[2026–2027] Week 1: Benjamin Graham’s…

Ok, you officially win question 0. I only came up with 21 in my article ;).

Great list, I struggled more with this than I thought I would. I especially like your points on business cycle investing and ownership. I think many investors have different strategies investing in cyclical industries "buy when the PE is high" vs buying during the growth phase. Insider ownership, institutional ownership is something that can be important to consider.

Chris Carothers

Oct 6

Thank you for the list. I like the business cycle investing dimension when thinking about certain stocks. Example Winnebego (WGO). That then combines with market sentiment.

https://www.linkedin.com/pulse/making-financial-reality-obvious-when-metrics-tell-real-tonkikh-hnsse

Oct 5

Interesting list, thought-provoking.

Agreed!

L. S. Chang, I particularly liked your distinction between companies that constantly make headlines and those that remain largely unnoticed.

I think this raises an important question about how we select stocks in the first place.

Most of the companies we discuss, analyze, and consider investing in are already familiar names. But what about the thousands of others? Are they really less attractive investments, or do we simply know less about them?

The problem is that our investment choices are often limited before the analysis even begins.

I've been working on a different approach, which I call the Sorted Stock Universe. The idea is to evaluate and rank the entire stock universe using consistent, quantitative criteria, so that every company has a chance to be considered, regardless of its popularity or media coverage.

I recently explained this approach in the first part of my manifesto:

For me, the key question is not how many stocks we eventually buy, but whether we have considered the full range of opportunities before making that choice.

Enrico

Question 1) First edition of security analysis has been published in 1934. Graham and Dodd worked on the book from 1930 to 1934. The background in which the book has been written is that of collapse of wall street and the subsequent great depression. More important, in my opinion, is that the ideas that lie inside were conceived before the 1929 in an era of exagerated optimism. It can be said that the work of Graham and Dodd is a kind of anthidote manifest against the irrationality and, looking deeper, a translation in finance of the Hegel philosophy where he forecasts the human behaviour as an endless cycle in which every behaviour is brought to paroxysm and then fell back.

Question 2) Graham thinks that the investor must go trough an hard and scroupolous work of analysis. The main goal of analysis is to exclude the stock or bond that does not have the "margin of safety" . So the main work of the investor is to exclude, is to have a safeguard against what can reasonably happen to the business he is investing in. In short words the investment philosophy is avoid to lose money.

Question 3) I would like to imitate the discipline in the selection process. At the same time I am worringly consider not to have the sufficient strenght.

Question 4) an investiment is the one that after a deep analysis promise the safeguard of capital and a satisfying yield. The operations that do not satisfy these requirements are speculations. In the sentence the main concepts of Graham phylosophy are condensated. "Analysis", "Safeguard of capital", "yield". So the focus of the investor (NOT the speculator) has to be put in these 3 axes. Hence the investor must go through the hard work of analysis in order to exclude the "not safe" opportunity of investment (and the safeguard of capital) and choose those that will preasumably guarantee a reasonable yield. The implication is that the investor mist be like a blind who relies on his stick (the analysis) and ruthleslessy focus on the "sound oportunity"

Andrei Tonkikh

1. Investment Horizon: Short-term ↔ Long-term

2. Decision Process: Discretionary / Judgment-based ↔ Systematic / Rules-based

3. Analysis Orientation: Qualitative ↔ Quantitative

4. Forecast Dependence: High ↔ Low / No forecasting

5. Valuation Sensitivity: Low ↔ High

6. Investment Universe: Narrow / Selective ↔ Broad / Comprehensive

7. Company Characteristics: Distressed / Weak ↔ High-quality / Strong

8. Source of Return: Current Income ↔ Capital Appreciation

9. Market Dependence: Market/Price-driven ↔ Fundamentals-driven

10. Company Size: Small-cap ↔ Large-cap

In 1934, after the 1929 stock-market crash.

Environment: The Dow Jones lost around 90% from its peak. The Great Depression. Falling prices. Corporate bankruptcies. Banking crises. Limited standardization and availability of information. Weak market regulation.

How this environment influenced his work:

The book was a response to the failure of the speculative culture of the 1920s.

Greater attention to the risks of:

- paying too much relative to underlying value;

- mistaking temporary market optimism for the real value of a business;

- losing capital.

Graham’s investment philosophy is to buy securities with a margin of safety, meaning at a price significantly below their intrinsic value.

He considers this approach best because:

- an investment should primarily protect the investor’s capital;

- thorough analysis reduces the likelihood of error;

- a margin of safety protects against inaccurate valuation and adverse circumstances;

- after protecting the capital, the investor can seek a satisfactory return.

For Graham, it is not necessary to predict the future accurately. What matters is buying an asset at a price that leaves room for error.

What I would like to imitate.

First, the reliance on financial statements. Everything that actually happens to a company is reflected, one way or another, in its financial indicators. But the purpose of analysis is not to extract as much information as possible from financial statements. It is to find relevant information that actually shows what is happening to the company. More indicators, ratios, and data do not necessarily mean a better understanding of the business. For me, the relationships between financial indicators and their mutual dynamics are especially important. They allow us to turn a collection of numbers into a picture of the company’s financial reality.

Second, Graham’s skepticism about forecasts. At the same time, I am not against forecasting as such. I simply do not think a forecast is necessary to evaluate a stock’s prospects. Any forecast is based on certain assumptions, which are also the conditions under which that forecast can come true. The same analyst can build base, bull, and bear scenarios for the same company and arrive at very different, sometimes opposite, conclusions.

We can make a different assumption: if, in the past, a stock price reacted in a certain way to a certain structure and dynamics of the company’s financial indicators, this relationship may continue to matter in the future. This assumption is no less reasonable than the assumptions on which a forecast is based. But there is an important difference: future financial results are a hypothesis, while the results the company has already achieved and the actual price reaction to them are facts. If a stock’s prospects can be evaluated without making a separate forecast of future results, I prefer to rely on facts rather than replace them with an additional hypothesis.

Where I only partly agree with Graham.

This is the priority of preservation of capital over return. This view is consistent with the traditional risk-return trade-off: reducing risk usually means giving up some potential return.

But individual stocks show that these two characteristics do not necessarily have to be in conflict. A stock can provide both strong capital preservation and very high returns over many years. It is interesting, for example, to ask how Graham would classify NVIDIA: years of enormous appreciation without a permanent loss of capital, while its major drawdowns occurred mainly during broader market declines.

So for me, the question is not which should come first — preservation of capital or return. What matters more is their combination. I would prefer to evaluate both characteristics together rather than give one of them unconditional priority.

My main disagreement with Graham is intrinsic value.

I am not even sure that objective intrinsic value exists as a property of a stock or a company. Market price exists. Revenue, earnings, equity, and cash flow exist — we can observe them. Intrinsic value exists only as an analyst’s estimate.

Two analysts can study exactly the same company, have exactly the same factual information, and arrive at completely different intrinsic values. Moreover, the same analyst can arrive at different values simply by changing assumptions about growth, margins, future cash flows, or the discount rate. A mathematical model makes those assumptions formal, but it does not turn the result into an objective fact.

In essence, intrinsic value is a forecast, with all the limitations that come with forecasting.

Intrinsic value also creates an artificial boundary. Suppose a stock trades at $70 and I estimate its intrinsic value at $100. The price reaches $100. But what happened to the company at the moment the price crossed that level? Nothing. The market price simply reached a number produced by my assumptions. If the company continues to improve its results and the stock eventually rises to $200, then $100 was not an objective boundary of its value. It was a boundary created by my model.

There is also a behavioral problem. Intrinsic value can turn from a tool for testing an investment idea into a tool for confirming it. An analyst studies a company, forms an opinion, builds a forecast, chooses assumptions, and arrives at a fair value that confirms the original opinion:

opinion → assumptions → intrinsic value → confirmation of the original opinion.

This does not have to be deliberate manipulation. The analyst may sincerely believe that the assumptions are the most reasonable ones. But in that case intrinsic value does not necessarily reduce the subjectivity of the decision. On the contrary, it can give a subjective opinion the appearance of objective numerical justification. And the more work that has gone into the model, the harder it can become psychologically to admit that the original idea may have been wrong.

And there is one more question: does the market agree?

Even if the analyst correctly forecasts the company’s development, why should the market price eventually reach the intrinsic value calculated by that analyst? The market does not know that number. Other investors use different models, different assumptions, and different criteria. So the idea that price should eventually converge toward intrinsic value is itself another assumption.

We now have two levels of hypotheses:

I correctly understand the company’s future → the market will eventually agree with my valuation of that future.

In my approach, I prefer not to determine where the market should value a company. I would rather observe how the market has actually reacted to a particular structure and dynamics of the company’s financial indicators.

So my main objection to intrinsic value is not that it is difficult to calculate. It is more fundamental: a subjective estimate of an unknown future cannot be an objective measure of a stock’s investment attractiveness.

This also explains my view of margin of safety.

If we do not know an objective intrinsic value, we cannot know an objective margin of safety either. The difference between the market price and our estimate of value exists mathematically, but that does not mean that it actually represents a margin of safety.

