Born in eighteen ninety four, Benjamin Grossbaum as he was then known grew up in New York. His childhood was blighted by poverty but he was a supremely bright student finishing second in his class when he graduated from Columbia University. The world of academia threw its doors open to him, offering him employment as a lecturer. However, it was his experience of poverty as a young child that motivated him. He wanted to make sure he and his future family would never have to experience what he went through as a child. Graham wanted to earn lots of money and fast and so he took a job on Wall Street.
It was there he teamed up with his business partner, Jerry Newman, to create the Graham-Newman Partnership. This exciting new investment vehicle adopted some radical strategies in its approach to safeguarding its clients’ investments. He took parallel positions in the market. When he bet that a stock price was going to rise, he would place a second bet that another price was going to fall. By using this method, he could put all of his investors’ cash to work instead of having to keep a cash cushion to one side. His approach won praise with his clients and the partnership outperformed the top mutual fund over the previous five years by forty four percent. Over a ten year period, they produced a six hundred and seventy percent return. It was off the back of these extraordinary figures that a new Wall Street legend was born.
But luck was not on Graham’s side. The Wall Street Crash in nineteen twenty nine all but wiped out his wealth. This transformed him into a more risk-averse investor. He realised that a new approach was needed that could maximise profit and minimise his risk of loss. Over the next five years he worked with Columbia Business School Instructor David Dodd and wrote the now legendary investment manual, “Security Analysis”.
Graham recognised that, pre-crash, he had invested his money based upon the sentiment at the time on Wall Street. In other words, the trend was his friend. If he saw a stock going up, he piled money into it. If it was going down, he shorted it like his life depended on it. He believed in the wisdom of crowds, ignorant to the fact that billions of dollars were being lent to inexperienced investors who spent their lives blindly following each other. We saw the very same trend in China in twenty fifteen and, true to form, that ended in a major stock market crash just like it had done in nineteen twenty nine.
Graham’s newly written investment manual encouraged readers to look at what the real value of a business was before investing. How much did it have in assets, property and patents? Was it making a decent margin on its activities and paying it back to shareholders as dividends? Did the stock price look overvalued or undervalued? Investor sentiment would always drive prices. No book, not even theirs would change that. But what their book did was demonstrate that, whilst some market sentiment could be justified, much of it should not be relied upon. It’s a lesson which still rings true today. Sentiment swings all the time in favour of or against certain companies, certain sectors, certain currencies and even certain economies.
So are you interested in trying Benjamin Graham’s approach for yourself? If you are, here’s a quick rundown of his seven proven and time-tested criteria for finding the most exciting stocks with the biggest growth potential.
One. Your stocks must be companies of an adequate size to be financially stable. Around half a billion dollars in turnover at today’s prices.
Two. Buy companies with a strong financial condition, meaning a ratio of current assets to current liabilities of at least two.
Three. Look for earnings stability – no losses reported in the last ten years.
Four. The company should have a twenty year track record of paying dividends.
Five. Net income per share should have increased by at least one third in the last ten years
Six. The price of the share should not exceed fifteen times earnings over the past three years .
Seven. The price should be no more than one pointy five times the last reported book value of the assets.
By following these rules, you’ll have as good a chance as any of replicating Benjamin Graham’s success nearly one hundred years ago. However, as many value investors are finding, companies that meet these criteria in today’s hyped up, QE-manipulated markets are about as easy to find as a diplomatic statement by Donald Trump. So if you’re plan is to follow Benjamin Graham’s seven rules to the letter to make your fortune, be very careful out there.