Legacy of Benjamin Graham: The Original Adjunct Professor

“Through chances various, through all vicissitudes, we make our way. . . .”
—Aeneid

This is a great video with interesting comments from a lot of great people who knew him. Also contains Ben himself.

The video contains the following parts:

  • On Teaching
  • In the Classroom
  • Renaissance Man
  • On His Book “The Intelligent Investor”
  • On Value Investing
  • On His Generosity
  • Ben Graham’s Legacy
  • 85 Years Graham & Dodd, Columbia Business School

Comments in the video provided by:

  • Warren Buffett (Former Student/Employee)
  • Marshall Weinberg (Former Student)
  • Thomas Graham Kahn (Son of Irving Kahn)
  • Edwin Schloss (Son of Walter Schloss)
  • Henry Schneider (Former Student)
  • Irving Kahn (Former Student/Teaching Assistant)
  • Charles Brandes (Former Mentee)
  • Benjamin Graham Jr. (Son of Benjamin Graham)

Warren explaining what Ben told him about money:

“Don’t worry too much about making money.
It won’t change the way you live.”

Q&A: The Intelligent Investor – Chapter 10: The Investor and His Advisers

Below are my reflections and answers to the discussion questions posted at Modern Graham for chapter 10 – The Investor and His Advisers – of the Intelligent Investor written by Benjamin Graham. The Intelligent Investor

1. What quote from this chapter do you think best summarizes the point Graham is making?

“Our basic thesis is this: If the investor is to rely chiefly on the advice of others in handling his funds, then either he must limit himself and his advisers strictly to standard, conservative, and even unimaginative forms of investment, or he must have an unusually intimate and favorable knowledge of the person who is going to direct his funds into other channels.”

2. Do you rely on any investment advisers?  To what sources do you turn in your investment research?

No, I do not rely on any investment advisers. I haven’t done before and I’m not planning to do it either, at least not at the moment.

Sources for my investment research are original documents in the form of annual and quarterly reports, 10-K’s and 10-Q’s and earnings calls or transcripts etc. I sometimes use Morningstar.com when I want to get a quick glance at the financials and key ratios, this without seeing the share price. I manage to do this by having the financials section key ratios page for some small or unknown company as a bookmark, and then searching the ticker field from this page, which takes me directly to the same page for the company I want to look up. Beware anchoring bias. I also use the Swedish site Borsdata.se to get a quick look at the financial numbers for companies listed in Sweden.

Also regularly follow a few investment blogs.

3. If you are an investment adviser, what is your response to Graham’s points here?

Not an investment adviser myself, so not applicable.

4. What did you think of the chapter overall?

A good walkthrough of the different kinds of advisers working in the field of investing, and also what an investor should consider when thinking about using their services.

Q&A: The Intelligent Investor – Chapter 8: The Investor and Market Fluctuations

Below are my reflections and answers to the discussion questions posted at Modern Graham for chapter 8 – The Investor and Market Fluctuations – of the Intelligent Investor written by Benjamin Graham. The Intelligent Investor

But first a short note, before I go on to discuss the questions.

So, here it comes, the infamous chapter eight about Mr. Market that Buffett has been mentioned so many times over the years. In his most recent letter to shareholders Warren wrote “In contrast, Ben’s ideas were explained logically in elegant, easy-to-understand prose (without Greek letters or complicated formulas). For me, the key points were laid out in what later editions labeled Chapters 8 and 20. (The original 1949 edition numbered its chapters differently.) These points guide my investing decisions today.”

Another quote I picked from Warren is “If you understand chapters 8 and 20 of The Intelligent Investor (Benjamin Graham, 1949) and chapter 12 of the General Theory (John Maynard Keynes, 1936), you don’t need to read anything else and you can turn off your TV.”

In the preface to the fourth edition of the Intelligent Investor Warren writes “If you follow the behavioral and business principles that Graham advocates—and if you pay special attention to the invaluable advice in Chapters 8 and 20 you will not get a poor result from your investments. (That represents more of an accomplishment than you might think.) Whether you achieve outstanding results will depend on the effort and intellect you apply to your investments, as well as on the amplitudes of stock-market folly that prevail during your investing career. 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.”

So here it is, the much talked about “Chapter 8”. Read it, learn from it, and get back to it every now and then.

1. What quote from this chapter do you think best summarizes the point Graham is making?

“Let us close this section with something in the nature of a parable. Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly. 

If you are a prudent investor or a sensible businessman, will you let Mr. Market’s daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.

