Benjamin Graham on Value Investing
The Intelligent Investor - 4th Edn.
Benjamin Graham, author of the book on value investing, The Intelligent Investor, has been described as the father of value investing and the greatest investment adviser of the 20th century.
Does one need to say any more in order to suggest that this book on investing is essential reading in order to discover the Graham value investing approach?
While this revised 4th edition is long, the edition contains updates with new commentary in each chapter by Jason Zweig.
Unfortunately, the comments are not always relevant to the chapter content and do not always add to the quality of Benjamin Graham's writing.
Some Notable Comments
Benjamin Graham is very forthright in indicating that it is not always easy for the average investor to beat the market.
One of his comments that has remained in my mind is that if you don't have the time or skills to do sufficient research, it is better to invest in an index mutual fund.
His approach is a conservative one which relies on focusing on the business and how it is run. The soundness of the business as a long-term investment is a vital consideration.
As a result, he views the day-trading, short-term approach as speculation.
If asked to distil the central concept of investment into a single phrase, Graham ventures the motto MARGIN OF SAFETY. This is a thread that runs through all his discussion of investment policy.
Warren Buffett suggests in the preface to the 4th edition that ...
"if you pay special attention to the invaluable advice in Chapters 8 and 20 - you will not get a poor result from your investments".
His Valuation Formula
In his investment book, Graham provides a straight-forward formula for the valuation of 'growth' stocks which is intended to produce results similar to those from more refined mathematical calculations such as discounted cash flow (DCF) calculations.
His formula is:
Intrinsic Value = Current (Normal) Earnings x (8.5 + twice the expected annual growth rate)
He discounts the intrinsic value to provide a margin of safety. He suggests that the growth rate should be that expected over the next seven to ten years.
This immediately suggests to me that the formula may work best for stocks with a higher than average stability in earnings growth in order to better predict that growth rate.
He also cautions that any reasonably dependable stock evaluation based on anticipated future results must take interest rates into account - which he suggests is an exercise fraught with uncertainty.
Benjamin Graham's text is very sensible and clear, and is an essential investing book for beginners looking for stock investing information.
His way of analyzing the markets, and his approach to considering the inherent worth of investments has made this book on value investing
a seminal text.
The related articles below examine the importance of each of the topics referred to above in more detail.
An index fund
- is a type of managed or mutual fund in which the fund manager makes no judgements about companies or future market movements, they only seek to accurately reflect the stock market index they are tracking.
discounted cash flow methodology - is based on determining future likely cash flows for the life of the company. Because money in the future is worth less than it is today, this estimate is 'discounted' to determine the company's worth today. The 'discount' or discount rate applied (as a percentage) is the return the investor wished to make.
stability in earnings growth - measures how consistent the earnings per share growth of a company is. The more stable the earnings per share growth of a company, the more accurately one can forecast future earnings, and to a lesser extent future price earnings ratios.
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