Ben Graham's investment principles

 

The core principles of Benjamin Graham can be summarized thus:

A stock is a legal share in a business or corporation.

A stock is a legal share in a business or corporation, and all its profits and assets.
By owning a share, you legally own a piece of a running, working company

Stocks are the most liquid and the most profitable of all investments (note that the highest average annual returns expected from stocks is 25-30%, even by the world's most successful investors).

The assets of a company are not only growing in value, but are also working to generate profits. For this reason, ignoring short-term fluctuations, stocks have consistently proven to be the most profitable of all investments.
Owning a good stock is thus no different from owning any other asset like land or gold, just more profitable.

Book Value (BV) and Earnings per Share (EPS) are both important important for evaluating a stock.

Each company is divided in a different way.
Book Value or BV is the value of the tangible assets that each share is worth.
EPS, or Earnings Per Share are the profits the company is earning for its shareholders.

All other things being equal, it's riskier to buy a lower BV share.
But it's OK if the company regularly earns more than an identical company that has higher BV.

Other numbers/information about a stock can all be classified under:
a. Straightforward numbers that indicate stability of the company like Total Sales, Asset Ratios, Debt Ratios, Earnings History and Dividend History.
b. More complex numbers like ROE, EV/EBITDA etc that only indicate factors already covered by the basic numbers.
c. Projections as to future prices and growth rates like Charts, Technical Analysis, PEG ratios etc.

Projections, Charts, Trends and Technical Analysis in general are inherently unreliable.

When any significant number of people act on a trend, it changes the trend itself. Like when people started believing the January effect and started buying in December, the prices started going up in December instead. This concept has been called 'reflexivity' by another legendary investor, George Soros, famous for short selling fundamentally weak companies.
The market is thus unpredictable in the short term and higher trading frequency only results in higher trading expenses and a poorer overall performance.

But stock brokers consistently sell technical analysis to their customers because they charge a percentage of transactions, not a percentage of profits. They stand to earn more from higher transactions.
Most companies also give more importance to technical analysis and short-term numbers simply because they don't have good long term performance figures. The number of such sub-par companies and public offerings in play is always higher during bull markets and a lot of them don't survive the eventual market corrections.

The most important principle in making money is to not lose any.

Higher returns at the risk of losing the principal is not a viable long-term investment strategy. Sooner or later, the losses will wipe out the higher gains.
Graham's first and foremost principle is thus always the safety of the principal, or as he calls it - The Margin of Safety.

The market is not efficient.

The market price of a stock not only reflects all the information present about it in the market but also
a. Rumors and emotions prevalent about the company.
b. Erroneous but common practices of stock evaluation.
c. The general financial ineptitude of the common people buying and selling stocks.

Thus by checking the financial and historical numbers of lots of companies in detail, it is usually possible to find stocks that are not correctly priced.

Graham's other general principles.

a. It is easy to match the average returns of the market - with a simple index fund - but it is extremely difficult to beat that average.
b. The market is predictable in the long-term but unpredictable in the short-term. Thus more trading usually only results in more expenses.
c. After paying salaries, expenses and commissions, most mutual funds and professional traders rarely beat the market average.
d. Stock brokers work on commission and hence always encourage more trading activity.
e. Higher risk does not equal higher rewards in the long-term. A 50% gain can be negated by a 30% loss.
f. Avoiding losses from risky investments is thus far more effective in the end than making an occasional higher profit.

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