The true investor is in that very position when he owns a listed common stock. He can take advantage of the daily market price or leave it alone, as dictated by his own judgment and inclination. He must take cognizance of important price movements, for otherwise his judgment will have nothing to work on. Conceivably they may give him a warning signal which he will do well to heed—this in plain English means that he is to sell his shares because the price has gone down, foreboding worse things to come. In our view such signals are misleading at least as often as they are helpful. Basically,
price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”

2. How have you seen the parable of Mr. Market play out in your experience?  Any examples of a company that has been grossly mispriced at some point?

One example that comes to mind at the moment is American Express (AXP) back in the financial crisis in 2008-09. Looking at the fundamentals of the business in the years before the financial crisis hit, it’s pretty clear that what we have here is a great business that faced some difficulties due to the financial crisis. The question was the severity of these problems.

See financials below. Source: Morningstar

AXP2

The AXP price per share, see below (Source: Morningstar), took a dive from $65 in April 2007 to $9.71 in June 2009, a fall of 85%. Having reached this low the share price started to climb up to where it’s trading today, at a price per share of $86, a gain of 686%. If I had had a better understanding of the business I might have had the courage to buy.

AXP1

3. On page 192 Graham notes that as investing formulas have gained popularity their reliability dwindles due to new market conditions and the widespread use of the formula undermining its previously held advantage. In what ways has Graham’s formula lost reliability? How has it managed to stay useful?

Graham’s formula is still of value. The formula focuses on businesses that has demonstrated an ability to grow earnings without taking on too much risk to do this. In the end, this is what counts, the value creation in a certain business. Then it’s all about paying a fair price for this value creation based on a reasonable and conservative assumption about the intrinsic business value.

4. Graham mentions that one issue with the formula plans is that they leave the potential for the market to “run away” from investors. What steps do you take to ensure that the market doesn’t run away from you, while also protecting yourself from a steep drop in prices such as the bear market of the early 2000s?

Always be on the look out for great businesses selling at fair prices. The most important thing is to never pay too much for a business.

5. Graham seems to advocate that the Intelligent Investor find a way to have “something to do” as an outlet of pent-up energy as the market advances, rather than allowing oneself to become entangled with the market movements.  Do you have any example of what you could do in that regard?

Read about as many businesses as possible to prepare for less good times and for Mr. Market to offer some of them at a good price.

6. What did you think of the chapter overall?

The highlight of the chapter is the parable of Mr. Market. The final section “Fluctuations in bond prices” I read only briefly. Overall a great chapter.

Q&A: The Intelligent Investor – Chapter 7: Portfolio Policy for the Enterprising Investor: The Positive Side

Below are my reflections and answers to the discussion questions posted at Modern Graham for chapter 7 – Portfolio Policy for the Enterprising Investor: The Positive Side – of the Intelligent Investor written by Benjamin Graham. The Intelligent Investor

1. What quote from this chapter do you think best summarizes the point Graham is making?

“There is no reason at all for thinking that the average intelligent investor, even with much devoted effort, can derive better results over the years from the purchase of growth stocks than the investment companies specializing in this area. Surely these organizations have more brains and better research facilities at their disposal than you do. Consequently we should advise against the usual type of growth-stock commitment for the enterprising investor. This is one in which the excellent prospects are fully recognized in the market and already reflected in a current price-earnings ratio of, say, higher than 20. (For the defensive investor we suggested an upper limit of purchase price at 25 times average earnings of the past seven years. The two criteria would be about equivalent in most cases.)”

2. What do you think of Graham’s suggestions of activities for Enterprising Investors?

I think that Graham’s recommendation here for the enterprising investor sounds reasonable. Of the three different investment approaches Graham suggests I have spent most, if not all, my time in the first two categories, i.e. the relatively unpopular large company and in purchasing bargain issues. Up until this day I have not engaged in any special situations, or as Graham calls them “Workouts”. Maybe that time will come. The main reason is that I have kept myself pretty busy doing the first two categories. So for me personally, this is more a question of time than anything else.

Graham states that “To obtain better than average investment results over a long pull requires a policy of selection or operation possessing a twofold merit: (1) It must meet objective or rational tests of underlying soundness; and (2) it must be different from the policy followed by most investors or speculators. Our experience and study leads us to recommend three investment approaches that meet these criteria. They differ rather widely from one another, and each may require a different type of knowledge and temperament on the part of those who assay it.”

