Thursday, August 9, 2012

Mr. Market and Value Investing ... The Teachings of Ben Graham and His Student Warren Buffett

Benjamin Graham has long been acknowledged as the guru of value investing. His most famous student and follower is Warren Buffett.

Graham authored "Security Analysis" in 1934 and later "The Intelligent Investor" in 1949. Although both are certainly well worth reading, the latter one is perhaps the easiest to follow and the most entertaining as well.

In "The Intelligent Investor," we are introduced to the concept of value investing through the allegory of Mr. Market, an obliging fellow who appears each day to offer to buy or sell his shares to us at a specific price.

Frequently, Mr. Market's offered price seems reasonable. At other times, however, it's ridiculous.

As an individual investor, we are free either to agree with Mr. Market's price and trade with him or ignore him completely. Mr. Market doesn't mind what we choose to do, and he will return tomorrow to quote another price. And every day thereafter, too.

Charting a Map for Investors reviews the new book "The Einstein of Money" which covers both the life story and invest philosophy of Benjamin Graham. We'll stick with Graham's "value" investment approach herein:

"The notion that the prices of stocks and bonds bear a sane relationship to their underlying value is not, at present, in high regard. Wall Street is widely said to be a betting parlor, if not an adjunct of the underworld. Its repute was even worse when Benjamin Graham published "Security Analysis," an investment manual that urged investors to calmly dissect securities and then plunge into issues trading at a sizable discount to intrinsic value. Stocks at a discount, Graham wrote, offered a "margin of safety"—a cushion that would protect the investor from loss and, in time, assure him of a reasonable gain.

Given that "Security Analysis" was published in 1934, at the depths of the Depression—when Graham had not collected a salary from his investment business for six years—the book was a remarkable show of faith. The public had lost heart; stocks were a rigged game, or so it seemed. But Graham persevered. He helped to create and develop the profession of security analysis. From his perch at Columbia Business School, he nurtured legions of young disciples, among them Warren Buffett. He made sizeable profits for his investors, demonstrating the soundness of the value-investing approach.

Somewhat surprisingly, Joe Carlen is the first author since the 1996 publication of Graham's posthumous memoirs to attempt a cradle-to-grave biography. . . .  Mr. Carlen's title, "The Einstein of Money," is slightly misleading, however. Graham brought discipline, method and rigor to security analysis. . . .

Most famously, Graham liberated the ordinary investor from the tyranny of feeling enslaved to the market's gyrations. In "The Intelligent Investor," aimed at the lay reader and published in 1949, Graham wrote that the investor in stocks was like the partial owner of a business with a mercurial partner, whom Graham dubbed "Mr. Market." "Every day he tells you what he thinks your interest is worth." Some days Mr. Market goes overboard with enthusiasm; on others he is downright depressive. The trick is to invest only when Mr. Market offers a margin for safety—in the belief that, over the long haul, prices will revert to their intrinsic worth. "The Intelligent Investor" became a perennial favorite and, incredibly, remains among the 300 best-selling books on Amazon today (roughly on a par with "Nineteen Eighty-Four" and way ahead of "Shane," published the same year).
The Einstein of Money
By Joe Carlen
(Prometheus, 368 pages, $25)

Mr. Carlen . . . ably recounts Graham's rise from an impoverished childhood in New York City to his stature as a Wall Street sage. His father's early death—in 1903, when Ben was only 9—and his family's hard times provided a spark of material ambition, but Graham was always more interested in the life of the mind. . . .

It is enough to say that, warts and all, Graham was a kind-hearted genius who articulated the cardinal distinction between investing and speculation. As Mr. Carlen underlines: "He formulated a sound system for investment, which . . . can still be productively and profitably applied seven decades after its inception.""

Summing Up

Benjamin Graham's sage advice from long ago is still very much worth heeding.

We need to make every reasonable effort to strip away emotion from the buy-sell decision making process, and buy only when the share's intrinsic value offers us a considerable margin of safety. Then if we choose to sell later, we should attempt to sell only when the share price is considerably higher than its then intrinsic value.

It's the same with market prices generally. Buy when there's blood in the streets and sell when everybody else is buying.

We'll go into more detail about the concept of value in future posts. For now, however, let's recognize that it's absolutely critical to distinguish between the market price of a company's stock and the intrinsic economic value of that real world company.

Finally, let's also recognize and acknowledge that markets are extremely inefficient from time to time, and that we can use that inefficiency to our advantage when buying and selling stocks.

In fact, far too many individual investors have a tendency to buy high and sell low, which, of course, is just the opposite of what Graham advised and what value investing entails.

Let's firmly and irrevocably resolve not to be a part of that emotional trigger happy buy high, sell low "investing" gang that can't shoot straight.

In value investing, emotional overreactions and itchy trigger fingers aren't allowed. On the other hand, sober analysis is required.

Thanks. Bob.

No comments:

Post a Comment