Benjamin Graham is widely held up as not only a great investor, but also a great teacher of investing. It was Graham's guidance that largely shaped Warren Buffett into the stock market legend he is today.
We too can benefit from Graham's wisdom. Below you'll find eight lessons from a speech Graham gave in San Francisco in 1963. Each remains as brilliant today as it was then.
1. On salesmen and reading the fine print
[It's common that] calculating the gains that investors could have made in mutual-fund shares or in similar purchases over the last 14 years [are used] as a basis for trying to persuade [investors] to buy such securities at their present advanced prices. As you know, this kind of calculation is done all the time by mutual-fund salesmen to impress investors. The SEC requires it to be accompanied by a perfunctory statement that the calculation carries no warranty for the future, but I don't think very much emphasis is placed upon that qualification.
Since Dec. 31, 2008, the S&P 500 is up 134%. Since Dec. 31, 2007, the S&P 500 is up just 44%. If you were a salesman selling an investment today, which date would you choose to advertise?
Be wary of promises of future success based on past performance. Sometimes they're based on an arbitrary time frame that has no context or relevance to the market today.
2. On bubbles, then and now
We are still going to have wide fluctuations [in the market] in the future. ... My reason for thinking that we shall have these wide fluctuations -- of which we had a taste in 1962, is that I don't see any change in human natures vis-a-vis the stock market which is sufficient to establish more restraints in the public behavior than it showed over so many decades in the past.
Understanding human nature is critical to understanding market movements over the long term. Sometimes we get a bit too excited and lose sight of risks. Other times our pessimism blinds us to huge upside opportunities.
If we accept that the markets will overreact to both the upside and the downside with a cool, non-emotional mind, we can can take advantage of the opportunities that market swings present. Graham agrees, as he points out in the following lesson.
3. On anticipating market cycles (in order to buy great stocks when prices are low)
My basic conclusion is that investors as well as speculators must be prepared in their thinking and in their policy for wide price movements in either direction. They should not be taken in by soothing statements that a real investor doesn't have to worry about the fluctuations on the stock market.
In other words, plan for both bull and bear markets. When the market drops, don't panic; think of it as your chance to buy low.
4. On stock market "experts" and their predictions for the future
I would like to point out that the last time I made any stock market prediction was in the year 1914 [49 years and counting at the time of this speech], when my firm judged me qualified to write their daily market letter, based on the fact that I had one month's experience in Wall Street. Since then I have given up making predictions.
You could argue that Graham's central tenet is that the markets, broadly, are unpredictable. You'll see this theme come up again and again in this speech and in his other writings.
Humility is a great indicator of a true market expert, while hubris is the mark of a novice.
5. Graham would have loved modern index funds for the average investor
There is no indication that the investor can do better than the market averages by marking his own selections or by taking expert advice. The outstanding support for that pessimistic statement is found in the record of the investment funds, which represent a combination of about the best financial brains in the country, and a tremendous expenditure, of money, time, and carefully directed effort. The record shows that the funds have had great difficulty as a whole in equaling the performance of the 30 stocks in the Dow Jones Industrial Average or the 500 Standard & Poor's Index.
He then added wryly:
For obvious reasons it is impossible for investors as a whole, and therefore for the average investor or speculator, to do better than the general market. The reason is that you are the general market and you can't do better than yourselves.
6. The two conditions required to beat the market
One is that [the investor] must follow some sound principles of selection which are related to the value of the securities and not to their market price action. The other is that their method of operation must be basically different than that of the majority of security buyers.
If you don't want to passively invest in index funds -- which is likely what Graham would recommend for most people -- then you must have a strategy to succeed over the long term. Graham's strategy was to focus on value above all else.
How can an ordinary investor apply that strategy? Fortunately, he elaborates on that in our final lesson.
7. How to pick stocks
Buy on value rather than prospects or popularity. Some examples of this approach: 1) Select stocks of important companies which sell on a no-glamour basis [think blue-chips with low P/E ratios]. ... 2) Buy definitely "bargain issues." Typically these would be shares that sold for less than their value in working-capital alone, with nothing paid for fixed assets and goodwill. These were quite numerous up to as late as 1957, and were consistently profitable when diversification was observed. ... 3) Finally there is the wide field of "special situations" -- reorganizations, mergers, take-overs, liquidations, etc. This is a professional area, but it is not impossible for intelligent investors to profit handsomely from it if they approach security operations as they would commercial business.
There you have it. Look beyond the flashy stock-market darlings, find boring opportunities on the cheap, and don't be afraid to dive into the special situations that others avoid. The key to each, as Graham said, is to buy at a bargain.
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