A stock may appear to be 30% undervalued, then fall another 30%, and we can say that the margin of safety has become even larger. But later it may turn out that the original estimate of intrinsic value was simply wrong and that no margin of safety existed in the first place.

So margin of safety is a concept that can stretch in either direction, and we do not know in advance which direction that will be. We know the market price. But the “margin” exists primarily in our minds — and we cannot know in advance whether it was a margin at all.

Graham defines an investment as an operation that, upon thorough analysis, promises safety of principal and a satisfactory return. Operations that do not meet these requirements are speculative.

His choice of words is important:

- “thorough analysis” — an investment decision should be based on facts and analysis rather than expectations or market sentiment;

- “promises” — does not mean guarantees; investing always involves uncertainty;

- “safety of principal” — protection of capital is a necessary condition of an investment;

- “satisfactory return” — the objective is not to maximize return, but to obtain a return that the investor considers satisfactory.

The implication is that investment and speculation are distinguished not by the security itself, but by the basis on which the operation is undertaken. The same security can therefore be an investment under one set of conditions and a speculation under another.

Reply (3)

Love how you deconstructed Graham's words for question 4. He was definitely very deliberate in his definition. After all, he was writing to a shell-shocked investing public who likely thought anything that wasn't a government bond was a speculation given the carnage they had just experienced

Thank you, Gary! I agree. In the context of what investors had just experienced, Graham's careful distinction between investment and speculation becomes even more meaningful. What I find particularly interesting is how relevant that distinction remains today, even though the investment landscape has changed so much.

I really like your expansion on intrinsic value's uncertainty. I'm not convinced you're at odds with Graham and Dodd though. They sound quite probabilistic as well: "Our notion of the intrinsic value may be more or less distinct, depending on the particular case. The degree of indistinctness may be expressed by a very hypothetical “range of approximate value,” which would grow wider as the uncertainty of the picture increased," - pg. 67, 6th edition.

Thanks for the quote. I agree that Graham and Dodd recognized the uncertainty of intrinsic value. But my question goes a little further. It is not just how precisely we can estimate intrinsic value, but whether it exists as an objective property of a company in the first place.

A wider range of estimates acknowledges uncertainty, but it does not resolve the dependence of those estimates on the analyst's assumptions.

Appreciate your thoughtful post.

“Two analysts can study exactly the same company, have exactly the same factual information, and arrive at completely different intrinsic values. Moreover, the same analyst can arrive at different values simply by changing assumptions about growth, margins, future cash flows, or the discount rate. A mathematical model makes those assumptions formal, but it does not turn the result into an objective fact.”

This is completely true and frightening to me.

“I correctly understand the company’s future → the market will eventually agree with my valuation of that future.”

I do think the market is eventually a weighing machine. Even when the market does not agree a company could buy back shares, pay a dividend, or be acquired.

In my opinion intrinsic value is a fuzzy, broad range but it is still “real” and useful. We can buy businesses that are obviously undervalued and update our valuations as relevant information becomes available over time.

Thanks, Tony, for your thoughtful comment. I agree that dividends, buybacks, and acquisitions can provide returns even without the market recognizing an analyst's valuation.

But my approach is somewhat different. In my investment strategy, I do not estimate intrinsic value at all.

Instead, I look at the relationships and dynamics of a company's actual financial indicators — earnings, revenue, equity, dividends — and how its stock price has reacted to them.

Of course, this approach also involves an assumption: that the relationship between financial performance and market reaction observed in the past may continue to matter in the future.

But I don't think this assumption is any less reasonable than assuming that the market will eventually converge toward an estimated intrinsic value.

The difference, for me, is that intrinsic value depends on assumptions about an unknown future, while the financial results already achieved by a company and the market's actual reaction to them are observable facts.

So I'm not arguing that intrinsic value cannot be useful. I'm questioning whether estimating it is a necessary step in evaluating a stock's investment prospects.

Chris Carothers

I do not know if these are investing styles, but I broke each one on how we approached them while working for the newsletter.

1.Investor Risk tolerance vs volatility. High vs low. Normally directed toward a customer. After a risk profile evaluation, a rank of 1-5 was developed to give us a rule of thumb on how to proceed to invest.

2.Tax efficiency. High vs low. Took into consideration investment vehicles, such as Roth vs Trading account.

3.National, vs local vs international. Based on these we broke those up into categories. For the investment clubs I belonged to, we normally would take a vote to rank them for future study. Local was very popular.

4.Quality of earnings (consistency) vs valuation. High vs low. We would pay up for a higher valuation. We had a sliding scale based on P/E ratio 1-10, 11-15, 15-20 etc.

5.Large stock vs small stock. Did not have a scale but categorized them, labeling “emerging growth”.

6.Growth vs Income. Very important for the newsletter. For individual customers, that was also based on a risk profile.

7.Momentum vs growth (high vs low)- subcategory for growth. For momentum, we had a limit on how much we paid for the earnings

8.Sector vs individual stock ( ranked based on leadership). One of Investor Business Daily methods. They believed that the sector is just as important as a stock.

9. Income vs total return (high to low).

Question 1

The first edition was written in 1934. This was an environment of profound loss, not only in a financial sense, but emotionally and spiritually too. My previous boss Walter Pearson lived during that time and had to drop out of school during the ninth grade and work at a diner to feed his family. I learned through second hand stories about those tough times. So it does not surprise me he wanted to take a conservative approach.

Question 2. That leads into his investing approach of margin of safety and intrinsic value. The book was created to develop a system where safety of capital came first, and value was sought in the long run, not by chasing the next day, trend etc. When the ground is always shifting beneath you, it's hard to have a firm foundation.

Question 3. I want to go back to re-evaluate margin of safety and intrinsic value. I have recently joined a value website/ community as a help, as they constantly go through the stocks they like. They also have a built-in DCF calculator. I use software to chart the long and short term movement compared to its average (P/E, Price/sales). I also use a 5 percent yield as a floor for a quality company.

I understand that book value and other valuation methods have adapted over time as companies have trended toward asset lite business models, however over the last 10 years, I have had a hard time willing to pay for certain stocks because, in my opinion, indexing and ETFs tend to skew its valuation. I believe that those that invest in these products often do not concern themselves with valuation, and overpay for mediocre performance.

Question 4

To me an investment is a long term core holding where the overall purchase met and often exceeded its initial goals and matched. Example long term holding of Apple as a stock.

A speculation to me is a stock that I am reacting to based on new information. An example would be my purchase of Time Warner based on an interview with John Malone and the then CEO, and later comments from Professor Scott Galloway. That information led me to buy shares quickly without rigorous review that I should have done. This is one of the examples I was lucky with, as many other “high fiers” I have lost money on.

I believe he chose his words specifically to create the framework for his investing system as those definitions have not changed and have created an anchor for us to go back to.

Both the words intrinsic value and margin of safety separate this approach from others.

Reply (4)

Love the story about your former boss, thank you for sharing

I like that you put risk as the first dimension; it ties in to the rest of the responses nicely, especially the perspective from Walter.

Interesting comment about your former boss. Those experiences certainly left a mark on the people who lived through it. I had a relative who would never buy stocks because it was all speculation, although I think they ended up with some "T" because they worked for "the" telephone company.

Your comment about going back to intrinsic value and margin of safety caught my attention. One thing I increasingly wonder about with DCF is whether the model tests our investment idea or sometimes simply formalizes the assumptions we already believe. I would be interested to know how you deal with that when using a DCF calculator.

Chris Carothers

Right now, when I use the DCF model at this stage, I feel that it formalizes the assumptions because I still use it like a filtering process, rather than going on the idea. itself. Being here from Tampa, it reminds me like I'm a pirate looking for treasure.

Thanks, Chris. I like the distinction between using DCF as a filter and using it as the basis for an investment decision. And I like the pirate analogy. The difficult part, I suppose, is knowing whether the treasure is really there or whether our assumptions have convinced us that it is.

Oct 5

Question 0: Dimensions of an investing style

- liquidity [max time to cash out]

- accessability [venture, private, public]

- current yield [percent dividend or interest]

- business maturity [age of business]

- profitability [percentage]

- jurisdiction [laws with which the business must comply]

- social score [some metric regarding how the public regards the industry, like tobacco vs. baby food]

- market cap [dollars]

Question 1: When did Graham write/how the environment influenced

- 1934, the depression showed that the future is unpredictable and one must have a margin of safety, although at times he violated this and lost money speculating

Question 2: What’s Graham’s investment philosophy? Why does he think that’s best?

- You have to stick to your investment decisions regardless of exogenous events. These events are not predictable, so you should not attempt to trade around them.

Question 3: parts of his approach to imitate or not

- As I am nearing retirement, I need to be more conscious of the macro/geopolitical environment to avoid permanent loss of capital. Otherwise I intend to adopt a value-based approach.

Question 4: difference investment andspeculation? Why did Graham choose the words that he did to define it, and what are the implications of his choices for investing?

- I really think everything is speculation, but to the extent an idea depends on price appreciation instead of cash flows, it is more speculative.

