Benjamin Graham on Lessons from the Dean of by Janet C. Lowe Copyright © Janet C. Lowe, 1994 Used by arrangement with Penguin Books, A division of Penguin Putnam, Inc. 246 pages

Focus Take-Aways

Leadership & Mgt. • Benjamin Graham is called “The Dean of Wall Street” for his lifetime of managing, Strategy writing and teaching strategies.

Sales & Marketing • Value investing means using scientifi c techniques and formulas to assess a stock.

Corporate Finance • A value maintains a long-term investment strategy.

Human Resources • Early on, Graham thought that Calculating-Tabulating-Recording (CTR) would be a good investment. It became IBM. Technology & Production • Graham’s 1934 book, , is the seminal text on investing. Small Business • His book, , tells how to make rational investment decisions. & Politics • Graham’s classes at were so practical that Wall Street Industries & Regions professionals and other faculty members enrolled. Career Development • called Graham his second most signifi cant career infl uence (after Personal Finance his father).

Concepts & Trends • Graham’s greatest fi nancial achievement was purchasing a controlling interest in GEICO, and making the insurance company successful. • He maintained that surplus value in a company should be distributed to shareholders.

Rating (10 is best)

Overall Applicability Innovation Style 7 8 8 8

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What You Will Learn In this Abstract, you will learn: 1) Who Benjamin Graham was and why his investing advice is still relevant; 2) Six factors to evaluate in judging a stock based on the value of the company; and 3) Graham’s rules and advice for . Recommendation Value investing is back in vogue. And so is Benjamin Graham. His books — Security Analysis and the Intelligent Investor — are the seminal texts on the subject of investing. Numerous investors (including Warren Buffett) owe their success to Graham’s writings. Janet C. Lowe’s book adds to the Graham myth. It weaves the story of Graham as a husband, father and loyal friend into his public life as a fund manager, writer and teacher. Lowe breathes life into an otherwise sterile topic, but her emphasis is on Graham’s personal history more than on his investment advice. She does make it clear that Graham’s fi scal belief system emphasizes intelligent investing by both the professional and individual investor. getAbstract.com recommends this book to people who follow — and hope to profi t from — the vicissitudes of the and of its indelible characters.

Abstract

The Dean of Wall Street It was 1968, and Warren Buffett needed help. The market was down, and Buffet could fi nd no good stocks to buy. But the solution was clear. Buffett said to his friend Walter Schloos, “Let’s go out and see Ben and ask him what he would do.” “Be an investor, not a speculator.” “Ben” was Benjamin Graham. To many fi nancial professionals, he was the “Dean of Wall Street.” Buffett and dozens of other high-profi le investors held Graham in high regard for his management of the Graham-Newman Fund, his teaching at Columbia University and his publications on investing. In fact, Buffett claimed that Graham’s Intelligent Investor was the best investment book ever written. Graham was retired at the time that Buffett and a dozen other “students” made a pilgrimage to see him at the Hotel Coronado in San Diego. First, Graham quizzed his visitors on investing. He wanted them to realize that questionable accounting practices were commonplace — and that any investor who relied upon someone else’s coattails “The disciplined, was likely to get burned. The get-together was such a success that it became an annual rational investor neither follows meeting which Buffett continues to sponsor to this day. popular choice nor plays market The gospel according to Graham was value investing. He believed an investor should swings; rather he apply scientifi c techniques to the process of making investment decisions. He preached searches for that value investing requires the investor to ignore price cycles of individual stocks, or stocks selling at a price below their movements of the market as a whole. Instead, the investor should focus on the facts intrinsic value and surrounding a company’s fi nancial condition and its future earnings potential. The only waits for the consequence he attributed to market movement is that it makes buyable stocks either market to recog- harder or easier to fi nd. nize and correct its errors.” The Early Years The youngest of three sons, Benjamin Graham was born in in 1894. The next year, his family moved to New York. Graham was a very bright child, but money

