Big Mistakes

Humans naturally seek explanations for events in the world; neat little rules and tidy formulas that package things up into clear explanations. Unfortunately, the world is far too complex for this to really work – and as the legendary investor Benjamin Graham demonstrated, this is particularly true with investment.

Graham had a wildly successful financial career and authored the most influential investment book of all time: The Intelligent Investor, which was deemed “the best book on investing ever written” by the legendary Warren Buffett. But Graham’s most important act was pioneering a powerful new financial technique called value investing.

And at the heart of this concept is Graham’s observation that the price of a company fluctuates more than its value. This means that the cost of a company’s shares – its price – often doesn’t reflect the company’s value, which is a combination of things like revenue, assets and future potential.

So, why this difference between price and value?

Well, it’s because humans set prices while businesses set values – and because humans are more fickle and emotional than businesses, price and value can vary considerably. For example, when Graham watched General Electric’s valuation plummet from $1.87 billion to $784 million in the 1930s, he noted that nothing disastrous had happened to the company’s assets, employees or revenue that year – it was simply investor optimism and pessimism driving these changes.

But even Benjamin Graham couldn’t concoct a market-beating formula, and his philosophy almost ruined him during the Great Depression. After watching prices skyrocket during the 1920s, he sensed that prices and value were way out of sync. So, he decided to bet against the market, predicting prices would fall. And he was right – except he misjudged the extent of the fall.

By 1930, the stock market had taken a beating. Assuming that the worst was over, Graham began to invest heavily once again. But prices kept falling, and the market wouldn’t truly bottom out until 1932; by that time, Graham’s portfolio had lost 70 percent of its value.

Experiences like Graham’s prove there are no iron-clad laws in investing, and certainly no magic formula. Being aware of value is critical, but don’t be a slave to it. Cheap can always get cheaper.