Benjamin Graham is widely regarded as the father of value investing and his teachings laid the foundation for Warren Buffett’s investment philosophy. As a professor at Columbia Business School and the author of The Intelligent Investor and Security Analysis, Graham developed a systematic approach to investing that emphasised buying stocks at a discount to their intrinsic value to reduce risk and maximise returns.
Buffett studied under Graham at Columbia in the early 1950s and later worked for him at Graham-Newman Corporation. During this time, he absorbed the core principles of value investing – the importance of intrinsic value, the margin of safety and the irrationality of the stock market. These lessons shaped Buffett’s early investment strategies and guided his decisions in the first decades of his career.
However, while Graham’s influence on Buffett is profound, Buffett’s investment approach has evolved significantly over time. With the influence of Charlie Munger, Buffett transitioned from Graham’s strict deep-value investing principles to a more refined strategy that focuses on investing in high-quality businesses with durable competitive advantages. Understanding this evolution provides valuable insights for investors seeking to apply Graham’s timeless principles while adapting to modern markets.
CORE LESSONS BUFFETT LEARNED FROM GRAHAM
Value investing: Buying stocks below intrinsic value
One of the core tenets of Benjamin Graham’s philosophy is value investing, which focuses on identifying undervalued stocks trading below their intrinsic value. Graham believed that many stocks become mispriced due to market fluctuations, investor sentiment and economic uncertainty, which creates opportunities for disciplined investors.
Buffett adopted this principle early in his career, searching for companies whose market prices were significantly lower than their true worth. Graham’s method relied heavily on quantitative analysis, looking at metrics like the price-to-earnings (P/E) ratio, price-to-book (P/B) ratio and earnings stability.
Graham’s approach was often called ‘cigar butt’ investing – a strategy where investors seek out stocks that are so cheap that they still have a few puffs of value left before being discarded. This method focused less on the quality of the business and more on finding extreme bargains. Buffett’s early investments reflected this thinking, as he sought stocks that were selling for less than their net tangible assets, regardless of business quality.
An example of this in practice was Buffett’s early investment in Dempster Mill, a struggling windmill manufacturer. It was deeply undervalued based on its balance sheet, which showed more cash and assets than its market capitalisation. Buffett bought a controlling stake and improved the company's efficiency to unlock value – a classic Graham-style investment.
The margin of safety principle: Reducing downside risk
Graham emphasised minimising risk through the margin of safety principle. This principle states that investors should only buy stocks at a significant discount to their intrinsic value, providing a buffer against errors in judgment or market volatility.
The margin of safety acts as a protection against uncertainty. Even if an investor miscalculates a company’s value or unforeseen events occur, buying at a deep discount reduces the likelihood of significant losses. Buffett fully embraced this concept and has repeatedly stated that risk comes not from market volatility, but from not knowing what you are doing.
For Buffett, applying the margin of safety meant waiting patiently for opportunities where high-quality companies became undervalued. He has consistently avoided speculative investments and instead focused on preserving capital while maximising returns over time.
Market irrationality: Understanding Mr. Market’s emotional swings
One of Graham’s most famous concepts is Mr. Market, an allegory that illustrates the stock market’s emotional and irrational nature. Graham described Mr. Market as a manic-depressive character who offers investors wildly different prices for stocks on different days – sometimes overly optimistic and at other times deeply pessimistic.
Buffett took this lesson to heart, recognising that market prices do not always reflect a company’s true value. Instead of reacting emotionally to short-term price movements, he focuses on business fundamentals and long-term prospects.
This principle has been critical to Buffett’s ability to remain calm during market downturns. When others panic and sell during crashes, Buffett sees opportunities to buy great businesses at discounted prices. Conversely, when markets are euphoric and overvalued, he exercises caution and avoids overpaying.
DIFFERENCES BETWEEN BUFFETT AND GRAHAM
How Buffett evolved from deep-value investing to high-quality businesses
While Graham’s influence on Buffett was profound, Buffett eventually departed from strict value investing in favour of buying high-quality businesses with durable competitive advantages.
This shift was largely influenced by Charlie Munger, who helped Buffett realise that it is better to buy a great business at a fair price than a mediocre business at a bargain price.
Graham’s approach focused on finding statistically cheap stocks, often based purely on numerical metrics. Buffett, however, began to prioritise business quality, competitive advantages and strong management teams. Instead of only looking for deep-value plays, Buffett started paying fair prices for companies with exceptional long-term potential.
A clear example of this transition is Buffett’s investment in See’s Candies. The company was not statistically cheap, but it had a strong brand, loyal customers and pricing power. Buffett realized that the ability to generate consistent cash flow and reinvest profits efficiently was far more valuable than just buying assets at a discount.
The role of Charlie Munger in refining Buffett’s approach
Charlie Munger played a crucial role in shaping Buffett’s modern investment philosophy. Munger encouraged Buffett to move away from deep-value investing and instead seek out companies with long-term growth potential.
Munger’s influence led Buffett to:
Focus on economic moats: Competitive advantages that allow businesses to maintain strong profitability over time.
Invest in consumer brands and industry leaders: Coca-Cola, American Express and Apple fit this refined strategy.
Pay up for quality rather than obsessing over low price-to-book ratios.
This evolution allowed Buffett to compound capital more effectively over the decades, turning Berkshire Hathaway into one of the most successful investment firms in history.
KEY TAKEAWAYS FOR INVESTORS
How Graham’s principles remain relevant today
Despite Buffett’s evolution, Graham’s core principles remain timeless and applicable to modern investing. Investors can still apply his lessons by:
- Looking for stocks trading below intrinsic value.
- Ensuring a margin of safety to protect against market downturns.
- Recognising that markets are often irrational, creating buying opportunities.
Graham’s conservative, risk-averse strategy is especially valuable during economic uncertainty, as it prevents investors from making reckless decisions.
Balancing strict value investing with seeking quality companies
While deep-value investing can still work, Buffett’s transition shows that quality should not be ignored. Investors today can strike a balance by:
- Screening for undervaluation but prioritising companies with strong competitive advantages.
- Being patient and waiting for market opportunities to buy high-quality businesses at reasonable prices.
- Using Graham’s fundamental analysis as a foundation while incorporating Buffett’s focus on long-term growth.
By combining Graham’s value principles with Buffett’s focus on quality businesses, investors can develop a robust investment strategy that benefits from both undervalued opportunities and long-term compounding growth.
Buffett’s journey from a strict Graham-style value investor to a long-term business owner highlights the evolution of investment thinking. While he never abandoned Graham’s principles, he refined them to focus on business durability, economic moats and quality over deep-value bargains.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.