Understanding Ben Graham’s Principles of Operation

Principles of operation

The modus operandi or how to do it

In a speech in 1974 Ben Graham remarked that investing did not require genius: “What it needs is, first, reasonably good intelligence; second, sound principles of operation; third, and most important, firmness of character.” What did he mean by ‘principles of operation’? That’s what we will examine in this post.

Getting started

When we want to invest, we need to start somewhere. We need a foundation. This is simply our goal as investors. It might be something like maximum return after taxes. Next we look at what is variously called one’s investment philosophy, one’s investment style or one’s investment approach. My approach is to buy superb companies at bargain prices.

If the investment philosophy has been well conceived, the investor will have confidence to stick with it during the bad times. Paper losses on an all equity portfolio might, once or twice or perhaps even more, in an investing lifetime, exceed 50 percent at some point of extreme general financial crisis or deep recession.

That is not the point to be abandoning the philosophy. It is the time to see the bad times through and take advantage of opportunities. The investor seeking a superior return on their investments is happy that the stock market is both unpredictable and volatile. An investment approach based on sound principles of operation uses this to advantage.

Once you have that figured out, you need to settle on your investment process – the modus operandi. This is Ben Graham’s Principles of Operation.

Principles behind successful investing

Principles are just that. They are like policies or rules. I divvy them up into a dozen sub-topics. These range from looking at everything from a long term point of view to doing your homework and when to sell stocks.

What follows will be a listing of the Principles of Operation related to long term thinking. At the end of the post there is a link to other sub-topics.

The various Principles of Operation that follow are not things I have dreamed up. They are frequently quotes or exact formulations or wording from Benjamin Graham, Warren Buffett, John Templeton, Philip Fisher, Peter Lynch, John Neff, Maynard Keynes and others. The references are in the Motherlode.

First Principle of Operation – looking at the long haul

A long term view of things is critical. Psychologists call it framing. If you find yourself swept up in current events, the trick is to reframe for the long haul. Paradoxically, the long term in investing is more predictable than the short term. In the short term almost anything can happen. Long term things smooth out to averages.

Long term thinking

Explicitly set an investment horizon based on at least your life expectancy. For a 30 year old this might be 60 years. For a newly retired investor this might be 25 years.

Magic and, indeed, the power of long term compounding

Over the long haul stocks outperform other asset classes, thus maximize returns through common stocks

Saving on even 1% fees and commissions over the long term makes a huge difference

Buy shares only in companies whose earnings are virtually certain to be materially higher five, ten and twenty years in the future.

Buy only if you would be prepared to hold the shares for ten years.

Confine your investments to companies whose quarterly and annual reports demonstrate a credible commitment to a long term business philosophy.

Look for companies whose aggregate earnings have the potential to march upward over the years. They do not have to march steadily upward. There is a normal lumpiness to the earnings of even the best companies. The only earnings that grow steadily are those that are ‘managed’ (in the bad sense) by the CEO and CFO.

Expect that the bargain you buy may take several years to become fully priced
In evaluating companies study the long term business prospects of companies you are considering investing in and purposely underweight the ‘vistas immediately behind you’.

When looking back at the company’s record, underweight a few good years or a few bad quarters.

What you have just read is a summary list of principles promoting long term thinking in your investing. For a deeper read on the topic of promoting long term thinking see Chapter 12. Short Term Thinking and our Flower Garden . It particularly deals with the psychological side of the problem. As well you can look at my post: Overcoming mistaken short term thinking with Kahneman style risk policies

Other Principles of Operation

Readers can look at other topics in the following Sections of the Motherlode. At the end of each Section there is a link to a Chapter or Section of the Motherlode for a deeper read into that topic. For example, Section 27.04 The Economy, is followed by a link to Chapter 8. The Economy and the Stock Market – Cycles and Trends:

27.04 The economy

27.05 Superb companies

27.06 Company management

27.07 Homework

27.08 Value

27.09 Flexibility

27.10 Diversification

27.11 Balance

27.12 Buying

27.13 Selling

27.14 Managing yourself

27.15 Managing your portfolio

Want to dig deeper into the principles behind successful investing?

Click here for the Motherlode – introduction

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