Graham’s principle of investing in security market

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 winning philosophy.

Principle #1: Always Invest with a Margin
of Safety
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 for Graham.
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 volatility:
Dollar-Cost Averaging
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 market.

Thinks to learn from Walter schloss

Walter Schloss
1. “I think investing is an art, and we
tried to be as logical and unemotional as
possible. Because we understood that
investors are usually affected by the
market, we could take advantage of the
market by being rational. As [Benjamin]
Graham said, ‘The market is there to
serve you, not to guide you!’.” Walter
Schloss was the closest possible match
to the investing style of Benjamin Graham.
No one else more closely followed the
“cigar butt” style of investing of Benjamin
Graham. In other words, if being like
Benjamin Graham was a game of golf,
Walter Schloss was “closest to the pin.”
He was a man of his times and those
times included the depression which had
a profound impact on him. While his
exact style of investing is not possible
today, today’s investor’s still can learn
from Walter Schloss. It is by combining
the best of investors like Phil Fisher and
Walter Schloss and matching it to their
unique skills and personality that
investors will find the best results. Warren
Buffet once wrote in a letter: “Walter
outperforms managers who work in
temples filled with paintings, staff and
computers… by rummaging among the
cigar butts on the floor of capitalism.”
When Walter’s son told him no such cigar
butt companies existed any longer Walter
told his son it was time to close the firm.
The other focus of Walter Schloos was
low fees and costs. When it came to
keeping overhead and investing expenses
low, Walter Schloss was a zealot.
2. “I try to establish the value of the
company. Remember that a share of stock
represents a part of a business and is not
just a piece of paper. … Price is the most
important factor to use in relation to
value…. I believe stocks should be
evaluated based on intrinsic worth, NOT
on whether they are under or over priced
in relationship with each other…. The key
to the purchase of an undervalued stock
is its price COMPARED to its intrinsic
worth.”
3.”I like Ben’s analogy that one should
buy stocks the way you buy groceries not
the way you buy perfume… keep it simple
and try not to use higher mathematics in
you analysis.” Keeping emotion out of the
picture was a key part of the Schloss
style. Like Ben Graham he as first and
foremost rational.
4. “If a stock is cheap, I start buying. I
never put a stop loss on my holdings
because if I like a stock in the first place,
I like it more if it goes down. Somehow I
find it difficult to buy a stock that has
gone up.”
5. “I don’t like stress and prefer to avoid
it, I never focus too much on market
news and economic data. They always
worry investors!” Like all great investors
in this series, the focus of Schloss was
on individual companies not the macro
economy. Simpler systems are orders of
magnitude easier to understand for an
investor.
6. “The key to successful investing is to
relate value to price today.” Not only did
Schloss not try to forecast the macro
market, he did not really focus forecasting
the future prospects of the company. This
was very different than the Phil Fisher
approach which was focused on future
earnings.
7. “I like the idea of owning a number of
stocks. Warren Buffet is happy owning a
few stocks, and he is right if he is
Warren….” Schloss was a value investor
who also practiced diversification.
Because of his focus on obscure
companies and the period in which he
was investing, Walter was able to avoid
closet indexing.
8. “We don’t own stocks that we’d never
sell. I guess we are a kind of store that
buys goods for inventory (stocks) and
we’d like to sell them at a profit within 4
years if possible.” This is very different
from a Phil Fisher approach where his
favorite holding period is almost forever.
Schloss once said in a Colombia Business
school talk that he owned “some 60-75
stocks”.
9. “Remember the word compounding.
For example, if you can make 12% a year
and reinvest the money back, you will
double your money in 6 years, taxes
excluded. Remember the rule of 72. Your
rate of return into 72 will tell you the
number of years to double your money.”
Schloss felt that “compounding could
offset [any advantage created by] the
fellow who was running around visiting
managements.”
10. “The ability to think clearly in the
investment field without the emotions
that are attached to it is not an easy
undertaking. Fear and greed tend to
affect one’s judgment.” Schloss was very
self-aware and matched his investment
style to his personality. He said once” We
try to do what is comfortable for us.”
11. “Don’t buy on tips or for a quick
move.”
12. “In thinking about how one should
invest, it is important to look at you
strengths and weaknesses. …I’m not very
good at judging people. So I found that it
was much better to look at the figures
rather than people.” Schloss knew that
Warren Buffett was a better judge of
people than he was so Walter’s approach
was almost completely quantitative.
Schloss knew to stay within his “circle of
competence”. Schloss said once: “Ben
Graham didn’t visit management because
he thought figure told the story.”

