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AN HOUR WITH BEN GRAHAM: 1976 Interview by Hartman L. Butler, Jr., C.F.A. La Jolla, California March 6, 1976

AN HOUR WITH MR.

GRAHAM

by Hartman L. Butler, Jr., C.F.A. La Jolla, California March 6, 1976

lIB:

Mr. Graham, I do appreciate so much being able to come and visit with you this afternoon. When Bob Milne learned that Mrs. Butler and I would be in La Jolla, he suggested that I not only visit with you but also bring along my cassette tape recorder. We have much I would like to cover. First, could we start with a topical question-Government Employees Insurance Company-with GEICO being very much in the headlines.

Graham: Yes, what happened was the team came into our office and after some negotiating, we bought half the company for $720,000. It turned out later that we were worth-the whole company--over a billion dollars in the stock market. This was a very extraordinary thing. But we were forced by the SEC to distribute the stock among our stockholders because, according to a technicality in the law, an investment fund was not allowed more than 10 percent of an insurance company. Jerry Newman and I became active in the conduct of GEICO, although we both retired a number of years ago. I am glad I am not connected with it now because of the terrific losses. lIB: Do you think GEICO will survive?

Graham: Yes, I think it will survive. There is no basic reason why it won't survive, but naturally I ask myself whether the company did expand much too fast without taking into account the possibilities of these big losses. It makes me shudder to think of the amounts of money they were able to lose in one year. Incredible! It is surprising how many of the large companies have managed to turn in losses of $50 million or $100 million in one year, in these last few years. Something unheard of in the old days. You have to be a genius to lose that much money.
33

We gave up certain things we had been trying to do and concentrated more on others that had been more consistently successful. HB: Did you see that coming at all-were you scared? Graham: No. HB: Then in 1932. I didn't repeat that error after that.HB: Looking back at your own life in the investment field. were you better prepared for that? Graham: Well. The next thing that was really important to me-outside of having made a rather continuous success for 15 years-was the market crash of 1929. would you say? You went to Wall Street in 1914? Graham: Well. The next thing that happened was World War I broke out two months later and the stock exchange was closed. But lowed money. As a special favor. we seemed to be very brilliant people. which was a mistake. you began to come back? Graham: Well. We went along fine. In 1948. that led us to make some changes in our procedures that one of our directors had suggested to us. My salary was reduced to $10-that is one of the things more or less typical of any young man's beginnings. we sweated through that period. the first thing that happened was typical. HB: The 1937-1938 decline. I stayed away from the speculative favorites. I was paid $12 a week instead 0 f $10 to begin. but he started selling five years earlier. and we followed his advice. which was sound. we made our GEIeO investment and from then on. From then on. 34 . I felt I had good investments. we went along pretty smoothly. All I knew was that prices were too high. HB: Did anybody really see this coming-the crash of 1929? Graham: Babson did. By 1937. what are some of the key developments or key happenings. we had restored our financial position as it was in 1929. and I had to sweat through the period 1929-1932.

I decided to quit and to come out here to California to live. and the things that presented themselves were typically repetitions of old problems which I found no special interest in solving. That was the time Wall Street was really booming. I had the inspiration instead to learn more on the subject before I wrote the book. We felt we had nothing special to look forward to that interested us. We earned money in those years. HB: You earned money after World War II broke out? Graham: Yes. we did. HB: When did you decide to write your classic text. but we limited ourselves to a maximum of $15 million of capital-only a drop in the bucket these days. we had a course in security analysis and finance--I think it was called Investments-and I had 150 students. so I decided I would start teaching if I could. We were no longer very challenged after 1950. In 1928. I became a Lecturer at the Columbia School of Business for the extension courses. Security Analysis? Graham: What happened was that in about 1925.HB: What happened market-1940-1941 ? III the only other interim bear Graham: Oh. The question of whether we could earn the maximum percentage per year was what interested us. I felt that I had established a way of doing business to a point where it no longer presented any basic problems to be solved. 35 . About 1956. that was only a typical setback period. but annual rates of return that we were able to accomplish. About SIX years later. I thought that I knew enough about Wall Street after 11 years to write a book about it. That's why I kind of lost interest. we decided to liquidate Graham-Newman Corporation-to end it primarily because the succession of management had not been satisfactorily established. But fortunately. We could have built up an enormous business had we wanted to. We were going along on what I thought was a satisfactory basis. We had no real problems in running our business. It was not the question of total sums.

