Warren Buffett says this is 'by far the best book on investing ever written'

Warren Buffett.
Gerald Miller | CNBC

If you want to learn how to be a smarter and more successful investor, who better to take a book recommendation from than Warren Buffett? And the legendary investor and CEO of Berkshire Hathaway has a clear top choice: "By far the best book on investing ever written," he says, is "The Intelligent Investor: The Definitive Book on Value Investing," by Benjamin Graham.

Graham, who died in 1976, was an American economist who earned the nicknamed the "father of value investing." And Buffett's praise for Graham is no coincidence; Graham was Buffett's professor at Columbia Business School in 1951. 

Buffett says he attributes 85% of his investment style to Graham's principles — of course, Buffett's advice also is closely followed today. Here's what Buffett says he learned from Graham's widely acclaimed book, which you can apply to your own investment strategy, too. 

'Low [stock] prices became my friend'

Buffett bought Graham's book in 1949, before the two investing legends actually met. "My financial life changed with that purchase," Buffett wrote in his 2013 letter to Berkshire Hathaway shareholders. "Ben's ideas were explained logically in elegant, easy-to-understand prose." 

One of Graham's most accessible lessons is finding investments that are selling well below fair market value, and this strategy of "buying low" is key to his value investing philosophy. Graham teaches readers how to look for stocks that are essentially on sale.

Buffett had a revelation when reading chapter eight of Graham's book, which addresses how investors should view fluctuations in stock prices. "Immediately, the scales fell from my eyes, and low prices became my friend. Picking up that book was one of the luckiest moments in my life," he wrote in 2011. 

Buffett profited from Graham's book in a big way

In his 2013 letter to shareholders, Buffett gave an example of how he employed Graham's strategy, which paid off. In the original edition of Graham's book (it has been revised four times since it's original publish date in 1949), Graham recommended Northern Pacific, a railroad stock, which was priced well below its actual value, Buffett recounts.

That low valuation resulted from an accounting rule at the time, which required the company to remove the profits of its affiliate railroads, Buffett said in 2013. To an untrained eye, Northern Pacific wasn't a stock poised for big gains. 

"When I read the book, Northern Pacific had a market value of about $40 million. Now its successor (having added a great many properties, to be sure) earns that amount every four days," Buffett said seven years ago. 

Once Buffett knew how to look for hidden accounting details like this one, he was able to take advantage of opportunities to buy stocks that were worth much more than they appeared to be. And, in 2009, Buffett's Berkshire Hathaway bought Northern Pacific's successor, BNSF Corporation. He's made billions off the purchase

Putting lessons from Graham and Buffett to work

How does value investing apply to the majority of us, who should stick with investing in well-diversified funds over individual stocks? Just think of how volatile the market has been over the last few months.

Share prices have fallen, which is not always a reflection of a company's value, but a result of investor anxiety surrounding the unknown economic impacts of the Covid-19 pandemic, among other factors. Investors can come out ahead if they think of these events as opportunities not to panic sell but to invest more while stocks are essentially on sale.

Immediately, the scales fell from my eyes, and low prices became my friend. Picking up that book was one of the luckiest moments in my life.
Warren Buffett
Berkshire Hathaway chairman and CEO

"The sillier the market's behavior, the greater the opportunity for the business-like investor. Follow Graham and you will profit from folly rather than participate in it," Buffett writes in a preface to the fourth edition of "The Intelligent Investor."

While you can benefit from studying up on individual stocks using Graham's techniques, for most investors, "the best thing to do" is simply to invest in the market itself by buying index funds that track major benchmarks like the S&P 500, Buffett said at Berkshire's annual shareholder meeting last month. That's because the S&P 500 has delivered average annual returns of almost 10% going back 90-plus years. And, with index funds, you don't have to pick the winning stocks to benefit from the market's overall gains. 

"I can't remember what I paid for that first copy of 'The Intelligent Investor,'" Buffett said in 2013. "Whatever the cost, it would underscore the truth of Ben's adage: Price is what you pay, value is what you get. Of all the investments I ever made, buying Ben's book was the best (except for my purchase of two marriage licenses)."

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