Warren Buffett is widely considered one of the greatest investors of all time, but if you were to
ask him whom he thinks is the greatest investor,
he would probably mention one man: his teacher,
Benjamin Graham . Graham was an investor and
investing mentor who is generally considered the
father of security analysis and value investing .
His ideas and methods on investing are well
documented in his books, “Security
Analysis” (1934), and “The Intelligent
Investor” (1949), which are two of the most
famous investing texts. These texts are often
considered requisite reading material for any
investor, but they aren’t easy reads. In this article,
we’ll condense Graham’s main investing principles
and give you a head start on understanding his
Principle #1: Always Invest with a Margin of
Margin of safety is the principle of buying a
security at a significant discount to its intrinsic
value, which is thought to not only provide high-
return opportunities, but also to minimize the
downside risk of an investment. In simple terms,
Graham’s goal was to buy assets worth $1 for 50
cents. He did this very, very well.
To Graham, these business assets may have been
valuable because of their stable earning power or
simply because of their liquid cash value. It wasn’t
uncommon, for example, for Graham to invest in
stocks where the liquid assets on the balance
sheet (net of all debt) were worth more than the
total market cap of the company (also known as
“net nets” to Graham followers). This means that
Graham was effectively buying businesses for
nothing. While he had a number of other
strategies, this was the typical investment strategy
This concept is very important for investors to
note, as value investing can provide substantial
profits once the market inevitably re-evaluates the
stock and ups its price to fair value . It also
provides protection on the downside if things don’t
work out as planned and the business falters. The
safety net of buying an underlying business for
much less than it is worth was the central theme
of Graham’s success. When chosen carefully,
Graham found that a further decline in these
undervalued stocks occurred infrequently.
While many of Graham’s students succeeded
using their own strategies, they all shared the
main idea of the “margin of safety.”
Principle #2: Expect Volatility and Profit from It
Investing in stocks means dealing with volatility .
Instead of running for the exits during times of
market stress, the smart investor greets
downturns as chances to find great investments.
Graham illustrated this with the analogy of “Mr.
Market,” the imaginary business partner of each
and every investor. Mr. Market offers investors a
daily price quote at which he would either buy an
investor out or sell his share of the business.
Sometimes, he will be excited about the prospects
for the business and quote a high price. Other
times, he is depressed about the business’s
prospects and quotes a low price.
Because the stock market has these same
emotions, the lesson here is that you shouldn’t let
Mr. Market’s views dictate your own emotions, or
worse, lead you in your investment decisions.
Instead, you should form your own estimates of
the business’s value based on a sound and
rational examination of the facts. Furthermore, you
should only buy when the price offered makes
sense and sell when the price becomes too high.
Put another way, the market will fluctuate –
sometimes wildly – but rather than fearing
volatility, use it to your advantage to get bargains
in the market or to sell out when your holdings
become way overvalued .
Here are two strategies that Graham suggested to
help mitigate the negative effects of market
Dollar-cost averaging is achieved by buying equal
dollar amounts of investments at regular intervals.
It takes advantage of dips in the price and means
that an investor doesn’t have to be concerned
about buying his or her entire position at the top
of the market. Dollar-cost averaging is ideal for
passive investors and alleviates them of the
responsibility of choosing when and at what price
to buy their positions.
SEE: Take Advantage of Dollar-Cost Averaging and
Dollar-Cost Averaging Pays
Investing in Stocks and Bonds
Graham recommended distributing one’s portfolio
evenly between stocks and bonds as a way to
preserve capital in market downturns while still
achieving growth of capital through bond income.
Remember, Graham’s philosophy was, first and
foremost, to preserve capital, and then to try to
make it grow. He suggested having 25-75% of
your investments in bonds, and varying this based
on market conditions. This strategy had the added
advantage of keeping investors from boredom,
which leads to the temptation to participate in
unprofitable trading (i.e. speculating).
Principle #3: Know What Kind of Investor You Are
Graham advised that investors know their
investment selves. To illustrate this, he made clear
distinctions among various groups operating in
the stock market.
Active Vs. Passive
Graham referred to active and passive investors as
“enterprising investors” and “defensive investors.”
You only have two real choices: The first choice is
to make a serious commitment in time and energy
to become a good investor who equates the
quality and amount of hands-on research with the
expected return. If this isn’t your cup of tea, then
be content to get a passive ( possibly lower)
return but with much less time and work. Graham
turned the academic notion of “risk = return” on
its head. For him, “Work = Return.” The more
work you put into your investments, the higher
your return should be.
If you have neither the time nor the inclination to
do quality research on your investments, then
investing in an index is a good alternative.
Graham said that the defensive investor could get
an average return by simply buying the 30 stocks
of the Dow Jones Industrial Average in equal
amounts. Both Graham and Buffett said that
getting even an average return – for example,
equaling the return of the S&P 500 – is more of an
accomplishment than it might seem. The fallacy
that many people buy into, according to Graham,
is that if it’s so easy to get an average return with
little or no work (through indexing), then just a
little more work should yield a slightly higher
return. The reality is that most people who try this
end up doing much worse than average.
In modern terms, the defensive investor would be
an investor in index funds of both stocks and
bonds. In essence, they own the entire market,
benefiting from the areas that perform the best
without trying to predict those areas ahead of
time. In doing so, an investor is virtually
guaranteed the market’s return and avoids doing
worse than average by just letting the stock
market’s overall results dictate long-term returns.
According to Graham, beating the market is much
easier said than done, and many investors still find
they don’t beat the market.
Speculator Vs. Investor
Not all people in the stock market are investors.
Graham believed that it was critical for people to
determine whether they were investors or
speculators . The difference is simple: an investor
looks at a stock as part of a business and the
stockholder as the owner of the business, while
the speculator views himself as playing with
expensive pieces of paper, with no intrinsic value.
For the speculator, value is only determined by
what someone will pay for the asset. To
paraphrase Graham, there is intelligent speculating
as well as intelligent investing – just be sure you
understand which you are good at.
The Bottom Line
Graham served as the first great teacher of the
investment discipline and his basic ideas are
timeless and essential for long-term success. He
bought into the notion of buying stocks based on
the underlying value of a business and turned it
into a science at a time when almost all investors
viewed stocks as speculative. If you want to
improve your investing skills, it doesn’t hurt to
learn from the best. Graham continues to prove
his worth through his disciples, such as Warren
Buffett, who have made a habit of beating the