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Ben Graham's Winning Investment Advice

Written By Brian Hicks

Posted July 1, 2010

You may not realize this, but it’s true: For every successful investor you meet, there is an even greater mentor lurking somewhere in the shadows.

Let’s face it. No one was born to be great investor.

Instead, investing is a craft that is learned somewhere outside of your genetic code. Unlike the ability to sing or run a 4.2 forty, someone has to show you the ropes.

And when it comes to stock market investment advice, there’s no better place to start than with “the dean of Wall Street,” Benjamin Graham.

A scholar and financial analyst who is widely recognized as the father of value investing, Graham literally wrote the book when it comes to fundamental analysis.

In fact his book Security Analysis, written in 1934 with David Dodd, is practically revered as the bible by serious investors. Warren Buffet calls Graham’s Intelligent Investor “the best book about investing ever written.”

As a 19-year-old in Lincoln, Nebraska, Buffett even goes so far as to say one of the luckiest days of his life is when he first picked up a copy of the book in 1949.

“It not only changed my investment philosophy,” Buffett says, “it really changed my whole life.”

“I’d be a different person in a different place if I hadn’t foreseen that book. It was Ben’s ideas that sent me down the right path.”

Not too longer after, Buffett headed to grad school at Columbia University where Graham instilled in him the fundamental principles he used to build his great personal fortune.

Benjamin Graham on Mr. Market

It was there (undoubtedly) where Graham schooled a young Buffett in the ways of his favorite allegory — Mr. Market.

You see according to Graham, Mr. Market is an irrational sort of fellow. Some days, he shows up at your door offering ridiculous bids for the stocks you own, while on other days he sells at prices that much too low.

Smart investors like Graham profit from market folly rather than participate in it… Put another way, you should only buy when the price offered makes sense, and you should sell when the price becomes too high.

The key, then, is in knowing the difference between the two — which is why Graham always stressed doing your homework.

Intelligent investing at its best is business-like.

With that perspective in mind, the equity holders should not be too concerned with market volatility.

“In the short run the stock market behaves like a voting machine, but in the long term it acts like a weighing machine,” according to the legend.

Famously, Graham advocated buying a stock at a price well below the company’s intrinsic value — advice Warren Buffet still follows today. What’s more, Graham’s goal was to get a dollar of assets for less than 50 cents, purchasing only companies that were on sale.

That discount gives investors the “margin of safety” that Graham has become know for. Those large gaps between market price and intrinsic value are what ultimately protect them from the volatility of the markets.

When chosen this carefully, Graham found that further declines in these undervalued equities occurred infrequently — offering upside with little market risk.

Ben Graham’s investment advice

The concept behind Graham’s intrinsic value is basically buying cash at a discount or at “net current assets.”

Graham’s idea is that if you can pay as little as two-thirds of “cash” for a stock, you’ve really got nothing to lose.

The term “net current assets” refers to the value of company’s total current assets after all of its current liabilities have been subtracted. These tangible assets include cash, inventory, and accounts receivable — minus the debts.

Basically, it’s the amount of value left over if you were to pay off all the debt.

Also known as working capital, net current assets are a reflection of company’s short-term health on a balance sheet. And, if you find a company that’s going for two-thirds (or 66% of) the value of its cash… that company is on the bargain rack.

From the Intelligent Investor:

…if a common stock can be bought at no more than two-thirds of the working-capital alone—disregarding all other assets—and if the earnings record and prospects are reasonably satisfactory, there is strong reason to believe that the investor is getting substantially more than his money’s worth.

What’s more, whenever Graham found companies trading at 67% of their net current asset value, he would hold them until he had either a 50% gain or until he had held them for two years.

Not surprisingly, Graham was also adamant about investing in companies that pay dividends, preferring those with a 20-year history of steady payments. That way, Graham reasoned, he would still earn a payday even as the market persisted in undervaluing his shares.

These strategies allowed Graham to average returns of 17% a year during the 1930s and average annual returns of 33.7% during the 1970s, according to one study.

Those are returns most investors can only dream about.

Thirty-four years after his death, Benjamin Graham is a relevant as ever.

Your bargain-hunting analyst,

steve sig

Steve Christ
Editor, Wealth Daily

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