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Benjamin Graham is known as the father of value investing. The heyday of his investment career
spanned from the 1920s to the 1950s during which time he also lectured a popular course on finance at
Columbia Business School.
Many of his students went on to practice his method of security analysis and achieved outstanding
results over a number of decades. This elite group of disciples includes Warren Buffett, Walter Schloss,
Irving Kahn and Charles Brandis and they stand as a testament to the brilliance of Benjamin Graham.
In 1934 he wrote the investment classics "Security analysis" which set out an intellectual framework for
value investing. It has been used as a reference text by successful value investors ever since and much of
this lecture is based on material from that book.
In this short video we will cover three of the most important concepts to come out of Benjamin
Graham's work:
1. Intrinsic value,
2. Margin of safety
3. Earnings power.

We will then go on to study in more detail some of the analytical techniques that are derived from these
concepts lesson.

Lesson 1.
INTRINSIC VALUE
Intrinsic value defies precise definition and Graham himself called it any loose of concept. However,
intrinsic value is core to the understanding of a value investing philosophy. Let's see how Graham
described it in his own words.
In general terms it is understood to be that value which is justified by the facts: e.g, the assets,
earnings dividends, definite prospects, as distinct let us say, from market quotations established by
artificial manipulation or distorted by psychological excesses. The think about Graham's approach is
that we aren't required to measure intrinsic value precisely. We are only interested in how it compares
approximately to the Baili market price. The essential point is that security analysis does not seek to
determine exactly what is the intrinsic value of a given security. It needs only establish either that the
value is adequate or else that the value is considerably higher or considerably lower than the market
price. For such purposes an indefinite and approximate measure of the intrinsic value may be sufficient
To use a homely simile it is quite possible to decide by inspection that a woman is old enough to vote
without knowing her age or that a man is heavier than he should be without knowing his exact weight.
Key to success in value investing then is ensuring that your estimate of the intrinsic value is much
greater than the price you pay for that security
Lesson 2.
MARGIN OF SAFETY
This brings us onto margin of safety. Graph recognized that any estimate of intrinsic value would be
flawed. Much of the value of a security is based on future results. Results which are inherently
unknowable. This is why he always insisted on a margin of safety between the estimated intrinsic value
and the market price paid. It is available for absorbing the effect of miscalculations or worse than
average luck.
The buyer of the bargain issues places particular emphasis on the ability of the investment to with stand
ad verse developments. In practice, this means that opportunities may not arise that frequently since
securities may appear only mildly undervalued or overvalued most of the time. However, the value
investor must be patient in waiting for these opportunities to present themselves. Since we have
emphasized that analysis will lead to a positive conclusion only in the exceptional case. It follows that
many securities must be examined before one is found that has real possibilities for the analyst.
By what practical means as he proceeded to make his discoveries? Mainly by hard and systematic work.

Lesson 3
EARNINGS POWER
Graham criticized the market for placing too much importance on current year earnings and the
earnings trend of the market. These are criticisms that could apply equally today and they often cause
the markets have become overly optimistic or pessimistic. Graham suggests that an analyst should be
focused more on the historical record of the company. Only thorough analysis of the past can provide
any degree of confidence in the future. This is the thought process that inspired the concept of earnings
power. It combines a statement of actual earnings shown over a period of years with a reasonable
expectation that these will be approximated in the future unless extraordinary conditions supervene.
Rather than focus on the current year's earnings, as the market does Graham advocated taking an
average of past earnings as a guide to the future. He suggested looking back between five and ten years.
of course this was only a starting point and the analysts would then need to exercise judgment as to
whether this gave a reasonable approximation of future earnings power. In order for a company's
business to be regarded as relatively stable it does not suffice that the past record should show stability.
The nature of the undertaking considered apart from any figures must be such as to indicate an inherent
permanence of earnings power. While the market tends to apply a multiple to current year earnings.
Graham instead suggested applying a multiple to the earnings power in order to arrive at an appropriate
price. This does not mean that all common stocks with the same average earnings should have the same
value. The common stock investor e.g. the conservative buyer will properly accord a more liberal
valuation to those issues which have current earnings above the average or which may reasonably be
considered to possess better than average prospects or an inherently stable earning power. He
suggested that the intelligent investor should be conservative in the multiple of earnings power that is
paid. While he recommended varying the multiple based on the prospects of the company, he ventured
that a conservative investor should not pay more than 20 times for any stock.
Lesson 4
BENJAMIN GRAHAM AND GROWTH STOCKS
.