- He chose the words carefully so that they would apply broadly, for example including hedge positions. He uses analysis to determine whether there is a margin of safety. I was surprised to see the word promises in such a careful definition.

The current environment does seem potentially tricky on several fronts; I wonder to what degree that influenced your ordering of liquidity, accessibility, and yield as your first three dimensions? Are those particularly important in your strategy, or are there other dimensions you prioritize?

That's interesting, I didn't notice the order myself. In my situation I generally prioritize return of capital vs. return on capital, and that is even more important in this environment.

Oct 4

Q0/Answer

1. Time horizon [Long-term to short-term]

2. Long – Short [meaning the position]

3. Quantitative – Qualitative

4. Fundamental – Technical

5. Attitude towards risk [risk-averse to risk-tolerant]

6. Type of the target assets [stocks, bonds, and alternatives]

7. Industry focus [generalist to specialist]

8. Corporate Life Cycle [from Young through Mature to Decline]

9. Investor’s selection process [Active vs Passive (index funds]

10. Investor’s activism [Active – meaning goes into a proxy fight to unlock value, Passive – just holding the position]

11. Contrarian – Momentum [following the trend/ herd or intelligently “bet” against it]

12. Geographical [Global to country specific]

Q1/ Answer:

In 1934, right in the middle of the Great Depression and after the 1929 Crash. Before that, the roaring ‘20s lead to delusional pseudo-analyses of stocks without considering fundamental facts. On the story-side they were telling fairy tales. This resulted in the 1929 Crash. Benjamin Graham’s fund lost 70% - as far as I understand he also used leverage.

The way I see it, Mr. Graham i) intended to restore the dignity of security analysis itself, by guiding it back to fundamentals - facts based on financial reports and statistical data ii) applied extra caution (and risk aversion) in order to avoid 1929 to be repeated. His main focus was not to lose money. He went on defensively. His “safety net” was the book value. He was very skeptical about the concept of Earnings Power (in a meaning of taking the average of the past earnings and blindly extrapolating to the future).

This might be a natural reflexive reaction (cf. George Soros) after getting burned, risk aversion increases (cf. Howard Marks’s pendulum regarding the attitude towards risk).

Q2/Answer:

An attempt to summarize Graham’s philosophy:

Graham’s philosophy involves:

- determining intrinsic value through thorough fundamental analysis (heavily relying on quantitative factors),

- seeking safety of principal/ initial capital first (book value or adjusted book value is his safety-net),

- maintaining critical attitude towards accounting practices (making adjustments) asking the question: “where do they try to mislead me?”

- following a disciplined and selective process, and

- buying well below intrinsic value when the market offers that price.

I personally do not see the “cigar butt” concept much in his writings, but rather “paranoia” of losing money, and therefore a vigilant search for safety.

He believes his approach provides enough safety and flexibility to handle the uncertain future, while giving a chance of satisfactory return, without unnecessarily risking the capital invested at the first place. He believes that on the long-term price will converge to intrinsic value (cf. “voting machine” vs “weighing machine”) generating return to the investor.

Q3/Answer:

I try to incorporate his reliance of quantitative factors (BS, P&L (Income Account) analysis, with some additional statistics (including official industry). That may provide solid base to continue the analyzing process.

Graham’s principles and key points like:

- insisting on not overpaying for an asset,

- taking a critical approach and being selective with our investments,

- being conservative regarding predicting future earnings (cf. his critique on p 65 regarding “Earning Power”, 6th edition, McGraw Hill Education (India) Edition, 2008; 22nd reprint 2017), and not blindly extrapolating the past to the future (Ibid, p 84),

- recognizing the irrational behavior of the market (Ibid, p 69.) [this became later the “bipolar Mr. Market” concept],

- treating an investment like investing in an enterprise (Ibid p. 77) aka. a business (cf. business investment on p 109),

are also things I consider advisable to follow.

Although I did not find the term Margin of Safety in this reading assignment (as I remember I won’t find it in this book), the conservative appraisal approach – which takes into consideration analytical mistakes, or changes in the Intrinsic Value before it manifests –already incorporates the concept.

- However, his strong criticism of prevailing accounting standards is not necessarily still an issue nowadays as the changes in the regulatory environment solved most of them. (We have other ones, though.)

- As I understand (I may be wrong), although Graham lists the qualitative factors in an investment [i) nature of business, ii) characteristics of the business (industrial, physical, geographical, operating), iii) management, and iv) future outlook/ prospects of all of the above], he puts more emphasis on the quantitative factors.

I would like to incorporate the qualitative factors and the story-side equally into my process (allocating equal weight to them in the decision making) as per the teachings of Damodaran. Additionally: intelligently interpreting stories, words, texts may provide an edge for humans to operate on the market. In other words, quantitative analysis is the starting point only, the real work starts after that.

- Not to mention that the tools of behavioral economics or Howard Marks’ pendulum concept or his teachings on cycles are also things I would like to use in my standard operation procedure.

Q4/Answer:

“… an investment is a successful speculation and speculation is an unsuccessful investment.” – (p. 101, 6th edition, McGraw Hill Education(India) Edition, 2008; 22nd reprint 2017)

Jokes aside:

“An investment operation is one which, upon thorough analysis, promises safety of principal and satisfactory return. Operations not meeting these requirements are speculative.” (Ibid, p. 106)

“An investment operation is one that can be justified on both qualitative and quantitative grounds.” - (Ibid, p. 107)

Implications:

1- Investment is inseparable from diligent analysis, while on the other hand analysis loses its value in speculative operations - see: Chapter 1, subchapter: Analysis and Speculation, where he lists the arguments.

His focus is more on past facts than on expectations. (However, he takes into consideration the latter under qualitative factors.)

2- His focus is on avoiding losing money: safety of principal (capital) first, with return being secondary. (see above at Question 1) | Under safety he means: “protection against loss under all normal circumstances or reasonably likely conditions or variations.”

See also later: “For investment the future is essentially something to be guarded against rather than to profited from.” (Ibid, p 109)

3- Satisfactory return pushes the term into subjective territory; it depends on the expectations of a reasonable, intelligently behaving investor.

4- He also emphasizes that an investment shall be interpreted in connection with the market price, meaning that on one price level an asset may be considered as an investment, while on another price level it may not.

How I understood the difference between the two (incorporated other readings also):

Investment: We make assessments on the value of an asset – using different techniques but mostly based on fundamentals. This will be our intrinsic value. Then we compare the IV to the price the market offers, and based on our selection criteria we ignore or buy, hold, sell accordingly.

Speculation: We bet on price movements, largely based on our (or worse: others’) expectations. It will go up or down – because momentum or the charts say so or whatever our expectations are. It is possible to execute this type of operation intelligently, if we carefully analyze the quantitative & qualitative factors and the risk we take (cf. Ibid. p 110); and unintelligently without considering fundamentals in depth.

In addition, I personally consider taking a short position as speculation by default.

P.S. The formatting looked way better in Word.

Reply (5)

The tension/balance between Qualitative and Quantitative is a key theme in any investment process and all the Masters that we will study. No right answer here, but very important to think about.

Andrew H.

Oct 4

Thank you for this. I was wondering what a good comment would be given the instructions; this is a good example.

One of the several items on your list of dimensions that would not have occurred to me was taking long or short positions.

Damodaran is someone I likewise follow. I especially like his concept of a company's life cycle (startup to mature/declining) and it's implications for valuation. I think he is too dismissive of value investing in the traditional sense, however, and I suspect something closer to Graham's approach might do better in severe dislocations such as what Graham had just experienced.

https://www.youtube.com/shorts/S6SKfoT01oQ

Oct 5

Thank you for the kind feedback.

I'm not sure if it is a good example, but Mr. Mishuris will decide.

I became somewhat of a Damodaran fan after I finished most of his online courses (there are still a couple to go). I like his flexibility regarding different investment approaches. [It felt like being in the army, where we learned several different drills, and then during field training we had to choose which one to use considering the circumstances.]

Company Life Cycles are really interesting, especially given his message is that companies have to act according to their age.

His oppion on "old time value investing" is summarized in two shorts:

This one actually resonates with the instructions we've received in the introduction and the first assignment of this seminar.

This one is just funny - especially because I remember how hard it was for me to read Security Analysis the first time:

https://www.youtube.com/shorts/GQBcUjsxPPM

I think it is natural that a discipline evolves over time. It has been almost 100 years ago since Graham wrote the original book, and even his style changed later.

I think most of the content is still valid, it is just not enough anymore. Other aspects have to be taken into consideration. (We are doing this seminar under the blog called Behavioral (!) Value Investor. So I assume Kahnemann/Tversky or Akerlof will come later on.)

There is an article from Kai Wu, which details how Warren Buffett (as the greatest of Ben Graham's disciples) evolved his investment style over his career with the changing economy: https://www.sparklinecapital.com/post/intangible-value

I've found Pr.Damodaran the be very insightful, in particular his idea, that I don't think I've heard anyone else touching, of minimizing Regret. An idea akin to that of tilt in poker, but with specific recommendations in investing to reduce the distortive impact of regret across time.

