Benjamin Graham: Father of the Efficient Market Hypothesis?

“Warren [Buffett], don’t worry too much about making money. It won’t change the way you live. It’ll change the way your wife lives.” – Benjamin Graham

The first investment book I ever read was The Intelligent Investor by Benjamin Graham. Graham’s analogy about Mr. Market that he used to describe the stock market is still the clearest explanation I’ve heard on how to think about investing in stocks and understanding investor psychology.

Last week I stumbled across this excellent video about Graham which includes old clips from his investment classes as well as some of his former students (including Warren Buffett, Rob Brandes and Irving Kahn) giving interviews about the effect the legendary investor had on them:

Here’s an interesting comment from Buffett on Graham’s investment approach that most investors that follow his advice probably don’t realize:

Ben was always thinking, at least when I knew him, as a passive investor. So he bought a little of everything. He was widely diversified.

He was passive but from a value investing framework. So he was basically the first factor investor way before smart beta was ever a thing.

There are plenty of other helpful lessons in the video but here’s a quote directly from Graham that I found interesting:

Everyone on Wall Street is so smart that their brilliance offsets each other. And that whatever they know is already reflected in the level of stock prices, pretty much. Consequently, what happens in the future represents what they don’t know.

This opinion is fascinating to me because so many investors point to Graham’s investment guidelines as one of the reasons to pick stocks to try to beat the market. Yet this strikes me as being much closer to the Efficient Market Hypothesis (EMH) laid out by Fama and French which states that market prices reflect all available information.

Generally, I find it’s a waste of time for investors to worry about proving or disproving theories like EMH. Investing is an art, not a science. There are only theories, not absolute facts about how to invest.

That’s why it’s called the Efficient Market Hypothesis. A hypothesis is a proposed, not proven, explanation for something. There’s never going to be a Good Will Hunting-type that comes along to fill up a chalkboard with equations that solves investing once and for all.

The obvious distinction that Graham makes from the extreme followers of EMH is the ‘pretty much’ that he threw in there. Cliff Asness shared his perspective on this topic at the recent Morningstar Conference when he said, “Clearly the markets are not perfectly efficient, but they are not easy to beat!”

And I think that’s what Graham was getting at. Although Mr. Market can throw out extraordinary deals at times, for the most part investors have most things reasonably priced in. It’s predicting the future that creates mispricings in the market since, as Graham stated, no one knows what will happen. In fact, you could argue that conflicting expectations about the future are the reason Graham’s form of value investing has worked for so long.

It’s also interesting to note that two great investors, from very different market environments, are both willing to admit that markets are mostly efficient. Yet so many investors today spend their time pointing out the market’s inefficiencies without ever figuring out ways to profit from them.

Michael Batnick pointed this out in a recent post:

What is truly astonishing is the loudest opponents of efficient markets are typically the same people that are most persecuted by the fact that for the most part, markets are efficient. 

Certain investors tend to use theoretical constructs to justify the way that they invest as a form of confirmation bias. Markets are perfectly efficient so the only way to invest is through index funds. No, there’s no way markets are efficient since investors are often irrational so of course you can beat the market.

But the question for investors shouldn’t be ‘Are the markets perfectly efficient or not?’

It should be ‘Does it makes sense for me to try to beat the market? And if so, is it possible for me to develop a consistent strategy to accomplish this feat after accounting for all costs, taxes and behavioral biases?’

These are the questions that investors need to answer when determining their investment philosophy.  It’s also what makes investing so interesting.

Further reading:
Why value investing works

Climate change and EMH (Irrelevant Investor)


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  1. Gregory commented on Jul 17

    Good writing!