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What Is Benjamin Graham’s Value Investing Theory?

Benjamin Graham was an investment theorist who lived from 1894 to 1976. Back in the 1934, Benjamin Graham began to develop his theories of “value investing” which have had a profound impact on security analysis and portfolio management in the decades and generations since.

I won’t be able to do justice to the Graham Theory in a short discussion of the subject, since value investing and Graham-Buffet Theory is a subject people working on their master’s degree might study, but I wanted to give a quick overview for those wanting to be introduced to the subject.

Mainly, I want to help those hoping to find some good stocks to add to their 401(k) account or their Roth IRA fund.

Benjamin Graham Quote on Investment

This Is Benjamin Graham’s Theory in One Pithy Quote.

Value investing is based on the idea of finding undervalued stocks. In the 1934 book, Security Analysis, Columbia professors Benjamin Graham and David Dodd laid down the groundwork for the theory.

Remember what years this book was written: 1933 and 1934. This was America at the height of the Great Depression.

In 1933 alone, over 3,000 US banks failed. Because the start of the Depression was traced back to the 1929 Stock Market Crash, these professors began studying what led to this crash. The major culprit is what they called investment based on “earning trends”–a shortsighted focus on a company’s reported earnings-per-share.

Instead of following the pack who put their money on reported earnings, Graham and Dodd suggested people find those stocks which were undervalued because the “pack mentality” had caused the stock to lose favor with the mass of investors.

In finding ways to reevaluate stocks, value investing gave savvy investors the ability to make money on the ignorance and herd mentality of their peers.

These teachings got a famous adherent when Warren Buffet studied under the authors in 1951

Warren Buffet and Value Investing

Warren Buffet attended undergraduate college at the Wharton Business School at the Ivy League University of Pennsylvania for two years, but he transferred to the University of Nebraska to complete his undergrad degree.

For his master’s studies, Warren Buffet chose the University of Columbia after he learned that the author of his favorite book, “The Intelligent Investor”, taught at Columbia. That author was, of course, Benjamin Graham. Hoping to study under genius securities analysts like Graham and Dodd, Warren Buffet went to New York City for his post-graduate studies at Columbia. It’s famous that Buffett was the only student at Graham’s seminar to receive an A+.

Since studying under Graham in 1951, Warren Buffett has gone on to become the world’s most famous investor. Using value investing, he’s turned Berkshire-Hathaway into THE American success story when it comes to Wall Street. His skills at securities analysis and value investments have earned him monikers like or the “Sage of Omaha” and “Wizard of Omaha“–Omaha being where Berkshire-Hathaway is headquartered.

Warren Buffett’s holding company has an unparalleled success rate, providing loyal shareholders who have held its stock for the last 44 years, Berkshire-Hathaway has averaged a annual growth in book value of 20.3% over that time. The company is the eighth largest public company on Earth (employing 260,000 people) and had a revenue of over $143 billion in 2011. One single Class A share of Berkshire-Hathaway sells for $121,775 (as of May 2012).

Assets fully owned by the Berkshire-Hathaway company include GEICO, Fruit of the Loom, Dairy Queen, Acme Brick, Helzberg Diamonds, and Burlington Northern Santa Fe Corp. That’s just part of the story, though, because the list of minority holdings include some of the pillars of the U.S. economy. Minority holdings by the company include 5.5% of IBM, 4% of Procter & Gamble, 18.1% of the Washington Post, 9.8% of Anheuser-Busch, 13.1% of American Express, and 9.8% of The Coca-Cola Company.

Why Value Investing Is Important

Learning about value investing is important for anybody new to the stock market or investing. Obviously, everyone isn’t going to grok the theory, but everyone who has money in stocks should at least be familiar with the broad concepts. You may not be the next Warren Buffett, but learning how to look at the underlying strength of a stock instead of the latest up-and-down trends is important. Learning to divert from the herd mentality is just as important, if for no other reason than the Graham Theory teaches people to think critically about their economic decisions.

Value investing is certainly going to appeal to the contrarians in the crowd, but this isn’t about simply being contrary. It’s a little like Moneyball was to Major League Baseball, where Billy Beane used sabermetrics to gain an advantage over big-spending teams by using a different method of evaluation.

In both cases, people have learned the techniques and perhaps blunted the advantage once held by the mere few who knew the process. In the case of security analysis, Benjamin Graham promoted a more systematic, screw-and-bolts approach to looking at companies. Stock evaluation is bound to have biases based on fears, anxieties, and sometimes even panic by the stock traders. That’s always going to create opportunities for the savvy who keep their heads about them, can evaluate a corporation or business for what it really is (and not what it seems to be), and has the good timing which comes from reasoned analysis in an unreasonable market.

Investment Psychology

If you want to watch a few moments of Benjamin Graham giving a lecture himself, here is an old, old video of this economics professor on YouTube.

Benjamin Graham’s ideas still hold water in the 21st century. In fact, the kind of sound reasoning Professor Graham imparted on the investor class can be imparted on American consumers, too. In an age where financial literacy is starting to be taught in grade school, it pays for spenders to think about their personal economic philosophies, too.

In business, have an investor’s psychology and not a speculator’s psychology. In personal finance, have a conservator’s mentality and not a consumer’s mentality. Keep your sense about you and you’ll do well in this world.

All of this might be a bit much for people who are just getting their credit score in order. While I want to give you good tips for improving your credit history, ending your debt to VISA and MasterCard, and raising your score, the purpose of financial literacy is to take things to the next step. Once you’ve developed the self-discipline and good habits to turn around your personal finances, you’ll have the inner resources to begin building wealth.

It’s never too early to start thinking on the flip side of interest. Eventually, you’ll want to stop worry about debt and start worrying about savings, so it doesn’t hurt to begin understanding the mentality of others who have thought long and deeply on this subject.

Good luck.

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