Graham was weary of investing in growth stocks for two reasons: 1. unusually rapid growth does not
keep up forever; 2. the price may already discount future growth. It must be remembered that
automatic or normal economic forces militate against the indefinite continuance of a given trends.
Competition, regulation, the law of diminishing, returns etc are powerful foes to unlimited expansion.
Graham is telling us that the analyst should be very cautious about extrapolating recent trends because
conditions for the business can and often will change.
He demonstrates this point with reference to one of the most popular growth stocks of the 1920s COTY
EPS which still exists to this day as a manufacturer of beauty products. In 1929 COTY was earning more
than it had in any of the past ten years and the trend looks spectacular. The market was happy to price
the stock on the basis of 1929 earnings and moreover was willing to apply a multiple of 30 times to the
earnings because it imagined the recent trend would continue. In the event earnings plunged over the
next three years and the multiplier contracted sharply.
By 1932 earnings had fallen nearly 90 percent and the multiplier applied was only four and a half times
at the low point. The stock had dropped from a high of 82 dollars in 1929 to a low of 1,5 dollars in 1932.
Graham cautioned that whole industries were also subject to rapid change even where demand
remained strong supply would often grow faster. The growth industries of Graham's era included radio,
aviation, electric refrigeration and silk hosiery. All these industries saw a period of high demand
followed by a period of increasing supply leading to depressed returns. Graham recounts how the
Preferences of the market would shift with time. In 1922 Department stores were very favorably
regarded because of their excellent showing in the 1920-1921 Depression, but they did not maintain this
advantage in subsequent years. The public utilities weren't popular in the 1919 boom because of high
costs. They became speculative and investment favorites in 1927 to 1929, in 1933 to 1938 fear of
inflation rate, regulation and direct governmental competition again undermined the public's confidence
in them In 1933.
On the other hand the cotton Goods industry long depressed forged ahead faster than most others.
Equally Graham caution we should be wary about automatically assuming that a downward trend will
continue forever where the trend has been definitely downward the analysts will assign great weight to
this unfavorable factor. He will not assume that the down curve must presently turn upward nor can he
accept the past average which is much higher than the current figure as a normal index of future
earnings. But he will be equally cherry about any hasty conclusions to the effect that the company's
outlook is hopeless. That its earnings are certain to disappear entirely and that the stock is therefore
without merit or value.

Lesson 5
THE BALANCE SHEET
As is the case today in Graham's day tended to overlook the valuable information that could be gained
by looking at the balance sheet. Graham value the balance sheet as an analytical tool because assets and
liabilities are much harder to manipulate than earnings. This remains just as true today. He saw the
balance sheet as useful in two distinct ways:
a. Where the balance sheet justifies a higher price than is prevailing in the market. Here Graham would
look for securities that sold below net current assets which he used as a proxy for liquidation value. In
the 1930s there were plenty of securities meeting this criteria. Sadly in today's markets it's very rare to
find any such cases.
b. To detect the presence of financial weakness. Graham focused on three factors to monitor weakness
in the balance sheet.
1. Cash - is the Cash Level Adequate
2. Working Capital Ratio - equal to current assets divided by current liabilities. Here Graham accepts the
prevailing standard of the day that the working capital ratio should be greater than 2. He also advocates
it’s looking at the acid test otherwise known as the quick ratio. This ratio is the current assets less
inventories divided by current liabilities which Graham suggested should be greater than 1.
3. Debt Falling Due in the Near Term - Financial difficulties are almost always heralded by the presence
of bank loans or other debt due in a short time. Whenever the statement shows notes or bills payable
the analysts will subject the financial picture to a somewhat closer scrutiny than in cases where there is
a clean balance sheet.

Lesson 6
QUANTITATIVE vs. QUALITATIVE ANALYSIS
Graham's view was that the markets focus excessively on qualitative factors with little regard to
quantitative factors. It is therefore not a surprise that his books focus predominantly on the quantitative
factors. Athough the stock market has very definite and apparently logical ideas as to the quality of the
common stocks that it buys for investments. Its quantitative standards governing the relation of price to
determinable value are so indefinite as to be almost non-existent.
Graham recommended the application of a number of quantitative tests all of which have been covered
earlier in this lecture.
1. The earnings have been reasonably stable
2. The average earnings bear a satisfactory ratio to market price
3. The financial setup is sufficiently conservative and the working capital position is strong.

However he adds to this that the analyst must balance those quantitative factors with qualitative
analysis. Quantitative data are useful only to the extent they are supported by a qualitative survey of the
enterprise. Graham understood that thorough security analysis would often lead to a different
conclusion to the market. Crucial to success in value investing is understanding that the market doesn't
always get it right and that market values may deviate significantly from the intrinsic value. That is what
the value investor is always looking to take advantage of. It is customary to refer with great respect to
the “bloodless verdict” of the market place. As if it represented invariably the composite judgment of
countless shrewd, informed and calculating minds. Very frequently, however, these appraisals are based
on mass psychology on faulty reasoning and on the most superficial examination of an adequate
information.

We hope this lecture has given you a taste for value investing. if you want to read about Graham's
philosophy in more detail we can recommend two excellent books for you:
1. "Security Analysis" by Benjamin Graham and Grahame Dodd. This book was first published in 1934
and sets how Graham's investment philosophy in great details
2. "The Intelligent Investor" by Benjamin Graham. This book was targeted more toward the layman, it
was first published in 1949 and is based on principles covered in security analysis. Once you've
honed your value investing skills show us what you've learned on the stock views platform. We have
many like-minded investors seeking out the kind of stocks.