In The Intelligent Investor, Benjamin Graham famously writes that: “Investment is most intelligent when it is most businesslike.”
Graham viewed any purchase of a stock or bond as an investment in a business, rather than the purchase of just a piece of paper. And if you are looking to make profits from your investments, then you are embarking on a business venture of your own.
Consequently, successful investing must be conducted in accordance with tried-and-true business principles.
In the very last pages of The Intelligent Investor, Benjamin Graham points out four accepted business principles that should also be applied to investing:
1. Know Your Business
Know what you are doing – know your business.
Benjamin Graham
In order to be successful, the operator of a business needs to know the value of the goods that he or she is selling – in order to set a correct price – and the value of raw inputs – in order to pay a fair price.
As an investor, you shouldn’t try to earn excess returns from an investment unless you know as much about the value of the asset as you would need to know about the value of merchandise if you were running your own business.
2. Managers Must Be Honest and Competent
Do not let anyone else run your business, unless (1) you can supervise his performance with adequate care and comprehension or (2) you have unusually strong reasons for placing implicit confidence in his integrity and ability.
Benjamin Graham
For an investor, this rule should determine the conditions under which you’d permit someone else to decide what is done with your money.
If you are investing in a stock, is the CEO an honest and capable manager? If you are investing in an actively managed mutual fund, have you done your due diligence on the portfolio manager?
3. Keep Away from Projects in Which You Have Little to Gain and Much to Lose
Do not enter upon an operation – that is, manufacturing or trading in an item – unless a reliable calculation shows that it has a fair chance to yield a reasonable profit. In particular, keep away from ventures in which you have little to gain and much to lose.
Benjamin Graham
This means that your investing decisions should be based on arithmetic, and not optimism. If you are limiting your investment return (e.g. in a bond purchase), then you better be limiting your risk too.
4. Have the Courage to Act – Even Though Others May Hesitate or Differ
Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it – even though others may hesitate or differ.
Benjamin Graham
As Benjamin Graham puts it:
You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.
In the world of value investing (where a contrarian position is often the norm), courage becomes the most important virtue (once adequate knowledge and thorough analysis have been achieved).
Summary
Benjamin Graham looked at investing as (a) an investment in a business, and (b) a business operation itself. This is something that rubbed off on Warren Buffett.
Check out some of these quotes from the Oracle of Omaha:
Buy a business, don’t rent stocks.
Never invest in a business you cannot understand.
Draw a circle around the businesses you understand and then eliminate those that fail to qualify on the basis of value, good management and limited exposure to hard times.
I am a better investor because I am a businessman and a better businessman because I am an investor.
An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.
Not only do these quotes reflect Benjamin Graham’s idea that investing should be businesslike, but they also reflect the 4 business principles Graham thought should also apply to investing.
In fact, the 4 principles Warren Buffett applies to all of his investment decisions are nothing more than an updated version of Benjamin Graham’s own 4 business principles:
- “Know your business” (Graham) becomes “A business we understand” (Buffett)
- “Management must be able and competent” (Graham) becomes “Operated by able and trustworthy management” (Buffett)
- “Keep away from projects in which you have little to gain and much to lose” (Graham) becomes “With favorable long-term prospects” (Buffett)
- “Have the courage to act – even though others may hesitate or differ” (Graham) becomes “Available at a very attractive price” (Buffett)
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