I should say, Senator, that I am something of an academic man myself. … They made me a professor because I am a practical operator.
—BENJAMIN GRAHAM
Photo courtesy the Columbia University archives, all rights reserved.
On an early spring afternoon in 1911, sixteen-year-old Benjamin Graham took the West Side subway from Fulton Street in downtown Manhattan all the way uptown to 116th Street, then walked a few blocks to the home of Frederick Keppel, dean of Columbia College. Graham was self-conscious about his grimy work clothes and hands still dirty from working all day in a machine shop. But after work was the only time he could get away, and so Dean Keppel accommodated him by suggesting an early evening meeting at Keppel’s house. The year before, Graham had been devastated when Columbia turned him down for a scholarship, and he had no idea why the dean was so interested in seeing him now.
Meeting in his study, in the glow of fresh embers from the fireplace, Keppel explained the reason he asked Graham to visit. “You know, we’re frightfully embarrassed about you in the registrar’s office. The fact is, Grossbaum, you won a scholarship here last year but we didn’t give it to you.”
Graham—his family changed their name from Grossbaum to Graham during the wave of anti-German sentiment brought about by World War I—was perplexed. Precocious and intellectually ambitious, he’d had his heart set on entering Columbia College at age fifteen. He was a math prodigy but also a devotee of the classics of literature. Growing up he lived in the worlds of the Iliad and the Odyssey and devoted one of his preteen summers to learning French so he could read authors in the original. When he was interviewed for the Pulitzer Scholarship the year before and was asked about the most meaningful book he ever read, he responded enthusiastically that is was all the volumes of Edward Gibbon’s Decline and Fall of the Roman Empire—he said that he personally identified with Septimius Severus and other Roman heroes. The rejection that had followed this interview was a profound blow to the young intellectual’s ego. But suddenly, that rejection seemed to be undergoing a reversal, and Graham was at a loss. “How … how did that happen?”
“You have a brother or a cousin, Louis Grossbaum, who has been here for three years on a Pulitzer Scholarship,” Keppel replied. “When we awarded yours the registrar’s office got the names mixed up. They couldn’t give a scholarship to a boy who already had one, so they gave yours to the next fellow in line.”
The error had been even more costly than Graham first understood. As the dean explained, he hadn’t been awarded the Pulitzer Scholarship but had actually won the more comprehensive full-tuition Columbia Alumni Scholarship, given to the student with the highest entrance examination score. Keppel said that Columbia would set the matter straight by awarding him the Alumni Scholarship for the coming fall.
“But I’ve lost a whole year,” Graham said.
“True, true, and we’re genuinely sorry about our mistake,” Keppel responded, “but you would have been much too young to get the most out of college if you had started a year ago. This machine-shop training of yours is the best thing for you. You’ll have much more savoir faire and maturity than the other boys of your age.”1
For Graham, of course, the work at the machine shop wasn’t done simply to develop savoir faire. His failure to receive a scholarship had left him with no choice but to abandon his Columbia ambitions; after a rapid decline in family fortunes, he simply had no means to afford a college education. When he was one year old, the Grossbaums—father, mother, and three sons—moved to New York from London to expand the family’s china and bric-a-brac business, and Graham remembered an upper-middle-class early childhood, with “Mademoiselle,” his French governess, supervising play in Central Park and “Cook” preparing the family meals. But his privileged life ended abruptly when his father succumbed to pancreatic cancer at age thirty-five and, shortly after, the family business folded under the inept management of Graham’s uncle Maurice. His mother was forced to turn their home into a boardinghouse, and the family shuffled between living there and living at Uncle Maurice’s flat, where Graham and his brothers shared bedrooms and one bathroom with his cousins.
Growing up, Graham held dozens of successive jobs to shore up his family’s precarious financial situation, beginning with delivery of the Saturday Evening Post and including his current job at the Fulton Street machine shop. Before starting his most recent job, he attempted to salvage his college hopes and briefly attended the City College of New York, an institution with free tuition. But in what he acknowledged as “pure, unadulterated snobbishness,” he was profoundly dejected by the quality of his classmates and dropped out of CCNY in favor of pursuing a blue-collar career.
His ultimate decision to start at Columbia the following fall did not mark an end to his working days. Though Columbia’s tuition was handled by the alumni scholarship, Graham still had to finance his living expenses with a string of part-time jobs, including tutoring the children of army officers, ushering at a vaudeville house, cashiering at a movie theater near the Bowery, and operating a punch-card machine for an express delivery company. But even with the burden of balancing work and studies, Graham finished Columbia’s four-year program in two-and-a-half years, more than making up the year he had lost because of the registrar’s clerical error. He was elected to Phi Beta Kappa and, by virtue of attaining the second-best grades among his classmates, served as the class salutatorian.
