Ben Graham’s 4 Guiding Business Principles

Ben Graham’s 4 Guiding Business Principles by Vintage Value Investing

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In The Intelligent Investor, Ben Graham famously writes that: “Investment is most intelligent when it is most businesslike.”

Graham viewed any purchase of a stock or bond as an investment in a business, rather than the purchase of just a piece of paper. And if you are looking to make profits from your investments, then you are embarking on a business venture of your own.

Consequently, successful investing must be conducted in accordance with tried-and-true business principles.

Ben Graham's 4 Guiding Business Principles

In the very last pages of  The Intelligent Investor, Ben Graham points out four accepted business principles that should also be applied to investing:

1. Know Your Business

“Know what you are doing – know your business.”

In order to be successful, the operator of a business needs to know the value of the goods that he or she is selling – in order to set a correct price – and the value of raw inputs – in order to pay a fair price.

As an investor, you shouldn’t try to earn excess returns from an investment unless you know as much about the value of the asset as you would need to know about the value of merchandise if you were running your own business.

2. Managers Must Be Honest and Competent

“Do not let anyone else run your business, unless (1) you can supervise his performance with adequate care and comprehension or (2) you have unusually strong reasons for placing implicit confidence in his integrity and ability.”

For an investor, this rule should determine the conditions under which you’d permit someone else to decide what is done with your money.

If you are investing in a stock, is the CEO an honest and capable manager? If you are investing in an actively managed mutual fund, have you done your due diligence on the portfolio manager?

3. Keep Away from Projects in Which You Have Little to Gain and Much to Lose

“Do not enter upon an operation – that is, manufacturing or trading in an item – unless a reliable calculation shows that it has a fair chance to yield a reasonable profit. In particular, keep away from ventures in which you have little to gain and much to lose.”

This means that your investing decisions should be based on arithmetic, and not optimism. If you are limiting your investment return (e.g. in a bond purchase), then you better be limiting your risk too.

4. Have the Courage to Act – Even Though Others May Hesitate or Differ

“Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it – even though others may hesitate or differ.”

As Graham puts it, “You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.”

In the world of value investing (where a contrarian position is often the norm), courage becomes the most important virtue (once adequate knowledge and thorough analysis have been achieved).

Summary

Ben Graham looked at investing as (a) an investment in a business, and (b) a business operation itself. This is something that rubbed off on Warren Buffett.

Check out some of these quotes from the Oracle of Omaha:

“Buy a business, don’t rent stocks.”

 

“Never invest in a business you cannot understand.”

 

“Draw a circle around the businesses you understand and then eliminate those that fail to qualify on the basis of value, good management and limited exposure to hard times.”

 

“I am a better investor because I am a businessman and a better businessman because I am an investor.”

 

“An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.”

Not only do these quotes reflect Graham’s idea that investing should be businesslike, they also reflect the 4 business principles Graham thought should also apply to investing.

In fact, the 4 principles Warren Buffett applies to all of his investment decisions are nothing more than an updated version of Graham’s own 4 business principles:

  1. “Know your business” (Graham) becomes “A business we understand” (Buffett)
  2. “Management must be able and competent” (Graham) becomes “Operated by able and trustworthy management” (Buffett)
  3. “Keep away from projects in which you have little to gain and much to lose” (Graham) becomes “With favorable long-term prospects” (Buffett)
  4. “Have the courage to act – even though others may hesitate or differ” (Graham) becomes “Available at a very attractive price” (Buffett)

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Ben Graham's 4 Guiding Business Principles




About the Author

VintageValueinvesting
Ben Graham, the father of value investing, wasn’t born in this century. Nor was he born in the last century. Benjamin Graham – born Benjamin Grossbaum – was born in London, England in 1894. He published the value investing bible Security Analysis in 1934, which was followed by the value investing New Testament The Intelligent Investor in 1949. Warren Buffett, the value investing messiah and Graham’s most famous and successful disciple, was born in 1930 and attended Graham’s classes at Columbia in 1950-51. And the not-so-prodigal son Charlie Munger even has Warren beat by six years – he was born in 1924. I’m not trying to give a history lesson here, but I find these dates very interesting. Value investing is an old strategy. It’s been around for a long time, long before the Capital Asset Pricing Model, long before the Black-Scholes Model, long before CLO’s, long before the founders of today’s hottest high-tech IPOs were even born. And yet people have very short term memories. Once a bull market gets some legs in it, the quest to get “the most money as quickly as possible” causes prices to get bid up. Human nature kicks in and dollar signs start appearing in people’s eyes. New methodologies are touted and fundamental principles are left in the rear view mirror. “Today is always the dawning of a new age. Things are different than they were yesterday. The world is changing and we must adapt.” Yes, all very true statements but the new and “fool-proof” methods and strategies and overleveraging and excess risk-taking only work when the economic environmental conditions allow them to work. Using the latest “fool-proof” investment strategy is like running around a thunderstorm with a lightning rod in your hand: if you’re unharmed after a while then it might seem like you’ve developed a method to avoid getting struck by lightning – but sooner or later you will get hit. And yet value investors are for the most part immune to the thunder and lightning. This isn’t at all to say that value investors never lose money, go bust, or suffer during recessions. However, by sticking to fundamentals and avoiding excessive risk-taking (i.e. dumb decisions), the collective value investor class seems to have much fewer examples of the spectacular crash-and-burn cases that often are found with investors’ who employ different strategies. As a result, value investors have historically outperformed other types of investors over the long term. And there is plenty of empirical evidence to back this up. Check this and this and this and this out. In fact, since 1926 value stocks have outperformed growth stocks by an average of four percentage points annually, according to the authoritative index compiled by finance professors Eugene Fama of the University of Chicago and Kenneth French of Dartmouth College. So, the value investing philosophy has endured for over 80 years and is the most consistently successful strategy that can be applied. And while hot stocks, over-leveraged portfolios, and the newest complicated financial strategies will come and go, making many wishful investors rich very quick and poor even quicker, value investing will quietly continue to help its adherents fatten their wallets. It will always endure and will always remain classically in fashion. In other words, value investing is vintage. Which explains half of this website’s name. As for the value part? The intention of this site is to explain, discuss, ask, learn, teach, and debate those topics and questions that I’ve always been most interested in, and hopefully that you’re most curious about, too. This includes: What is value investing? Value investing strategies Stock picks Company reviews Basic financial concepts Investor profiles Investment ideas Current events Economics Behavioral finance And, ultimately, ways to become a better investor I want to note the importance of the way I use value here. It’s not the simplistic definition of “low P/E” stocks that some financial services lazily use to classify investors, which the word “value” has recently morphed into meaning. To me, value investing equates to the term “Intelligent Investing,” as described by Ben Graham. Intelligent investing involves analyzing a company’s fundamentals and can be characterized by an intense focus on a stock’s price, it’s intrinsic value, and the very important ratio between the two. This is value investing as the term was originally meant to be used decades ago, and is the only way it should be used today. So without much further ado, it’s my very good honor to meet you and you may call me…