Graham recommends the three investment approaches as follows:

  • The relatively unpopular large company: This is according to Graham “…an investment approach that should prove both conservative and promising.” This approaches implies that “…the enterprising investor concentrate on the larger companies that are going through a period of unpopularity.” A warning is also made regarding small companies that could “…also be undervalued for similar reasons, and in many cases may later increase their earnings and share price, they entail the risk of a definitive loss of profitability and also of protracted neglect by the market in spite of better earnings. The large companies thus have a double advantage over the others. First, they have the resources in capital and brain power to carry them through adversity and back to a satisfactory earnings base. Second, the market is likely to respond with reasonable speed to any improvement shown.”
  • Purchase of bargain issues: Graham’s definition of a bargain issue is that “…an issue is not a true “bargain” unless the indicated value is at least 50% more than the price.” Graham then goes on and talks about how the investor can find these bargain issues.  “There are two tests by which a bargain common stock is detected. The first is by the method of appraisal. This relies largely on estimating future earnings and then multiplying these by a factor appropriate to the particular issue. If the resultant value is sufficiently above the market price—and if the investor has confidence in the technique employed—he can tag the stock as a bargain. The second test is the value of the business to a private owner. This value also is often determined chiefly by expected future earnings—in which case the result may be identical with the first. But in the second test more attention is likely to be paid to the realizable value of the assets, with particular emphasis on the net current assets or working capital.
  • Special situations, or “Workouts”: “The typical “special situation” has grown out of the increasing number of acquisitions of smaller firms by large ones, as the gospel of diversification of products has been adopted by more and more managements. It often appears good business for such an enterprise to acquire an existing company in the field it wishes to enter rather than to start a new venture from scratch. In order to make such acquisition possible, and to obtain acceptance of the deal by the required large majority of shareholders of the smaller company, it is almost always necessary to offer a price considerably above the current level. Such corporate moves have been producing interesting profit-making opportunities for those who have made a study of this field, and have good judgment fortified by ample experience.”

3. Have you limited yourself to these activities in your investments?

Guess I already answered this question above. But anyways, up until today I have limited myself to the first two of the investment approaches.

4. Do you think it is ever possible to time the market or profit from arbitrages?

I think that it’s possible, but also that the probability of succeeding is rather low, implicating that total returns from such market timing activities should not be expected to be satisfactory in the end.

An investor putting his time to such endeavors has stopped being an investor and become a speculator. So being an investor time is best spent in focusing the effort on finding great companies at fair prices for the long run. In doing so enterprising investors get the best odds out there when it comes to succeeding, that is to enjoy a satisfactory return and thus avoiding a permanent loss of capital.

5. How do you decide which growth companies will continue to perform well?

When talking about investing the question regarding future growth is the most difficult one, but also one of utmost importance due to the part it plays in the calculation of the underlying intrinsic value of a business. First, an investor will do best in trying to purchase stocks without paying up for the growth component inherent in the future prospects of the business. Second, if an investor pays up for growth this must be done on a conservative basis due to the speculative part always present through the uncertainties in future growth.

In his 1992 letter to shareholders Warren Buffett talked about value and growth as follows.

“…most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth.” Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing.

We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.

In addition, we think the very term “value investing” is redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value – in the hope that it can soon be sold for a still-higher price – should be labeled speculation (which is neither illegal, immoral nor – in our view – financially fattening).

Whether appropriate or not, the term “value investing” is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics – a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield – are in no way inconsistent with a “value” purchase.

Similarly, business growth, per se, tells us little about value. It’s true that growth often has a positive impact on value, sometimes one of spectacular proportions. But such an effect is far from certain. For example, investors have regularly poured money into the domestic airline business to finance profitless (or worse) growth. For these investors, it would have been far better if Orville had failed to get off the ground at Kitty Hawk: The more the industry has grown, the worse the disaster for owners.

Growth benefits investors only when the business in point can invest at incremental returns that are enticing – in other words, only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor.”

To make decisions about growth I try to follow the fundamentals of the business and the industry that it’s in. Doing this I try to observe any signs and changes in major factors impacting the value of the business.

But as stated above, be careful when it comes to growth and remember the old adage If something sounds too good to be true, it probably is.”

6. What did you think of the chapter overall?

A great one. I especially like Graham’s discussion about the three different investment approaches.

A Quote: Earning Power

“As far as the use of earning power or earning prospects in Wall Street is concerned, let me point out that in most of the current thinking earning power is not considered along the lines of an average over a period of time of medium duration. It is either considered as the earnings that are being realized just now, or those right around the corner, such as the next twelve months; or else the earnings are considered in terms of the long and almost endless future. A company with good prospects, for example, is supposed to be a company which will go on and on, more or less indefinitely increasing its earnings; and therefore it is not necessary to be too precise about what earnings you are talking about when you are considering the company’s future. Actually that idea of the long-term future of companies with good prospects shows itself, not in the use of any particular earnings, but in the use of the multiplier which is applied to the recent earnings or to the average earnings of the past.”Benjamin Graham

This quotation is not as of today, even though it could have been. These are Ben Grahams words back in 1946 from lecture number four of his class at Columbia University.