Nevertheless, he found little personal joy in college, reflecting ruefully that “I had always dreamed of college life as the halcyon period of youth, a wonderful combination of education, friendship, romance, athletics, and all-around fun. Alas! Looking back at my own college career, I recall no such happy interlude.”2 His comments reflect a lifelong regret about his inability to cultivate friends, develop personal relationships, and think beyond his own ambitions. In another reconsideration of his college years he said, “At Columbia, a group of such friends did me the honor of inviting me to join the leading Jewish fraternity—Zeta Beta Tau. I declined, saying I could afford neither the time nor the money involved. I should have made the time and borrowed the money.”3
Graham may not have been enchanted by Columbia, but Columbia was enchanted with him. In the month preceding his graduation in the spring of 1914, he was offered teaching positions in the departments of mathematics, philosophy, and English. But Dean Keppel, who continued as Graham’s trusted advisor throughout his brief stay at Columbia, counseled him to delay accepting a life in academia and to enter the business world instead. Shortly afterward Keppel introduced him to Samuel Newburger, a partner in the Wall Street firm of Newburger, Henderson & Loeb. Graham, who had dropped the sole economics course he had enrolled in, hardly knew the difference between a stock and a bond. But with his personal and family financial conditions still shaky, Wall Street looked promising, and he took the job Newburger offered. Starting at $12 per week he delivered securities to and from the firm’s headquarters on Broadway, with the prospect of becoming a bond salesman after he learned the business from the ground up. Few would have guessed, least of all Graham, that he would someday return to Columbia with the informal title of “Dean of Wall Street.”
Mr. Market and Intrinsic Value
By the time Graham retired from Wall Street in 1956, investing in common stocks had become a respectable endeavor, and that respectability was due in some important measure to Graham’s methodical and commonsense approach to what would become known as value investing. But upon his arrival at the Newburger firm in 1914, putting common stocks in a portfolio was not considered to be a legitimate form of investing but rather a speculation that had appeal only to the naive and greedy—and to the market operators who stood ready to take advantage of such naiveté and greed. As a result, well-recommended young men looking to enter the respectable sector of high finance often began their career as bond salesmen. Like Graham, they rarely had any familiarity with the bond market when they entered the business. Nick Carraway, F. Scott Fitzgerald’s narrator in The Great Gatsby, may have been typical, saying, “I graduated from New Haven in 1915 and decided to learn the bond business. Everybody I knew was in the bond business, so I supposed it could support one more single man.”4
But unlike Nick Carraway, Graham had little of the self-assurance and few of the social contacts needed to deal comfortably with the old-money bond buyers who managed the trust and insurance companies where the bonds were placed. He recounted that after some time on the job, “I had brought in absolutely no bond sale commissions to offset my $12 per week emolument.”5 But he did develop a keen understanding of how bonds were structured, and in his early days at Newburger, Henderson & Loeb he diligently read—practically memorized—Lawrence Chamberlain’s The Principles of Bond Investment, the definitive textbook on the subject. Yet his book knowledge produced no revenue for the Newburger firm, and he found himself eyeing a job as a “statistician” with a rival firm, where he could put his analytical and writing skills to work by preparing reports for use by the sales force—and enjoy a raise to $18 per week.
When he announced his planned resignation to Samuel Newburger, however, the managing partner was incensed that another firm had violated Wall Street protocol by stealing a valued employee. Graham protested, “But I’m not cut out for a bond salesman; I’m sure I’d do better at statistical work.” Newburger, not wanting to lose his bright young employee, replied, “That’s fine. It’s time we had a statistical department here. You can be it.”6 Graham stayed, even though his initial raise for doing so was only to $15. Over the succeeding nine years at Newburger, Henderson & Loeb, with most of that time coinciding with his twenties, Graham rose rapidly through the firm’s ranks, and by 1923 he was a full partner with an unusual arrangement under which he had no liability for any of the firm’s risks but was nevertheless entitled to 2.5 percent of its profits.
Graham’s success might reasonably be ascribed to his development of a single revolutionary concept in the field of securities analysis: intrinsic value. Heretofore, common stocks were often bought and sold based primarily on the prospects for movements in their price, with little thought given to what the underlying business of the company was worth—or even what its business was about. With the full-disclosure requirements of securities laws still decades away, common stockholders received precious little information about publicly traded companies after they had purchased shares of stock in an initial offering. Absent that information, investors—in reality, speculators—attempted to time their stock purchases by divining the length and breadth of market moves. The players in the infamous stock pools that would reach their disastrous zenith later in the 1920s based their decisions on tips, rumors, inside information, and a gut sense of price “momentum.”
