Benjamin Graham Value Investing Principles That Still Work Today
Look, before Warren Buffett became Warren Buffett, he learned everything from one guy. Benjamin Graham. The Father of Value Investing. He passed away in 1976, but his principles are so solid that the best investors on the planet still follow them today, almost unchanged. In a world where every financial “innovation” has a half-life of about three years, Graham’s ideas have survived for nearly a century.
I am an engineer by training. I like things that work reliably. Graham’s approach is the closest thing I have found to engineering principles applied to money. Systematic, quantitative, designed to protect you from your own stupidity. Let me walk you through the core ideas.
Margin of Safety – The One Principle That Matters Most
The idea is dead simple. Figure out what a company is actually worth – its intrinsic value. Then buy it for significantly less. The gap between what you pay and what it is worth? That is your margin of safety.
Think about it like buying dollars for fifty cents. If you estimate a company is worth $100 per share, you do not buy at $95. You wait until you can get it for $50 or $60. Even if your analysis is partially wrong, even if the company hits rough patches, you still come out okay. The margin of safety absorbs your mistakes.
This is not about buying garbage companies because they are cheap. You want businesses where the future is neither terrible nor amazing – just average. Buy those at deep discounts, and even mediocre performance delivers satisfactory returns.
Graham took this to its extreme. His preferred method was finding companies trading below their net working capital – you buy the stock, get all the current assets (cash, receivables, inventory), and pay nothing for the buildings, machinery, brand. Everything fixed is free. Sounds impossible, but Graham found over 150 such stocks in 1957. Even in 1971, with elevated markets, about 50 such opportunities existed. They are always somewhere if you look hard enough.
Mr. Market – Your Emotionally Unstable Business Partner
Imagine you own a small stake in a private business. One of your partners, Mr. Market, shows up every single day offering to buy your shares or sell you more of his. Sometimes his price is reasonable. Other times he is absolutely unhinged – manic one day, depressed the next, quoting prices that have nothing to do with reality.
Would you let this emotionally unstable guy determine what your shares are worth? Of course not. You would value the business based on actual operations, actual earnings, actual balance sheet. You trade with Mr. Market only when his price is obviously wrong in your favor.
That is exactly how the stock market works. Daily price quotes are just Mr. Market knocking on your door. Take advantage of his mood swings or ignore him. Never let his emotional state determine your estimate of value.
Price fluctuations have one useful purpose: they give you chances to buy wisely when stocks drop sharply and sell wisely when they get absurdly expensive. The rest of the time? Ignore the market. Focus on dividends and operating results.
Think Like a Business Owner, Not a Stock Trader
Graham pioneered a now-obvious idea that was revolutionary at the time: a stock certificate is an ownership stake in an actual business. You are a part-owner of a real enterprise with real assets and real revenues. You are also holding a piece of paper that can be sold at prices often disconnected from business reality.
Smart investors think like business owners. Graham had four principles:
Know your business. Do not try to earn profits from securities unless you understand values as well as a manufacturer understands merchandise. Real money deserves real homework.
Do not outsource without oversight. Be very careful who you trust with your money. If you hand it to an advisor, you must be able to evaluate their performance.
Demand reasonable profit. Do not enter any operation unless the math shows fair chance of reasonable return. Stay away from situations where you have little to gain and much to lose. Arithmetic, not optimism.
Have courage of your convictions. If your analysis is sound, act on it. You are not right or wrong because the crowd agrees or disagrees. You are right because your data and reasoning are right.
Investing vs. Speculating – Know Which One You Are Doing
Graham drew a sharp line. An investment operation, after thorough analysis, promises safety of principal and adequate return. Everything else is speculation.
Speculators believe they have odds in their favor because “the timing feels right” or “this stock is going up.” Those claims rest on subjective judgment with no evidence. A real margin of safety is demonstrated with numbers, logic, and experience. Feelings do not count.
Buying “hot” stocks, buying on margin, making decisions based on where the market is heading – all speculating by definition. If you want to speculate, fine. Separate account. Small one. Never mix speculative and investment operations in the same account or even in the same part of your thinking.
Pricing Over Timing – The Defensive Investor’s Edge
Two ways to profit from price swings. Timing: predict market direction. Pricing: buy below fair value, sell above it.
Graham was crystal clear: focus on pricing, get satisfactory results. Focus on timing, end up a speculator with a speculator’s results.
Even the simplest form of pricing – just making sure you do not overpay – is enough for the defensive long-term investor. You do not need to be a genius. Just ask “how much?” before you buy, same way you compare prices at the grocery store.
