Investing Advice From Benjamin Graham

One of the underpinnings of Benjamin Graham’s financial advice to investors is that, at a certain price, ninety-nine out of one hundred companies in existence become attractive at a certain price. This is true even for the companies that you identify as mediocre, simply because they could theoretically reach a price so low that you can’t help but do all right.

Take a company I would never want to own over the long-term: Best Buy. Under a Graham analysis, there is a point where the company gets so cheap that it would necessarily become a successful investment over the intervening years. Let’s stipulate that the investors in the marketplace somehow decide to value the shares at $10 each. That would knock the valuation down from the current $14 billion down to $3.5 billion. Meanwhile, the company is still pumping out $850 million in annual profits. It’s hard not to get rich when you buy a stock with a 24% earnings yield. Best Buy could simply pay out all of its profits as dividends, you’d have your investment returned to you within four years simply due to the cash extracted from the enterprise.

That’s an extreme example, but it’s how Graham’s analysis works: you size up every company, and calculate at what prices things would get so cheap that you could not help but make money. Very few stocks will be trading at those “gimme prices”, but when they are, you should seize the opportunity and buy.

Instead, though, I want to talk about the 1 in 100 (or whatever the rare odds may actually be) cases in which Benjamin Graham actually advocated that investors should refuse to even consider investing in the stock.

The first situation is when the company does not have accurate accounting. When Joseph Silveira killed himself after analyst Mark Roberts called the popcorn and kettle chip maker’s accounting policies into question, you’re not supposed to react: “Oh, shares are down 20%, therefore it’s a bargain and I should buy.” The logic is that if you can’t trust the numbers, then you can’t perform real analysis. The determination that a stock is cheap is based on understanding the relationship between a company’s profitability and the stock price you can acquire your ownership stake, and if you can’t trust the numbers on the profitability, then you can’t make an informed decision without that proper foundation.

Lawsuits, product recalls, shrouds of reputational risk, and so on, are reasons why investors should flock to a company in search of a “value” investment. But, according to Graham, you shouldn’t go run to a company that has accounting issues. That’s an opportunity best left unpursued.

The other issue, and the one that I think is most discarded right now because of the relative peace in the world, is that you should not invest in a country whose economic infrastructure and legal protections that you do not trust. For the most part, all of my investments are domiciled in the United States or Great Britain, and I’m open to going to Switzerland for Nestle at some point in time.

But I would have no desire to own stock in a company in which it is even a low likelihood possibility that we could go to war. During the Second World War, it was typical for certain communist/socialist countries to cancel the stock certificates of American investors and reissue the ownership at discounted rates to political patrons. Heck, China even called the stock certificates of some Chinese investors during the war, nationalizing the ownership stakes so that the government could run them.

During prolonged peace times, it is easy to get lulled into complacency against thinking that the world can change in an instant. The best protection, I believe, is to keep most of your wealth in American stocks, British stocks, and potentially, Swiss stocks. You don’t want to really on a potentially hostile government to enforce your legal ownership interests.

When Graham was giving speeches in New York after the World War, he cautioned against pursuing seemingly lucrative investments in war-torn Europe because he did not have faith that his ownership stake would be fully enforced.

The point isn’t to be paranoid, but rather, to recognize that peace-time can encourage investors into taking risks that they may not normally consider. Personally, I’m content to get exposure to China through blue-chip operations. Buy some Pepsi stock, and know that 10-15% of their profits come from Asian operations. That strikes me as the most sensible way to “globally invest.” That way, I’m participating in their growth, but if something adverse happens, I don’t get wiped out. If China shut its borders to Pepsi, I’d only take a 15% earnings hit and I’d still benefit from soda sales in the United States, Canada, Mexico, and so on. I’d rather calculate my risks into other countries through large multinational enterprises rather than invest abroad in Chinese domiciled corporations outright, but that’s just me.

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4 thoughts on “Investing Advice From Benjamin Graham

  1. mjwrona says:

    Tim – This is a good point.  Political stability is often overlooked.  

    The only country I would add to your list of ok countries is Canada.  They are just as much a part of the Anglo-American system as the US and Great Britain.  And Canadian telecoms and banks are great values for dividend investors.  I suppose the same case could be made for Australia.

    Gotta go now and actually pay for the new Bruce CD.

  2. scchan_2009 says:

    Remind a joke my uncle said: He claimed he had found a great way for Uncle Sam to clean up his debts: If PRC goes to war with US, all the T-Notes and T-Bonds held by Chinese banks will become worthless (laugh).

    I do wish to note after WWII, the world has generally been comparatively peaceful. Most of the most politically dangerous nations are "uninvestable" (like Sudan or Afghanistan) by retail investors to begin with. The possibility of a major conflict between major powers has actually been decreased after the first nukes were dropped in Japan; instead PRC and US (possibly the world largest rivalry now) are so dependent with each other and are mutually destructive that it means the possibility of conflict is thin. I am more worry what would North Korea or "Osama II" will do (neither like US, and Islamic fundamentalists hate Uncle Sam as much as PRC).

  3. mpaggeot says:

    I see you mentioned NESTLE.  Doesn’t computershare offer NSRGY?  Whey do you mention the Swiss shares?  I’m just curious, because nestle is on my current buy list.  I started a drip with Royal Dutch Shell at computershare and I wasn’t real happy that they were A shares.  Just curious.  ty

  4. scchan_2009 says:

    Nestlé is a buy and hold forever stock. 🙂 Too bad I bought Unilever, so I am officially an “enemy” of Nestle and P&G now (laugh).
    Shhh you can’t go wrong too much with any of the above three 😉

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