But throughout the craziness of the Roaring Twenties, Graham was designing and implementing a much more rational and profitable method of investing in the stock market, one based on digging up enough information on a business to ascertain its fundamental value and then comparing that value to the price at which the security was trading in the market. His commonsense procedure created easy decision rules. If, based on analysis, it is possible to determine that the underlying or intrinsic value of a stock is $20, but at the same time you find that it is selling in the market at $18, the stock is presumably worthy of purchase. Graham was fond of putting the disparity between calculated intrinsic value and market price into a Mr. Market metaphor. Sounding like a character out of a children’s book about the stock market, Graham describes Mr. Market as your obliging partner
who every day 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.7
So, if Mr. Market stands willing to sell you shares of common stock for $18 that you calculate to be worth $20 each, should you buy them? By Graham’s investment approach, not necessarily. He imposes a second condition that is central to his decision making: an adequate margin of safety; that is, a difference that is large enough to absorb any miscalculations made in estimating the intrinsic value or just some amount of bad luck that might be encountered. So an $18 price may not be low enough—but that, of course, raises the question of how large the cushion needs to be. Graham devoted significant thought to this question, and a quick example involving his first major success at Newburger, Henderson & Loeb is illustrative.
In a stock pick that Graham would credit with being “the real beginning of my career as a distinctive type of Wall Street operator,”8 he carefully calculated the value of the several holdings of the Guggenheim Exploration Company that would shortly be available to the company’s shareholders upon the earlier announced intention to dismantle the holding company and distribute shares of the individual businesses to the stockholders. At the completion of his analysis he was certain that the sum of the Guggenheim parts was greater than the whole, meaning that the price for which Mr. Market was willing to sell the whole company was less than the value the shareholders would receive a few months later upon liquidation. By Graham’s calculations, the total value of Guggenheim’s interests, mainly its holdings of copper mining companies throughout the West, equated to a per-share stock price of $76.23. Yet the price of Guggenheim’s own shares on the New York Stock Exchange was just $68.88. So in Graham’s parlance, Mr. Market was willing to sell those shares at a price that discounted their value by $7.35, or nearly 10 percent.9 It was a discovery that the youthful Graham would describe in hyperbolic terms: “Here was I, a stout Cortez-Balboa, discovering a new Pacific with my eagle eye. Imagine!”10
Cortez-Balboa or not, that discovery was just the first of many “arbitrage” opportunities that Graham would unearth. Putting a successful arbitrage in place was fairly simple. In the case of the Guggenheim transaction, for instance, it required the simultaneous purchase of shares of Guggenheim and the short sale of the appropriate number of shares in companies that Guggenheim owned, including shares in such companies as Kennecott Copper, Chino Copper, and American Smelting. But was the margin of safety sufficient to protect against the risks? There was always a possibility that the Guggenheim shareholders would not approve the proposed transaction or some legal problem would delay or scuttle the whole plan. Also, the sale of the separate holdings would be a short sale, and all sorts of problems could crop up in that connection.
But as Graham would recount, the 10 percent cushion was all that was needed in this case: “The dissolution plan went through without a hitch; the profit was realized exactly as calculated; and everyone was happy, not least myself.”11 Besides making his mark at Newburger, Henderson & Loeb, he also made a great deal of money for himself. He had earlier negotiated a new arrangement whereby he would be allocated a 20 percent share of the firm’s profit on the transactions he engineered—a profit in the Guggenheim case that totaled $7.35 for each of the “fair number” of shares the firm purchased. Whatever his personal profit from the transaction, it was sufficient to establish his value to Newburger, Henderson & Loeb, and his weekly salary more than tripled to $50 week. His profit was also sufficient to buy his first car and announce his engagement to Hazel Mazur, the first of his three wives.12
Unlocking Value
By 1923, Graham was not just serving as Newburger, Henderson & Loeb’s “lead statistician,” but also running much of the firm’s operations and systems business, handling its over-the-counter business, and, despite a self-professed ineptitude at selling, bringing in a respectable number of new customers. But as was probably inevitable for someone with his intellect and drive, Graham soon outgrew the confines of a traditional Wall Street firm. So after nearly a decade with the Newburger firm, he left to open his own money management company, where he could focus on his well-developed competence in securities analysis and enjoy hefty performance fees from his clients. After going it alone for a few years, he formed an agreeable partnership with Jerome Newman, one that would last for thirty years. Newman handled the administrative aspects of what would become the Graham-Newman Corporation and, between the two of them, they raised the initial several hundred thousand dollars from investors eager to tap into Graham’s recognized money management abilities.
