A Dozen Things I’ve Learned from Benjamin Graham about Investing

1.  “The last time I made any market predictions was in the year 1914, when my firm judged me qualified to write their daily market letter based on the fact that I had one month’s experience.  Since then I have given up making predictions.” You will not outperform the market in making macroeconomic forecasts.  This series of blog posts makes that same point over and over.  The record of the great investors in this series demonstrates that there is a way to outperform the market without doing any macro forecasting.

2. “Abnormally good or abnormally bad conditions do not last forever.” The market will be cyclical even though you can’t beat the market with macro forecasts.  While it is in those swings that opportunity is created, it is by ignoring the temptation to make macro forecast that these great investors find success.  Yes, markets will swing up and down. No, you do not need to forecast those swings to be a successful investor.

3.  “The disciplined, rational investor … searches for stocks selling a price below their intrinsic value and waits for the market to recognize and correct its errors. It invariably does and share price climbs. When the price has risen to the actual value of the company, it is time to take profits, which then are reinvested in a new undervalued security.” When you focus on intrinsic value you need not time how and when the market inevitably swings.  By focusing on the micro (e.g., the value of individual company or bond), the macro takes care of itself.  By understanding the simple system you need not understand the complex adaptive systems in which it sits.

4.  “The function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future.” Everyone makes errors and mistakes and so having insurance against those mistakes is wise.  With a margin of safety you can be somewhat wrong and still make a profit.  And when you are right you will make even more profit than you thought. Finding a margin of safety is not a common event so you must be patient. The temptation to “do something” while you wait is to hard for most people to resist. The best investors are those who have a temperament which is calm and rational. Excitement and expenses are the investor’s enemy.

5.  “Market quotations are there for [your] convenience, either to be take advantage of or to be ignored.” This is consistent with Buffett’s point that one should value the market for its pocketbook not its wisdom.  That the bipolar Mr. Market can offer you liquid is wonderful.  That the market is somehow wise at any given point is a bad bet since that happens relatively rarely as it swings back and forth.

6.  “The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices.”  and  “An investment is based on incisive, quantitative analysis, while speculation depends on whim and guesswork.” If you are trying to predict the behavior of a crowd you are a speculator.  Great masses of people have a strong tendency to herd which inevitably produces swings in prices. By focusing on value instead of price the intelligent investors can find profits over the long term.  “In the short run, the market is a voting machine but in the long run it is a weighing machine.”

7.  “Investment is most intelligent when it is most businesslike. It is amazing to see how many capable businessmen try to operate on Wall Street with complete disregard of all the sound principles through which they have gained success in their own undertakings. ”  A share of stock is partial ownership of a business.  Too many investors abandon all that they have learned in business.

8.  “It is bad business to accept an acknowledge possibility of a loss of principal in exchange for a mere 1 or 2% of additional yearly income. If you are willing to assume some risk you should be certain that you can realize a really substantial gain in principal value if things go well.”  It is only acceptable to undertake a risky investment if you are properly compensated for that risk. Too often investors take on “return free risk.”

9.  “There are two requirements for success in Wall Street. One you have to think correctly; and secondly you have to think independently.”  This is consistent with Howard Mark’s point that to beat the market you must occasionally take a position that is contrary to the market and you must be right about that view. Following the crowd in all cases guarantees that you will not outperform the market, especially after fees and costs.

10.  “To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.” Buying an index fund is easy and smart for a know-nothing investor (dumb money becomes smart when it buys a low fee index fund).  Beating the market as a know-something investor (generating alpha after fees and costs) is hard.

