Guru Speak: Some More Excerpts from Benjamin Graham’s Writings

Continuing on the topic of investing wisdom from Benjamin Graham, here are a few more excerpts from the Master’s writings.

1. On Portfolio Policy: We are thus led to put forward for most of our readers what may appear to be an oversimplified 50-50 formula. Under this plan, the guiding rule is to maintain as nearly as practicable an equal division between bond and stock holdings. When changes in market level have raised the common-stock component to, say 55%, the balance would be restored by a sale of one-eleventh of the stock portfolio and the transfer of the proceeds to bonds. Conversely, a fall in the common-stock proportion to 45% would call for the use of one-eleventh of the bond fund to buy additional equities.

2. On The Defensive Investor and Common Stocks: No one has yet discovered any other formula for investing which can be used with so much confidence of ultimate success, regardless of what may happen to security prices, as Dollar Cost Averaging. (Quoted by Graham from another study)

3. On Portfolio Policy: Investment policy depends in the first place on a choice by the investor of either the defensive (passive) or enterprising (aggressive) role. There is no room in this philosophy for a middle ground, or a series of gradation, between the passive and aggressive status. Many, perhaps most, investors seek to place themselves in such an intermediate category; in our opinion that is a compromise that is more likely to produce disappointment than achievement.

4. On Market Fluctuations: In any case, the investor may as well resign himself in advance to the probability rather than the mere possibility that most of his holdings will advance, say 50% of more from their low point and decline the equivalent one-third or more from their high point at various periods in the next five years. A serious investor is not likely to believe that the day-to-day or even month to month fluctuations of the stock market make him richer or poorer.

5. On Market Fluctuations: It is for reasons of human nature, even more than by calculation of financial gain or loss, that we favor some kind of mechanical method for varying the proportion of bonds to stocks in the investor’s portfolio. The chief advantage, perhaps, is that such a formula will give him something to do.

6. On Market Fluctuations: A true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would be spared the mental anguish caused to him by other persons’ mistakes of judgment.

7. On Investment Advisers: If the reason people invest is to make money, then in seeking advice they are asking others to tell them how to make money. That idea has some element of naiveté.

8. On the Central Concept of Investment: In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase, “This too will pass.” Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, Margin of Safety.

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Guru Speak: Timeless Wisdom from Benjamin Graham

bengrahamBenjamin Graham, widely known as the Father of Value Investing, was a professor and an investment manager. Known as the founding father of the profession of security analysis, Graham wrote two of the most valuable books in the area of investing: “The Intelligent Investor” and “Security Analysis”. Credited by Buffett as the key influence on his investing approach, Graham is also famous for his timeless gems of investing wisdom that have stood the test of time.

1. Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble… to give way to hope, fear and greed.

2. Wall Street people learn nothing and forget everything.

3. The individual investor should act consistently as an investor and not as a speculator. This means… that he should be able to justify every purchase he makes and each price he pays by impersonal, objective reasoning that satisfies him that he is getting more than his money’s worth for his purchase.

4. I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities.

5. To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.

6. Even the intelligent investor is likely to need considerable willpower to keep from following the crowd.

7. It is absurd to think that the general public can ever make money out of market forecasts.

8. If you are shopping for common stocks, choose them the way you would buy groceries, not the way you would buy perfume.

9. Individuals who cannot master their emotions are ill-suited to profit from the investment process.

10. The underlying principles of sound investment should not alter from decade to decade, but the application of these principles must be adapted to significant changes in the financial mechanisms and climate.

11. Obvious prospects for physical growth in a business do not translate into obvious profits for investors.

12. The investor’s chief problem – and even his worst enemy – is likely to be himself.

13. Finance has a fascination for many bright young people with limited means. They would like to be both intelligent and enterprising in the placement of their savings, even though investment income is much less important to them than their salaries. This attitude is all to the good. There is a great advantage for the young capitalist to begin his financial education and experience early. If he is going to operate as an aggressive investor he is certain to make some mistakes and to take some losses. Youth can stand these disappointments and profit by them. We urge the beginner in security buying not to waste his efforts and his money in trying to beat the market. Let him study security values and initially test out his judgment on price versus value with the smallest possible sums.3

14. Most businesses change in character and quality over the years, sometimes for the better, perhaps more often for the worse. The investor need not watch his companies’ performance like a hawk; but he should give it a good, hard look from time to time.

15. Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.

16. The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell.

17. It is far from certain that the typical investor should regularly hold off buying until low market levels appear, because this may involve a long wait, very likely the loss of income, and the possible missing of investment opportunities. On the whole it may be better for the investor to do his stock buying whenever he has money to put in stocks, except when the general market level is much higher than can be justified by well-established standards of value. If he wants to be shrewd he can look for the ever-present bargain opportunities in individual securities.

डर के आगे जीत है: Why Long Term Investors should not fear Market Crashes

canwepanicnow“Can we panic now?” asked Ron Weasley to Harry Potter in “The Chamber of Secrets” when they suddenly find themselves surrounded by giant spiders in the Forbidden Forest. That is how a lot of us feel in the current market situation, perhaps. It is one of those times when everyone seems to ask everyone else this question. Is it time to panic?

Like so many things in finance, this is the wrong question with many answers that seem right. The reality is everyone may have a view, but no one can claim to know the answer for sure. The fact is that it is the wrong question to ask.

There is no doubt that in stomach churning times of volatility, the first thought that strikes you may be – sell everything and run. Sometimes, the second thought may be – buy everything quick, because things have gotten cheaper. Both the views are wrong because they depend on timing activities based on market events, rather than based on a plan.

Mr Market can get into manic-depressive moods as well as exuberant moods at the drop of a hat. If it forces one to get either too happy or too sad, one is turning one’s basic advantage into a disadvantage. Think of stocks as a crate of coke or a basket of potato chips that you buy for weekend parties. If you bought something on Wednesday, and your neighborhood supermarket announced a 10% off sale on Friday, will you think – Oh no! I think I should sell the coke and chips I have, and conserve some cash! At best you may think, let me buy more as the prices are great, and I am going to need them next weekend anyway. If you are a rational consumer, you are likely to weigh your decision – based on whether you need more coke and chips, whether you think it is worth stocking up, and whether you think the sale is genuine or is it on old stock. Unfortunately, a lot of individual investors do not think about stocks like that, and hence the fear associated with market falls. Therefore, headlines read ‘Global Bloodbath’ instead of ‘Sale, Sale Sale!’

Take this quiz that Buffett wrote in his 1997 letter to his shareholders – “If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices. ”

And finally he adds: “So smile when you read a headline that says “Investors lose as market falls.” Edit it in your mind to “Disinvestors lose as market falls — but investors gain.” Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other.”

darrkeaagejeethaiThe really good long-term returns from equity come not despite the falls, but because of the falls. For someone who invested in US equity 10 years back and forgot it, he may look at his portfolio today and say – this has gone nowhere. Similarly, for some one who invested in Indian equity 4-5 years back, again the scenario is similar – broader market levels in August 2011 are more or less where they were in August 2007. But for someone who rode the falls, and invested at that time to whatever small degree, even partially in the right stocks or funds, the returns have come. So it is not that the long-term returns from equity have come despite the fall. The long-term returns from equity come because of the fall. The problem is no one can say for sure whether a fall is the end of the falls, or the beginning of another set of falls. Life has to be lived in forward mode, and can only be analyzed in reverse mode later.

But one thing is clear. It is during the times of sudden, big falls that fear is at its highest. It is in such times where it is most important for an investor – firstly not to sell, secondly do nothing, and thirdly buy something. Because truly, in such times, the risk of permanent loss of capital gets lower. If one manages to neglect the value of investments already made (and hence notional losses or reduction in profits), buy the right things in large proportions during times of ‘darr’, and can withstand, or better still, buy more during further falls if they happen, he is sure to be on his way to ‘jeet’  – may be not in a few weeks or months, but surely in a matter of many years. As long as one is committed for the really long haul, and makes rational choices, there is no doubt that there is truth in the saying – डर के आगे जीत है.