I do, however, find Damodaran to be as peculiar as I find him insightful. His obsession with calculating risk-free rates and cost of capital always felt to me like a guy with a hammer banging nails everywhere he goes (I think he is now coming around slowly). And similarly his excitement about doing Monte Carlo simulations across a full distribution of predictions for a variety of DCF inputs, in my opinion, can only cause false sense of precision and sophistication in anyone using it within their analysis. Finally, as if to be controversial within the value investing circles, he leans hard on the efficient markets argument - which has worked out just fine for the last 17 years, but I think Graham might still hold on to his view that at inflated market valuation levels (on inflated earnings) one has to pay more attention to the risk of a possible reset than to the risk of missing some of the gains to be had from accepting "the new permanent plateau" outlook.

I use his ERP and CRP calculations to "cut corners". In his course he do emphasize that we should focus more on the nominator (meaning we should spend more time on it) of the DCF model and less on the denominator.

I do agree that false sense of precision may mislead us. In this first assignment Graham also mentions, that our valuation is enough if we can decide if it is a buy or a sell. No need for absolute precise results and perfection.

Thank you for your links. Previously, I started to review Professor D's class videos but shelved them for later. He has a class review of Disney that I found extremely valuable as I now look at that stock with a changed perspective.

"I personally do not see the “cigar butt” concept much in his writings, but rather “paranoia” of losing money, and therefore a vigilant search for safety." I found this comment interesting and had a similar take. I have not read Graham before and expected "cigar butt" investing from everything I've heard about Graham. He definitely had a huge emphasis on safety but in the first section I don't see "cigar butt", maybe that will change as we continue on with the book.

I think Warren Buffett came up with the analogy, when he was talking about Graham's style.

Incredibly thorough response! I'm curious about your perspective on "intelligently interpreting stories, words, texts may provide an edge for humans to operate on the market" in the context of sentiment analysis and modern LLMs + broadly available AI.

Oct 11Edited

My training of interpreting stories comes mostly from my legal background. I've got use to it that I should not take anything for face value and check: who is saying it? why? what is their incentive behind it? etc.

I read so many BS especially during Venture Capital investment procedures (they alwys wanted to conquer the world with their hockey stick charts). We needed to narrow down the story to the key points, and even then there were no guarantees.

Interesting point about price eventually converging to intrinsic value. But this is exactly where I struggle with the concept. If two reasonable analysts can arrive at very different intrinsic values for the same company, which intrinsic value should the market eventually converge to?

Hopefully to the one we calculated :). I guess that is why they say that investing/ valuation is an art, not a precise procedure. The subjective element makes it still relevant today in the world of algorythms and AI. I always try to come up with my own idea, sometimes I fail, sometimes the inputs are changing meanwhile, so I have rethink my stance.

The greats (whether it is Damodaran, Graham, Marks etc.) are only source of mental models to me.

Question 0:

Quantitative investing vs Qualitative.

Future growth vs current value.

Industry/sector concentration vs sector agnostic.

Home country vs global.

Question 1:

Graham wrote the first edition of Security Analysis in 1934, during the Great Depression and in the aftermath of a stock market crash. This environment influenced his work in an emphasis on safety, not relying on future growth expectations.

Question 2:

Graham’s investment philosophy is focused on quantitative factors and making investments at a price significantly less than their intrinsic value.

He believes this is best based on the following factors: Quantitative factors are more factual and easier to ascertain than qualitative factors. A balance sheet is more factual and easier to quantify than the quality of management. Quality of management is hard to measure, it is subject to bias and opinion. Defining a good business vs a bad business is inherently subjective, relies on future expectations and most importantly can change rapidly.

Qualitative factors can also be seen in quantitative facts. A strong balance sheet and earnings can give us evidence of a quality business and/or management. Qualitative factors can be harder to identify on their own, and discovering them through quantitative data can keep us from double counting them.

Question 3:

I would like to imitate his emphasis on risk aversion, margin of safety, and to some degree limited reliance on future expectations.

Truly successful investors rarely act, waiting for great opportunities. I sometimes have a tendency to find a reasonably good company at a decent price and act, when I would be much better served waiting for an opportunity that is glaringly undervalued. While calculating a precise intrinsic value can be difficult, a true bargain should be obvious. I want to build the discipline to act only on these obvious mispricings.

Graham's avoidance of future earnings growth is a double-edged sword that I would like to modify. Many of the best investments in recent history have been of high growth companies, growth can be a very powerful thing. In modern times we might not have many opportunities trading for less than liquidation value.

However, I think Graham’s caution is still very relevant. Graham lived through a time of economic depression and war. It is possible an unexpected economic disturbance could happen again, just as it has in the past, whether due to a recession, AI changes, or something else. I found Graham's reference to the war in Europe especially interesting and foreboding. Could the current war in Europe, the Middle East, or some other conflict grow and have an unexpectedly significant impact on the economy and business? I would like to give serious thought to what the valuation of a company looks like without expected growth, or no growth in cash flow or earnings at all. I don't want to invest based on “this time is different” or with rosy expectations without solid value based on current facts.

Question 4:

An investment is based on thorough analysis, safety of principal, and a satisfactory return. An investment is made based on unchanging standards, while speculation relies on the changing standards of the market. For an investment the future is something to be guarded against, while a speculation is reliant on future expectations that are not based on past performance.

Graham emphasized a systematic process, where the safety of principal was of key importance to him. Avoidance of loss rather than expectation of future growth was the basis for his investment choices.

I think you are right that Graham's caution is still very relevant today, even though we live in a very different investing/economic/market environment than the one that Graham was writing in. If anything, caution is more, not less, important in frothy market environments.

Tony, I particularly liked your point that qualitative characteristics can be revealed through quantitative facts. I think this is very important.

I would add that it is not only the individual financial indicators that matter, but also the relationships between them and how those relationships change over time.

Revenue, earnings, equity, and cash flow tell us much more about a company when we examine their dynamics together rather than separately.

For me, this is one of the most valuable ideas behind fundamental analysis: understanding the business through what its financial results actually reveal, rather than relying primarily on subjective judgments about its quality.

Minh

Q0 Dimension in investment style: Enterprise vs Term

In Chapter 2, Graham distinguishes the character of the enterprise from the terms of the commitment (price, provisions of the issue, and its status). For the trained analyst, he favors attractive terms over an attractive enterprise. A good enterprise depends on an uncertain future, which can change its intrinsic value, whereas the main risk of attractive terms is that the price adjusts slowly. In Figure 1, Graham was willing to buy in bad enterprise at a good price. Buffett and Munger later moved to good enterprise at a good price.

The first edition of Security Analysis was published in 1934 (Graham and Dodd), after the 1929 crash and during the Great Depression. That setting shaped the book in four ways.

Safety over forecasting. Graham lost heavily in the great Depression crash and the early 1930s. Chapter 1 describes analysis being discredited twice: before the crash by “imaginary values,” and after it by the “disappearance of real values.” This pushed him to treat the future as a hazard to guard against and to define safety as protection against loss.

A public of individual investors. Because the market was driven by individuals, he describes it as a “voting machine” of reason and emotion, and he writes for readers without financial training (such as the widow in Chapter 2).

Weak disclosure. Companies published little before the 1933-34 securities laws, so Chapter 3 stresses primary sources and fuller reporting.

Graham’s philosophy centers on safety: protection against loss under normal or reasonably likely conditions, assured by standards rather than by the investor’s confidence. An operation must be justified on both quantitative and qualitative grounds. He values qualitative factors such as industry prospects, management and stability, but I read them as support for conclusions drawn from the numbers (balance sheet and earning power), not as the basis for a decision.

Price is always part of the judgment, because almost any issue is cheap at one price and dear at another. He treats the market as a voting machine, not a weighing machine, so prices can drift from value.

Finally, he favors stable businesses and diversification to reduce the risk of concentration.

Graham believes this approach is best for two reasons. First, the alternative failed publicly. The 1929 “new era” buyers treated any price as acceptable for a good company, and their sense of safety rested only on “the psychology of the purchaser,” which collapsed with the market. Second, his approach rests on what can be verified. Assets, earnings and price can be checked against standards, whereas prospects, management quality and trends are predictions that must prove right or wrong.

What I would imitate

1. Building a thesis from facts. I would justify intrinsic value through analysis of assets, earnings and coverage, and treat it as a range, not an exact number. Graham needs only enough evidence to show that value is adequate, or clearly above or below the price.

2. Starting from price. He warns that “the danger of paying the wrong price is almost as great as that of buying the wrong issue,” and that nearly every issue might be cheap at one price and dear at another.

3. Putting safety first and staying patient. His 1912 bank-stock buyer paid prices he considered conservative, sold when a speculative market pushed prices out of line with standards of value, and waited for a reasonable price before buying again. I would buy when the price sits clearly below my range, be cautious when it sits above, and wait when it is out of line.

