CHAPTER 1

Benjamin Graham and the Evolution of Value Investing

During an investment career that spanned more than half a century, BenjaminGraham had a greater influence over the way stocks are analyzed, bought, andsold than any other investor in the history of the stock market. Grahampracticed his trade during an era in which the stock market evolved from aninvestment that was utilized almost exclusively by the very wealthy to apervasive investment that was used by almost everyone with a job and aretirement savings account. As a professor, author, and stock market trader,Graham turned stock market investing from a frenzied, speculative practice basedon intuition, emotion, and momentum to a precise science that relied on strictformulas, meticulous analysis, and methodical timing.

Graham, who died in 1976 at the age of 82, has been referred to as the "Dean ofWall Street," the "Father of Security Analysis," and the "Father of ValueInvesting." As an author, he expounded on his methodology in two of the mostsuccessful investment books ever published: Security Analysis, which hewrote in 1934 with David Dodd, and The Intelligent Investor, which hewrote in 1949. Both books have been periodically updated and still sell brisklytoday.

To understand Graham's impact on the financial world, all you really need toknow is that he was Warren Buffett's mentor for more than two decades beforeBuffett struck out on his own.

Graham is probably most widely recognized for his contribution to valueinvesting, a methodology that relies on strict analysis and timing to acquireundervalued stocks when they're trading at a discount to their intrinsic valueand sell them once they've earned a suitable return.

But until now, one of Graham's most brilliant revelations has been all but lostto the investing public. Although his name is nearly synonymous with valueinvesting, Graham also began to see the value of growth stock investing late inhis career. He even developed a formula and a methodology for growth stockinvesting that he introduced in the 1962 edition of Security Analysis ina chapter entitled "Newer Methods for Valuing Growth Stocks." Unfortunately,although Security Analysis was reissued in 1988, 1996, and 2009, thischapter was omitted from all the subsequent editions.

There's no real explanation for why this chapter was removed—a decision,oddly enough, that was made long after Graham's death in 1976. (The chapter isreprinted in Chapter 3 of this book.) Regardless of the reasons for theomission, investors who have read the newer editions of Graham's book over thepast two decades have been denied one of the most significant investmentinsights ever offered by Graham.

The primary objective of this book is to unlock Graham's lost formula andmethodology so that investors—both individual and professional— cantake advantage of his insights on analyzing and buying growth stocks. I considermyself one of the fortunate few investment managers to have come across Graham'sformula early in my career, and I have used it with great success ever since.

THE MAN AND HIS METHODOLOGY

Graham's investment philosophy was rooted in two important premises: that asecurity should be analyzed independently of its price, and that the futureperformance of any security is uncertain. He suggested that intelligentinvestors should aim to purchase a security at a discount to its assessed valuein order to provide a margin of safety that can protect their investment againstloss. Both the risk and the return of the investment are dependent on thequality of the analysis and this "margin of safety."

Graham did not stop there. With these principles firmly in hand, he laid out acomprehensive series of treatises on successful investing for the professionaland lay investor alike. In Security Analysis, he focused primarily onthe proper emphases and techniques to apply in the selection of investmentsecurities. In The Intelligent Investor, which is widely considered hismost influential work, Graham turned his attention to the investors themselvesand laid out his philosophy of investment.

If the power of Graham's work was due to the simple truth at its foundation, itstimelessness has been due to the quality of the craft Graham built upon it. Hedidn't construct a philosophy of investment in an academic vacuum; he derived itfrom long years of hard experience.

Graham was born in England in 1894 and moved with his parents to America thenext year, where his father opened an import business. But the business failed,and his father died while Ben was still a child. In 1907, an economic crisiswiped out what little was still left of his mother's savings. But Grahamexcelled as a student and was able to get into Columbia University, where hegraduated as class salutatorian at the age of 20. Columbia offered him a jobteaching mathematics, English, or Greek and Latin philosophy, but he declinedthe offer to seek his fortune on Wall Street. He began working there forNewburger, Henderson & Loeb in 1914, and rose quickly in the firm. Within fiveyears, he was making more than half a million dollars a year—a vast sumfor a 25-year-old in 1919.

But that fortune didn't last. Graham and Jerome Henderson, who became Graham'sbusiness partner in the 1920s, nearly lost their business in the crash of 1929.But with the help of friends and the sale of most of their personal assets,Graham and Henderson were able to retain their business and rebuild it from theground up. The lessons Graham learned from his early mistakes shaped hisinvestment philosophy for the rest of his life.

Graham worked until the 1950s and continued writing into the 1970s, and duringthis period, he endured some of the greatest price dislocations and economicupheavals in modern history. Throughout, he refined his understanding andinsight in subsequent editions of his published work. He was a successfulpractitioner and brilliant thinker living through extraordinary times, and heleft us one of the most important bodies of work on investing ever written.

Not only was Graham a groundbreaking investment manager and prolific author, buthe also taught evening classes in finance at Columbia from 1928 to 1955. One ofhis students was...