As part of my Mastermind Value Investing Course, I ask students to watch the following video created by ‘The Heilbrunn Centre for Graham and Dodd Investing’ of Columbia Business School, where Benjamin Graham taught value investing in the late 1920s.
This video showcases Graham giving a lecture, and also his students’ views on the legacy of this great man whom the world now knows as the ‘Father of Value Investing’.
If you can’t watch the video above, click here.
My exercise for Mastermind students is to watch the complete video and share the “one” big idea from it that inspires them the most from Graham’s teachings or from what his students say of their teacher.
Well, I have read a lot of brilliant answers from students over the past two years, but here is one that was posted by Uday very recently, and which led me to re-think deeper what Graham should really mean to the students and practitioners of value investing, and how we should look at one of the two most important concepts he created – margin of safety (the other is dealing with Mr. Market).
Here is the response Uday posted on what he learned from the video…and the first time I read it, I knew I had to share it with you…
The one big thing that stood out for me while watching the video was the pioneering influence of Ben Graham.
He was charting unknown waters. He laid out a roadmap. He laid a frame-work for us to tread upon.
Pioneers need to be gauge the ground they tread upon. They need to be ready to embrace what works. Graham saw that what was working in the markets was going against the psychology of the masses. He had the strength to embrace this, against how everyone was behaving.
He carved his actions into a philosophy – a workable, scalable and transferable philosophy. We are benefiting today.
What I would like to underline is the spirit in which this was done.
Sure, you had the humility angle, the largesse and the charitable nature of Graham, but that’s not it…
I’m talking about the pioneering angle. He was a leader. He did something BIG. There were no text-books. He made one. This is the one page I wish to take forward, with me, always. Sure, some things will never change in the markets. However, a few minor things might, or will. That’s the way our human bodies are made.
The 4-minute mile was almost unachievable in the ’60s. Today, every third college team fellow is running a 4-minute mile. My take-away is that I accept this philosophy for what it is…GREAT. However, that one channel in my mind will always remain open for something pioneering. I wish to retain the pioneering spirit of Graham because it will be required to tackle scenarios which weren’t around when Graham did the rounds.
The essence for me is to take the spirit, and make it work optimally – TODAY and for the next 50 YEARS.
Brilliant observation, isn’t it?
While we all remember (if we remember) Graham for what he taught us, it’s easy to ignore the fact that he was walking on a path where no one else had been before him.
While dealing with his own investment practices and losses after the Great Depression, he created a philosophy from scratch that we now know as value investing, and especially one that goes against the crowd. How difficult could that have been?
Anyways, the second part of the above exercise for Mastermind students is to pick up their copies of Graham’s The Intelligent Investor, and read through Chapter 20 where he writes about the concept of “margin of safety”, and then share their own thoughts on this concept and how they plan to employ it in their investing lives.
Here is how Uday answered to this exercise…
Margin of safety seems to be the central concept that binds value investing together and gives it its line of life.
Value investing involves sitting. Most of the time, your funds don’t move. Why should they move without finding appropriate reason to?
What is that reason?
Safety of principal. Adequate return. Promised through thorough analysis.
When you see the former two clearly, after performing the latter, yes, that is a good enough reason for your funds to move. And, it should be your central reason, because, remember, that is also the most business-like reason.
Bought without margin of safety, your “well-researched” investment won’t let you sit in peace during market-turmoil. You’ll take a wrong decision. Your dynamics are off. There is no coherence. Emotionally, your losses will make you a wreck. Recovery times required will be unrealistic. It’s a write-off.
Bought with margin of safety, your well-researched investment will also let you sit peacefully during the most difficult market conditions. Your investment might be down during such times, but even the notional loss will be bearable. You’ll sit it through. It shall pass for you, because you’ve paid attention to the biggest, most crucial / pivotal point – margin of safety.
About how I choose to employ it?
Words are words. Alone words are not enough to understand margin of safety. One must put one’s money where one’s mouth is. One must feel margin of safety in action – or the lack of it. I’ve bought many times without margin of safety, and have sorely missed it in tough times. I’ve not been able to sit because margin of safety was missing. My body-mind system understands what was lacking, and, hopefully, my system won’t move forward with any investment without the crux presence of margin of safety.
I will pray to have the mental strength to pass upon the best of businesses if margin of safety is lacking.
If I like a business and if the numbers meet my criteria, I will pray that I remember to look for adequate margin of safety. For me, that would be at least a 50% discount to the underlying’s intrinsic value.
I will try my best to make my entire investment approach revolve around this one basic and all-important concept. Sure, there are other important concepts in investing too. However, their importance comes into play only when margin of safety is present.
Margin of safety demands obsession. That it will get from me.
As Uday rightly mentions, words are words…and alone words are not enough to understand margin of safety.
You must feel margin of safety in action – or the lack of it.
In the recent mania we saw in the stock market, I found a lot of people ignoring “margin of safety” in the lure of “moats”.
And this is the question I asked them – “Would moats benefit you in the absence of any margin of safety?”
“Moats will always remain expensive,” I was told. “So, let’s buy before they get even more expensive.”