Benjamin Graham on Value Investing © Copyright 2003 getAbstract 2 of 5 was always tight. Fortunately, he did well enough in school to receive a scholarship to Columbia University. However, even with the scholarship money, he had to drop out “Buffett and his of day classes and take a full-time job as a researcher with U.S. Express. He worked friends had gone on a census project in which he used newly developed punch card technology. The to California to company that supplied this technology was called Calculating-Tabulating-Recording. consult with Ben Graham for two Later, it would change its name to IBM. simple reasons. Graham knew Graham’s fi rst fi nancial job was with the Wall Street fi rm of Newberger, Henderson more about the & Loeb. He made $12 per week working as a runner. Soon, he was assigned to write subject of stocks concise descriptions of the fi rm’s daily bond purchase list. Not long after, he began and bonds than anyone they knew writing the fi rm’s market letter. Eventually, the fi rm promoted him to statistician after and they trusted one of his company debt analyses reached a partner’s desk. his insight.” As statistician, Graham conducted an evaluation of CTR bonds and stock. He determined that although CTR was selling for $40 a share, it had a book value of $130 a share. He also thought the company had good products and prospects. He took this information to the head of the fi rm, who told him to forget the company — that it was mostly “water” (goodwill and other ephemeral assets). The operating principle was that companies with too few assets and sales were poor . Buying stocks was like playing bridge — it was more important to play a hand right than to play it successfully. Graham listened, and took his employer’s position to heart. He never purchased a share of CTR or IBM. “He unfl inchingly treated investing Partner, Owner and Teacher as a science.” By the time he was 26, Graham was named partner at Newberger, Henderson & Loeb. He started to write for several fi nancial publications. One of his fi nest articles was “Lessons for Investors,” which details the genesis of his investment philosophy: “A …cannot be a good investment, because speculation is based on anecdote rather than actuality. The absence of verifi cation pushes the risk far too high.”

Graham’s fi rst attempt at independence came in 1923, when he raised $500,000 from friends and other contacts to start the Graham Fund. The fund invested in Du Pont and “A speculation, he taught, cannot be shorted General Motors, because Graham had spotted an imbalance between Du Pont’s a good investment, ownership of General Motors stock and the undervalued Du Pont stock. Graham also because specula- shorted Shattuck Corporation, the owners of the Schrafft’s restaurant chain. The Graham tion is based upon anecdote rather Fund eventually dissolved after Graham could not get his partner to agree to higher than actuality.” management compensation. Graham then started his Ben Graham Joint Account.

During this period, he took on the Rockefeller Trust, the largest owner of eight oil pipeline companies. Reviewing U.S. Interstate Commerce Commission documents, Graham discovered that the Rockefeller companies held substantial amounts of investment-grade bonds. In some cases, the value of the bonds was greater than the value of the companies that held them. According to Graham, holding these bonds in reserve was an injustice to the shareholders of these companies — which included the Ben Graham Joint Trust. “An investment, he Graham calculated that Northern Pipe Line traded at $65 per share, but had an additional explained, was $95 per share value if the investment grade bonds were included in the calculation. When based on incisive, quantitative analy- he approached the president of the company for a shareholder distribution of the surplus sis, while specula- value of the bonds, the president rebuffed him. Graham won the ensuing battle after he tion depends upon fought a proxy war. His return on investment was 54%. whim and guess- work.” Graham returned to Columbia in 1928 to teach Advanced Security Analysis. In those days, any qualifi ed undergraduate or graduate student could take his class, and the

Benjamin Graham on Value Investing © Copyright 2003 getAbstract 3 of 5 university also allowed other Columbia faculty members and professionals who worked on Wall Street to enroll. Graham’s course attracted a broad following, because by then “Graham was a he had developed a “reputation for formulating theories that worked well in practical pioneer in the application.” Graham taught in the evenings, using the Harvard case system as his development of teaching model. His relationship with Professor David L. Dodd, who recorded the class hedging tech- niques and in the discussions, matured over the years. The two teachers eventually collaborated on the discovery of arbi- classic text, Security Analysis: Principles and Techniques. trage opportuni- ties.” The Illogical Market Security Analysis was published 1935. The book’s underlying theme was that “the stock market is a highly illogical place where sheeplike participants follow the fl ock and buy when prices rise and just as mindlessly sell as prices fall.” The authors urged that the “disciplined rational investor neither follows popular choice nor plays market swings;

