Published June 25, 2007

Meet Mr Market

In the third of a series on the world's greatest investors, LIN ZHAOWEI takes a look at the works of influential economist Benjamin Graham

KNOWN as the 'dean of financial analysis' and the 'father of value investing', Benjamin Graham is a legendary investor who also sought to share his financial knowledge with others. His two most celebrated works - Security Analysis (1934) co-authored with David Dodd, and The Intelligent Investor (1949) - are classics in finance literature and have never been out of print.

But the legend had humble beginnings - he was born in London to a poor Jewish home. His family moved to New York when he was just one year old, and they had to change the family name from Grossbaum to Graham during World War I when German-sounding names were viewed with suspicion. A star student, he graduated from Columbia University at the age of 20 and was the salutatorian of the class of 1914. Although he was offered teaching positions in three different faculties at Columbia, he went to work on Wall Street to support his family.

Graham began his career as a messenger at brokerage firm, Newburger, Henderson and Loeb. There, he rose up the ranks to become a partner at the firm, earning an annual salary of US$600,000 by the time he was 25. In 1926, he formed the Graham-Newman Partnership, where he averaged an annual return of about 20 per cent until his retirement 30 years later.

His analytical methods helped him build up a fortune in the 1920s, only to see much of that go down in flames during the Wall Street crash of 1929 and the Great Depression. His partnership only scrapped through with help from others. Graham did not give up and his successful search for hidden value in corporate assets during the difficult times set him apart from other investors, cementing his reputation on Wall Street. Graham's seminal work Security Analysis was written during this period.

Academic Roger Murray, who co-authored the fifth edition of Security Analysis, commented in an article in the Financial Analysts Journal in 1984 that, 'Graham and Dodd's disciplined approach to financial analysis represents a permanent enhancement of the quality of decision making in finance and a lasting contribution to the increased efficiency of markets in the allocation of resources'.

GRAHAM'S CONCEPT OF VALUE INVESTING

Graham says that if the spread between the price of a stock and the intrinsic value of the company - known as the margin of safety - is large enough, a stock is worth buying. He wrote that a company's intrinsic value is 'that value which is determined by the facts' and these facts include a company's assets, its earnings and dividends and future earnings. This ran against the grain of conventional thinking then, as intrinsic value was believed to the equivalent of a company's book value.

Graham's definition meant that this value can never be definite, but it is only essential to get an estimate - comparing this against the selling price will be sufficient to gauge the margin of safety. Armed with this knowledge, you are able to construct a portfolio of sound investments by buying stocks at 'reasonable prices'.

Graham had two approaches to investing: buying a company for less than two-thirds its net asset value and focusing on stocks with low price-to-earnings ratios.

Graham emphasised that the potential for payoff from skilled financial analysis was more likely to exist among those companies that are unpopular, complicated and neglected by the financial community.

Financial statement analysis is at the heart of his approach to security analysis and selection. He wrote: 'There are unbounded opportunities for shrewd detective work, for discovery and pointing out a state of affairs quite different from that indicated by the publicised per-share earnings.'

Graham also often personified the market to illustrate the importance of looking at the market as one would a business partner: 'Mr Market offers to buy you out or sell you his interest daily. But his quotes may not make sense all the time. You as the retail investors have the freedom to say 'no' to him - he will always come back the next day with new quotations.'

OTHER CONTRIBUTIONS

Besides his investment work, Graham taught a class in security analysis at his alma mater from 1928 until his retirement. His keen interest in helping others invest in stocks led him to write 'The Intelligent Investor', which provides practical advice to the common investor. Warren Buffett describes 'The Intelligent Investor' as 'by far the best book on investing ever written'.

Graham is said to have spent the better part of his retirement years on new, simplified formulae to assist average investors in their investment decision making. His emphasis on financial analysis also meant he was an early supporter of the Financial Analysts Federation and the Institute of Chartered Financial Analysts, seeking to strengthen the both analytical and ethical standards for security analysts.

GRAHAM'S RELEVANCE TODAY

'There is no doubt that Graham's books are essential reading, especially for value investors. Graham's ideas have provided the basic foundation for many great investors today,' says Singapore Management University undergraduate Lam Zhao Bin, who applies Graham's teachings to a mock portfolio he co-manages with four friends. He points to the continued success of Graham's students such as Warren Buffett and William Ruane as testimony to the relevance of his ideas.

Indeed, it is said that Graham's classic texts are essential reading for aspiring investors and fund managers, even up till today.

In 1994, the centenary of Graham's birth, his most famous student Warren Buffett said in an address to the New York Society of Security Analysts, 'The basic ideas of investing are to look at stocks as businesses, use market fluctuations to your advantage, and seek a margin of safety. That's what Ben Graham taught us. A hundred years from now they will still be the cornerstones of investing.'