New York Times columnist David Leonhardt take an interesting look at how stocks and the market are valued, and how it differs from the way the Benjamin Graham, the father of securities analysis, believed in evaluating stocks.

When investors talk about price/earnings ratios today, they are generally referring to the past year's earnings. But Graham believe that that number could be misleading, and instead thought that investors should look at earnings over a period of at least 5 years. That approach seems quaint today. I would bet that most portfolio managers routinely buy stocks without looking at an earnings statement from 3 years ago, let alone the 10-year old statements that Graham suggested.

But in looking at Graham's analysis and applying it to the broader market, Leonhardt may be erring. Having been wiped out in the Great Crash, Graham learned that it isn't wise to try to predict market fluctuations. Applying Ben Graham's philosophy to the broader market just doesn't make sense. As Ken Fisher showed in his most recent book, the current price/earnings ratio of the market is not an indicator of future performance: Buying indices when the ratio is low and selling when it's high does not create alpha. Given that, it's surprising how much time is devoted to discussing the market's p/e ratio. While Leonhardt talks mostly about p/e ratios, Graham was a big fan of the price/book ratio. Graham's strategy was to buy a diversified portfolio of stocks trading below their net current asset values, and hold them until the market became more rational. Today's markets may indeed be more rational, because there are less than a handful of stocks meeting this criteria.

A lot of Graham's strategies are very dated today. The idea of buying stocks under net current asset value is impossible. Graham believed in wide diversification, and that just isn't possible with the kind of stocks he wanted. Late in his life, Graham conceded that most investors should probably just buy and hold index funds.

So what can we learn from Graham today? I believe the value of his teachings lies more in the philosophical way that he looked in the market, rather than the rudiments of his investment strategy. If you haven't already seen this analogy from Graham, print it out and post it next to your computer, and read it every time you are about to buy or sell a stock. From Wikipedia:

Graham's favourite allegory is that of Mr. Market, an obliging fellow who turns up every day at the share holder's door offering to buy or sell his shares at a different price. Often, the price quoted by Mr. Market seems plausible, but sometimes it is ridiculous. The investor is free to either agree with his quoted price and trade with him, or to ignore him completely. Mr. Market doesn't mind this, and will be back the following day to quote another price. The point is that the investor should not regard the whims of Mr. Market as determining the value of the shares that the investor owns. He should profit from market folly rather than participate in it. The investor is advised to concentrate on the real life performance of his companies and receiving dividends, rather than be too concerned with Mr. Market's often irrational behaviour.

In the final analysis, that is Graham's most valuable contribution to investment theory.