Benjamin Graham: 3 Timeless Lessons from the Dean of Wall Street

Take a look at the annual returns of Berkshire Hathaway and you will see a well-known result: between 1964 and 2021, a $100 investment in the S&P 500 would have returned $30,209, but the same investment in Berkshire would have returned $3,641,613. If Berkshire were to lose 99% of its value overnight, it would still outperform the market over its lifetime. This astounding record came about partially because of Warren Buffett’s greatest influence: legendary investor Benjamin Graham. As the intellectual father of value investing, many of Graham’s ideas remain at the core of finance today, and should be studied carefully by any aspiring investor.

The Life of a Legend

The Beginning

Benjamin Grossbaum was born to a Jewish family in London, UK in 1894. Just a year after his birth, Graham’s father, a furniture salesman uprooted the family to America, where they settled in New York City. As a young child, Graham’s family was quite wealthy, and enjoyed luxuries such as a four-story house on Fifth Avenue and a full-time service staff. Unfortunately, tragedy struck the family soon after: when Graham was just eight years old, his father passed away. Through liquidating the family business and selling many prized possessions, Graham’s mother was able to maintain a good life for her three sons without slipping into poverty, but tragedy soon struck again when the Panic of 1907 caused the stock market to fall almost 50%. Graham’s mother, who knew little about the market and was convinced by a broker to use a margin account, lost all her investments. The family was saved from ruin once more by help from relatives, but these experience instilled in Graham a lifelong appreciation for hard work and thrift and a disdain for unscrupulous financiers.

Despite his hardships, Graham excelled in school. He read voraciously, tutored to make money, and developed a lifelong skill in mathematics and love for poetry, literature, and history. In high school, he graduated at age sixteen at the top of his class, then enrolled in Columbia on a full scholarship the following year. Despite working throughout college, he managed to graduate in just two and a half years as salutatorian. He was so talented academically that he received offers to join three different faculties: English, philosophy, and mathematics, as well as a full scholarship to Columbia Law School. Despite these, Graham opted to go into finance, accepting a job offer as bond salesman at Newburger, Henderson, and Loeb and soon being promoted to security analyst.

Graham on Wall Street

With thorough research, Graham soon discovered inefficiencies between the prices of companies and their intrinsic value, something that would become his main strategy for the rest of his career. In particular, he liked to buy “net nets”, companies trading at less than two-thirds of the value of their current assets minus their liabilities and preferred stock. Despite some setbacks, such as losing much of his money during the World War I bear market of 1917, Graham became a junior partner at his firm, a regular contributor to The Magazine of Wall Street, and a money manager for various friends and relatives. With Graham’s mounting success, he left the firm in 1923 to pursue his own investments. Three years later, he founded his famous mutual fund, the Graham-Newman Corporation, with his friend Jerome Newman.

In 1926, Graham-Newman made one of its most famous investments ever. Graham discovered that the Northern Pipeline Company, an offshoot of Standard Oil, was trading at $65 a share and yet paid a $6/share dividend and held $95 a share of cash and bonds. Graham bought a 5% stake in the company and met with the company’s president to discuss liquidating its bond assets and distributing the profits to shareholders. The president refused, and suggested that Graham sell his shares if he lacked confidence in management. Undeterred by the company’s lack of shareholder orientation, Graham bought more shares and forced a proxy vote. The company distributed its assets to its shareholders, Northern Pipeline stock rose to over $110 a share, and Graham profited handsomely.

Graham’s financial success led him back to Columbia, where he began teaching a course called Security Analysis, which quickly became one of the business school’s most demanded courses and is still taught today. Graham’s prosperity, however, was not to come without challenges. In 1929, the stock market collapsed. While Graham did better than the market average at first due to his partnership’s short positions, he was increasingly forced to cover his shorts with money he didn’t have. Graham-Newman was now deeply in debt, and lost 70% of its market value from 1929 to 1932.

Despite his financial difficulties, Graham stayed busy. Alongside his work giving expert testimony in valuation cases, as well as writing three full-length plays, he began work with Columbia Business School assistant professor David Dodd on what would become his academic magnum opus: the textbook Security Analysis. First published in 1934, Security Analysis eventually became the foundational text for value investing. It taught investors to focus on the discrepancy between a company’s listed stock price and its intrinsic value, to always rigorously research the fundamentals of a stock or bond, and to think contrary to the irrationalities of the market. Security Analysis is currently on its sixth edition, and is still widely used in the finance world today.

The stock market eventually recovered, and Graham-Newman with it. By December 1935, the partnership had already recouped all of its losses. Throughout the following years, Graham continued to broaden his interests: one such project was attempting, ultimately unsuccessfully, to convince the US government to back the dollar with a basket of commodities, rather than with gold. He also became a key founding member of what would become the Institute of Chartered Financial Analysts, and a regular writer in their journal.

Graham the Legend

In 1948, Graham discovered the Government Employees Insurance Company, a small auto insurer whose price, despite the post-World War II bull market, had been depressed by Wall Street. Despite it appearing optically more expensive than Graham’s typical deep bargains, he spent nearly a quarter of his firm’s assets on a 50% stake in the company. Why? Because of its tremendous intrinsic value and growth potential. The company had no agents or branch offices, so it spared those costs from customers and could offer them as much as 30% off other auto insurance policies. Even with lower costs, the company was able to boast profit margins far exceeding other auto insurers. Premiums written had increased sixteenfold in ten years, and were continuing to grow rapidly. Graham, now the company’s controlling shareholder, became chairman of the board of directors and remained so for seventeen years. Despite the company’s price appearing to exceed his estimate of its value, Graham never sold. By 1972, Graham’s investment had appreciated more than 20,000%, far exceeding the gains on every other investment in his decades-long career - combined. While Graham typically sold investments quickly to find new deep value stocks, this experience showed him the value of holding on to superior companies for the long term. Today, GEICO is the second-largest auto insurer in the world, and its premiums written have increased from $1.6 million in 1945 to $33.9 billion in 2022.