Many of the new firm’s early successes followed the pattern of the Guggenheim Exploration transaction, with Graham-Newman making money for its clients and, of course, for the firm’s two partners by ferreting out profitable arbitrage and other special situations. Through his financial detective work, for instance, Graham determined that the market was placing a value on the chemical company E. I. du Pont de Nemours that was no more than the value of its holdings in General Motors stock. That meant that the chemical business effectively had no recognized value—Mr. Market was willing to sell all of DuPont at a stock price that reflected only its ownership in General Motors. To take advantage of that anomaly, Graham put in trades to purchase DuPont common stock and at the same time sell short seven times as many shares of General Motors. His firm benefited handsomely when the rest of the market woke up to the obvious mispricing of the DuPont stock. At the conclusion of the transaction, Graham no doubt understated the profitability of the transaction for the Graham-Newman partners and investors by remarking matter-of-factly that “in due course a goodly spread appeared in our favor, and I undid the operation at the projected profit.”13
Likewise, he discovered by searching through public records at the Interstate Commerce Commission that the pipeline companies spun off from the Standard Oil Company under the provisions of a 1911 antitrust action owned an enormous amount of investment-grade railroad bonds—and that the value of those bonds alone exceeded the market value of the publicly traded common stocks of the pipeline companies that held the bonds. Graham made large investments in the Northern Pipeline Company, and by 1928 Graham-Newman was its second-largest shareholder, behind only the Rockefeller Foundation. Taking an activist approach to investment that would not fully bloom on Wall Street for years to come, Graham led a series of shareholder actions and lawsuits against Northern Pipeline to coerce its recalcitrant management to put the shareholders’ interest in front of their own by distributing the bonds to the owners of the Northern Pipeline common stock. It took years, but Graham eventually prevailed in having the bonds turned over to the company’s shareholders. Between that distribution and an increase in the price of Northern Pipeline’s stock, Graham and his firm more than doubled the value of what became one of Graham-Newman’s major investments.14
Although most of the investments undertaken by Graham-Newman over the decades were not strictly arbitrage-related like Guggenheim, DuPont, and Northern Pipeline, most were, in one way or another, special situations in which securities could be purchased at less than their liquidation value. Those special situations were discovered through Graham’s painstakingly thorough screening of investment opportunities, in which he looked for companies whose intrinsic value had gone unrecognized by Mr. Market and that offered a substantial margin of safety to mitigate risk. In his methodical style, Graham categorized special situations into six separate classes: class A: standard arbitrages, based on a reorganization, recapitalization, or merger plan; class B: cash payments, in recapitalizations or mergers; class C: cash payments on sale or liquidation; class D: litigated matters; class E: public utility breakups; and, as a catch-all category, class F: miscellaneous special situations.15
A Signature Investment
The most “special” of Graham’s special situations would be an investment in a business that could, if necessary, be liquidated at any time at a profit but which also had the potential for unexpected—“speculative” in Graham’s way of looking at things—upside benefits in the future. Fitting this description perfectly, especially the upside benefits part, was Graham-Newman’s 1948 purchase of a half-interest in the Government Employees Insurance Company. This became, by far, the firm’s most successful investment.
Known more commonly as GEICO, and nowadays often associated with its green, Cockney gecko mascot, the company at the time of the investment was a twelve-year-old automobile insurance operation that sold its policies directly to government employees through the mail. It enjoyed reduced costs through bypassing agents and selling its insurance products to a set of policyholders who had fewer than average accidents. A low-cost, low-risk business like GEICO was made to order for Graham. When GEICO’s founder was willing to sell his half-ownership at the very reasonable price of $720,000, Graham jumped at the opportunity, even though that amount represented about one-quarter of Graham-Newman’s assets under management at the time.16
Due to provisions of the Investment Company Act of 1940, it was not permissible for investment managers to own more than 10 percent of any company, so the GEICO shares were distributed to the Graham-Newman investors. By the time Graham-Newman shut down its business in 1956, the value of the GEICO shares had risen over elevenfold, from $51 to $614. For the investors who held on to those shares, the value of the GEICO holdings at their peak would reach a 1972 high of $16,823 per share.17
Graham’s GEICO investment illustrates another aspect of his investment approach that is even more fundamental than his Mr. Market and margin of safety maxims, namely his assertion that “investment is most intelligent when most businesslike.”18 When he bought the controlling position in GEICO, he was buying a business for the long haul, a totally different mind-set than that used by most investors, who buy or sell a stock if and when it hits some near-term price target.
