Graham's Twelve Investment Principles

Red and Green Guide:

Benjamin Graham often said that there is no get-rich-quick method in the world, and often the simplest method is the best. He advised investors to maintain the right attitude, trust common sense, and think for themselves.

Principle 1: Maintain the Right Attitude

The primary goal of value investors is to protect capital and avoid losses. This simple logic teaches us that we can sacrifice some returns for safety while also controlling investment costs.

When your investment returns are not as good as your neighbor's, don't complain or let disappointment and dissatisfaction take over your mind. Maybe your neighbor is taking risks. As long as you still have your principal and your returns grow steadily and reasonably, your assets will continue to grow. If you lose your principal, whether in savings or investments, you lose the foundation.

An empty investment account cannot grow no matter what.

Principle 2: Ignore Predictions

Everyone has their own opinions about the economy, and many like to recommend their favorite stocks to others. Discussions and debates about the stock market reach fever pitch. Strangely, when the market rises, forecasters invariably believe it will continue; when the market falls, everyone thinks recovery is far away.

"I don't estimate or predict," Buffett said. "That often leads us to illusions about clear facts. The more cautious you are, the more anxious you become.

We don't make any predictions, but we pay close attention to and deeply study a company's historical performance. If a company's track record is poor but its prospects are promising, that's an opportunity." Charles Brandes believes that making predictions about investments is counterproductive, especially those promoted by analysts and the media.

"People gather all the information out of interest in a certain outcome, which inherently carries subconscious subjectivity. The so-called accurate conclusions they draw are precisely their fatal flaw. They remind me of Mark Twain's famous saying: 'A mine is just a hole in the ground owned by a liar.' Predictions about the U.S. are often proven to be rumors, though not necessarily intentionally. Worse, those who make predictions often believe in them."

Everyone has their own opinions, but that doesn't mean you shouldn't examine potential investment opportunities from multiple angles. Investing or building a portfolio depends on a company's past and future performance, but even the experienced Graham believed that predictions about the future can only be a "rough number" or pure fabrication. He also said that when analyzing, leave some room to ensure your margin of safety so you can sleep soundly at night.

Principle 3: Stick to Facts

William O'Neil repeatedly reminds us not to follow the crowd when investing. "People always like to refer to others' opinions, and personal opinions are often wrong." Although strong and inherent opinions can affect our view of reality, Buffett and other investment masters tell us that intuitive judgment based on training, experience, and information is the most powerful investment tool. Of course, so-called intuition must come from rich knowledge and reasonable judgment.

Principle 4: Look for Investment Opportunities That Don't Align with Market Conditions

David Einhorn points out that a stampede is a sign that the market is already overheated. "When an industry accounts for more than 30% of the index, it shows that the industry is generally popular with investors, such as the tech industry in 1999. It also shows that a lot of capital has entered these industries, and over-supply will inevitably lead to lower returns. If you're still in this industry, get out quickly."

He prefers companies that are out of sync with market conditions—those that operate steadily, have competitive advantages, and reasonable profit margins. Contrarians choose high-quality companies that are unpopular, such as Kraft Foods. These companies are inconspicuous in the market, and their actual value is often distorted, with prices higher or lower than intrinsic value.

When the economy was in trouble, tractor and agricultural equipment manufacturer John Deere successfully defied all analysts' predictions with its 2009 net income. During the same period, the S&P 500 fell by 0.3%, while the company's stock price unexpectedly rose by 5%.

Principle 5: Stay Away from Debt

"The only way a smart investor goes bankrupt is by borrowing," Buffett said. "When the market is up, leveraged investing makes investors ecstatic, but when the market is down, they're helpless. Smart investors don't support investments with borrowed money. When the market is rising, investors get carried away by success and lose control of their borrowing. When everyone is doing it, be careful to protect yourself."

Stick with companies with low debt levels and ample cash flow, and use your investment funds wisely. In addition, Buffett added, never treat your home as an investment asset or use it as a source of funds to buy a yacht, invest in real estate, or start a company.

"The real estate storm around 2009 taught homebuyers, lenders, brokers, and the government a good lesson, and this will ensure market stability in the future. Homebuyers should honestly pay a down payment of no less than 10%, and monthly loans should be within their means. When applying for a loan, the homebuyer's income level and situation should be thoroughly verified."

Principle 6: Embrace Market Volatility

Most of the time, stock market volatility is just normal short-term fluctuations. David Einhorn says market volatility hasn't stopped since Graham's time. "We all know the market has a certain cyclicality, fluctuating around a company's actual value."

