1. Don’t trust the market to value a stock. You’ve heard about the efficient market, where investors’ knowledge magically and correctly sets the best price for a stock? Baloney. Even when bales of information are available through the click of a mouse, the market is too often inefficient and prices don’t always reflect values. As Graham put it in the 1930s: “The market price is frequently out of line with the true value; there is an inherent tendency for these disparities to correct themselves.” Painfully, we might add. The fact that a hot young technology company is trading at $280 a share does not make it worth $280 a share. Its price could reflect a small float of available shares and the temporary effect of momentum traders, the ones who buy because a stock is already moving.2. Don’t think it’s easy to beat the market. You have to approach stock picking with a certain humility. It’s pretty hard to beat a broad-based index fund over a long period of time. After a lifetime of analyzing investment results, he wrote, “A creditable, if unspectacular, result can be achieved by the lay investor with a minimum of effort and capability; but to improve this easily attainable standard requires much application and more than a trace of wisdom.”3. Trend-following works over short periods, not long ones. Momentum investing–buying the stocks that have already had good runs in the past few months or so–has worked well recently. It can’t keep working. At some point the stocks that are already expensive become absurdly expensive. And then they crash.What’s the opposite of trend-following? The philosophy that price matters. Your objective as an investor is to pay less than a company is intrinsically worth as a business concern–worth being defined in terms of earnings, liquidating value or (perhaps) future prospects. Norfolk Southern is worth something because it owns tracks and has demonstrated an ability to collect more cash from these assets than it consumes. Microsoft is worth a lot because it generates far more revenue than it needs to pay in salaries to keep that revenue coming in. The software firm may be worth a higher multiple of its earnings than the railroad because its prospects are better, but it is not worth infinitely more.4. You can’t time the market. As someone with a mathematical bent, Graham spent much of his career trying to devise a good formula for when to get into–and out of–the stock market. All formulas, he concluded, failed. Stocks should be bought when they are available for comfortably less than your best estimate of their intrinsic value, and sold when you can collect comfortably more than that sum. But the broad direction of the market is impossible to gauge.In Graham’s view it was acceptable to let the apportionment of your wealth between stocks and bonds fluctuate somewhat, but he insisted that neither allocation ever exceed 75%. He also insisted on the wisdom of diversification–owning at least 10 stocks and preferably 30. In light of the larger number of issues available today, 100 is not too many. The first index fund was just being cranked up when Graham died, but we can surmise that he would have approved of it for investors without the time to do meticulous research.5. Base your expectations not on optimism but on arithmetic. In 1934 Graham summarized the kind of investing that leads sooner or later to capital losses: the view that a company’s assets are irrelevant and that past earnings don’t mean anything because values are only a function of the future. He was criticizing the prevailing frame of mind just before the 1929 crash. He could just as well have been describing today’s day traders. Graham would have found the Internet sector problematic, to put it mildly. Collectively the companies in this sector have no dividends, earnings or tangible assets to speak of. A favored alternative is revenues. But even this measure raises the eyebrows of no less an investor than Warren Buffett. In a series of recent speeches he warned against valuing stocks based merely on how much money they churn through.Graham wanted an investment that could benefit from an economic expansion but also survive a real crunch. For all investors but the ones willing to do the most extensive spadework, he recommended companies with strong balance sheets, a record of earnings for seven years and a dividend.Dividends? True, they make no sense to taxable investors, and Buffett’s own Berkshire Hathaway refuses to pay one. But for the majority of U.S. businesses, dividends remain the most convincing evidence that the reported earnings are real. The inflation-adjusted return on U.S. stocks over most of this century has been 7%, with more than half of that from dividends. Take a look at the returns of the Massachusetts Investors Trust from a $15 monthly investment beginning at the eve of the 1929 crash. Principal of $37,000 would have been transformed by now into a $3 million portfolio. One third of that return came from income, far more because it was reinvested.6. Buy OPOs, not IPOs. That is, buy old public offerings–not new ones. The problem with initial public offerings is that you’re buying what someone is trying too hard to sell. That should make you suspicious. Nowadays technology firms allow underwriters to deliberately under price their shares so that the shares will pop up on the first day of trading. But note that you usually can’t participate in the first-day run-up unless you are a favored customer of the broker.7. Buy cold industries. A new study by Ibbotson Associates going back to the depth of the Depression shows that with very few exceptions buying companies selling at a low P/E provided significantly higher returns. The 1990s were a stunning counterexample to this long-term principle. Okay, you wish you had bought Dell ten years ago. But what now?Graham was skeptical of technology companies because the “experts do not have dependable ways of selecting and concentrating on the most promising companies in the most promising industries.” Does that mean that companies on the forefront of developments are bad investments? Absolutely not. “In investment theory there is no reason why carefully estimated future earnings should be a less reliable guide than the bare record of the past,” he wrote.The problem arose, he said, because, typically, projections have been too optimistic for winners, too dire for losers. “The better a company’s record and prospects, the less relationship the price of its shares will have to book value,” he wrote, but that comes at a cost. “The greater the premium above book value, the more this ‘value’ will depend on the changing moods and measurements of the stock market.”Do you sincerely want to be rich? Don’t stake your future on a narrow bet. Invest with a view to underlying business values, and with plenty of diversification. But also invest like that exuberant bull John Raskob, with steady additions to your portfolio. If you do, you will survive a crash–and even prosper from it.8. Hang in there. Poor John J. Raskob. In his infamous, ill-timed interview in the August 1929 Ladies’ Home Journal, he declared: “Everybody ought to be rich.” And the way to do it was to invest $15 a month in the market–on margin. He wasn’t an idiot: Raskob was the financier who helped create General Motors and DuPont. His fatal error was overconfidence. Minus the leverage, Raskob’s advice was sound.”The common stocks of this country have in the past ten years increased enormously in value because the business of the country has increased,” he said. “It may be said that this is a phenomenal increase and that conditions are going to be different in the next ten years,” he continued. “In my opinion, the wealth of the country is bound to increase at a very rapid rate.” Sound familiar?
But there was a very important kernel of wisdom in Raskob’s plan. Today we call it dollar-cost averaging: a steady investment, month after month, year after year. Although the system is of dubious value in accumulating a single stock, it makes perfect sense as a formula for investing in a diversified portfolio