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For example — Reliance Industries uses Rs. The new factory generates an annual profit of Rs. Reliance Industries is using financial leverage to generate a profit of Rs. A couple of years later, they incur a loss of Rs. This is three times their original investment. Now, they have a loss to work up to and a loan amount to repay.
In other words, it must be less than less than 1. Particularly for industrial companies. Current ratio This is an important indicator which investors need to reflect on. The current ratio is a liquidity ratio. It is also known as the working capital ratio. Graham preferred companies with ratios over 1. Current ratio of more than one means the company is able to manage its short-term obligations. Such companies are more preferable for investment. Current ratio of less than one means that the company can face cash crunch while repaying its creditors.
This happens if the current liabilities are more than the current assets. The chances of the company defaulting on payments is also high. PE ratio helps us understand if we are buying the stock at its fair value. It also helps us understand their ability to pay dividends. Benjamin Graham advises one must select a company with a low to moderate PE ratio.
A negative EPS suggests that the company is making losses for its shareholders. Book value is the total asset of the company minus its outstanding liabilities. A higher price to book value ratio depicts that the stock is expensive. Investors should select companies with a price to book value ratio of less than 1.
Preservation of capital Graham recommends preserving capital first and then let the investments grow. This is a conservative investment strategy. It suggests that investors should invest in the safest short-term fixed-income securities. For example, treasury bills and certificates of deposits. He recommended dividing the portfolio between stocks and bonds.
This preserves capital during extreme market crashes. The same is to be modified on the basis of broader market valuations. Margin of safety and diversification Benjamin Graham recommends having a bigger margin of safety. He suggests buying stocks when they are available cheap. The margin of safety is the margin required to ensure safety for unpredicted risk.
To reduce this risk, the art of diversification comes to the rescue. The margin of safety blends in with diversification. Graham suggested holding at least 30 stocks in the portfolio to ensure diversification. For the margin guarantees only that he has a better chance for profit than for loss — not that loss is impossible. But as the number of such commitments is increased, the more certain does it become that the aggregate of the profits will exceed the aggregate of the losses.
That is the simple basis of the insurance-underwriting business. The first book Graham wrote revolutionised investing for everyone. It was Security Analysis. Another book which is often quoted by everyone is considered to be the bible of Investment. It is The Intelligent Investor. It was written during the start of the Great Depression. Graham was a lecturer at Columbia Business School at that point. They then managed to create wealth by outlining a strategy in the latter half of the century.
Security Analysis lays down the fundamentals of value investing. The concepts of margin of safety and intrinsic value were introduced in this book. Warren Buffett has read this book at least four times! It does not specifically focus only on common stocks. A great proportion of the book is devoted to the analysis of bonds and preferred issues.
The techniques mentioned in the book remains applicable even today…seven decades after publishing! Benjamin Graham first published the book in It received global acknowledgment as the greatest investment advisor of the 20th century. Graham says that two things remain common with value investors. Regardless of which technique one follow — They are disciplined and consistent, refusing to change their approach even when it is unfashionable.
They think a great deal about what they do and how to do it, but they pay very little attention to what the market is doing. Buffett has praised The Intelligent Investor on several occasions. My financial life changed with that purchase. It lays the foundation for laymen by giving a thoughtful yet simple approach to investing. Conclusion Benjamin Graham died in the year But, his work lives on and is still extensively used in the twenty-first century.
Common Misconceptions About Graham Today Misconception 1: Graham only recommended cheap or deep value stocks Benjamin Graham is rightly considered the father of value investing. But the popular perception of the term "value" as meaning "inexpensive" has resulted in the general misconception that Graham only recommended cheap stocks. Graham actually recommended Defensive and Enterprising stocks before NCAV stocks; and both required far greater Qualitative checks and were allowed far higher Quantitative valuations.
Graham did advocate paying more for Quality. His only prerequisite was that there be the Margin of Safety between price and value, whether the value be Qualitative or Quantitative. In fact, when we look at Graham's actual stock selection rules, we see that most of the rules were concerned with the qualitative assessment of a stock. Real value is factor of both quality and quantity. Even something expensive can be bargain if it's worth more than what you pay for it.
This is what Graham was always trying to teach his students - that no matter how much they were paying, to make sure they are getting their money's worth. But due to a printing omission in recent editions of The Intelligent Investor, this formula is sometimes mistakenly used today instead of Graham's actual and more thorough methods. A lack of understanding of Graham's actual principles, and the true concept of "value" which includes quality 2. The common human tendency to overlook simple answers in favor of complex ones.
But Buffett himself has always credited Graham for his investment acumen Buffett even named his son after Graham! Buffett never wrote an article called The Superinvestors of Mungersville or Fishersville. But they too were students of Graham Kahn named his son after Graham too. Given below is part of the conclusion from a study by Robert F.
Bierig, of Duke University: "A naive observer of Buffett today would find it difficult to see the Ben Graham influence in many of his activities. Buffett continues to think about stocks as fractional ownership interests in underlying businesses, he continues to operate under the assumption that there is a distinction between price and value, and he continues to search for the largest discrepancy between those two items.
In other words, he continues to be a value investor. Misconception 4: Graham is not relevant because of Globalization This is another common argument today, along with the ones below about growth stocks and technology. Globalization is not a recent phenomenon.
The two world wars are often attributed to differences in international trade. IMF and the World Bank were formed early in the 20th century to regulate globalization. Misconception 5: Graham's principles do not work for growth stocks Graham's rules do include objective checks for growth. Graham's principles may not catch phenomenal stocks but the fact is that no other strategy can do so consistently either.
Making money on such a stock is really no different from winning the lottery. It's purely a matter of luck. Graham's principles recognize this and Graham's students don't look for lotteries. Instead, they follow strategies that are proven to consistently give good results for long periods of time.
They may miss the outliers but eventually, they fare better than everyone else in spite of ignoring "growth stocks". In fact, one might even say that to follow Graham is to stop looking for the lotteries, and to start treating investment as a business operation. Lotteries are exciting but ultimately, disappointing.
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Benjamin Graham: Biggest Secret of Value Investing
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