“Graham’s contri- rather he searches for stocks selling below their intrinsic value and waits for the market bution to American to recognize and correct its errors.” enterprise was a body of knowl- The investor’s job was to be aware that the intrinsic value of any security varies over edge, a framework time, and that, often, securities are mispriced in relation to their intrinsic value. Investors for thought, the drive for positive had to investigate a stock as if it “were an exercise in buying the entire business.” In change and inspi- short, investors must think for themselves. ration for gener- ations of future Security Analysis remains hugely successful. Five editions have appeared since 1935, security analysts and early editions of the books have become collectors’ items. A fi rst edition costs more and individual investors.” than $1,000 — if you can fi nd one for sale today. In total, the publishers estimate that more than 800,000 copies of the book have sold. Security Analysis cemented Graham’s reputation in the industry as the authority on value investing. The lack of self-promotion by the authors only increased people’s respect for the book. As Buffett said, “He [Graham] never was touting his own operation.” Students also found the book invaluable. Muriel Siebert, owner of the discount brokerage house that bears her name, said, “When “The concepts I was a student…Security Analysis was the fi rst one that really made a dent.” As late introduced in Security Analysis as 1990, journalist Thomas Easton wrote that Graham’s and Dodd’s “words are now were absolutely considered gospel on Wall Street.” revolutionary and enlightening at the The Intelligent Investor time they were fi rst The success of Security Analysis prompted Graham to consider writing a text for the presented, and the book is still a valu- individual investor. He was very concerned about educating and protecting consumers able source for when it came to their personal investments. The Intelligent Investor, published in 1949, anyone with a seri- was an instant success. ous interest in fi nancial markets.” The Intelligent Investor established the investor’s defense. Graham believed that the individual investor “lacked the time and temperament to track his securities on a regular basis.” The individual investor, therefore, should invest with “simpler and longer-term objectives” than the professional investor. The investor’s defense: average a company’s earnings over a seven- to ten-year period to determine its true earnings power. This “Confronted with a prevents the investor from falling prey to a company that uses insider tricks to make challenge to distill earnings look better than they really are. the secret of sound investment into three words, we Graham introduced six essential business factors to consider in evaluating company venture the motto performance: profi tability, stability, growth, fi nancial position, and price ‘Margin of Safety’.” history. He measured profi tability as a ratio of operating income to sales. He assessed stability by the trend of per-share earnings over a ten-year period. He compared the

Benjamin Graham on Value Investing © Copyright 2003 getAbstract 4 of 5 growth of earnings per share to the Dow Jones Industrial Average. He determined fi nancial position by a company’s debt ratio. He evaluated dividends through a history “Rake the market of interrupted payments. He also evaluated price history over time — with a steady for bargains.” appreciation being most desirable.

Graham identifi ed 14 pointers for individual investors making investment decisions: 1) Be an investor, not a speculator; 2) Know the asking price; 3) Rake the market for bargains; 4) Buy the formula; 5) Regard corporate fi gures with suspicion; 6) Don’t stress out; 7) Don’t sweat the math; 8) Diversify, rule number one: 25% Bonds, 25% Stocks and 50% mix of stocks and bonds; 9) Diversify, rule number two: have at least 30 different holdings; 10) When in doubt, stick to quality; 11) Dividends are a clue; 12) Defend your shareholders’ rights; 13) Be patient; and 14) Think for yourself.

GEICO All investors have stories about the best investments they ever made. Graham’s biggest “Warren Buffett met Ben Graham success story was about GEICO. In 1948, GEICO sent representatives to Wall Street in an the way most attempt to sell a large piece of the company. The concept of a direct investment was very American inves- appealing to Graham. He used more than 25% of his fi rm’s assets ($712,000) to purchase tors did — he hap- pened across a a controlling interest in the company. The deal was consummated so rapidly, it was only copy of the Intel- afterward that Graham learned that, by law, an investment fi rm could not own more than ligent Investor and 10% of an insurance company. The Securities and Exchange Commission helped him read it.” correct this by agreeing to let him sell shares in an over-the-counter market to his fi rm’s investors. He retained his own shares and kept his position on the Board of Directors.

GEICO shares dramatically increased in value. By 1972, the original investment had made a market gain of around $300 million. GEICO had become the “Cinderella” stock that everyone hopes to fi nd during an investing career. For Benjamin Graham, it was the crowning achievement of a lifetime of hard work and intelligent investing.

About The Author

Award-winning business journalist Janet C. Lowe frequently speaks on investing before live audiences and on television and radio. She is the author of Dividends Don’t Lie (co-authored by Geraldine Weiss), The Super Saver, The Secret Empire and Keys to Investing in International Stocks.

Buzz-Words

Value investing

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