Throughout his investing and writing careers, Graham felt the need to clarify, over and over again, the importance of approaching investment as a business proposition. At its core, his admonition to think like a businessperson is a plea to fully understand the fundamentals and risks of the business one is considering investing in. Further, if the investment conclusion is based on facts and solid judgment, Graham encouraged investors to trust their knowledge and experience and make investment decisions independent of the opinions of others—especially the opinions of those who have commission or other incentives.
When the market wouldn’t conform to his rational approach to investing, he could, like a frustrated schoolteacher, slip into a scold, as he did in a Forbes article he wrote at the nadir of the stock market in the early 1930s. Stockholders, he wrote,
have forgotten that they are owners of a business and not merely owners of a quotation on the stock ticker. It is time, and high time, that the millions of American shareholders turned their eyes from the daily market reports long enough to give some attention to the enterprises themselves of which they are the proprietors, and which exist for their benefit and at their pleasure.19
The tone of the 1932 article no doubt reflected Graham’s frustration with Mr. Market’s inability to assign a correct value to common stocks, many of which were selling far below their liquidating value. But it also underscores a crucial requirement of successful value investing—the recognition of irrational pricing by other investors coupled with a willingness to think like businesspeople and correct their mistakes by buying or selling at the “right” prices. During the 1930s, however, Mr. Market was stubbornly refusing to adhere to rational business behavior. What Graham was experiencing was an apt confirmation of the remark attributed to John Maynard Keynes that “markets can remain irrational a lot longer than you and I can remain solvent.” He scaled back his stock market investments, but in the irrational 1930s the joint account he was managing fell in value from $2.5 million in 1929 to around $750,000 at the time of his Forbes article.20
The GEICO investment also illustrates another of Graham’s short but profound principles of value investing: If a common stock is a good investment it is also a good speculation. That statement, first attributed to him in a pamphlet he wrote for Newburger, Henderson & Loeb’s customers, called “Lessons for Investors,” would serve as the lynchpin of much that he would later say and write about successful investing.21 In the case of the GEICO investment, the $51 price per share paid in 1948 could be easily tested by the many financial yardsticks Graham applied—working capital, reserves, stability of cash flow, and so forth—to justify its current value without regard to any improvements or growth in its operations that might unfold in the future. GEICO’s future prospects might brighten later, but the $51 price didn’t include any need for that to happen—and, as usual with his investments, the price had a built-in margin of safety in the event things somehow worsened.
In poker terms, Graham didn’t bet on the come; he played the hand he was dealt and never assumed cards that would come his way later would improve that hand. Walter Schloss, a prominent investor who happened to be in the Graham-Newman office at the time the GEICO investment was made, recalls Graham saying “Walter, if this purchase doesn’t work out, we can always liquidate it and get our money back.”22
So why is a good investment like GEICO at $51 in 1948 also a good speculation for future years? In a word, because any upside benefits are free. If good things happened to GEICO’s business beyond 1948—which they certainly did—the investor enjoys the eventual upside without paying for it up front. Graham believed that investors, like all mortals, are incapable of divining the future and therefore should not pay up for long-term prospects. As Graham put it, “An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”23 Yet if a sound investment happens to also provide outsized returns, so much the better, and in a portfolio made up of solid investments, some, like GEICO, will go on to become bonanzas—“all this and heaven too,” as Graham would characterize such an investment.24
What the Record Shows
Graham was the ultimate empiricist. The success of an investment depended on the return that it produced; a money manager’s acumen was judged by the numbers and nothing but. Without the success of GEICO included, however, the long-term record of Graham-Newman is good but not sensational. In a 1977 monograph prepared by Irving Kahn and Robert Milne, both editors at the time of the Financial Analysts Journal, the authors attempted to compare the results of Graham’s investment partnerships over time and found that—again, without GEICO, it should be emphasized—the results for investors, after Graham and Newman’s fees were taken into consideration, were not significantly different from those realized by investing in the Standard & Poor’s 500 Index or the Dow Jones Industrial Average. John Bogle’s first index fund was still many years away, but investors would have done about as well investing in that kind of low-cost mutual fund as they did with Graham-Newman. For eleven-and-a-half years—from January 31, 1945, when public information about Graham-Newman’s investments became available through the Moody’s Manual of Banks and Finance Companies, until the firm’s dissolution in 1956—Graham-Newman experienced an annual rate of return of 15.5 percent. By comparison, the S&P 500 had a return of 18.3 percent.25
But during that time, the GEICO investment, to comply with Securities and Exchange Commission investment advisor requirements, had been distributed to the Graham-Newman partners. If it is assumed that the investors who received the GEICO stock held on to it until 1956, the record of Graham-Newman partners would have been much better. Kahn and Milne calculate that 100 shares of Graham-Newman would have appreciated in value from $11,413 on January 31, 1948, to $70,413 on August 20, 1956, the date of the firm’s liquidation. The same amount invested in the S&P 500 would have grown to only $30,968.26 Kahn and Milne also point out that on a risk-adjusted basis, a Graham-Newman stock portfolio would have been less risky than the S&P 500.