Naturally. HB: My own experience is that you have to be a student of industries to realize the great differences in managements. it came out the same time as a play of mine which was produced on Broadway and lasted only one week. Security Analysis was much more successful. he was indispensable to me in writing the book. The main point is to have the right general principles and the character to stick to them. HB: You had a play on Broadway? Graham: Yes. Dave was then Assistant Professor at Columbia and was anxious to learn more. HB: That was the book. to all the stocks 36 . The First Edition appeared in 1934. well now I have lost most of the interest I had in the details of security analysis which I devoted myself to so strenuously for many years. actually. The thing that I have been emphasizing in my own work for the last few years has been the group approach. To try to buy groups of stocks that meet some simple criterion for being undervalued-regardless of the industry and with very little attention to the individual company. I think we can do it successfully with a few techniques and simple principles.The result was it took until 1934 before I actually wrote the book with Dave Dodd. which. in a sense. I am just finishing a 50-year study-the application of these simple methods to groups of stocks. has put me opposed to developments in the whole profession." It was produced twice under two titles. wasn't it? Graham: They called it the "Bible of Grahf-m and Dodd. I would not deny that. I think that this is one thing an analyst can bring to the solution. Graham: Well. It was not successful. He was a student of mine in the first year. Actually. "Baby Pompadour" or "True to the Marines." Yes. But I have a considerable amount of doubt on the question of how successful analysts can be overall when applying these selectivity approaches. Fortunately. My recent article on three simple methods applied to common stocks was published in one of your Seminar Proceedings. I feel that they are relatively unimportant.

Grallam: Yes. Graham: Imagine-there seems to be practically a foolproof way of getting good results out of common stock investment with a minimum of work.5 percent earnings yield rather than 40 times earnings. My research indicates the best results come from simple earnings criterions. and a maximum multiple of 7 times even when interest rates are above seven percent as they are now. HB: I have always thought it was too bad that we use the price/earnings ratio rather than the earnings yield measurement. What I want is an earnings ratio twice as good as the bond interest ratio typically for most years. A maximum multiple of 10 even when interest rates are under five percent. I received in Chicago last year the Molodovsky Award. It would be so much easier to realize that a stock is selling at a 2. I found the results were very good for 50 years. I want to double the interest rate in terms of earnings return. it seems to stand up under any of the tests that I would make up. But all I can tell you after 60 years of experience. you can take half of the earnings yield to estimate a substainable dividend yield. HB: I understand that you have about completed this research. Basically. They certainly did twice as well as the Dow Jones. I have set two limits. One can also apply a dividend criterion or an asset value criterion and get good results. HB: Then with roughly a 50 percent dividend payout.in the Moody's Industrial Stock Group. 37 . However. And so my enthusiasm has been transferred from the selective to the group approach. So typically my buying point would be double the current AAA interest rate with a maximum multiplier between 10 and 7. I would try to get other people to criticize it. Consequently. in most years the interest rate was less than five percent on AAA bonds. The earnings yield would be more scientific and a more logical approach. Graham: Yes. My research has been based on that. It seems too good to be true.

You can't lose when you do that. If you buy 30 companies of that sort. a number of professors started to work on the random walk. the "3M's". are there other ways of doing this? HB: Are there any other ways? Graham: Well. I would say that if a stock with $50 working capital sells at $32. you have a dependable indication of group undervaluation? That's what our own business experience proved to us. What do you think about this? Graham: Well. as I do. am I right in saying if you buy stocks at two-thirds of the working capital value.HB: By some coincidence as you were becoming less active as a writer. mainly profits. because of their long-term futures or to decide that next year the semiconductor industry would be a good industry. naturally. These don't seem to be dependable ways to do it. but the idea of saying that the fact that the information is so widely spread that the resulting prices are logical prices-that is all wrong. I am talking very practically in terms of dollars and cents. that would be an interesting stock. you're bound to make money. they say that the market is efficient in the sense that there is no particular point in getting more information than people already have. One is. The second question. I don't see how you can say that the prices made in Wall Street are the right prices in any intelligent definition of what right prices would be. It's hard for me to find a good connection between what they do and practical investment results. 38 . But what everybody else is trying to do pretty much is pick out the "Xerox" companies. I am sure they are all very hardworking and serious. There are two questions about this approach. That might be true. when we talk about buying stocks. There are certainly a lot of ways to keep busy. Graham: Well. HB: It is too bad there have not been more contributions from practicing analysts to provide some balance to the brilliant work of the academic community. profits and losses. In fact. the thing that I have been talking about so much this afternoon is applying a simple criterion of the value of a security.