What I would rather not imitate

I would not dismiss qualitative factors. Graham treats them as hard to appraise and prone to overvaluation, but Buffett later built on the idea of a durable competitive advantage, or moat. A moat is mostly qualitative, and it explains why some businesses keep earning high returns, which a snapshot of past numbers may not show. Treating qualitative factors as supporting evidence only could mean missing such businesses

An investment is, in Graham’s words, “an operation which, upon thorough analysis, promises safety of principal and a satisfactory return.” Anything that fails this test is speculation. He adds that an investment must be justified on both qualitative and quantitative grounds.

Why these words

“Operation,” not “security.” Investment character depends on price, diversification and even hedging, not on the label of the issue. A bond can be speculative at the wrong price.

“Thorough analysis.” Facts and established standards, not opinion or prestige, must support the decision. This is why the 1929 “blue chip” buyer, who let the market set the standard, does not qualify.

“Promises safety.” Safety means protection under normal or reasonably likely conditions, and it must be judged in advance. Judging by result would make investment “a successful speculation.”

“Satisfactory return.” This is wider than income, so it allows capital appreciation, and “satisfactory” is subjective so long as the investor acts with reasonable intelligence.

Implications for investing

Labels such as “bond” or “blue chip” do not make something an investment, and a security can change status as its price moves. Graham argues that most stocks of strong companies are speculative at prevailing prices, so the burden of proof falls on anyone claiming to invest. He does not condemn speculation, only the failure to recognize it, and he separates intelligent from unintelligent speculation

Your breakdown of Graham's definition of investments vs. speculations is very thorough and insightful!

As for moats, I wonder if they are also fairly quantitative, in addition to having a qualitative nature? For example, comparing market share over time and growth of competitors?

Lattice Notes

Question 0: Come up with as many other dimensions of an investing style as you can and provide a scale for each of those dimensions (e.g. Diversification [high to low]).

1. Company Size – Small to Large

2. Geo Based – Home vs Other Countries

3. Industry Focus – Single vs Multiple

4. Individual Stocks vs Funds – 0-100%

5. Self-directed vs Professionally managed – 0-100%

6. Style Purity (Value vs Growth vs Momentum) – Single vs Multiple Approaches

7. Analytical focused vs Business Story – quantitative only to qualitative only

8. Company phases – early stage to mature companies

9. Dividend Focus Investing – none to key focus

10. Asset Class Specific (Stocks, Bonds, Commodities, Real Estate etc.) – Single vs Multiple Classes

11. Market timing – none to key focus

12. Leverage – none to significant

13. Short Selling – none to key focus

14. Options – none to key focus

15. Active vs Passive – 0-100%

16. Holding period – short term to long term

17. Rules vs judgement based – rules only to judgement only

18. Technical vs Fundamental analysis focus – technical only to fundamental only

19. Quality – High Quality only to Junk

20. Valuation – Any Business at a wonderful price to wonderful business at any price

Q1: When did Graham write the first edition of Security Analysis and how did the environment during which he was operating and writing influence his work?

A: Graham first published the book in 1934. It was right after a crash and during an ongoing economic depression. The recency of such events made Graham more focused on an analytical approach to understand types of securities, and focused on protecting one's capital from future failures. He personally saw a cumulative loss of 70% of his partnership’s investment by 1932, which reinforced focus on margin of safety. He had seen the complete cycle starting with the boom of the 1920s and the bottom of 1932 to bargains now available again. Another change that he experienced was less regulation in the market in the 1920s, to more disclosure requirements and regulations after the crash, making it easier to do deeper analysis of any investment. Therefore, his focus was to understand the types of securities based on their characteristics, and defining the objective of that investment. The suggested new classifications 1/ Securities of the fixed value type 2/ Senior securities of the variable value type 3/ Common stock type reflect this focus on characteristics versus just the labels as bonds being safe or stocks being risky because in a crash many bonds turned out to be unsafe. (p119)

Q2: What’s Graham’s investment philosophy? Why does he think that’s best?

A: Graham's philosophy of investment is focused on safety of principal and earning a satisfactory return. He is focused on understanding the intrinsic value of an investment versus price. Intrinsic value is justified by the facts like the assets, earnings, dividends, definite prospects, and not from market quotations. He also points out that security analysis does not seek to determine exactly what is the intrinsic value. It only needs to establish either that value is adequate or considerably higher or lower than the market price. (p70) For example, it is quite possible to know if someone is old enough to vote without knowing their exact age. So it’s best to establish a margin of safety for any investment. He thinks it's the best approach to achieve safety of principal and satisfactory returns because of inherent obstacles in applying security analysis 1/ Inadequate or incorrect data 2/ Uncertainties of the future and 3/ Irrational behavior of the market. (p72)

Q3: Which parts of his approach do you think you want to imitate? Which ones do you think you would rather not? Why?

A: Parts that I think I would like to imitate would include 1/ Putting safety of principal first 2/ Classifying securities by characteristics, instead of just thinking about stocks and bonds as labels 3/ Valuing securities based on facts instead of market price, and accepting that value only needs to be roughly correct, instead of a precise number. This is primarily based on my temperament to avoid significant mistakes vs chasing the highest returns.

Something that I would likely not be able to imitate as well would be to highly focus on quantitative factors to find securities with most value. This is primarily limited by time spent on analyzing number of securities. I’d be ok to own a quality business at a fair price, maybe not at the best price.

Q4: What’s the difference between an investment and a speculation? Why did Graham choose the words that he did to define it, and what are the implications of his choices for investing?

A: Graham's definition is “an investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” He specifically chooses the term “investment operation” to think beyond just an issue. He's referring to the act of investing, which may justify a specific issue at a certain price and not at another, or a combination of issues which together may justify making an investment. Additionally, thorough analysis, promise of safety, and satisfactory return are not precise. Thorough analysis requires study of fact against standards of safety and value. Safety is not absolute or complete. It means protection against loss under all normal or reasonably likely conditions or variations. Satisfactory returns allow for capital appreciation or profit, as well as current interest or dividend yield. Satisfactory is a subjective term to show any rate or amount of return that an investor is willing to accept, provided he acts with reasonable intelligence. (p109) So his ideas are focused on avoiding serious misunderstandings such as bonds are investment and stocks are speculations. He also talks about the four elements of investment - 1/ The security 2/ The price 3/ The time and 4/ The person. (Ch 2) Person refers to the circumstances of the investor. Time refers to when an issue is analyzed, which may affect the conclusion. Price determines margin of safety as the danger of paying the wrong price is almost as great as that of buying the wrong issue. The Security refers to the character of the enterprise and the terms of the commitment. Instead of asking in what security and at what price, we should ask in what enterprise and on what terms is the commitment proposed? Together these factors help answer “Should security S be bought (or sold or retained) at price P, at this time T, by individual I?”

https://www.linkedin.com/pulse/making-financial-reality-obvious-when-metrics-tell-real-tonkikh-hnsse

Lattice Notes, your point about the time required to analyze a large number of companies caught my attention.

I have been working on exactly this problem, but from a different angle.

What if we could evaluate thousands of stocks using the same quantitative rules, rank the entire investment universe, and only then decide which companies deserve deeper research?

The idea is not to replace fundamental analysis, but to avoid limiting our investment opportunities simply because we cannot research every company individually.

I call this approach the Sorted Stock Universe. Rather than screening stocks out, we keep the entire market in view, ordered by investment priority.

I recently published the methodology in the first part of my manifesto, if you're interested:

I'd be interested in your view on whether this could change the trade-off between research depth and market coverage.

Oct 9Edited

### Question 0: Come up with as many other dimensions of an investing style as you can and provide a scale for each of those dimensions (e.g. Diversification [high to low]).

1. Risk [0-3 month US treasuries *to* 0DTE OTM options]

- This axis is arguably where one draws their line in the sand for investing vs speculating vs gambling, but I like to push the axes to the boundaries as I perceive them (process focused rather than definition focused).

2. Intended holding period [µs *to* decades]

- I know HFTs are a bit extreme but figured I'd include them, even though that's arguably trading rather than investing.

3. Growth vs. Income [no dividend *to* no expected change in principal]

- Again, pushing to boundary conditions regardless of instrument.

4. Long vs Short [long only, long/short, short only]

5. Fundamental vs. Technical [balance sheet and income driven only *to* pure data analysis on price action alone]

6. Trend-following vs. Contrarian [riding momentum *vs* finding mispriced assets that are actively being beaten down by momentum]

7. Hedged vs Unhedged [long stocks + protective puts *to* long/short only]

- I'm sure there are more advanced mechanisms of hedging, and one could argue this is a subset of the 'Risk' axis.

8. Mathematical vs. Psychological [purely numbers driven *to* purely narrative driven]

- Tough to imagine a purely narrative-driven investor, other than con artists and frauds, but again we're pushing to the boundary as most folks would probably incorporate it to some degree.

9. Passive vs. Active [buy an index or allocation of assets and hold for life *to* consistent study of individual company financials for selection of individual securities]

10. Unleveraged vs. Leveraged [full ownership of an asset *to* futures or forex at 20:1 or beyond]

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### Question 1: When did Graham write the first edition of Security Analysis and how did the environment during which he was operating and writing influence his work?

