The intelligent way to invest

Benjamin Graham's four investing principles.

a woman

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"Investment is most intelligent when it is most business like."

Benjamin Graham, considered one of the fathers of value investing and mentor of Warren Buffett, chairman and CEO of Berkshire Hathaway Inc (NYSE: BRK.A, BRK.B), wrote that sentence in his famous book The Intelligent Investor.

He was lamenting the way people, especially business people, give up their business principles when they choose and manage investments. Buying stock is buying a piece of a real business, so the same sense of ownership applies.

If a new owner of your workplace showed up for the first day of work, and told you: "As soon as this company's earnings go up 20%, I'm ringing the register and moving on," that would ring some alarm bells. Investing is not about the biggest score in the shortest time, but earning a reasonable rate of return to grow your capital over the long-term.

What business principles did he think all investors should follow? Simply put, he followed four.

1. Know the business you want to invest in.

Hearing that Westfield Retail Trust (ASX: WRT) operates the Australian shopping centres of Westfield Group (ASX: WDC) and "everyone knows Westfield" may be a great start to investigate its business strategy. However, it would not be a good enough reason to rush out and purchase stock.

How does it make money? What are its competitors like? Is it a growing industry still? Where can it go from here? A new executive in the company would be expected to understand these issues and so should you.

2. Don't let anyone else run your business unless you can supervise them with adequate comprehension, or unless you have complete trust in their ability and integrity.

A financial advisor must be fully vetted to handle your funds and safeguards set in place to monitor activity. Most financial managers want to do their best and they have adequate training and experience, but no one will protect and look after your money like yourself.

If you have professionals manage your money, then choose them as if you were going to hire them for the position. Interview them so you understand their investment strategies and philosophy to see if they match your own.

You can even invest in a number of companies like Perpetual Limited (ASX: PPT), BT Investment Management Ltd (ASX: BTT) and Magellan Financial Group Ltd (ASX: MFG), if you want to take advantage of their good business growth outside of direct funds management.

3. Don't enter into an operation unless a reliable calculation shows that it has a fair chance to yield a reasonable profit.

That means to do your homework, work out what you expect the company to do and don't let sheer enthusiasm or market exuberance drive your investing decisions. A company like SEEK Limited (ASX: SEK), the online employment ads and listings portal is well known, but what has it done in the past and where can it go from here?

The company has grown profits from $19.2 million in 2004 to $152.7 million in 2013 at a compounded annual growth rate of 29.5%. It is the biggest jobs website in Australia and is expanding into new regions overseas. Yet expansion costs money and other companies like Fairfax Media Limited (ASX: FXJ), which once held the jobs listings crown through its print media business, are vying to take market share from it.

You can find sound and solid balance sheet strength and steadily growing earnings in Woolworths Limited (ASX: WOW). Shareholders have seen the share price almost triple over the past 10 years from about $12.00 to $34.97. It, like Wesfarmers Ltd (ASX: WES), may not be a fast grower, but it should continue to mirror the growth rate of the Australian population and GDP.

Foolish takeaway

The fourth principle is to have the courage of your knowledge and experience.

You've done your homework, learned about the business, calculated what you expect from it and now it's time to act. Good judgement only comes from experience. You have done the best you can and it's the compounding work of time that does the real heavy lifting.

Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned. 

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