The One Investment Rule That Will Never Lead You Astray

When Bejamin Graham talked about stock market valuations, he often relied on trailing metrics like the P/E ratios over the past ten, fifteen, twenty year timeframe to determine whether a company was appropriately valued or not. You may wonder why this would be advisable, given that it is the growth of the business and the dividends paid out after you make your initial purchase that matters—not what the trailing metrics indicate.

What Graham understood was this: Using trailing P/E ratios rather than forward forecasts forces the investor to incorporate a margin of safety whether he likes it or not. It is a great way to guard yourself against undue optimism that sets the stage for disappointment. In his supplement to the shareholder letter this weekend, Charlie Munger explained one of Berkshire’s methodological advantages in this way: “It never had the equivalent of a ‘department of acquisitions’ under pressure to buy. … Read the rest of this article!