The Rediscovered Benjamin Graham
Posted on December 22, 2008 by Richard Beddard
Filed Under Editor's choice, Investing, Reading list |
This is going to be a long review, but considering many of the words will be quotations from the mouth, or pen, of an icon, perhaps you’ll forgive me.
The Rediscovered Benjamin Graham is a collection of articles and lectures written and given by Benjamin Graham, plus a few interviews with him. It gives insight into the ideas of the father of value investing and the man who co-wrote Security Analysis, in the words of our own Peter Temple “the ultimate source book for all analysts”.
Graham’s career spanned The Roaring Twenties, the Wall Street Crash, the Great Depression and the Second World War. If you need a guide to investing through extreme times, Graham is it. He retired in 1956 with nothing left to prove, later declaring in an interview republished in the book:
I had established a way of doing business to a point where it no longer presented any basic problems to be solved.
The rediscovered Benjamin Graham tells you how he got to that point. Through lectures, articles and interviews published between 1932 and 1976, he explains his methods of picking bargain stocks (don’t overpay, buy companies with a future), the importance of diversification (a single stock is risky, twenty or thirty aren’t) and asset allocation (own more shares when they’re cheap, own more bonds when shares are expensive).
But Graham wasn’t just a fund manager, or even, judging by the fees he charged and methods he employed, a hedge fund manager. He was, perhaps pre-eminent; teaching at Columbia University, corresponding with Keynes, testifying before the senate, and proposing an international commodity reserve currency at Bretton Woods. His motto, ‘honesty is the best policy’, has, perhaps, been forgotten by subsequent generations of money managers.
Writing for Forbes in 1932 he partly blamed the frauds exposed as markets crashed on investors who, seduced by the promise of ever-increasing profits, gave up on their responsibility to scrutinise management, and company accounts:
…All these strange happenings fall from the failure of the stockholder to recognise that he occupies the same fundamental position and enjoys the same legal rights as the part owner in a private business… If it only could be brought home to the millions of investors the country over, a long step would be taken in the direction of sounder corporate practices and sane attitude towards stock prices.
Investors in Madoff, banks, and any business that isn’t viable in a recession, take note. By 1956, though, in a speech on The Ethics of American Capitalism, he was lauding a kinder, gentler capitalism.
Addressing the Financial Analysts Society In 1958, he dealt a deathblow to discounted cash flow, still a standard method of calculating the present value of a business’ future profits:
…The concept of future prospects, and particularly of continued growth in the future, invites the application of formulae out of higher mathematics to establish the present value of the favoured issues. But the combination of precise formulae with highly imprecise assumptions can be used to establish, or rather to justify, practically any value one wishes… But paradoxically, that very fact… will be seen to imply that no one value, or reasonably narrow range of vales, can be counted on…
This new speculation in stocks, he warned in 1959, had changed investors into get rich quick merchants, which doomed them to lose money in the end. Concluding his lecture series on ‘Current Problems in Security Analysis’ in 1946 and 1947, he had similar thoughts:
In one important respect we have made practically no progress at all, and that is in human nature. Regardless of all the apparatus and all the improvements in techniques, people still want to make money very fast. They still want to be on the right side of the market. And what is most important and most dangerous, we all want to get more out of Wall Street than we deserve for the work we put in.
This wasn’t moralising. Graham was describing the behavioural foibles; herding, greed and fear that students of behavioural finance are just beginning to unravel. The problem with financial theory, which was evolving while Graham was writing and lecturing, was that it ignored the behavioural side. In ‘The Renaissance of Value’, an article he wrote for Barron’s in 1974, Graham tackled the newfangled Beta coefficient, which measures price fluctuations:
What bothers me is that authorities now equate the Beta idea with the concept of “risk”. Price variability yes; risk no. Real investment risk is measured… by the danger of a loss of quality and earning power through economic changes or deterioration in management.
The joy of this book, apart from the fact that in the format of lectures and articles Graham is forced to be more succinct than in a textbook like Security Analysis, is that we can see how Graham’s ideas developed, and the historical contexts in which he developed them. Since those contexts invariably involved booms, and succeeding busts, they’re redolent today.
He told the Senate Committee on Banking and Currency that in boom times, when prices were high and there too few of his favoured ‘bargain issues’ to fill a diversified portfolio, he switched to special situations like public utilities soon to be broken up. It may also surprise die-hard value investors that he relaxed his value criteria by 50% too, justified by basic improvements in business and government’s commitment to avert deep depressions. The older, he said in an interview in 1974, and:
…The more experienced I get, the less confidence I have in judgemental choice as distinct from the figures themselves.
That’s why in an interview in 1976 he said he preferred The Intelligent Investor, his book for private investors, to Security Analysis, his textbook for professional analysts:
…Now I have lost most of the interest I had in the details of security analyis… I feel that they are relatively unimportant, which, in a sense has put me opposed to developments in the whole profession. I think we can do it successfully with a few techniques and simple principles. The main point is to have the right general principles and the character to stick to them.
Having read The Intelligent Investor, I’d put the book Graham didn’t know he was writing, The Rediscovered Benjamin Graham, at the top of the pile.