The first edition was published in 1934, coming out of the trough of the Great Depression. The examples in the text were striking; for example, "In 1939, despite a short-lived surge of trading on the outbreak of World War II in Europe, the turnover ratio had fallen to a shockingly low 18.4%. (For comparison, in 2007, the ratio of trading volume to listed shares amounted to 123%.)" - pg. 5, 6th edition

The drop in the markets, and especially the bank failures, set a tone unlike anything in the modern era. The lack of turnover described in the quote struck me because liquidity is a major factor when contemplating risk. It's tough to imagine selling or buying without moving the price when there is such a lack of liquidity, and that would really make one feel trapped in their position. It's a sentiment that Buffett carried forward and echoed in interviews over the years, saying he couldn't care less if the market was closed for the next few days, or years even. I appreciate the depth of analysis and experience that leads one to have such courage in their convictions and conclusions.

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### Question 2: What’s Graham’s investment philosophy? Why does he think that’s best?

Graham begins chapter one by discussing the power of analysis and the scientific method while acknowledging that investing is still an art with room for subjective judgement. Nonetheless, to mitigate the role of chance, to preserve the safety of capital, and to maximize odds of higher expected returns, he prefers to purchase assets with a higher perceived intrinsic value than the current market price. Published financial data lays the groundwork for this model, with less emphasis on forecasts and future earnings projections, yet he points out that one must leave room for uncertainty in one's model of intrinsic value; thus, the importance of a margin of safety.

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### Question 3: Which parts of his approach do you think you want to imitate? Which ones do you think you would rather not? Why?

This is a tough question. In principle, I want to use the information in 10Q/K statements to form a rigorous model of intrinsic value. I'm not sure I've made it far enough in the book to come up with any concrete objections or differences I have thus far. Of course, one has to update for current business models, many of which are (were?) capital light, and instruments available to express one's stance.

Perhaps one difference is that I anticipate buying commodities, managed futures ETFs, etc as diversification mechanisms. While one might call them speculative based on Graham's definitions, it is tough to argue with historical data from the last 100+ years that something like gold can serve a role during periods of intense inflation coinciding with stretched equity valuations.

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### Question 4: What’s the difference between an investment and a speculation? Why did Graham choose the words that he did to define it, and what are the implications of his choices for investing?

"An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative." pg. 106, 6th edition.

Graham chose these words to put the focus on risk while providing methodological grounding.

One implication Graham proposes is that investments guard against the future and are grounded in the past (data), whereas speculation often depends entirely upon future prospects. Similarly, Graham contends that stocks of quality companies will often be pushed to prices that he regards as speculative and that much of Wall Street may disagree. Another implication is that one may break the current price into a sum of investment value and speculative value.

Investing is definitely part art and part science.

I think, Graham said that he judges "investment operations" for their promise of safety and return, not a security or an individual transaction precisely in order to allow for something like your idea of commodities, gold or managed futures to be part of a portfolio in order to add a Reasonable expectation of return at an improved safety profile at the portfolio level. I don't know enough about your specific tools mentioned to try to guess whether Graham would've seen them as being reasonably likely, after an indepth analysis, to provide that improved portfolio return and safety, but his definition of (intelligent) Investing did not proclude you from making that judgment.

Along those lines, Mark Spitznagels Safe Haven investment (2% on deep OTM puts) would feasibly have passed Graham's test even though it's a complete "speculation" at the transaction level.

I think you're right; Graham would likely take an operational rather than transactional view.

I really enjoyed reading "Chaos Kings" about Mark and Nassim's tail hedging!

Oct 14

Thank you for the book recommendation.

Just to make it sure; did you mean this one? https://www.goodreads.com/book/show/62918551-chaos-kings?ac=1&from_search=true&qid=FcB3DQWEsD&rank=5

Oct 14

Yeah, that's the one. It's mostly narrative as opposed to technical; it might be a good candidate for listening to the audiobook version while commuting, exercising, or something :)

Question 1: Graham was investing heavily up until October 1929. When the large crash happened. At that time he still had some fundamental ideas and fundamentals about companies. But the crash happened and it lost 20% and he thought he was in the clear but it continued for another couple years and he lost almost 70%. That's around when he started writing Security Analysis in 1934. And looking at really how to protect himself for from future calamities. So valuing businesses and getting a margin of safety to reduce any risk of large drawdowns or reduce that risk of large drawdowns. At this time also the SEC was being formed and that was also maybe part of his thought process as well in terms of more information coming from companies and the ability to do some more due diligence.

Question 2: Graham’s major investment philosophy was to find companies that are trading within their, investment price, rather than speculation price. Looking at net nets or liquidation value and determining what the company is actually worth.

Question 3: What resonates with me is the margin of safety, figuring out roughly what a company is worth and using that as a means to buy. Treating the investment as a business rather than a stock ticker is a critical mindset. Focusing on liquidation value or very cheap stocks, misses some of the great businesses that exist.

Question 4: Graham’s words or his thoughts were investment is defining the actual value of the company, whether that's liquidation value or the value that he's deeming. Speculation is any amount above that. He viewed that any portion that is speculation may no longer exit. So if a company is trading for $30 and the value of the balance sheet or the liquidation is 15, then 15 is the investment and anything above that is speculation. Those are chosen words to help clarify the downside that exists, the speculation portion can disappear at any moment.

Q0:

- Valuation prism - Relative vs Absolute

- Research space - Technical vs Fundamental

- Research space - Quantitative vs Qualitative (Story Investing)

- Valuation basis - Growth (prospective value) vs Existing Value

- Process - Quant screen based vs Research based

- Decisions Making - Rules vs Judgment

- Segment focus - Stable/Predictable vs Turnaround investing

- Divergence - sector and factor balanced vs solely value driven

- Fishing area - home market, core sector competency vs open to anywhere value appears to surface

- Ongoing and/or growing concern valuers vs liquidation or take-over valuers

- Technical Arbitrage (vs whatever non-arbitrage type of investing would be defined as)

Q1:

First edition was written in 1934, when the US markets, and his own fund, had suffered extreme losses, combined with a deep financial market depression and its economic and social impact. It’s hard to believe but, allegedly, Graham went into the peak of the bubble with 40%+ leverage and in the crash lost 70% of his fund’s value. I can appreciate how those years would’ve crystalised many of the ideas he might have had already but previously thought of them as suggestions to be judged based on his day-to-day expert outlook.

Q2:

Graham’s investment philosophy centers on looking for Margin of Safety on stable, and thus somewhat reliable, intrinsic business value. "Never lose money" was a very attractive guiding light in his day, and while it might feel a bit dusty in today's market, I believe its gravitas will be proven out in the coming years.

Q3:

Parts of his approach I would like to imitate - critically reviewing the existing market to look for sources of trouble and then selecting a logical and safe(r) avenue to generate reasonably reliable, good risk-return outcomes - net-nets at times in his era, something different but equally ‘intelligent’ currently.

I wouldn’t want to focus on net-nets literally as the quality of the companies in the current net-nets universe might be rather “cheap for a reason”.

Within his context he comes down rather more than less on the side that investing with a substantial expectation for the future growth is a speculation, but that might be less clear cut if he were to write the book today.

I think it's hard to know what Graham would think about investing in the current markets because he wrote at a time of:

A market of average PE of 10-15 and a large portion of the market’s earnings being returned to the owners via dividends

Very limited corporate transparency

Stock markets early in their maturation - weak and passive SEC, very limited authority and participant oversight of company shenanigans

Limited globalisation - limited competition from overseas competitors with advantaged costs of factors of production

Most production being closer to commodity-like and largely local extraction of cost of capital level margin on production capex+opex

Very limited brand and intangible values

Almost inexisting companies with products of variable cost near zero

Very limited global monopolies with large economies of scale and network effects

Assuming that Graham was no less smart than Buffet and Munger and knowing that his greatest investment was in a fast-growing tangibles-light Geico I wouldn't be completely shocked if in 2010 we would have found Graham investing in global monopoly tech stocks (like Buffett chided himself not doing with google).

This doesn't negate at all the eternal precepts of Graham of - you're buying a business, market is a manic depressive servant and buying should be done below conservatively judged total future business returns.

Q4:

“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return”. Given his focus, at least in part, on making this book a practical guide for the individual investor in the 1940 market and the then-present complexity and risks involved in building a robust equity portfolio, he leaned hard on the side of senior securities with an unquestionable coverage of their obligations under the most strenuous market conditions. Because of the much greater inefficiencies of the 1940s markets, it was somewhat easier, also as per Buffett’s admission, to make high returns safely while doing the most common-sense things. Since then many of these opportunities have been arbitraged away and so beating the market now requires more particular or more contrarian insights, or more sophisticated or high-friction execution.

I enjoyed reading your characterization of the regime during Graham's era. I wonder if M2 or credit expansion and QE were significantly different from recent times and might be one of the driving forces? I also wonder if/whether that can/will continue. If it can't, it could be a catalyst for gravity to reassert itself, per your gravitas comment 😅

I haven't looked specifically at 1935-1940 period but the Great Depression involved a very large contraction of M2, which could even be a partly-good thing (Austrian School of Economics) but probably not when it happens as fast as it did then and with some limitations on how fast the prices could adjust (deflate).

