Investment — Benjamin Graham’s Definition

In these heady times, with average PE ratios at over 20, it becomes easy to forget the basics of sound investing. Remember the words of Buffett’s own sage, Ben Graham, and return to earth before the market does.

In 1934, Graham intoned, “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”

Graham’s classic book, Security Analysis, was written in 1934, soon after the market crash of ‘29. Like Philip Fisher and the investing community at large, Graham was hurt badly in the crash. Like Fisher, but unlike the investor community, he went into the market heavily during the market’s nadir in the early 30s, and had already made out well by the late 30s, even before the Depression was over.

So Graham’s definition of investing is forged by the Depression, and sounds sort of like the Hippocratic Oath: first, do no harm to your principal. Whatever you do, don’t take a poorly understood or significant risk of losing your money, whether by overpaying or by buying something excessively speculative.

Think about what acts as a rational basis for the price you are paying, because that’s what will act as a floor when a shock comes.

For example, what is the company’s tangible net worth? How stable are earnings? How does the earnings yield compare to debt instruments of similar risk?

If you invest individually, make sure you understand the basics about what happens when the economy has a major shock, or the company you’re invested in has serious problems.

For example, do you know how your securities will be valued if the underlying company goes bankrupt? Many people simply don’t know that stock, especially common stock, is usually worthless after a bankruptcy, while bonds, particularly senior bonds, can retain much of their value.

A great source of information is the Securities Exchange Commission. Hey, you’re already paying for it in the form of taxes — might as well visit and read what they have to say about protecting your own wealth.