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It’s Christmas and I’m giving a copy of my book of the year to the reader whose correspondence I have valued the most. It’s a hard choice this year, between Behavioural Investing, reviewed right at the beginning of the year and which owes much to Benjamin Graham, The Subprime Solution, and The Rediscovered Benjamin Graham. It seems only fair to give him the choice.
Merry Christmas, everyone.
Footnotes:
- The book contains edited highlights of Graham’s lectures, ‘Current Problems in Security Analysis’. Here’s the unabridged series.
- Excerpts from Graham’s autobiography: Memoirs of the Dean of Wall Street.
Comments
9 Responses to “The Rediscovered Benjamin Graham”
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Hi Richard,
Merry xmas!
I have been out of the market for just over a year now and plan to stay out for a while yet. Good luck with investing.
Deborah
Hi Deborah, a belated Happy Christmas and New Year to you! I hope to see you back blogging in the spring
Hi Richard,
My chosen book ‘The Rediscovered Benjamin Graham’ has arrived. Many thanks for your gift. As you say, it is a superb introduction to value investing, particularly for someone like me who has never really thought about it in too much detail.
I was particularly amused by the following quote about using complex mathematical models to drive investing (p42) and written in 1958!
“Whenever calculus is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience, and usually also to give speculation the deceptive guise of investment”
I suspect that this applied to my momentum tracker LP, although this has still to be disproved! Momentum collapsed before I had enough data.
Anyway, I have recently been thinking about my long term future and I realise, before anything else, I want to ensure my mortgage is paid out and I also have a reasonable guaranteed retirement income, based on very modest yield assumptions. To help me in this I will actually write a linear program (even though Graham rightly frowns on the use of higher mathematics).
Specifically I want to try to get a reasonable spread between
- Index link gilts
- Corporate bonds
- Income generating equities
- Cash
- Government pension assumptions
- Inflation assumptions
Once I have established what I will need to drive this, then I will try to introduce an element of growth equities which is more speculative.
My only problem is that I fear that you would need to put aside an awful lot of money now in order to safely get enough income to have even a modest standard of living (and you still need to pay off the mortgage!)
If I have any interesting results I will keep you posted.
Regards
Robin
Glad you liked it Robin. He is very quotable! Good luck with your policy of extreme diversification - I think there are many people thinking along similar lines. I’m sure paying off mortgages has never been more fashionable
Here is another excellent observation from Graham’s book regarding EMT he made in 1974(p.76/77). He does not dispute that everyone has most of the important information relating to a stock, however he does dispute that people have a capability to use that information effectively!
He quotes from Descartes:
“It is not enough to have good intelligence … the principle thing is to apply it well”
I’ve got so many bits of paper sticking out of my copy highlighting quotable bits I should go through it so I can start trading quotes with you. I think that quote is brilliant and it shows that Graham was a behavioural finance guy thirty, or at least twenty, years before it became fashionable (in fact much longer because he had to wait for EMT to be invented before he could start criticising it!).
In some ways it feels like finance took a bit of a wrong turn back in the ’60’s. Certainly Benoit Mandelbrot thought that when I interviewed him, and it’s only in the last decade or two with behavioural finance theorists, the chaos theorists and so on that alternatives are beginning to be explored again.
They had all this stuff from Graham but so little has been built on it!
I touched on Graham the behaviouralist in a recent article for Money Observer. I’m going to blog about it shortly, but you can get to it from this page: http://beddard.net/
Hi Richard,
I know this post is getting a bit old now to be making comments, but here is one anyway!
I had another thought when I was reading this book. It struck me that there is a basic flaw in the so called ‘free-market system’ which value investing attempts to exploit. The flaw is that a company is valued as an isolated entity and not in terms of its value to the overall economy.
So, for example, Graham says a company should not trade below its quick asset value because then it would be worth more to ‘certain’ investors if they buy and liquidate it as opposed to keeping it running as a going concern.
So the book value generates a fake lower bound on the share price of a company as it is always under threat of liquidation in these circumstances.
If the fundamental value of a company is measured in terms of
1) It’s quick asset value
2) Its value to the overall economy (in terms of losing the skilled staff and supporting the unemployed people)
Then the second aspect of valuation would make it much more difficult to liquidate a company if the rule was enforced by law.
Anyway, this of course leads to the phenomenon of a company being too big to fail. I suspect that the ‘free market system’ only works for a lot a small companies and not a relatively small number of very big companies.
Hi Robin, thanks for the comment - it’s never too late. There are still interesting comments being added to the first Naked PE post, published a couple of years ago
I see what you’re getting at, though the theory is likely to be tested in the coming year! Maybe the wider value of a big company makes it too big to fail quickly, the state just props it up until it becomes small enough to fail. Perhaps this is what happened to the British car industry, and what’s happening to the US auto industry…
Incidentally, a criticism of Ben Graham’s net-net method might be that the rules have changed since his day and its harder to fold a company and receive the value of the assets these days because they get paid out to employees as redundancy money and so on first. I’m not sure about that, and buying bombed out companies still seems to work statistically, but I thought I’d mention it.
It would be interesting to know how often shareholders get anything, let alone profit from a company going into administration these days.
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