The authors—one of whom, Kahn, was an assistant to Graham at Columbia University—attempt to portray Graham’s value-based investment style as producing an alluring combination of low risk and superior return. Yet when looking at the record, with and without GEICO, it’s an inescapable conclusion that some measure of the Benjamin Graham lore is based on his being lucky in addition to being very smart and diligent. Graham, always straightforward if not self-effacing about his investment record, would reflect in 1973 that “ironically enough, the aggregate profits accruing from the GEICO investment decision far exceeded the sum of all the others realized through twenty years of wide-ranging operation in the partners’ specialized fields, involving much investigation, endless pondering, and countless individual decisions.”27
Supporting the irony, Graham notes that the GEICO investment broke many of his own rules. It was indeed purchased at an initial price that was below what it could presumably be liquidated for, but other parts of the Graham-Newman rule book were summarily disregarded, including the rule of never investing more than 5 percent of the fund in any one security; the GEICO investment was closer to 25 percent. And later, when the price of GEICO’s common stock soared past any reasonable estimate of its liquidation value, Graham still hung on to the investment, embracing the price momentum philosophy of a growth investor. Graham’s response to these contradictions? “There are several different ways to make money in Wall Street.”28
Something of an Academic
So while Graham was clearly a talented money manager, this alone cannot account for the legendary status he has achieved. At Graham-Newman’s high point, the firm was managing no more than $20 million, not a major amount even in the 1950s, and its record, if GEICO is stripped away, was at best average. So if he had simply run Graham-Newman as a successful but low-profile operation using his profitable investment rules and standards, his name might be little remembered. But he was at heart more of an academic than an operator, and his widely aired ideas on investments and investing changed the way Wall Street worked. It was Graham’s intellectual contribution of rationalizing the basis for buying and selling securities that gave him such high standing in the investment world.
In his 1955 testimony before Senator James W. Fulbright, chairman of the Committee on Banking and Currency of the U.S. Senate, the “Dean of Wall Street” made his focus clear:
GRAHAM: I should say, Senator, that I am something of an academic man myself.
FULBRIGHT: I did not know that.
GRAHAM: I have the title of adjunct professor of finance at Columbia University, and I give a course in the evaluation of common stocks.
FULBRIGHT: I saw you on television in an Ed Morrow show, but I did not understand that you were a professor. I thought they had brought you in as a practical operator to tell them how it was done. I misunderstood.
GRAHAM: They made me a professor because I am a practical operator.29
Indeed, throughout his long career as a “practical operator,” Graham’s academic side was always evident. During his early days at Newburger, Henderson & Loeb, he gravitated toward writing rather than selling, preparing analytical write-ups for the firm’s sales force and customers, and as his investment philosophy began to take shape, he wrote pamphlets for nonprofessionals, called “Lessons for Investors.” For the investment community, he prepared several articles for a leading publication of the time called the Magazine of Wall Street, with the first article, “Bargains in Bonds,” hinting at his opportunistic investment approach. His later articles in the same magazine developed analytical frameworks far beyond anything that had been used in the past, prompting the editor of the magazine to confide to Graham: “Ben, neither I nor anyone else around here can make head or tail of your formulas. It looks as if you’ve done the whole thing with mirrors. But I’ve enough confidence in you to publish the article anyway.”30
After dozens of articles for the Magazine of Wall Street—with occasional pieces prepared for more theoretical publications such as the American Mathematical Monthly—Graham began thinking of writing a textbook to put in one place the ideas he had formulated and successfully practiced over the years. In 1927, just a year after he had formed his partnership with Jerome Newman, he approached Columbia University with the idea of giving a series of evening lectures, collectively called Security Analysis, on both bond and common stock investing in order to test and refine his approaches in front of interested Wall Street professionals. The university was receptive, and Graham began to teach his course to a large and growing audience, always assisted by the young Columbia faculty member, David Dodd, who faithfully compiled notes from each of the lectures with an eye toward organizing them later into a book. Because of the breakthroughs in the field of investment selection covered by the lectures and because of the heightened interest in the stock market in the 1920s, Graham’s courses soon were vastly oversubscribed, with standing room only availability in Columbia’s lecture halls.
