Sage advice from the past still relevant for today’s investors
• Benjamin Graham says investors should not try to forecast but focus on current valuations
The lockdown has been a good time to turn again to the classics. Many of us have more time on our hands and no access to activities such as golf. And we don’t want our minds to turn to mush glued to Netflix or DStv. For some it will be a good time to read or reread the Charles Dickens and Jane Austen novels gathering dust on the shelves.
Business textbooks will probably make us feel even more depressed. But Benjamin Graham’s The Intelligent
Investor, published in 1949, doesn’t read like a textbook — unlike works of the patron saints of the chartered financial analysts (CFA) world, such as Harry Markowitz and Bill Sharpe. Graham was not a stats-driven theoretician. He had worked on Wall Street and even made a substantial amount by investing in Geico, an early adopter of what we would call the Outsurance model of insurance.
There is a lot of common sense in Graham’s views. You needn’t be a card-carrying value acolyte to enjoy it. The discipline he taught to giants such as Warren Buffett and Sir John Templeton was management economics with as much psychology as statistics. Perhaps it is significant that Graham was not an American and never entirely thought like one; he was born Benjamin Grossbaum in London. He certainly exhibited a very un-American disapproval of people who get rich quick.
His first chapter looks at the difference between investors and speculators. In his breakout work Securities Analysis, with long-time collaborator David Dodd, he argued that an investment operation is one which, through analysis, promises safety of principal and an adequate return. All other operations are speculative.
Of course, we have seen how this safety can be an illusion.
Almost all analysis of Sasol two years ago would have called it a blue chip with privileged access to our petrol tanks. Investment in Sasol today would be considered speculative as there is a real chance it will collapse.
In the three years after the Wall Street crash, from 1929 to 1932, it was widely argued that bonds are investments and all equities are speculation. This spurred Graham and Dodd to put the case for equities in
Securities Analysis, first published in 1934.
By the time Graham revised
Intelligent Investor in the 1960s, there was the opposite problem. Everyone transacting on the stock exchange was called an investor. An inexperienced member of the public selling a few stocks for emotional reasons was never an investor in the first place, he said.
In 1948, just before Intelligent
Investor first hit the bookshops, more than 90% of people considered investing in shares to be a gamble. Yet by any measure US equities were selling at attractive prices, and we now know they were to begin the greatest advance in their history in the post-war recovery and unprecedented affluence of the Eisenhower presidency.
Graham predicted that some day stock exchanges would be held responsible for speculative losses. He probably never expected that the main threat to Wall Street by 2008 would come not from common stocks but from Wall Street’s own monster creation, the mortgagebacked security.
Graham said there is nothing wrong with assuming unknown risks if it is done professionally by an investment bank. But it is not intelligent when you are investing or speculating seriously without professional knowledge. If speculation is a pastime using pocket change it can’t do too much harm.
And whether you are Mr Dlamini or Lehman Brothers, it is reckless to risk more money than you can afford to lose. Graham advised readers never to mingle speculative and investment activities in one account. He said aggressive investors (or speculators, according to taste) tried to outperform the market in several ways. One is what we now call the momentum strategy, with which Graham would never have agreed. This aims to ride the trend in shares by buying those going up and selling those going down, often shorting the latter.
There is also short-term selectivity, which we now call an earnings revision strategy. This has been adopted successfully by Ninety One’s SA equity team. Then there is the classic growth style, codified by T Rowe Price, a US fund manager with nearly $1-trillion under management. Growth investors look at past growth of companies and their fundamentals to determine their prospects, hardly a reckless activity. Buffett says growth and value are joined at the hip. But Graham believed true investors should not try to forecast the future but concentrate on today’s price valuation.
He says there are fewer special situations than in the 1960s and before. There are fewer opportunities to arbitrage different classes of securities as most special share classes have been abolished. Mergers used to present sitting-duck opportunities for fund managers as they would usually lead to a large surge in the price of the company being bought out. Now the merger process is slow for regulatory reasons so it takes a long time for shareholders to profit.
THERE IS A LOT OF COMMON SENSE IN HIS VIEWS. YOU NEEDN’T BE A CARDCARRYING VALUE ACOLYTE TO ENJOY IT
GRAHAM ADVISED READERS NEVER TO MINGLE SPECULATIVE AND INVESTMENT ACTIVITIES IN ONE ACCOUNT