Book Synopsis: The Intelligent Investor by Benjamin Graham

Have read “The Intelligent Investor” by Benjamin Graham many times, and every time I read it fully or even in part – I am amazed by the depth, clarity and advice laid out in the book, and relevant every bit today, irrespective of the fact that it was written in the 1940’s. Such a piece of Investment Advice is available nowhere else in such crisp form for the individual investor. It is almost like financial philosophy, akin to the ‘Bhagavad Gita’ of investing and finance for the individual investor – whenever you pick it, you learn a new piece of investment wisdom every time.

TheIntelligentInvestorIt is difficult to pick up the best parts from such a book which is so all-encompassing – it covers everything from definition of investment to specific criteria for stock selection. Here are some of the key takeaways from the book that are invaluable for the individual investor – many of which are well discussed, but still worth repeating and re-reading.

1. Investment versus Speculation: Graham presents a very clear definition of investing, which in his view, means any operation that on thorough analysis promises safety of principal and an adequate return. Anything not meeting these – i.e. there must be thorough analysis, must promise principal (he does not use ‘guarantees’ but promises), it must have adequate return (which he goes on to elaborate later), and finally, it must be like an ‘operation’ – business-like.

2. Bonds versus Stocks in Asset Allocation: He presents a simplistic 50:50 formula of allocation between fixed income bonds and stocks that works for most investors – giving a leeway of 25% on either side. i.e. at no time should the allocation of either stocks or bonds fall below 25%. The guiding rule is to keep re-adjusting this allocation when one component increases above a certain defined limit, like 60%, by selling the additional 10% of the increased component and buying the other. This does not guarantee the highest returns – but is a mechanical program that is most likely to practically work – simply because it advises selling and buying when it is counter intuitive, and “chiefly because it gives the investor something to do”.

3. Defensive versus Enterprising Investors: Graham makes a distinction between types of investors not based on risk taking abilities or age – as was traditionally thought. Return is not dependent on risk, but rather on the amount of intelligent effort that is put into an investment operation. The Defensive investor will place emphasis on avoidance of serious mistakes and losses, and seeks freedom from effort, annoyance and the need to make frequent decisions. The Enterprising investor will be able and willing to put in time and effort in the selection and tracking of securities that may appear to be better valued than the general market from time to time – which may help him achieve better returns than the market over long periods of time. Majority of investors would fall into the Defensive category. To achieve satisfactory results available to the defensive investor is easier than most people realize, to achieve superior results sought by the enterprising investor is harder than it looks.

4. The famous Mr.Market: This is perhaps the most valuable part of the book – on how to approach the widely fluctuating markets that an investor will face number of times in his investing life. Treat the market as an obliging, emotional partner in your businesses – i.e. the securities of which you own.  Every day, he tells you what he thinks of the value of the share of business that you own, and offers to buy your share at a price or sell you his share at a price. Sometimes his fears overtake him offering you rock bottom prices, while sometimes he is too excited about the future offering you great prices. The best part is he does not mind being neglected – he will come back again tomorrow if you neglect him. Your best interests are then served if you only transact with him if and when you agree with his prices – the rest of the time, it is best for you to neglect him and focus on the operations of your business.

In the book, Graham goes on to provide clear stock selection criteria for defensive and enterprising investors – with great examples to help stock evaluation practically. But more than those, the clear framework based on the above – definition of investment, asset allocation, the decision on type of investor, and the attitude towards market fluctuations – are most valuable for an individual investor to go about his investment operations.

Graham’s advice and wisdom are unlikely to make anyone rich in a hurry – perhaps only when one gets old. But the principles are timeless and practical, and unlikely to be available in such fullness anywhere else in today’s financial clutter. That alone makes it a case for the ‘best book about investing ever written’ in Warren Buffett’s words, to be a guiding light on your desk throughout your investing lifetime.

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