In 1949, Graham made perhaps his greatest contribution ever to the world of finance: publishing the first edition of The Intelligent Investor. While Security Analysis was targeted at serious students of stock and bond research, The Intelligent Investor applied Graham’s principles to the layman. One such layman was a college student from Omaha, Nebraska named Warren Buffett. Graham’s teachings had such a profound impact on Buffett that he moved to New York and enrolled at Columbia Business School to study under him. Buffett and Graham, two very similar people, developed a close relationship. Buffett received the only A+ in the history of Graham’s Security Analysis course, and eventually worked for Graham’s company for two years.

In 1956, at age sixty-two, Graham retired from active investing and closed his partnership. He moved to Beverly Hills, where he became a professor at UCLA’s Graduate School of Business. He spent his time teaching, testifying as a stock expert, and working on the Institute of Chartered Financial Analysts. As he got older, Graham dedicated more time to his more intellectual interests: poetry, literature, and philosophy among them. He soon retired again, this time to work on his memoirs and travel between La Jolla, California, the island of Madeira, and southern France. In 1976, he co-founded his last investment vehicle, a diversified value fund called the Rea-Graham Fund, and died in Aix-en-Provence, France at the age of eighty-two.

Despite his early loss of his father, his childhood poverty, his lifelong difficulty making close relationships, his three painful divorces, and the tragic loss of two of his six children, Benjamin Graham became one of the most influential people in Wall Street history. His disciples include not only Warren Buffett, but such legendary investors as Walter Schloss, Irving Kahn, Bill Ruane, Seth Klarman, and Bill Ackman. According to Buffett, Benjamin Graham once told a friend “Every day, do something foolish, something creative, and something generous”. Graham exemplified these. His willingness to look foolish enabled him to profit greatly from the irrationalities of the market. His lifelong passions for writing poems and plays were certainly creative. Most importantly, his charity and efforts to educate as many people as he could on investing showed his generosity.

Graham’s Lessons

Benjamin Graham came from a different time in the financial world. Scarred by many losses throughout his career, including losing nearly 80% of his personal wealth during the Great Depression, Graham was notoriously risk-averse and rigid in his methods. He would only buy companies that appeared significantly underpriced relative to their assets or earnings, and sell them quickly as soon as they showed an adequate return. He often held hundreds of stocks in his portfolio, causing his returns to suffer due to reversion to the mean. These strategies, while effective in the wild and inefficient markets of the early 20th century, faltered in the much more stable and prosperous second half of the century. In the 1960s, Warren Buffett started expanding Graham’s ideas, largely by focusing on a few superior companies to hold for the long run, and has since earned returns far exceeding Graham’s. Nevertheless, some of Graham’s concepts are timeless, and every investor would benefit greatly from learning them.

A stock is a piece of a business

A stock is not just a number, a ticker symbol, or a line that goes up and down. Instead, a share of stock represents a part ownership interest in an actual business. Owning stock usually entitles you to a share of the company’s earnings, dividend payments, proceeds from the liquidation of assets, and voting power to decide the company’s board of directors and corporate actions and policies. The price of a share of stock is not set randomly, but is based on the market’s best estimates of its future cash flows¹. As a result, a company's stock price and returns will eventually reflect its cash flow and profitability. When buying a stock, it is best to focus on the company's intrinsic value, rather than guessing how its price will fluctuate in the short term.

Mr. Market

In the short term, however, stock prices can fluctuate wildly. In just the first half of 2022, for example, investors have had to deal with the world’s economy reopening, record-high inflation, interest rate hikes, the Russian invasion of Ukraine and its effect on gas prices, supply chain issues, rising US-China tensions, the tech bubble bursting, and many more. The S&P 500 began the year at 477, bottomed at 366, and today (August 15) sits at 429. In The Intelligent Investor, Graham developed the concept of Mr. Market to reflect this. Imagine you have a business partner named Mr. Market who, every day, gives you a price at which he will buy your interest or sell you his. Sometimes the price is ridiculously high or low, and you will respond accordingly, but most of the time it is wiser to form your own ideas based on thorough analysis of your business.

Margin of Safety

Not only would Graham exclusively buy businesses trading at prices below their intrinsic value, but he would make sure that his investments traded significantly cheaper than their intrinsic value. In Security Analysis, he described this difference as “margin of safety”. Since investing is a game of limited information and sometimes even the best-looking decisions can go wrong, investments must be carefully selected so that even in the worst case, the loss to the investor is minimized. This has perhaps been Graham’s single most influential concept.

Despite dying nearly fifty years ago, Benjamin Graham has influenced generations of investors. From his massive profits with Northern Pipeline and GEICO to his landmark works Security Analysis and The Intelligent Investor to his role as Warren Buffett’s mentor, it’s hard to find someone who’s developed the world of investing more.

1. As described by Harvard economist John Burr Williams, the intrinsic value of an investment (stock or bond) is equal to the sum of its future cash flows discounted back to the present at an appropriate interest rate. What this means in practice is that since a share of stock entitles you to own part of a company’s cash flow, it should be fairly valued as the net present value of future cash flows. We use the discount rate to reflect the fact that humans prefer money now to money later, so the farther out in the future a company’s cash flows are, the less valuable they will be in the present. More on this in a future article.