GUEST AUTHOR BLOG: The Test of Time: Ben Graham in 2012 by Joe Carlen, author of “The Einstein of Money: The Life and Timeless Financial Wisdom of Benjamin Graham.”
It was 1914, nearly one hundred years ago, when a twenty-year old Benjamin Graham began working on Wall Street. Within a few years, his views on the market were already being circulated in the financial press of that era.
By 1932/1933, wizened by his experiences during the Roaring Twenties and The Great Depression and six years of teaching security analysis, his views had crystallized into a comprehensive system of bond and common stock selection.
During that time, Graham, along with his assistant course instructor David Dodd, codified that system in a 600+ page volume drawn mainly from Graham’s already legendary security analysis classes at Columbia University.
The 1934 publication of Security Analysis provide to be a landmark event in the evolution of the security/financial analysis profession. In that book, the authors state that a fundamental principle of sound investing is: “To discover and acquire undervalued [or, as some prefer, underpriced] individual securities as the result of comprehensive and expert statistical investigations.” In simple terms, one’s independent analysis of a company’s capital position and earnings performance determines the intrinsic value of the security in question. If this value is sufficiently greater than the current market price, one can purchase the security with a margin of safety. From the vantage point of the early 1930’s, Graham and Dodd observed how this principle was discarded in the euphoria of the previous decade.
As the market veered into the stratosphere in the late 1920’s, the investing public continued buying absurdly priced securities under the mistaken belief that a “New Era” of investing had arisen in which the old rules no longer applied. In other words, the principle of intrinsic value was all but forgotten in the mad obsession with price trending. All that mattered was where the market price of a security seemed to be heading; value (and margin of safety) be damned. Regarding the ultimate outcome of this misguided approach, Graham and Dodd point out that “The results could not fail to be tragic.” According to them, this was the primary culprit of the market carnage of 1929-1932.
In 2012, seventy-eight years since the publication of Security Analysis, we have several decades of stock market history with which to evaluate the soundness of Graham’s view of market behavior and the price/value dichotomy. The electronics bubble of the sixties and the Internet bubble of the late nineties are two of the most dramatic examples of how market behavior falls into the same patterns – in precisely manner predicted by Graham. In both instances, such old-fashioned considerations as earnings, capital position, and the like were shunned in favor of the exciting trends exhibited by high-flying stocks of a “New Era” of technology. Of course, the results “did not fail to be tragic” in these instances either.
More recently, some electronic trading practices, driven by micro-movements in market price, are yet another indication that much of the market’s behavior is still driven by price-trending as opposed to value hunting. The latter is conducted through a dispassionate analysis of income statement and balance sheet fundamentals. This, in Graham’s view, is the basic homework for which there is no substitute. As stated in Graham’s other classic, The Intelligent Investor, those seeking profitable investment opportunities “should do their elementary jobs before they study stock-market movements [or] gaze into crystal balls…” Those are timeless words from a timeless thinker.
Joe Carlen is the author of “The Einstein of Money: The Life and Timeless Financial Wisdom of Benjamin Graham” of which The Economist wrote: “Joe Carlen explains [Graham’s] ideas well and by switching between Graham's philosophy and his personal life, he gives the book narrative drive.”
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