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BENJAMIN GRAHAM AND THE POWER OF GROWTH STOCKS
LOST GROWTH STOCK STRATEGIES FROM THE FATHER OF VALUE INVESTING
By Frederick K. Martin, Nick Hansen, Scott Link, Rob Nicoski
The McGraw-Hill Companies, Inc.Copyright © 2012The McGraw-Hill Companies, Inc.
All rights reserved.
Benjamin Graham and the Evolution of Value Investing
During an investment career that spanned more than half a century, Benjamin Graham had a greater influence over the way stocks are analyzed, bought, and sold than any other investor in the history of the stock market. Graham practiced his trade during an era in which the stock market evolved from an investment that was utilized almost exclusively by the very wealthy to a pervasive investment that was used by almost everyone with a job and a retirement savings account. As a professor, author, and stock market trader, Graham turned stock market investing from a frenzied, speculative practice based on intuition, emotion, and momentum to a precise science that relied on strict formulas, meticulous analysis, and methodical timing.
Graham, who died in 1976 at the age of 82, has been referred to as the "Dean of Wall Street," the "Father of Security Analysis," and the "Father of Value Investing." As an author, he expounded on his methodology in two of the most successful investment books ever published: Security Analysis, which he wrote in 1934 with David Dodd, and The Intelligent Investor, which he wrote in 1949. Both books have been periodically updated and still sell briskly today.
To understand Graham's impact on the financial world, all you really need to know is that he was Warren Buffett's mentor for more than two decades before Buffett struck out on his own.
Graham is probably most widely recognized for his contribution to value investing, a methodology that relies on strict analysis and timing to acquire undervalued stocks when they're trading at a discount to their intrinsic value and sell them once they've earned a suitable return.
But until now, one of Graham's most brilliant revelations has been all but lost to the investing public. Although his name is nearly synonymous with value investing, Graham also began to see the value of growth stock investing late in his career. He even developed a formula and a methodology for growth stock investing that he introduced in the 1962 edition of Security Analysis in a chapter entitled "Newer Methods for Valuing Growth Stocks." Unfortunately, although Security Analysis was reissued in 1988, 1996, and 2009, this chapter was omitted from all the subsequent editions.
There's no real explanation for why this chapter was removed—a decision, oddly enough, that was made long after Graham's death in 1976. (The chapter is reprinted in Chapter 3 of this book.) Regardless of the reasons for the omission, investors who have read the newer editions of Graham's book over the past two decades have been denied one of the most significant investment insights ever offered by Graham.
The primary objective of this book is to unlock Graham's lost formula and methodology so that investors—both individual and professional— can take advantage of his insights on analyzing and buying growth stocks. I consider myself one of the fortunate few investment managers to have come across Graham's formula early in my career, and I have used it with great success ever since.
THE MAN AND HIS METHODOLOGY
Graham's investment philosophy was rooted in two important premises: that a security should be analyzed independently of its price, and that the future performance of any security is uncertain. He suggested that intelligent investors should aim to purchase a security at a discount to its assessed value in order to provide a margin of safety that can protect their investment against loss. Both the risk and the return of the investment are dependent on the quality of the analysis and this "margin of safety."
Graham did not stop there. With these principles firmly in hand, he laid out a comprehensive series of treatises on successful investing for the professional and lay investor alike. In Security Analysis, he focused primarily on the proper emphases and techniques to apply in the selection of investment securities. In The Intelligent Investor, which is widely considered his most influential work, Graham turned his attention to the investors themselves and laid out his philosophy of investment.
If the power of Graham's work was due to the simple truth at its foundation, its timelessness has been due to the quality of the craft Graham built upon it. He didn't construct a philosophy of investment in an academic vacuum; he derived it from long years of hard experience.
Graham was born in England in 1894 and moved with his parents to America the next year, where his father opened an import business. But the business failed, and his father died while Ben was still a child. In 1907, an economic crisis wiped out what little was still left of his mother's savings. But Graham excelled as a student and was able to get into Columbia University, where he graduated as class salutatorian at the age of 20. Columbia offered him a job teaching mathematics, English, or Greek and Latin philosophy, but he declined the offer to seek his fortune on Wall Street. He began working there for Newburger, Henderson & Loeb in 1914, and rose quickly in the firm. Within five years, he was making more than half a million dollars a year—a vast sum for a 25-year-old in 1919.
But that fortune didn't last. Graham and Jerome Henderson, who became Graham's business partner in the 1920s, nearly lost their business in the crash of 1929. But with the help of friends and the sale of most of their personal assets, Graham and Henderson were able to retain their business and rebuild it from the ground up. The lessons Graham learned from his early mistakes shaped his investment philosophy for the rest of his life.
Graham worked until the 1950s and continued writing into the 1970s, and during this period, he endured some of the greatest price dislocations and economic upheavals in modern history. Throughout, he refined his understanding and insight in subsequent editions of his published work. He was a successful practitioner and brilliant thinker living through extraordinary times, and he left us one of the most important bodies of work on investing ever written.
Not only was Graham a groundbreaking investment manager and prolific author, but he also taught evening classes in finance at Columbia from 1928 to 1955. One of his students was Warren Buffett, who managed to persuade Graham to hire him at his investment firm after he graduated from Columbia. It was there that Buffett learned the principles of investing that ultimately led him to become perhaps the most famous and successful stock market investor in America. Buffett subsequently built upon Graham's work over the course of his career. In fact, Buffett claims that Graham was the inspiration behind his widely read annual letters to shareholders that he writes for the Berkshire Hathaway annual report. In these letters, not only does Buffett provide readily accessible insight, but he does so in a fashion that is consistently both intellectually honest and humorous.
GRAHAM AS A GROWTH INVESTOR
To say the least, describing Graham as a growth investor is highly controversial and almost heretical among his many value investing disciples. The two strategies are considered almost polar opposites. Value investing focuses on paying a lower price for current assets or earnings in order to risk less capital against an uncertain future, while growth investing is traditionally characterized by the willingness of investors to pay a higher price for a company's current assets or earnings in the expectation that the future growth of the company will stimulate a rising stock price.
To support this assertion concerning Graham, then, we must r
Excerpted from BENJAMIN GRAHAM AND THE POWER OF GROWTH STOCKS by Frederick K. Martin. Copyright © 2012 by The McGraw-Hill Companies, Inc.. Excerpted by permission of The McGraw-Hill Companies, Inc..
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