s a high chance you’ll make big profits when the market eventually corrects.