It was seven years before the Security Analysis lecture course became a comprehensive textbook by the same name—and Graham was grateful that the book took so long to produce. He needed the input from his students to better shape the book to their needs, but even more important, he wanted to incorporate the lessons from the horrendous damage of the extended stock market collapse of the 1930s. For Graham that damage was experienced firsthand, as the accounts he was managing on his investors’ behalf plummeted in value from $2.5 million in 1929 to less than a third of that amount by 1933.31 In his words, he was able to “pour into Security Analysis wisdom acquired at the cost of much suffering.”32 (Recognizing that this suffering was felt more tangibly by his investors than by himself, Graham entered into an agreement with those investors to reduce his management compensation at the beginning of 1934 until the investors were made whole—which happened by the end of 1935.33)
Security Analysis became his magnum opus and was eventually published in 1934—a seven-hundred-page doorstop of a book coauthored with Dodd. In the first paragraph of the book’s preface, the authors set the tone, stating that it is “not addressed to the complete novice” and that the book’s emphasis is on “distinguishing the investment from the speculative approach.” Then, in fifty-two comprehensive, detailed, and well-written chapters, the authors describe the various financial instruments for investment and set forth an analytical framework for determining their value. Nothing like Security Analysis had ever been written and, for the adherents of the value approach to investing, nothing has been written like it since. The best known of the large number of value investors today is Warren Buffett, one of the world’s two or three richest individuals. In the foreword to the sixth edition of Security Analysis in 2009, Buffett proclaims that the book, and later his personal association with Graham and Dodd while he was a student at Columbia in 1950 and 1951, provided the road map for his own investing and that “there’s been no reason to look for another.”34 As though other endorsements are needed, Barton Biggs, a noted hedge fund investor and the developer of Morgan Stanley’s research department, recalls that when he was first considering a career in securities research, his father gave him a copy of Security Analysis and instructed him to read it from cover to cover. After he did so and returned the dog-eared, underlined book, his father gave him a new one, saying, “Do it again.”35
Thankfully for nonprofessional investors—those who consider themselves closer to the “complete novices” referred to by Graham and Dodd than to Warren Buffett—there is another road map. Fifteen years after the publication of the first edition of Security Analysis (subsequent editions of the book would follow in 1940, 1951, 1962, 1988, and 2009), Graham wrote a book for the lay investor called The Intelligent Investor. That book, subtitled A Book of Practical Counsel, narrows the investment focus primarily to common stocks, and the “intelligent investor” who picks up the book need only be capable of understanding the basic measures of investment value for those stocks (dividend yields, price-to-book ratios, price-to-earnings ratios, and the like). But in yet another ringing endorsement, Buffett states in a revised edition of The Intelligent Investor that when he read the book for the first time in early 1950 as a scrawny nineteen-year-old—he claims to have read every book in the Omaha Public Library on investing by the time he was eleven—he was certain it was the best book on investing ever written. Though he presumably graduated to the next level by studying Security Analysis at Columbia, he avers that he still holds that opinion about the merits of The Intelligent Investor.36
Gone Are the Good Old Days
In 1956, less than ten years after the publication of The Intelligent Investor, the sixty-two-year-old Graham decided to dissolve the Graham-Newman Corporation and distribute the fund’s securities to its investors. His decision was marked by a yearning to leave the marketplace and devote himself more fully to a stimulating life of the mind. “We were no longer very challenged after 1950,” he wrote, “and the things that presented themselves were typically repetitions of old problems which I found no special interest in solving.”37 So he parted without tears from the day-to-day money management business and New York City, and moved to Beverly Hills where he had time to fulfill his far-ranging intellectual interests, including teaching at the University of California–Los Angeles and translating novels.
But among his reasons for shutting down Graham-Newman must have also been the changes in the financial markets that made the mission of his firm increasingly difficult to accomplish. In annual reports to his investors he had set forth a twofold investment strategy:
1. To purchase securities at prices less than their intrinsic value as determined by careful analysis with particular emphasis on the purchase of securities at less than their liquidation value.