Things I’ve Learned from Philip Fisher

1. “I had made what I believe was one of
the more valuable decisions of my
business life. This was to confine all
efforts solely to making major gains in
the long-run…. There are two
fundamental approaches to investment.
There’s the approach Ben Graham
pioneered, which is to find something
intrinsically so cheap that there is little
chance of it having a big decline. He’s got
financial safeguards to that. It isn’t going
to go down much, and sooner or later
value will come into it. Then there is my
approach, which is to find something so
good–if you don’t pay too much for it–
that it will have very, very large growth.
The advantage is that a bigger
percentage of my stocks is apt to perform
in a smaller period of time–although it
has taken several years for some of these
to even start, and you’re bound to make
some mistakes at it. [But] when a stock is
really unusual, it makes the bulk of its
moves in a relatively short period of
time.” Phil Fisher understood (1) trying to
predict the direction of a market or stock
in the short-term is not a game where one
can have an advantage versus the house
(especially after fees); and (2) his
approach was different from Ben Graham.
2. “I don’t want a lot of good
investments; I want a few outstanding
ones…. I believe that the greatest long-
range investment profits are never
obtained by investing in marginal
companies.” Warren Buffett once said:
“I’m 15% Fisher and 85% Benjamin
Graham.” Warren Buffett is much more
like Fisher in 2013 than the 15% he once
specified, but only he knows how much. It
was the influence of Charlie Munger
which moved Buffet away from a
Benjamin Graham approach and their
investment in See’s Candy was an early
example in which Berkshire paid up for a
“quality” company. Part of the reason this
shift happened is that the sorts of
companies that Benjamin Graham liked no
longer existed the further way the time
period was from the depression.
3. “The wise investor can profit if he can
think independently of the crowd and
reach the rich answer when the majority
of financial opinion is leaning the other
way. This matter of training oneself not
to go with the crowd but to be able to zig
when the crowd zags, in my opinion, is
one of the most important fundamentals
of investment success.” The inevitable
math is that you can’t beat the crowd if
you are the crowd, especially after fees
are deducted.
4. “Usually a very long list of securities is
not a sign of the brilliant investor, but of
one who is unsure of himself. … Investors
have been so oversold on diversification
that fear of having too many eggs in one
basket has caused them to put far too
little into companies they thoroughly
know and far too much in others which
they know nothing about .” For the “know-
something” active investor like Phil
Fisher, wide diversification is a form of
closet indexing. A “know-something”
active investor must focus on a relatively
small number of stocks if he or she
expects to outperform a market. By
contrast, “know-nothing” investors (i.e.,
muppets) should buy a low fee index
fund.
5. “If the job has been correctly done
when a common stock is purchased, the
time to sell it is almost never.” Phil
Fisher preferred a holding period of
almost forever (e.g., Fisher bought
Motorola in 1955 and held it until 2004).
The word “almost” is important since
every company is in danger of losing its
moat.
6. “Great stocks are extremely hard to
find. If they weren’t, then everyone would
own them. The record is crystal clear that
fortune – producing growth stocks can be
found. However, they cannot be found
without hard work and they cannot be
found every day.” Fisher believed that the
“fat pitch” investment opportunity is
delivered rarely and only to those
investors who are willing to patiently work
to find them.
7. “Focus on buying these companies
when they are out of favor, that is when,
either because of general market
conditions or because the financial
community at the moment has
misconceptions of its true worth, the
stock is selling at prices well under what
it will be when it’s true merit is better
understood.” Like Howard Marks, Fisher
believed that (1) business cycles and (2)
changes in Mr. Market’s attitude are
inevitable. By focusing on the value of
individual stocks (rather than just price)
the investor can best profit from these
inevitable swings.
8. “The successful investor is usually an
individual who is inherently interested in
business problems.” A stock is a part
ownership of a business. If you do not
understand the business you do not
understand that stock. If you do not
understand the business you are investing
in you are a speculator, not an investor.
9. “The stock market is filled with
individuals who know the price of
everything, but the value of nothing.”
Price is what you pay and value is what
you get. By focusing on value Fisher was
able to outperform as an investor even
though he did not look for cigar butts.
10. “It is not the profit margins of the
past but those of the future that are
basically important to the investor.” Too
often people believe that the best
prediction about the future is that it is an
extension of the recent past.
11. “There is a complicating factor that
makes the handling of investment
mistakes more difficult. This is the ego in
each of us. None of us likes to admit to
himself that he has been wrong. If we
have made a mistake in buying a stock
but can sell the stock at a small profit, we
have somehow lost any sense of having
been foolish. On the other hand, if we sell
at a small loss we are quite unhappy
about the whole matter. This reaction,
while completely natural and normal, is
probably one of the most dangerous in
which we can indulge ourselves in the
entire investment process. More money
has probably been lost by investors
holding a stock they really did not want
until they could ‘at least come out even’
than from any other single reason. If to
these actual losses are added the profits
that might have been made through the
proper reinvestment of these funds if
such reinvestment had been made when
the mistake was first realized, the cost of
self-indulgence becomes truly
tremendous.” Fisher was very aware of
the problems that loss aversion bias can
cause.
12. “Conservative investors sleep well.” If
you are having trouble sleeping due to
worrying about your portfolio, reducing
risk is wise. Life is too short to not sleep
well, but also fear can result in mistakes.