Ben Graham & Value Investing

Ben Graham & Value Investing

It was 1934 when “Security Analysis” was published for the first time, introducing to the world the concept of value investing, then treated again in the essay “The Intelligent Investor” in 1949.

The authors were Benjamin Graham, a professor at Columbia Business School, and his colleague David Dodd.

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What is value investing?

Keeping it simple, value investing is an investment strategy in which stocks are selected to be bought at a “discount” from their intrinsic value.

The first distinction we need to make is between the price of a stock and its value; in fact, while the price of a stock is actually its share price (total capitalization divided by number of shares outstanding), the value (or intrinsic value) of it has to deal more with the company’s fundamentals than with the fluctuations of the financial market.

For instance, the share price of a company can go up a lot because of the general positive trend which is prevailing in the market; the same applies to negative trends, which make the share prices generally go down.

However, the intrinsic value of a company, that can be approximately determined by the analysis of the company’s financial statement and ratios, can vary a lot from the price of its shares.

If the instrinsic value is higher than the share price, then the stock is undervaluated and it could be a good bargain for a value investor; on the contrary, if the intrinsic value is lower than the share price, it means that the stock is overvalued and, sooner or later, it will go down to reach again its true value.

In fact, while in the short-run the market sometimes tends to “be wrong” and to overvalue or undervalue some stocks (often just because they are not fashionable for the public at the moment), in the long-run the market recognizes its “errors” and re-establishes the equilibrium between the share price and the instrinsic value.

Having said this, a question naturally arises in our minds: does value investing work? Or, more properly: can someone really make money through value investing?

The answer is: yes, but there is a condition.

Looking at some of the most famous value investors of all times (some of them have been direct disciples of Graham) we can notice that they have had quite huge financial successes; for example, the most famous follower of Ben Graham’s advices, Warren Buffett, is actually (2016) the third wealthiest man in the world, while other important financiers, like Bill Ackman and Seth Klarman, claim to have used value investing too in gaining their billions.

The unique condition for allowing value investing to work is time: since the market takes quite a long time to recognize the true value of a stock, it could be necessary for a value investor to hold an investment for years and years before gaining a profit.

However, if you can afford to wait enough, value investing will certainly satisfy your patience.

As Warren Buffett himself once said:

“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for ten years.”

Sources:

  • Security Analysis, Benjamin Graham & David Dodd
  • The Intelligent Investor, Benjamin Graham
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