The Bond Allocation Question
Graham was more enthusiastic about bonds than most famous investors. His guideline: never less than 25% and never more than 75% of your portfolio in stocks, with the inverse in bonds. Default split? 50-50.
Stocks get cheap in a bear market, shift more toward stocks. Stocks get dangerously expensive, shift toward bonds. Not market timing – valuation-driven allocation.
Bond interest and principal payments are much better protected than stock dividends and price appreciation. When stock yields compress and bond yields rise, bonds become the better deal. Graham’s approach prevented going all-in on either asset class at the worst time. He warned against all-bond portfolios too – inflation risk makes that dangerous. The defensive investor needs both.
A Reasonable Approach to Diversification
Graham’s rules for the defensive investor’s stock portfolio were practical:
- Own between 10 and 30 different stocks. Enough diversification to avoid catastrophic loss from one company, but not so many that you cannot keep track.
- Each company should be large, prominent, and conservatively financed.
- Each company should have a long record of continuous dividend payments – at least 20 years.
- Do not pay more than 25 times average earnings over the past seven years, and no more than 20 times the most recent twelve-month earnings.
That is it. No exotic strategies. No complicated optimization. Just sensible rules that keep you out of trouble.
The Graham Number – A Quick Valuation Sanity Check
Graham developed a formula that combines earnings and book value into a single number – the maximum price you should pay for a stock:
Graham Number = Square root of (22.5 x Earnings Per Share x Book Value Per Share)
This captures both income statement performance (earnings) and balance sheet strength (book value) in one metric. Most valuation ratios look at only one dimension. The Graham Number forces you to consider both. Stock trades above it? Too expensive.
Net Current Asset Value and Net-Net Working Capital
Graham’s most aggressive bargain-hunting tools are NCAV and NNWC.
Net Current Asset Value (NCAV) equals current assets minus all liabilities. Graham recommended buying stocks only when they traded below two-thirds of this number. You are essentially paying nothing for the company’s fixed assets – buildings, equipment, brand, everything.
Net-Net Working Capital (NNWC) goes even further by discounting individual balance sheet items for uncertainty:
- 100% of cash and short-term investments
- 75% of accounts receivable (some customers will not pay)
- 50% of inventories (some inventory is worth less than stated)
- Minus 100% of all liabilities
Stocks trading below NNWC – called “net-nets” – are rare, especially in overvalued markets. But when you find them, the margin of safety is enormous. You are buying a business for less than its most conservative liquidation value.
Management – Important but Unknowable
Here is a surprising one: Graham placed very little emphasis on analyzing management. Not because management does not matter – it does. But there is no objective, quantitative way to measure managerial competence.
Good results already reflect good management in the earnings history. Counting management quality as a separate bullish factor leads to overpaying – you are double-counting what the numbers already show.
One exception: recent leadership changes not yet reflected in financials. A turnaround CEO at a struggling company, for example. Otherwise? Management is “important but unknowable.” Stick to the numbers.
How This Applies Today
Graham’s principles are not relics. They are more relevant than ever in markets driven by hype cycles, meme stocks, and algorithmic trading.
Use margin of safety ruthlessly. Estimate intrinsic value, demand a significant discount. Math does not work? Walk away.
Treat Mr. Market as your servant, not your master. Market crashes 20%? That is Mr. Market having a bad day, not a reason to panic.
Run the numbers. Graham Number, NCAV, price-to-earnings. Simple calculations that take minutes, save you from expensive mistakes.
Diversify sensibly. 10-30 solid companies. Meaningful bond allocation. Adjust ratios based on valuations, not emotions.
Key Takeaways
Margin of safety is everything. Buy assets for significantly less than they are worth. Bigger discount means more room for mistakes.
Mr. Market is your unstable partner. Use his mood swings to your advantage. Never let daily quotes determine your view of business value.
No margin of safety, no investment. If you cannot demonstrate it with numbers and logic, you are speculating.
Pricing beats timing. Focus on what you pay relative to value, not on predicting market direction.
Think like a business owner. Know your business, demand reasonable returns based on arithmetic, have courage to act on sound analysis.
Graham Number, NCAV, net-net working capital are quantitative filters. Use them before buying anything.
10-30 stocks plus bonds. More stocks when cheap, more bonds when stocks get expensive.
Management matters, but numbers matter more. Do not overpay because you like the CEO.
Graham’s genius was making investing systematic and safe. Follow the math, ignore the noise, demand a margin of safety, let time work. It worked in 1934, it worked in 1971, and it works today.