The M2 expansion since 1980s and the grave distortions of the interest rates are very worrying indeed because of the second part of the quote - "How do you go bankrupt: slowly at first and then all at once". But because of the first part of the same quote, it's not clear how long we might keep muddling along, and hence unclear how to (counter)act this distortion.

Tibor V

I would like to apologize if my answers repeat or in a certain way similar to the thoughts and comments which have been already shared by my fellow members, but

as I prefer not to look at all on the earlier comments before posting my answer, I should fully assume (and apologize again) for any (potential and intentional) risk of repartition.

Before sharing my suggestions, I would prefer add some explanations in respect of my interpretation and thoughts about the dimensions and scale.

Depth of Research: Shallow or Deep

When we are talking about research, I am thinking mostly about the quality of it, which in general should be influenced by the energy, intelligence, analytical skills, experiences, the insights, perseverance of the individual who is performing it.

In order to be able to grasp the scale here, I would think about a bit more quantifiable factor(s) such as time spent on or invested in the research process. Once we have the time spent as a key factor for the scale, let’s add also a limitation of 1 year as a time frame for direct research to be able to suggest discrete values between the extremes of deep and swallow.

For simplicity, let’s assume that we have a year with 52 weeks, from which 2 weeks are “allocated” to holidays and it leave us 50 weeks available for work on the research potentially. If we consider that each week we have 5 days with 6-8 hours effective research each day, we will have ideally 1500 - 2000 hours per year.

For the sake of simplicity again, let’s use 2000 hours per year of direct research available on the companies in the portfolio.

It gives us also maximum discrete value 2000 (= 2000 hours) on the Depth of Research axis in case if we have only 1 company in the portfolio and based on the number of companies the discrete values are decreasing from 2000 to the minimum value and inversely the depth of research goes from deep to swallow.

Please note that for the sake of simplicity, the 1 year of direct research takes into account the time spent on each company once the investment decision made and the company was integrated in the portfolio.

Diversification: Very Diversified and Highly Concentrated

For the diversification dimension and scale, I will share some categories and examples based on qualitative and quantitative criteria. Please note that obviously these categories are subject of my subjective point of view and criterions (qualitative or quantitative).

In contrary to the Depth of Research dimension and scale, where I started at the maximum discrete value of 2000 (2000h), let’s go here for the minimum discrete value for this dimension’s starting point:

1. “Founders Mindset”

The Founders Mindset suppose that you are 100% (or around 99%) concentrated in one business or one stock.

We can add here as a (“classical”) example

⁃ Sam Walton (and his family) with Wall-Mart;

⁃ Bernard Arnault with LVMH;

⁃ Warren Buffet with Berkshire Hathaway.

2. Highly Concentrated

# of holdings: 5-10.

Examples:

⁃ Charlie Munger at Wheeler, Munger & Co.: By the end of 1974 the 2 mains holdings (Blue Chip Stamps, New America Fund) made up of 84% of the entire partnership’s value and as far as I know there were no significant number of other holdings.

⁃ Nick Sleep and Quais Zakaria at Nomad Investment Partnership: In their final year, they had only 3 holdings (AMZN, COST, BRK).

⁃ Li Lu at Himalaya Capital Management LLC Investments: the recent holdings are made up of 8 companies.

3. Very concentrated

# of holdings: 10-20.

Examples:

⁃ Mohnish Pabrai at Pabrai Wagon ETF: The top 10 holdings represent 65% of the portfolio’s value and knowing Mohnish indirectly I think it is highly doubtful that he has a portfolio with significant number holdings, i.e. >20.

⁃ Bill Ackman at Pershing Square: 14-15 holdings.

4. Concentered

# of holdings: 20-50.

Examples:

⁃ Seth Klarman at Baupost Group with around 25 holdings.

⁃ David Einhorn at Greenlight Capital with around 50 holdings.

5. Diversified

# of holdings: 50-70.

Example:

⁃ William Higgons at Independence AM with around 55 holdings.

6. Very Diversified

# of holdings: 70-200.

Example:

⁃ Joel Greenblatt at Gotham Asset Management with around 200 holdings.

7. Highly Diversified

Very Diversified portfolio from 200 holdings.

8. Entire market segment based on market capitalization

Let’s take the US larger capitalization (traded) companies represented by S&P 500 for example and translated into the portfolio either by an equally weighted or some subjective weighting of 500 companies.

9. Entire market for a given geographical area

Let’s take the US (traded) equity market represented by Russel 3000 and translated into the portfolio either by an equally weighted or some subjective weighting.

10. Entire market covering more than one geographical area

Let’s take the US and European (traded) equity markets represented by a combination of Russel 3000 and Stoxx 600 and translated into the portfolio.

For the scale, I would choose 1 (=1 company, holding). But for analytical purposes it is probably better to reason by category, which means 10 in this dimension.

Meaning that the hours spent on research for the first category should be around 2000h (=Deep research 2000), for the second category around 400h (=Deep research 400) per company (by taking the mid-point of the 2-10 companies), for the third category 134h (=Deep research 134) per company (again by taking the mid-point of the 10-15 companies) and so on.

As said, the categorization is quite subjective and in case of adding more categories or subcategories or increasing the number of holding by adding further market segment and geographical areas, the 10 categories proposed as solution for this question can be adjusted and multiplied by 2x/3x/10x.

If I am not mistaken the first edition of Security Analysis was written in the early 1930s and went for printing sometimes in 1933. This period was just right after of the Wall Street Crash of 1929 and the middle of the Great Depression and was characterized also by very depressed share prices and a gold mine of opportunities from the point of view of market price of the companies compared to their book values, intrinsic values or net asset values. Other main characteristics of this period, especially compared to today, the availably, quality of information and financial reporting and the lack of regulatory oversight over the companies.

Quoting from Graham-Newman Corporation letters to stockholders, Benjamin Graham’s corporation general investment policy (and a proxy for his also) was defined as:

⁃ “To purchase securities at price less than intrinsic value as determined by careful analysis with particular emphasis on the purchase of securities at less than their liquidation value.

⁃ To engage in arbitrage and hedging operations in the securities field.”

Unless we are in a situation where we bought a value trap, a business in a declining or though industry with difficult future perspectives (the relevant examples to add here can be Hathaway Manufacturing Company and Berkshire Fine Spinning Associates in the 1950s), the first point mentioned above can ensure that there is a very high probability that there won’t be a loss of capital and what we own is worth more, at the point of given time, compared what we have paid for.

The second point mentioned above if I am not mistaken required more unconventional approach at that time compared to the “mainstream” investment approach and philosophy, but at the end of the day the key elements should have been the intrinsic value (and the opportunity explained by the difference in prices), the probability of the success of the given operations and the time frame necessary that the operation folds out.

By talking about Graham’s investment philosophy, it is important to highlight the concepts or taking into consideration also the elements below:

⁃ Intrinsic value;

⁃ Basic concept of margin of safety;

⁃ Uncertainness of the future;

⁃ The irrational behavior of the market;

⁃ The importance of analytical judgment;

⁃ Fundamental analysis including qualitative and quantitative analysis of the company and the management.

I think that most of the element listed above for Q2 are quite relevant for me.

I would only underline one point, which I would use with some moderation or just as starting points: This is the Net Net or NCAV or cigar butt approach, as we only focus on the value in relation to liquidation value without considering the other main factors.

In my case, I would rather try to gravitate between the following 3 angles:Price/Value, Quality, Risk.

The easiest way for an answer is starting with quote from Security Analysis (In my case it is the second edition from 1940 and it comes from the page 63):

“An investment operation is one which, upon thorough analysis promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”

Really enjoyed your thorough thoughts and your reference to Graham's partnership language in your answer to Q2

Tibor V

Thank you for your kind words.

To add some further thought about Benjamin Graham's investment philosophy (nb. as I was a bit more generous in my explanation for Q0 in the earlier post I should manage frugally the “credits/space” for answer for the other questions which means I did not add this part), I like thinking also the following PostScript from the Intelligent Investor (Revised edition 2006, the page 533):

“Ironically enough, the aggregate of profits accruing from this single investment-decision far exceeded the sum of all the others realized through 20 years of wide-ranging operations in the partners’ specialized fields, involving much investigation, endless pondering, and countless individual decisions.

Are there morals to this story of value to the intelligent investor? An obvious one is that there are several different ways to make and keep money on Wall Street. Another, not so obvious, is that one lucky break, or one supremely shrewd decision – can we tell them apart? – may count for more than a lifetime of journeyman efforts. But behind the luck, or the crucial decision, there must usually exist a background of preparation and disciplines capacity. One needs to be sufficiently established and recognized so that these opportunities will knock at his particular door. One must have the means, the judgment, and the courage to take advantage of them. “

=> Story about Benjamin Graham widely known investment philosophy and (vs) his investment in Geico.

https://www.linkedin.com/pulse/making-financial-reality-obvious-when-metrics-tell-real-tonkikh-hnsse

Tibor, I found your attempt to quantify the relationship between research time, depth of analysis, and the number of companies particularly interesting.