10.   “It is undoubtedly better to concentrate on one stock that you know is going to prove highly profitable, rather than dilute your results to a mediocre figure, merely for diversifications sake.” This is ideas advanced by Charlie Munger including: (1) if you are a know something investor, you must do an opportunity cost analysis when decided whether to buy a given stock and (2) closet investors are fooling others and maybe themselves too.  http://25iq.com/charlie-munger-book-to-date-chapters-1-5/

11.  “Exactly the same mathematical advantage which practically assures good results in the investment field may prove entirely ineffective where luck is the overshadowing influence.” This is consistent with Michael Mauboussin’s point that the investor’s focus should be on the right investing process not the investing result in a given case.  Luck, both good and bad, happens. http://25iq.com/2013/07/11/a-dozen-things-ive-learned-from-michael-mauboussin-about-investing/

12.  “The investor’s chief problem – and even his worst enemy – is likely to be himself.”  My post on the psychology of investing is at: http://25iq.com/2013/07/01/a-dozen-things-ive-learned-about-the-psychology-of-investing/

11 thoughts on “A Dozen Things I’ve Learned from Benjamin Graham about Investing

  1. This knowledge has been widely known and still not widely adopted. I’ll address the issue of why it’s not widely adopted and my personal experience in adopting these values. Maybe Tren will also share his 12 steps to internalize a long term oriented approach.

    Some reasons why it’s not widely adopted:
    1. Bezos once asked Buffett – You are the second richest guy in the world and your investment thesis is so simple, why doesn’t everybody copy you?
    Buffett replied- because no one wants to get rich slow
    Buffett is talking about investing but human decisions in all areas will favor the short term overwhelmingly so this will show up in all decisions that are valuing options that have a different time duration in achieving the results.

    2. An excerpt from “Judgement in managerial Decision Making” by Max Bazerman -Pg 191
    In fact, Kagel and Levin(1986) do show a reduction in the winner’s curse in the auction context as the market (but not necessarily specific players) “learns” over time. However, much of this learning can be attributed to the phenomenon in which the most aggressive bidders go broke and drop out of the market. Additional learning occurs by observing the consistent losses being suffered by “winners” in the auction.
    Clearly, life experiences help us to improve numerous skills and abandon many bad habits. Unfortunately out judegmental distortions might not be among them. Tversky and Kahneman (1986) have argued that basic judgemental biases are unlikely to correct themselves over time.

    3. My own analysis is that these decision biases exist and survive because they increase an individual’s life expectancy.

    Now onto what it feels like to internalize these learnings:
    1. You have to be wired to absorb these values and internalize them.
    Buffett on the skills to hire his replacement (http://www.berkshirehathaway.com/letters/2006ltr.pdf) – We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered.

    2. Create the environment where this lessons can be practised. Since the biases cannot be eliminated, the environment should be such that it makes more rational decision making possible and that includes everything from not using leverage, keeping long term committed capital and making decisions to rule out yourself from having the ability to make the errors you are most likely to.
    Here is an example from Bill Gates about changing the environment to not support his decision:
    Gates developed a rebellious academic pattern: He would not go to the lectures for any course in which he was enrolled, but he would audit classes that he was not taking. He followed this rule carefully. “By my sophomore year, I was auditing classes that met at the same time as my actual classes just to make sure I’d never make a mistake,” he recalled. “So I was this complete rejectionist.” http://harvardmagazine.com/2013/09/walter-isaacson-on-bill-gates-at-harvard

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  3. taking advantage of irrational market fluctuations so as to buy low, sell high is exactly what most people think of as market timing, whether or not this is what graham meant by market timing

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  5. Buffett seems to have moved significantly away from Graham. I do not think Graham would have ever bough Heintz at 22x .. 24x multiples that Buffett bought… ditto with Coke when he bough coke and many other buys including IBM

    Buffett today looks more like Phil fisher disciple than Grahams

    I think buffett benefited enormously by using the insurance float wisely, which is something NOT mentioned sufficiently either in books or in his interviews

    would love to know your take on this


    • Buffett has been this way for some time. He’s been buying ‘quality’ (a stock with good earnings at a fair price) for decades, as well as buying derivatives and loaning money at excellent terms (for himself) to businesses in need. He’s a multi-strategy manager whether value investors like it or not.

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