the thing for people to do is to try to study the behavior of stock prices and try to profit from these interpretations. though. they would claim that if they are correct in their basic contentions about the efficient market. would be to start with the index concept-the equivalent of index results. or to the extent by which you improve it. Graham: And all you have to do is to listen to "Wall Street Week" and you can see that none of them has any particular claim to authority or opinions as to what will happen in the stock market. no. Now in the group discussions of this thing. rather.HB: Would you have said that 30 years ago? Graham: Well. all have opinions and they are willing to express them if you ask them. say Standard & Poor's results. that is not a very encouraging conclusion because if I have noticed anything over these 60 years on Wall Street. it is that people do not succeed in forecasting what's going to happen to the stock market. provided they would accept personal responsibility for the success of the variation that they introduced. They. I assume that basically the compensation ought to be measured by the results either in terms of equaling the index. Then turn over to managers the privilege of making a variation. To me. HB: The efficient market people have kind of muddied the waters. But I don't think they insist that their opinions are correct. I would not have taken as negative an attitude 30 years ago. HB: That is certainly true. say 100 or 150 stocks out of the Standard & Poor's 500. I have a feeling that the way in which institutional funds should be managed. haven't they. But my positive attitude would have been to say. the typical money managers don't accept the idea and the reason for non-acceptance is chiefly 39 . in a way? Graham: Well. HB: What thoughts do you have on index funds? Graham: I have very definite views on that. at least a number of them. and economists. that you could have found sufficient examples of individual companies that were undervalued.

And if you start on a sound basis. then I say that one should do this and stick to it. intelligence. 40 . and find out whether they can identify an approach to investment they feel would be satisfactory in their own case. That's what we did with our own business. on a sound basis. and I think that's favorable for the young analyst. We never followed the crowd. So I think any experience of the last 20 years. he did do that-he had no great difficulty in starting his business on that basis. I have some practical advice to give you which is this. And if they have done that. All investments require satisfactory results. It did work out all right and then the big bull market came along and. study their own capabilities. and talk. and I think satisfactory results are pretty much the same for everybody." Well. They have never been able to convince me that that's true in any significant degree-that different investors have different requirements. he moved over to other fields and did an enormous amount of speculative business later. let's say. You can buy closed-end investment companies at 15 percent discounts on an average. But at least he started. of course. I said to him. pursue that without any reference to what other people do or think or say. would indicate that one could have done as well with Standard & Poor's than with a great deal of work. what advice would you have to a young man or woman coming along now who wants to be a security analyst and a Chartered Financial Analyst? Graham: I would tf~J1 them to study the past record of the stock market. Graham. Stick to their own methods. If he or she reads The Intelligent Investor-which I feel would be more useful than Security Analysis of the two books-and selects from what we say some approach which one thinks would be profitable. I had a nephew who started in Wall Street a number of years ago and came to me for some advice. HB: Mr. Get your friends to put "x" amount of dollars a month in these closed-end companies at discounts and you will start ahead of the game and you will make out all right. "Dick.that they say-not that it isn't practical-but that it isn't sound because different investors have different requirements. you are half-way along. I think.

There is a famous passage in Bagehot. there has been plenty of sunshine since the middle of 1974 when the bottom of the market was reached. in my opinion. I think this business of greed-the excessive hopes and fears and so on-will be with us as long as there will be people. HB: This has been a most pleasant and stimulative visit. and I'll say about the Wall Street people. They used to say about the Bourbons that they forgot nothing and they learned nothing. I am very cynical about Wall Street. the growth cult. Apparently. literally. it is available to be lost and they speculate with it and they lose it-that's how panics are done. Thank you so much. you have to think independently. One. here in La]olla. Merry-Go-Round. the two-tier market. aren't there? Graham: Yes.HB: Do you think that Wall Street or the typical analyst or portfolio managers have learned their lessons of the "Go-Go" funds. you can bet your Dow] ones Average on that. and secondly. I have no confidence whatever in the future behavior of the Wall Street people. You will be back on that. Mr. in which he describes how panics come about. is that they learn nothing. Typically. The sun is trying to come out now. the English economist. But that such experiences will be duplicated in the next five years or so. and the next pessimism will be overdone. There are two requirements for success in Wall Street. the one-decision stocks. But nobody seems concerned with what are the possibilities that 1970 and 1973-1974 will be duplicated in the next five years. The present optimism is going to be overdone. We will look forward to receiving in Charlottesville your memoirs manuscript. and all? Graham: No. HB: Yes. HB: But there are independent thinkers on Wall Street and throughout the country who do well. correctly and independently. stocks as a whole are not overvalued. typically. What do you see of the sunshine on Wall Street? Graham: Well. you have to think correctly. if people have money. and you are back on the Ferris Wheel-whatever you want to call it--Seesaw. nobody has given any thought to that question. and they forget everything. And my guess is that Wall Street hasn't changed at all. Graham! 41 . Right now.

Notes
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