Personal Finance

The classic Graham vs Buffet debate

Siddharth Bothra | Updated on May 17, 2020 Published on May 17, 2020

While the essence of both the schools is similar, the difference lies in approach

If investing were a religion, the two dominant cults would be ‘value’ and ‘growth’.

The disciples of Benjamin Graham are referred to as ‘value investors’, while the disciples of Warren Buffett/ Charlie Munger are referred to as ‘growth investors’.

The basic tenets of both, we believe, are the same. Only the approach differs.

Evolution of styles

Ben Graham is commonly credited with establishing security analysis as a discipline and is called ‘the father of value investing’.

Graham’s aim was to buy securities only when their market price is significantly below the calculated ‘intrinsic value’. He referred to this gap, between value and price, as the ‘margin of safety’.

Buffett had started off as a Grahamite. However, his style of investing transformed after he met Charlie Munger.

From finding bargains through price, his focus shifted to finding bargains by buying superior businesses, with sustainable and profitable long-term growth.

Despite Buffett’s transition to growth investing, the key essence of capital protection remained, which is reflected in the Buffett’s most famous quote: “Rule No 1: Never lose money. Rule No 2: Don’t forget rule No 1”. Therefore, while the essence of both the schools is similar, the difference lies in the approach and how one measures the ‘margin of safety’.

Key differences

Bruce Greenwald, the Robert Heilbrunn professor emeritus of finance and asset management at Columbia Business School, says value investors consider the following three-element approach to calculating intrinsic value: i) the reproduction cost of company’s assets (asset valuations); ii) the current earnings power value of any franchise (EPV); and iii) the value of its earnings growth within that franchise (profitable growth).

Prof Greenwald identifies both the value and growth school as branches of ‘value investing’ and refers to Graham followers as the ‘classic value investors’ and Buffett followers as the ‘contemporary value investors’.

The key difference between the two styles can be summarised as follows: i)Graham followers believe in ‘diversification’ and ‘tangible assets’, while Buffett followers believe in ‘concentration’ and ‘franchise value’ ii) Graham followers’ approach is to buy ‘un-representable and wounded ducks’ stocks at cheap price, while Buffett investors believe in buying attractive (not sexy) or wounded Eagles at reasonable prices, iii) lastly, and most importantly, Graham investors believe in “mining or shifting through sands to find specks of gold’; while Buffet followers look to ‘Find Nuggets of Gold — hiding in plain sight’.

Traditional value investors have contempt for growth investors who attempt to value the present value of future cash flows of high growth companies.

While Buffett believes that forecasting has no place in investing, he does not say the future is unpredictable.

Buffett’s view is that markets will eventually reward companies which are able to increase their shareholder value in the long run.

But one cannot predict precisely when that will occur.

So, Buffett’s way outlines frameworks for identifying great businesses, which have ‘enduring’ and ‘widening’ moats that protect excellent returns on invested capital over long periods of time to allow the magic of compounding to occur.

Conclusion

Just like many personal choices in life such as religion and beliefs, there is no right and wrong in investing, too. The real test for a practitioner is to ensure that they stick with their philosophy across thick and thin and not attempt to time and chase the latest fads.

The writer is Senior VP and Fund Manager, Motilal Oswal Asset Management Company

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Published on May 17, 2020
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