But perhaps we don't need to allocate those 2,000 hours across companies in the traditional way.

What if we first evaluate the entire stock universe using the same formal, quantitative criteria and rank thousands of companies by investment priority? We could then concentrate our research time on the most promising candidates without losing sight of the rest of the market.

This is the idea behind my Sorted Stock Universe approach. I recently described its principles in the first part of my manifesto:

I noticed that you even mentioned the Russell 3000 and STOXX 600. These are exactly the kinds of investment universes I believe should be systematically evaluated rather than narrowed down in advance.

I'd be interested to hear what you think about this alternative to the traditional trade-off between research depth and market coverage.

Tibor V

Dear Andrei,

Thank you for your comments and question.

I think that because of one of my hero, Mohnish Pabrai, for answering the Q0, I went instead of a mile wide approach by an inch wide and a mile (2000h) deep approach.

Which means also from me that by trying to manage wisely (or at least not stupidly) this symbolic 2000h, if we are passionate about the subject matter, we should try to protect our attention, focus

If I am thinking about also this symbolic 2000h, if it is fully available to our passion, our obligation is to try to manage it wisely or at least not stupidly by protecting its allocation, our focus and attention.

Let me take one more step and try to develop my thoughts about the 2000h (and its protection) a bit further/deeper with the following 2 approaches:

Approach 1

If I should ask the question about the potential utilization of 2000h on investment opportunities (sourcing, research, analysis), in case of a “classical” filter-based sourcing, independently of “the tool” for the screening (Moody’s manual, Japan Company Handbook, or any Online Stock Screener) I like thinking about Venn diagrams in case of universe and efforts (i.e. protection of 2000h)

Let’s take the following theoretical examples:

Our main objective is to find a Good (Very Good) Quality Companies at a Cheap Price that can ensure with higher probability the loss of capital and reasonable or superior investment returns.

In this example, we can have the following categories for the companies at the specific period:

⁃ Cheap (or Very Good Value for a given price);

⁃ Not Cheap;

⁃ Good;

⁃ Not Good.

If we take an universe of 3,600 companies, in general we can see the following breakdown between categories (trying to consider a midway between a bubble and a burst situation):

⁃ Cheap - 1,440 (40%);

⁃ Not Cheap - 2,160 (60%);

⁃ Good - 720 (20%);

⁃ Not Good - 2880 (80%).

By applying a Venn diagram approach, we can have the following options for our universe

⁃ Cheap and Not Good;

⁃ Not Cheap and Not Good;

⁃ Not Cheap and Good;

⁃ Cheap and Good.

By looking for the “Holy Grail”, we focus only on the one reasonable option, i.e. “Cheap and Good”.

Nb. For the sake of simplicity, let’s ignore here the potential hit rate of the investor and related decision tree/probabilities and detailed distribution. We can intuitively see based on the numbers that the less crowded option should be also this last one.

Now, if we factor in the protection of 2000h, we should pay attention also on how we define our Holy Grail population, how we ask the question about it:

⁃ Is it first a Cheap company and then it should be a Good one also, or

⁃ Is it first a Good company first which should be a Cheap one at the moment of decision.

Given the number of companies for the key categories (Cheap - 1,440 vs Good - 720), the starting question and the Venn diagram can help to optimize the 2000h, maybe not stupidly.

Approach 2

For the second approach, I asked my “friend” Mohnish Pabrai for the following inspiration:

In order to avoid a) falling in love with a company, an investment opportunity; b) being caught by some confirmation and availably bias; c) spending too much time and deep dive for a late negative answer at the end, we should start thinking and identifying the NOs (why it is not a good investment opportunity, why it should be avoided, etc.) in order to eliminate the given opportunity as soon as possible and go for the next opportunity.

Let me excuse if it was a bit longer for a short answer, but I hope I could lay out my thoughts in an understandable way.

As for your question about Sorted Stock Universe approach, after a quick look, it made me think about James O’Shaughneessy and his strategies, especially the one with the application Value Composites. It can be very worthwhile to put in practice and see how it works.

Oct 13

Tibor, thank you for such a thoughtful response. I particularly liked your emphasis on protecting the investor's time, focus, and attention. In fact, this is very close to the central idea behind the Sorted Stock Universe: not to spend thousands of hours researching thousands of companies, but to organize the entire universe so we know where to focus our attention.

Your Cheap and Good example also highlights an important difference in our approaches.

I find the concept of "cheap" problematic because it cannot really be assessed independently of a company's other characteristics. Price is an observable fact, but whether a stock is cheap depends on how we define its value.

This is also where my approach differs from James O'Shaughnessy's value composites.

I don't try to estimate intrinsic value or identify cheap stocks through valuation multiples. Instead, I rank companies according to how consistently their actual financial results satisfy a set of predefined criteria, looking not at individual indicators in isolation, but at the relationships between them and how those relationships evolve over time.

I also consider how stock prices have actually reacted to changes in those fundamentals.

The result is not a division of the market into Good/Bad or Cheap/Expensive companies, but a continuously ranked investment universe. The investor can then concentrate deeper research on the most promising candidates without losing sight of the alternatives.

And I agree with your final point: putting the approach into practice and testing its results is essential. That's exactly what I'm working on now.

Andrew H.

Oct 8

I am primarily invested in actively managed mutual funds. What does Security Analysis have to do with that? I would submit: a lot. My investment philosophy has been shaped in large part by Graham and Dodd and their successors through the decades, and a primary task for me has been to identify mutual fund managers who share my views, whom I would trust with our money and our future.

I will look at the list of distinctions between investment and speculation listed on page 51 (reprint of 1934 first edition by McGraw-Hill, 1962). For all five of these distinctions I lean toward the investment side.

Investment - Speculation

1. In bonds - In stocks

I do have a large bond position, almost all of it in TIPS (which did not exist in Graham's day) and a short term Treasury fund. As for equities, Graham writes "certain especially sound common stocks have been rated as investment issues and their purchasers regarded as investors and not as speculators." I seek equity mutual funds that hold "especially sound common stocks."

2. Outright purchase - Purchase on margin

I avoid mutual funds that use leverage, or much of anything beyond currency hedges for international stocks. If nowhere obvious, this information is usually in the notes of the statutory prospectus.

3. Permanent holding - For a "quick profit"

The fund's annual turnover is a good indication.

4. For income - For profit

"... the doctrine that common stocks were the best long-term investments resulted in a transfer of emphasis from current income to future income and hence inevitably to future enhancement of principal value. In its complete subordination of the income element to the desire for profit, and also in the prime reliance it placed upon favorable developments expected in the future, the new-era style of investment.... was practically indistinguishable from speculation." (p. 52)

It is difficult to find mutual fund managers who would agree in practice with this. When they exist, their fund performance has lagged the indicies by a large margin for long enough that their client base has eroded.

Here, it important to distinguish between those whose stated investment goals sound like value investing, but who in practice are closet indexers to avoid lagging too far behind their benchmark. A few years ago, a well known value oriented balanced fund included six of the Mag Seven among their top ten equity holdings. So, I look at least at the top ten holdings and a cursory glance at any I don't recognize to gain a quick sense as to whether I would want to own them.

5. In safe securities - In risky issues

That brings me to Graham's famous dictum: "An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative." (p. 54)

The best one can do in seeking a mutual fund that engages in investment by this definition is to read critically their statutory prospectus and statement of additional information, and several annual reports, and investor letters. I pay little attention to past performance, but a great deal to these things, with low fees as another deciding factor.

This is a lot of work for one mutual fund. But my Intent is to find someone with whom to entrust our money for the long term. That deserves the same level of attention as the purchase of shares in a company.

These are ways in which Graham and Dodd have greatly influenced my investment philosophy and practice.

Andrew, I found your approach to selecting fund managers interesting, especially your emphasis on their investment philosophy and process rather than past performance.

But I have a question. Can we really assess the quality of an investment process without giving much weight to its actual results? A manager can follow a disciplined and consistent philosophy for years, but that does not necessarily mean the approach works.

And since you also look at the funds' holdings, how deeply do you evaluate the individual stocks? Is it mainly a check that the manager follows your investment principles, or do you also make your own assessment of their investment attractiveness?

Andrew H.

Good questions. Yes, the ultimate goal of investing (and speculating) is to make money. A seemingly perfect process and philosophy that consistently loses money has problems. But the process might underperform for decades and become a leader when conditions change, such as the vicissitudes of deep value investing over the decades. There are no certainties.

I do pay more attention to a fund's performance relative to its peers as opposed to funds with a very different style that might be outperforming by a large margin. I learned that from my early days in the 1990s and the dotcom crash; at that point, I was leaning too hard on overall past performance without regard to fund styles and watched one of my funds crash with as much vigor as it had skyrocketed, while my other fund, a stodgy equity income fund that avoided the high flying stocks because they paid no dividends, did relatively well through the multi-year decline that followed. I still am in it, and it has again been stodgy for over a decade, but it's thirty year performance has been more than adequate.

No, I don't do deep dives on the fund's top holdings, just a cursory look. Life is short.

Thank you for reading and commenting on my thoughts.