"I like market fluctuations," Einhorn said. "When market movements contradict the reality reflected by fundamentals, opportunities also emerge. Think of small-cap stocks in 1999, junk bonds in 1991, and large-cap stocks and long-term bonds in 1982—all confirm this fact."

Einhorn isn't the only one who holds this view. Charles Brandes also saw opportunities in the 2007-2008 market crash. "We know very well that past performance doesn't guarantee future performance, but it's at least somewhat instructive."

Brandes said, "We believe that when people look back on this period, they will believe it was a golden age for investing." Brandes went on to explain that after the market crisis, stock prices remained at low levels, and high-quality investment opportunities were waiting to be discovered and picked up.

Principle 7: Listen to the Crew's Advice

Although value investors actively embrace market volatility and don't meticulously calculate the best time to invest, the various investment tools mentioned in this book can still serve as a compass for your investments. They will warn you when the sea gets rough. Overheated markets sometimes take a long time to return to normal, but that day will come sooner or later.

Isn't gravity what makes it easy to fall and hard to rise? All investors, including those in exchange-traded funds and mutual funds, should pay close attention to market developments and make necessary adjustments accordingly.

Some truths about ships also apply to investing. For example, "a rising tide lifts all boats"—a market upswing will inevitably push up stock prices, but a market downturn will mercilessly leave boats that didn't make it to safety stranded. Another example is "sailing against the wind"—sailors constantly adjust their sails according to the wind, and no matter the wind direction, they can reach their destination.

There are two types of winds to be wary of: the herd mentality that overvalues the market and the hurricane that sends individual stocks to high prices. So, what we should do is build a sturdy ship, skillfully navigate it in the market's ocean, and when we learn of an approaching storm, set sail for a safer harbor. A real-life example is what Buffett did in 1969 when the market was overheated. He frankly told his clients that there were no more bargains in the market, and then he closed his company.

Principle 8: Stay Calm When the Market Is Overheated

Seth Klarman advocates that investors must be prepared for danger in times of peace and guard against unexpected events. In short, the best investment strategy is to buy stocks, not the stock market. Investment decisions should be based on fundamental analysis of individual stocks, plus the ability to identify an overheated market, which is enough to ensure your investments are in a safe zone. An overheated market shows the following signs:

Stock prices hit record highs;

Price-to-earnings ratios soar;

Little to no dividends, and even when there are, they're at historically low levels, lower than bond market yields;

A flood of new stock issues;

A surge in margin trading;

Increased volatility in stock indices;

In times of market frenzy, investors seem to repeat past mistakes one after another.

"These are old lessons," Buffett said thoughtfully. "They're nothing new, and everyone knows them, but they're quickly forgotten when people are happy."

Principle 9: Diversify Your Investments

If you could predict the future, you wouldn't need to diversify. If all assets rise and fall together, diversification is redundant. Diversification requires us to build a broad asset base to achieve investment growth and safety.

"I want to emphasize that every investor should hold a certain amount of gold," David Einhorn said again. "Real estate, stocks, and hard assets should all have a place in your portfolio. Real estate should be concentrated in markets without bubbles globally, and stocks should be diversified globally."

Principle 10: Inflation Won't Disappear

Inflation is our invisible and hidden enemy. It destroys economies, severely damages businesses, and devours our personal wealth and happiness.

"Inflation will always be with you," Buffett said. "Over the long term, even small inflation is highly destructive." He believes the best defense against inflation is to maintain your profitability. "Alternatively, choose companies with low capital requirements, like Coca-Cola. Holding its stock allows you to share in the returns of the U.S. economy."

Principle 11: Face Investment Mistakes Calmly

Everyone makes mistakes, and investing is no exception. Prepare in advance, don't blame yourself after making a mistake, and move on. In his 2009 letter to shareholders, Buffett admitted that buying a large amount of ConocoPhillips stock was a major mistake. "I didn't expect energy prices to plummet in the second half of the year," he said bravely, acknowledging the severity of his mistake. "The wrong timing of the purchase cost Berkshire Hathaway tens of billions of dollars."

Over the years, Buffett has admitted to many mistakes after the fact. Sometimes, he jokes that he should join AA to break his habit of investing in airlines. But his outstanding investment choices have offset the impact of his mistakes, making Berkshire Hathaway a model of success.

Principle 12: Enjoy the Investment Process

Investing is full of fun and challenges, and it also brings investors a sense of joy. Why not think of investing as an adventure in this wonderful world?