Benjamin Graham
Father of value investing
Benjamin Graham was a famous investor who believed in buying stocks that were undervalued by the market. He made his money by finding companies that were cheaper than their real worth and holding them until the market realized their value. His edge was understanding numbers and being patient.
In simple termsBenjamin Graham is like a detective who looks for hidden treasures in old, broken toys. He buys them cheaply because they look messy, but he knows they're actually valuable if fixed.
Graham Number / Net-Net
Benjamin Graham's stock-picking framework focuses on buying stocks that are significantly undervalued by the market, using strict financial metrics to identify companies with strong fundamentals and low risk.
Why: A lower P/E suggests the stock is cheaper relative to its earnings, making it more attractive for value investors who look for bargains.
How to check: Look at the company's P/E ratio on financial websites like Yahoo Finance or Morningstar.
Why: A low P/B means the stock is trading for less than its book value, which can indicate a potential bargain.
How to check: Check the company's P/B ratio on financial websites like Yahoo Finance or Morningstar.
Why: This shows that the company has enough liquid assets to cover its debts, which is important for stability and safety.
How to check: Look at the balance sheet of the company. Current assets should be greater than total liabilities.
Why: Stable or growing earnings suggest that the business is performing well and can sustain its operations.
How to check: Review the company's income statement for the last five years to see if earnings are consistent or increasing.
Why: A high debt level can be risky, especially during economic downturns. A low debt-to-equity ratio indicates financial stability.
How to check: Check the company's balance sheet for its debt-to-equity ratio.
Graham Number = sqrt(22.5 x EPS x Book Value per Share)This formula helps determine the maximum price an investor should pay for a stock based on its earnings and book value, ensuring it's not overpriced.
Example: If a company has an EPS of $2 and a Book Value per Share of $10, then Graham Number = sqrt(22.5 x 2 x 10) = sqrt(450) ≈ $21.21.
Net-Net Working Capital = Current Assets - Total LiabilitiesThis measures the amount of money a company has available after paying off all its debts, indicating how financially strong it is.
Example: If a company has $100 million in current assets and $60 million in total liabilities, then Net-Net Working Capital = $40 million.
- 1Check the P/E ratio of the stock. Is it below 15?
- 2Check the P/B ratio of the stock. Is it below 1.5?
- 3Look at the balance sheet and compare current assets to total liabilities. Are current assets greater than total liabilities?
- 4Review the company's earnings over the past five years. Are they stable or growing?
- 5Check the debt-to-equity ratio. Is it below 1.5?
Let's say we're looking at a fictional company called 'TechSafe'. We check its P/E ratio and find it is 12, which is under 15. Its P/B ratio is 1.3, also under 1.5. On the balance sheet, current assets are $50 million and total liabilities are $40 million, so current assets exceed liabilities. Earnings over the past five years have been stable. The debt-to-equity ratio is 1.2, which is below 1.5. Based on these checks, TechSafe would pass Graham's criteria and could be considered a potential investment.
- Start by learning how to read financial statements (income statement, balance sheet, cash flow statement).
- Use free tools like Yahoo Finance or Morningstar to look up P/E, P/B, and debt-to-equity ratios for companies.
- Practice screening stocks using the rules above. Try applying them to real companies you know.
- Read Benjamin Graham's book 'The Intelligent Investor' to understand his philosophy in depth.
- Keep a journal of your stock screenings and reflect on what works and what doesn't.
Philosophy & core principles
Graham thought markets are like mood swings — sometimes they're too excited, sometimes too scared. When people get scared, they sell things for less than they're worth. Graham waited for those moments to buy cheaply. He believed in logic over emotion and always tried to protect his money first.
- Always look for companies that are cheaper than their real value.
- Never pay more than a company is actually worth, even if it's popular.
- Be patient and wait for the right moment to buy.
- Diversify your investments so you're not putting all your eggs in one basket.
- Only invest money you can afford to lose.
Signature concepts
This means buying something for less than it's really worth, like getting a toy for half price when it's actually worth $10. It gives you room to be wrong and still come out ahead.
This is how much a company is truly worth based on its assets, earnings, and future potential — not what people think it's worth today.
The market price is what people are willing to pay for something right now, but intrinsic value is how much it's really worth. Graham believed the market often gets this wrong.
The step-by-step process
How they actually go from a blank page to owning a stock.
- 1Find cheap companies
Graham looked for stocks that were selling for less than what their assets and earnings suggested they should be worth. He used numbers to find these deals.
- 2Check the company's financial health
He made sure the company wasn't in trouble by looking at its debt, profits, and how it managed money. A strong balance sheet was important.
- 3Buy with a margin of safety
Once he found a good deal, he bought it but only if it was significantly cheaper than what it was worth — to protect himself from mistakes or bad luck.
- 4Hold for the long term
Graham didn't try to time the market. He held onto his investments until their true value became clear, which could take years.
✓ What they look for
- Companies that are cheap compared to what they actually own, like a store selling for less than the value of its inventory
- Businesses with strong financial health, like having more money in the bank than debt on the books
- Firms that have been overlooked or misunderstood by other investors, making them potentially undervalued
- Companies with consistent earnings over time, showing they can make money even when the economy is bad
✕ What they avoid
- Stocks of companies that are highly leveraged (have too much debt), which makes them risky if business slows down
- Investments in businesses that are hard to understand or have complex operations, like a company with many different parts that don't make sense together
- Stocks that are popular and expensive because everyone is buying them, not because they're actually good value
- Companies that have unstable earnings, meaning their profits change a lot from year to year
How they weigh & manage a position
- Price-to-earnings ratio (P/E) – how much you pay for each dollar of company profit
- Price-to-book ratio (P/B) – how much you pay for each dollar of company assets
- Current ratio – how much cash a company has compared to what it owes
- Earnings stability – whether the company makes money consistently over time
Graham would sell a stock if the company's value dropped below what he thought it was worth, or if the business changed in a way that made it less safe. He also sold when he found something better to invest in, but never because of short-term market changes.
He preferred to spread his money across many different companies to reduce risk, but not too many – like having a few good investments rather than dozens. He didn’t put all his money into one stock unless it was extremely cheap and safe.
Famous trades
Graham bought Coca-Cola when its stock price dropped below the value of its assets, seeing a great opportunity. Over time, as the company grew and became more valuable, his investment made him a lot of money.
Graham invested in General Tire when it was selling for less than its assets, believing it would eventually be worth more. The company later recovered and the stock price rose significantly.
He bought Woolworth at a discount to its book value, expecting the company to grow. It did, and his investment paid off well over time.
“The intelligent investor is a realist who sells to optimists and buys from pessimists.”
“In the short run, the market is a voting machine; in the long run, it's a weighing machine.”
“Investing is most intelligent when it is most businesslike.”
What to read to learn this approach
- 📖The Intelligent Investor — This book teaches how to think about stocks like a business owner, not just as pieces of paper. It emphasizes buying cheap and being patient.
- 📖Security Analysis — A detailed guide on analyzing companies' financials and understanding what makes a stock truly valuable.
Apply it yourself
Look for stocks that are selling for less than the value of their assets, check if they have strong finances, and avoid ones that are too expensive or risky. Buy only when you think the price is fair, and hold onto your investments unless something changes in the company's business.
Educational summary of a well-known investor's publicly-described approach. Not investment advice, and not affiliated with or endorsed by the investor.