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The

Benjamin Graham Investment Model

 

Although Benjamin Graham died in 1976, his investment philosophy still lives on.

 

Many call Benjamin Graham the father of financial analysis and value investing. Graham left his mark on the investment and securities world by introducing the concept of security analysis, fundamental analysis and value-investing theories. More than 30 years after his passing, he continues to have one of the largest and most loyal followings of any investment philosopher.

 

Graham implemented a fundamental analytical process which has been adopted by a generation of very successful money managers.  By using Graham’s techniques, many of these managers have been able to consistently beat market averages. Graham influenced investing giants such as: Warren Buffett, Mario Gabelli, Michael Price, John Bogle and John Neff.  Quite simply, Graham turned speculating into investing. By devising sound principles for analyzing a company's fundamentals and its future prospects, he enabled stock pickers to be analysts – instead of gamblers. He espoused many of these value-oriented principles in two timeless investing books - Security Analysis and The Intelligent Investor . These best-selling books detail how investors can arrive at a stock or bond's true intrinsic value through extensive fundamental research and financial statement analysis.

Here is a brief overview of Benjamin Graham's Investing philosophy:

Graham argued that even with the best research, investors will never know all there is to know about a company.  They also cannot predict the negative surprises that often send individual stocks harshly down.

Look for a "Margin of Safety"
One main, vital concept taught by Graham and still referred to today by Warren Buffett, is the "Margin of Safety". The basic meaning of this term is that investors should only buy a stock when it is available at a discount to its underlying intrinsic value -- what the business would be worth if it were sold presently.  In order to do this, the investor must be able to accurately estimate what the intrinsic value of any given company might be. Along those lines, Graham offered some guidelines as to how to calculate this intrinsic value.

The key point for investors to remember is that they should only invest in a company when its stock is trading below what the company would sell for in the open market.  Those investors who ignore valuation concerns and overpay for their investments are operating with zero margin of safety.  Even if their underlying companies do well, these investors can still get hurt.

 

Graham made his wealth by purchasing businesses that were so beaten-up and neglected that they sold for less than the value of their working capital (calculated as current assets minus current liabilities). He developed a Net Current Asset Value (NCAV) model to determine if the company was worth its market price. The NCAV formula subtracts all liabilities, including short-term debt and preferred stock, from the company's current asset balance. Graham's assertion was that by buying stocks that were trading below their NCAV, investors could manage to pay essentially nothing for a company’s fixed assets.

Go for Big Companies with Strong Sales
According to Graham, larger companies pose far less risk. Graham's rationale was that small companies have much more trouble dealing with economic downturns, so it is best to invest in larger corporations. Graham was an active investor in the 1930s during the Great Depression, where he saw hundreds of once-thriving small companies die out.  Based on his observations, he concluded that companies with a more diverse customer base and greater revenues had a better chance of surviving any sort of economic turmoil.

 

Pick Companies that Pay Dividends
Graham was adamant about investing in companies that pay dividends. He believed that conservative investors should only consider companies that have paid a dividend every year for at least the last 20 years. He argued that dividends are a sign that a company is profitable (dividends are paid from profits) and that they also offer investors a return even if the company's stock does not perform well. The dividend “pays you to wait.”

 

Buy Companies That Are in Strong Financial Health
Always being attentive to liquidity, Graham looked for companies whose current assets exceeded the sum of their current and long-term debt. Companies with ample access to cash (liquidity) are generally not as risky as those with low cash balances and heavy debt levels.

Buy Companies with Sustainable Earnings Growth
Graham looked for companies with steady, rising earnings. Graham believed that steadily improving earnings would lead to higher share price in the future.

Watch Price Multiples
Graham sought companies with price/earnings ratios that were below their historical average. Graham also took a careful look at price/book values. In fact, he wouldn't purchase a stock unless it was trading for less than 1.2 times its book value (total assets minus total liabilities) per share. Example:  A company with $1 billion in assets and $800 million in debt has a book value of $200 million. If the company has 10 million outstanding shares of stock, then its per-share book value is $20.  Graham would not pay more than $24 per share (1.2 times the book value per share) for this particular stock.