CHAPTER 1
Benjamin Graham
There Are No Iron‐Clad Laws

In my nearly fifty years of experience in Wall Street I've found that I know less and less about what the stock market is going to do but I know more and more about what investors ought to do; and that's a pretty vital change in attitude.

—Benjamin Graham

In 200 years, nobody will remember Bill Ackman's crusade against Herbalife. John Paulson's bet against the housing bubble will be long forgotten. Charlie's Mungerisms will be relegated to the dustbin of the twenty‐first century. Great investors come and go, and most of the ones featured in this book will be lost on future generations. But if I had to put my money on one name that will stand the test of time, it's Benjamin Graham.

The Dean of Wall Street, as he was known, will be remembered forever because his teachings are timeless. The lessons he provided in his seminal work, Security Analysis, are just as relevant today as they were in 1934 and will be 200 years hence. The passage of time won't change human nature or the fact that “in applying analysis to the field of securities we encounter the serious obstacle that investment is by nature not an exact science.”1 As gifted as Graham was in mathematics, he understood that the laws of physics do not govern security analysis. It's difficult to overstate how many trails he blazed. Jason Zweig wrote, “Before Graham, money managers behaved much like a medieval guild, guided largely by superstition, guesswork, and arcane rituals.”2 Ben Graham is to investing what the Wright Brothers are to flight, and just as their names will be forever linked to the airplane, so will Graham's to finance.

Graham understood what few did at the time – that the stock prices quoted in the newspaper and the underlying value in the business are not equivalent. Sticking with the Wright brothers, Graham wrote:

In the Wright Aeronautical example, the earlier situation presented a set of facts which demonstrated that the business was worth substantially more than $8 per share…. In the later year, the facts were equally conclusive that the business did not have a reasonable value of $280 per share…. It would have been difficult for the analyst to determine whether Wright Aeronautical was actually worth $20 or $40 a share…or actually worth $50 or $80…. But fortunately it was not necessary to decide these points in order to conclude that the shares were attractive at $8 and unattractive, intrinsically, at $280.3

Security Analysis was written for the Wall Street professional. However it's The Intelligent Investor that will keep Graham's name alive forever. This is the first financial book that I ever read, and it left such a strong impression that I chose it as the namesake for my blog, The Irrelevant Investor. Unlike Security Analysis, The Intelligent Investor was intended for laymen, and, with more than a million copies sold, it reached its target. Warren Buffett said, “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.”4 As long as people want to learn about investing, they will find Graham, who translated an exotic language with terms like net working capital and return on equity into plain English with words like price and value.

Ben Graham invented the field of financial analysis. Roger Lowenstein said, “Investing without Graham would be like communism without Marx – the disciple would scarcely exist.”5 He was a polymath whom Charlie Munger called “a brilliant man” and “the only intellectual in the investing business at the time.”6 At just 20 years old, in his final semester at Columbia, he was offered three invitations, from the English, mathematics, and philosophy departments. Overwhelmed by these offers, he turned to Columbia's dean for advice. By a stroke of luck, a member of the New York Stock Exchange happened to come in to see the dean at the same time and asked him to recommend one of his strongest students. Without hesitation, he introduced him to Ben Graham.

Graham began his career on Wall Street in 1914, just before the New York Stock Exchange would close for four months, its longest shutdown ever, in light of the events surrounding the Great War. At 20 years old, without having taken any economics courses in college, he started at the bottom of the ladder, delivering securities and checks. After a month, he was promoted as an assistant to the bond department, and just six weeks later, with his advanced intellect, Graham was writing a daily market letter.

Ben Graham taught at Columbia Business School for 28 years, beginning in 1928, and simultaneously taught at the New York Stock Exchange's school, now known as the New York Institute of Finance, for a decade. He attracted students like Walter Schloss, Irving Kahn, and Bill Ruane. His most famous pupil, of course, is Warren Buffett, who became the richest man on the planet by using the principles that Ben Graham taught him.

Graham is on the Mount Rushmore of investing, and despite the enormous success he had managing money and teaching future generations how to do the same, his career, like everybody else's, included some trying times. The lessons that Graham provided in the classroom, which he translated into books, will live forever. But we can also learn a lot from his failures. The most important lesson that investors should take from the person who taught us the difference between value and price is that value investing is not a panacea. Cheap can get cheaper. Rich can get richer. Margins of safety can be miscalculated, and value can fail to materialize.

Some investors search for companies that they expect will grow their earnings significantly faster than the broader market. Others prefer to look for companies whose future prospects aren't nearly as bad as their share prices reflect. Whether you consider yourself a growth investor, a value investor, something in between or entirely different, investors want stocks to be worth more than they pay for it. Value investing is the most effective way to determine whether the price you pay for a slice of the business is less than what the company is actually worth.

When Security Analysis was published, the Dow Jones Industrial Average was trading at 100. Today, 84 years later and hovering near 22,000, it's delivered 6.7% a year, not including dividends. Some of the best‐known investors, devotees of value investing brought mainstream by Graham, have earned far greater returns by following a few simple rules. These rules all boil down to what Graham referred to as a “margin of safety.” Graham defined this as “the discount at which the stock is selling below its minimum intrinsic value.”7 Yes, there were formulas involved, but they didn't need to be complicated. Graham liked stocks selling for one‐third less than their net working capital. He once pointed out, “Some extraordinary results could have been obtained since 1933 by buying each year the shares of the six companies in the Dow Jones Industrial Average which sold at the lowest multiplier of their recent earnings.”8

What made Graham so brilliant is not the calculations he performed to determine intrinsic value, but rather the understanding that determining exact values are both impossible and not a prerequisite for success. “It is quite possible to decide by inspection that a woman is old enough to vote without knowing her age or that a man is heavier than he should be without knowing his exact weight.”9

Graham was far ahead of his time, writing about behavioral economics, the study of how psychology affects financial decision making, long before the term even existed. Security Analysis was published the same year that Nobel laureate Daniel Kahneman, who took this field mainstream, was born. Graham identified some of the cognitive and emotional biases that caused investors to send a strong company diving 50% in 12 months. He examined the case of General Electric, which the stock market valued at $1.87 billion in 1937 and $784 million just one year later. Graham summarized it this way:

Certainly nothing had happened within twelve months' time to destroy more than half the value of this powerful enterprise, nor did investors even pretend to claim that the falling off in earnings from 1937 to 1938 had any permanent significance for the future of the company. General Electric sold at 64 ⅞ because the public was in an optimistic frame of mind and at 27 ¼ because the same people were pessimistic. To speak of these prices as representing “investment values” or the “appraisal of investors” is to do violence either to the English language or to common sense, or both.10

Graham taught his students and his readers that prices fluctuate more than value, because it is humans who set price, while businesses set value.

In The Intelligent Investor, he summed up the wild swings in price with a story he told about a hypothetical Mr. Market:

Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and...