Some things change, some things don’t.

Check out the ten lectures here. They are all great. Read, learn and apply the things you like the most to your own investment process. 

Q&A: The Intelligent Investor – Chapter 6: Portfolio Policy for the Enterprising Investor: Negative Approach

Below are my reflections and answers to the discussion questions posted at Modern Graham for chapter 6 – Portfolio Policy for the Enterprising Investor: Negative Approach – of the Intelligent Investor written by Benjamin Graham. The Intelligent Investor

1. What quote from this chapter do you think best summarizes the point Graham is making?

“The most useful generalizations for the enterprising investor are of a negative sort. Let him leave high-grade preferred stocks to corporate buyers. Let him also avoid inferior types of bonds and preferred stocks unless they can be bought at bargain levels—which means ordinarily at prices at least 30% under par for high-coupon issues, and much less for the lower coupons. He will let someone else buy foreign-government bond issues, even though the yield may be attractive. He will also be wary of all kinds of new issues, including convertible bonds and preferreds that seem quite tempting and common stocks with excellent earnings confined to the recent past.”

2. What do you think of Graham’s suggestions that Enterprising Investors avoid these types of investments?

I think it’s reasonable due to the risks inherent in these types of investments.

3. Have you invested in any such opportunities?

No, I have not.

4. How can we balance avoiding the risk inherent in these opportunities with the potential return they present?

Buy a basket of them and buy all of them at a great discount to intrinsic value. If this cannot be done, I think it’s best to stay away from all of them.

5. What other types of investments do you think should be added to the “Do not touch” list?

Stocks that are priced much too optimistic with expectations set too high compared to a reasonable and conservatively calculated intrinsic value. Except for this I’m not really sure I have anything to add, but clearly all kinds of investments that somebody tries to sell you where the incentives are not aligned with your own should be avoided. All businessmen promoting and selling investments that will make you rich should be kindly but definitely dismissed.

6. What did you think of the chapter overall?

Enjoyed the chapter and all the wisdom that is discussed by Graham in the text.

Q&A: The Intelligent Investor – Chapter 5: The Defensive Investor and Common Stocks

Below are my reflections and answers to the discussion questions posted at Modern Graham for chapter 5 – The Defensive Investor and Common Stocks – of the Intelligent Investor written by Benjamin Graham. The Intelligent Investor

1. What quote from this chapter do you think best summarizes the point Graham is making?

This is a rather long quotation, but it also points out the four rules that Grahams suggests the defensive investor to follow to make the selection of common stocks a relatively simple matter.

“The selection of common stocks for the portfolio of the defensive investor should be a relatively simple matter. Here we would suggest four rules to be followed:

1. There should be adequate though not excessive diversification. This might mean a minimum of ten different issues and a maximum of about thirty.

2. Each company selected should be large, prominent, and conservatively financed. Indefinite as these adjectives must be, their general sense is clear. Observations on this point are added at the end of the chapter.

3. Each company should have a long record of continuous dividend payments. (All the issues in the Dow Jones Industrial Average met this dividend requirement in 1971.) To be specific on this point we would suggest the requirement of continuous dividend payments beginning at least in 1950.

4. The investor should impose some limit on the price he will pay for an issue in relation to its average earnings over, say, the past seven years. We suggest that this limit be set at 25 times such average earnings, and not more than 20 times those of the last twelve-month period. But such a restriction would eliminate nearly all the strongest and most popular companies from the portfolio. In particular, it would ban virtually the entire category of “growth stocks,” which have for some years past been the favorites of both speculators and institutional investors. We must give our reasons for proposing so drastic an exclusion.”

2. What do you think of Graham’s general rules for Defensive Investors?

I like Graham’s general rules because they include important aspects regarding portfolio composition, companies with a favorable business and dividend payments history and also, maybe the most important thing, the aspect of how much to pay for a business average earnings.

3. How many companies do you have in your portfolio today?

Right now I have two companies in my portfolio. The remaining part of the portfolio is in cash, so I constantly look for great businesses at fair or great prices to buy to increase the number of companies.  But at the moment I cannot say that there are a lot of companies that meet my requirements.

4. How can we balance “buying what we know” with the neutrality that is needed for proper research?

By constantly being aware heuristics and human biases that affect us in our daily life, especially in the daily life of an business analyst and investor.

5. Do any of you experience differences of opinion with your partner about investing? How do you handle those situations?

Not applicable to me at the moment.

6. What did you think of the chapter overall?

Great chapter. Graham makes everything sound so obvious. The four rules for the defensive investor and the discussion about growth stocks and the note on the concept of risk are all great reads.