- Caution and cynicism that may have held you back elsewhere will keep you safe in the stock market, and that very safety is the key to investment success.
- True intelligence is the ability to recognize patterns, and to determine the best course of action given past events. This includes being able to tell when there is no pattern.
- Value Investing acknowledges the stock market's randomness and irrationality, and uses them to the investor's advantage; consistently outperforming more impressive looking strategies that stand on less tenable foundations.
Benjamin Graham — also known as The Dean of Wall Street and The Father of Value Investing — was a scholar and financial analyst who mentored legendary investors such as Warren Buffett, William J. Ruane, Irving Kahn and Walter J. Schloss.
In the past, we have seen how Value Investing as taught by Graham is an elaborate framework that includes extensive checks for Quality and Growth; and some of the wrong interpretations of Graham's methods that have resulted in Value Investing being mistaken for bargain hunting.
A Perfect Field For The Cynical
Buffett describes Graham's book The Intelligent Investor (in its preface) as:
"By far the best book about investing ever written"
One of the first lines that grabs one's attention in The Intelligent Investor is from the Introduction:
"While enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster"
The book continues this line of thought all through, in some of its most important chapters:
"You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right"
"Operations for profit should be based not on optimism but on arithmetic"
We see also similar ideas expressed in Warren Buffett's letters and interviews, but in a lighter vein, e.g.:
"It's only when the tide goes out that you learn who's been swimming naked."
Tragedy Of The Commons
We are often told that to succeed, one needs to be confident and even aggressive. In almost every facet of our lives — from driving in traffic to promotions at work — being sincere, cautious and diligent usually results in getting left behind.
One doesn't even need to get into more complex issues such as dating and elections. Even at something as commonplace as an ATM, others enjoy the benefits of your integrity and intelligence. You pay the price for their lack of it. This phenomenon is known in Economics as the Tragedy Of The Commons.
Then from a place one would least expect — the supposed capital of refined aggression, the stock market — comes someone who tells us that everything that held us back thus far is, in fact, the key to success here.
"To distill the secret of sound investment into three words, we venture the motto - Margin of Safety."
"Rule No.1: Never lose money. Rule No.2: Never forget rule No.1."
Suddenly, one no longer needs to be able to talk charmingly or "network", or "take the initiative", or worry about "it's not what you know, it's who you know".
In fact, most of these mind numbing exercises actually prove detrimental in the stock market. All one needs to be able to do well, is one's due diligence.
For anyone to whom life has started to seem like a unending sequel to H. G. Wells' Country of the Blind — and headed toward a similarly dismal end — Value Investing comes as a second lease of life. You begin to realize that the stock market is the probably the only place where it pays to be right when everyone else is wrong; and that it pays extremely well.
While pick-up artists and politicians use systemic inefficiencies to their benefit too, Value Investing allows one to do so without compromising on one's integrity.
The stock market is, when approached correctly, the true intellectual's dream come true — an application of pure intelligence to making money.
But What Is Intelligence?
Intelligence is often confused with knowledge. So people with impressive degrees or large vocabularies are often considered intelligent as a matter of course.
But real intelligence is the ability to think, not just read. This is why we often hear of college dropouts clearing Mensa or doing great at business, when many of their more educated counterparts fail at these endeavors. Beyond a certain point, education and intelligence have little to do with one another.
One of the tests Mensa uses to measure intelligence is known as the Raven's progressive matrices test. The test is unique because it's completely visual; no written questions whatsoever. The test simply checks the individual's ability to predict a fifth pattern when shown four progressive ones, over an increasingly complex series of patterns.
In very basic terms, that's all intelligence is — the ability to recognize patterns; the ability to determine the best future course of action, given past events.
But correct pattern recognition also includes being able to tell when a sequence of events is random. Some people see patterns where there actually are none, or do not recognize randomness correctly when they see it.
For instance, in the short term, the stock market is completely random. But many people still try to predict the market and profit from it.
Value Investing, however, acknowledges the stock market's randomness and irrationality, and uses them to the investor's advantage. This is why Graham's Value Investing framework consistently outperforms more impressive looking strategies that are based on the less tenable premise that the stock market can be predicted.
While it looks simple on the surface, Value Investing is a creation of pure genius. It's not for nothing that — in the preface to The Intelligent Investor — Buffett writes about Graham:
"Certainly I have never met anyone with a mind of similar scope."
Graham's Value Investing framework was developed over a period of nearly 50 years. Like Einstein's E=mc2, it looks childishly simple on the surface but derives from concepts that only a handful of people on the planet can probably understand.
One doesn't need to be able to understand the derivation to apply the end result though. One just needs to understand its significance, and the genius behind its external simplicity.
The Obstacle For Investors Today
Graham's framework itself has been spelled out quite clearly, and software such as Serenity's now automate the required statistical work.
The obstacle today is mostly in misunderstandings about the principles themselves. For many people, the very simplicity of Value Investing's premise is what makes it incomprehensible to them.
But like Einsten's equation, Value Investing too has proven itself over and over for decades in both domestic and international markets.
"The four most dangerous words in investing are: 'this time it's different.'"
To quote Buffett again from the preface to The Intelligent Investor:
"To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework. This book precisely and clearly prescribes the proper framework. You must supply the emotional discipline."
Buffett's concluded his article The Superinvestors of Graham-and-Doddsville, writing:
"Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper."
Serenity provides two web-based stock screeners:
1. A free Classic Graham screener that lets you screen 5000+ NYSE and NASDAQ stocks by a strict 17-point Benjamin Graham Value Investing assessment.
2. An Advanced Graham screener that lets you screen the same 5000+ stocks by customized combinations of the Graham Number and Graham's 15 other Value Investing rules.