I’m sure what these guys who preferred the interesting moats over the uninteresting margin of safety must be thinking now.
What Makes Us Overlook Graham’s Ideas
Drowned in the brilliance of Buffett and Munger, it’s easy to miss the teachings of Graham. The reason is not difficult to understand.
What Graham has taught sounds so simple and commonplace that it kind of seems like a waste of time reading his teachings, and especially after you are an MBA (huh!).
It’s the same as spending ten years learning spirituality and then having somebody tell you that the Ten Commandments were all that counted.
The Intelligent Investor and the rest of Graham’s teachings are based on a fundamental set of principles that he believed to be true 70+ years back, and which remain true even today. These principles are something that, no matter what the circumstances, are never to be broken.
The three basic principles of Graham, and you can call them the “golden rules of investing”, are –
- You should look at stocks as part ownership of a business,
- You should look at market fluctuations in terms of his “Mr. Market” example and make them your friend rather than your enemy by essentially profiting from folly rather than participating in it, and finally
- You must never forget margin of safety – the three most important words in investing – and always build a 15,000 pound bridge if you’re going to be driving 10,000 pound truck across it
As you can see, none of these three ideas are complicated or require any mathematical talent or anything of that sort. And that, I believe, puts people off in the same way a doctor who would prescribe steam as cure for cold instead of antibiotics would put his patients off.
“Just a steam? No antibiotics?” the patient would wonder. In the same way, a casual reader of a book review of Graham’s ideas would say, “Just these simple principles? Nothing else?”
That’s true, dear reader. And here is what Buffett has to say on these three ideas of Graham…
I think those three ideas 100 years from now will still be regarded as the three cornerstones, essentially, of sound investment. And that’s what Ben was all about. He wasn’t about brilliant investing. He wasn’t about fads and fashion. He was about sound investing.
And what’s nice is that sound investing can make you very wealthy if you’re not in too big a hurry. And it never makes you poor – which is even better.”
Essentially, Graham’s teachings are ones that help build the character of an intelligent investor. And that’s what a great teacher really does, right? You may be disappointed if you go to him with any other expectation.
Graham’s core idea is that you as an investor must build a good overall character – which most importantly includes developing self-control and emotional discipline.
When Buffett was asked what was the best money advice he ever got was, it’s no surprise that he turned to The Intelligent Investor –
Chapters 8 and 20 have been the bedrock of my investing activities for more than 60 years. I suggest that all investors read those chapters and reread them every time the market has been especially strong or weak.
Anyways, Graham loved the story of Ulysses, through the poetry of Homer, Alfred Tennyson, and Dante. He relished the scene in Dante’s Inferno when Ulysses describes inspiring his crew to sail westward into the unknown waters beyond the gates of Hercules thus –
Consider the seeds from which you sprang: You were made not to live like beasts, but to seek virtue and understanding.
Investing, too, is an adventure; the financial future is always an unknown world. With Graham and The Intelligent Investor as your guide, your lifelong investing voyage should be as safe and confident, even if it is adventurous at times.
Anyways, before I end, here is another Mastermind student, MBH, on his biggest idea from Graham’s video…
Graham’s philosophy was the common denominator for all things value investing. Infact look at this way his philosophy was like a grain of wheat! Yes wheat…now with wheat you can do so many things you can make a chapati, poori or even bread. All the three are different in style and taste yet all the three have the same common ingredient!
This is what Graham’s philosophy did to super investors of Graham and Doddsville; they all took that grain of wheat and made a type of bread which suited their style and temperament. Buffett (with much influence from Munger) moved from the Graham tenet of net-nets towards paying more for great businesses and looking beyond the tangibles.
And here are MBH’s thoughts on margin of safety…
Having stressed upon the right mindset which forms a basic foundation to value investing he (Graham) then goes to explain “margin of safety” and why it is required. You see with all things mathematical computations, there are bound to be different interpretations and permutations which can lead to lot of error.
Calculating an absolute fair price is not only difficult but rather a futile attempt. We just need to incorporate intelligent analysis and work out the fair price which supports our facts. The margin of safety is always dependent upon the price paid. The difference between the price and the appraised value is what is called safety margin. It is available for absorbing the effects of miscalculations or worse than average luck.
Graham sums up by saying a true value investment has a true margin of safety and such margin of safety can be explained by figures, persuasive reasoning and by reference to a body of actual experience.
Graham doesn’t stop at investing with margin of safety, he takes it further to your life, as he says – “I blamed myself not so much for my failure to protect myself against the disaster I had been predicting, as for having slipped into an extravagant way of life which I hadn’t the temperament or capacity to enjoy. I quickly convinced myself that the true key to material happiness lay in a modest standard of living which could be achieved with little difficulty under almost all economic conditions.”
Therefore if we are modest in our standards of living and in the management of our finances we would have incorporated margin of safety not only in our investing but also in our lives.
Well, I have nothing to add.
But I would love to have your views on the biggest idea you’ve learned from Graham, and what you understand of the concept of margin of safety and how do you apply to your investments. Please share in the Comments section of this post.