Graham thinks that it is futile for institutional investors to try to beat the market. He notes that if the average institutional investor were to beat the market, "that would mean that the stock market experts as a whole could beat themselves--a logical contradiction." As such, he thinks they should be content with market returns.
As has been widely notes, Graham suggests that he no longer thinks that individual investors should use the sort of security analysis that he pioneered to pick portfolios of individual stocks.
Here is the interesting part. Instead of suggesting that individual investors should buy index funds and accept market returns (as he does for institutional investors), Graham advocates two different strategies. The first strategy involves buying shares in companies that are selling below current net asset value. The second strategy is value tilting. I'll let Graham speak for himself here:I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook "Graham and Dodd" was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent I'm on the side of the "efficient market" school of thought now generally accepted by the professors. [emphasis added]
Now we have a puzzle. Graham seems to endorse the efficient market hypothesis. He thinks that security analysis is not a worthwhile endeavor for the individual investor because there are too many smart analysts doing the same thing. But then he ends the interview by claiming that the true investor can "exploit the recurrent excessive optimism and excessive apprehension of the speculative public." That doesn't sound like something that an efficient market proponent would say![The second strategy I advocate] consists of buying groups of stocks at less than their current or intrinsic value as indicated by one or more simple criteria. The criterion I prefer is seven times the reported earnings for the past 12 months. You can use others--such as a current dividend return above seven per cent or book value more than 120 percent of price, etc. [...] I have every confidence in the threefold merit of this general method based on (a) sound logic, (b) simplicity of application, and (c) an excellent supporting record. At bottom it is a technique by which true investors can exploit the recurrent excessive optimism and excessive apprehension of the speculative public.
Here is what I think Graham's view is, and it's a view that I rather like myself. The market price for a security can be thought of as its intrinsic value together with either a speculative discount or a speculative premium. Over time, the price of a security tends to converge towards its true value (i.e. there is reversion to the mean). Given the fierce competition when it comes to analyzing securities, it is nearly impossible to know whether or not a particular company is trading at a premium or a discount relative to its intrinsic value. But on the whole, by purchasing groups of stocks with low valuations, an investor increase her chances of buying securities selling at a discount.
Notice also that Graham doesn't think that the value premium is a risk premium. He thinks it has a behavioral explanation. Value investors outperform other investors because they are taking advantage of "excessive optimism and excessive apprehension of the speculative public." While this is a behavioral explanation, though, there is no particular reason to think that it will go away. Speculative excess will always be with us.
While he doesn't say it here, Graham's official view is that value investing reduces risk. This is because of the give more "margin for error." A growth stock with high valuations has to hit a home run just to be fairly valued. A value stock only needs a single.
In any case, the moral of the story is: You should read Benjamin Graham! He gives a fascinating perspective, from another era, on our own most pressing investment decisions.
That article was from nearly 40 years ago. Ben Graham said his approach from 40 years prior was obsolete by 1976. Is the 1976 approach still a viable investing methodology in 2014?