2. To engage in arbitrage and hedging operations.
From his early days at Newburger, Henderson & Loeb, he had invested in accordance with those two guidelines. As the years passed, however, developments in the securities markets had conspired against him. With respect to arbitrage and hedging, the number of players was growing, and it was increasingly difficult to find profitable transactions. Investment houses and other specialty Wall Street enterprises were setting up trading operations to locate money-making arbitrage situations, and while Wall Street might still offer acres of diamonds for the taking, there were now many more investors searching for those diamonds.
Making matters tougher—if fairer for investors generally—the passage of New Deal–era securities legislation made corporate information more current, accessible, and nonproprietary. It was no longer necessary to travel to Washington, D.C., as Graham had, to search through the bowels of the Interstate Commerce Commission for information about the bond holdings of the Northern Pipeline Company. Initially, Graham was skeptical about the value of the New Deal’s securities legislation, maintaining that the SEC’s disclosure requirements did not assure the soundness of securities and pointing to the questionable character of many of the stock offerings coming after the Securities Act of 1933. In The Intelligent Investor, written sixteen years later, he acknowledged that “the SEC has virtually revolutionized the conduct of investment banking and brokerage and has significantly affected the conduct of corporate affairs in relation to stockholders.”38 He held fast to his belief that the basics of successful investing remained intact and based on the cold, hard facts. But it is undeniable that, under the disclosure requirements of the far-ranging securities acts of the 1930s, those facts became available for all to see with far less effort—and over time the opportunities to benefit from mispriced securities became less frequent.
As for purchasing securities at less than their intrinsic value, the new securities reporting requirements were also making that task less arduous for analysts. With companies required to regularly prepare and disclose audited financial statements, the job of screening for investment opportunities that Mr. Market was undervaluing became far simpler. And to some extent, Graham, with his penchant for spreading the gospel of value investing, was acting as his own worst enemy. His well-attended lectures at Columbia University and his frequent articles on how to locate undervalued securities had the effect of creating more imitators—and fewer unique opportunities for Graham-Newman.
An even greater hindrance to finding sufficient opportunities that fit the bill for a Graham-approved investment was the long-term bull market that began in the post–World War II years and continued through the late 1960s. That market boom produced a great deal of new wealth for investors but at the same time frustrated Graham in his search for common stocks that had the defensive attributes and margin of safety he required in stock selection. The reason for the increased level of stock prices was, in his mind, obvious: the willingness of investors to use speculation about a business’s long-term prospects in determining the price they were willing to pay for a security. He believed long-term speculation was foolhardy and inevitably based on overly optimistic assumptions as to the rate and duration of earnings growth.
Graham regularly and vociferously decried the overvaluation of the stock market in talks in the 1950s, writing articles that bore titles such as “The New Speculation in Common Stocks” and “Stock Market Warning: Danger Ahead.” In the end, however, it must have appeared that speculation on Wall Street was not going to go away any time soon, and finding bargains in the market with Graham-Newman’s criteria would be a near impossibility. He lamented, “We can look back nostalgically to the good old days when we paid only for the present and could get the future for nothing. Shaking our head sadly we mutter, ‘Those days are gone forever.’”39 So, having long since created a fortune, he folded his long-running money management firm and headed to the warmer climes of California and, later, to Aix-en-Provence in France.
A Far-Ranging Intellectual
Graham was a man of monumental drive and accomplishment. By virtue of writing the original and revised versions of Security Analysis and The Intelligent Investor, teaching courses at Columbia, providing testimony as an expert witness, and writing for professional publications such as the Financial Analysts Journal (signing his articles with the pseudonym “the Cogitator”) and popular publications such as Forbes and Barrons, Graham accomplished as much or more than a full-time and very successful professor. All the while, of course, he was holding down his “day job” at Graham-Newman, one that would consume the full attention and energy of more ordinary individuals.
Still, he had many ambitions that extended beyond Wall Street—and for the most part he would remain unsatisfied in fulfilling them. He had long been an aspiring playwright, and in 1934 he wrote and produced a Broadway show called Baby Pompadour, a play that revolved around a big-time journalist and his loopy chorus-girl mistress. It closed after a few days when critics panned it. Another ultimately frustrated ambition was making a mark in public service. During the Great Depression, deflation was a major impediment to economic recovery, and he believed he had devised a commodity-based plan to stabilize the nation’s currency. His plan was encapsulated in a much-belabored book titled Storage and Stability that was published in 1937. After initial excitement about the plan being adopted by the U.S. government when Franklin Roosevelt’s advisor recommended it, that venture, like Baby Pompadour, also came to naught when the president ultimately rejected Graham’s ideas.
In any balanced analysis, Graham’s professional setbacks were few and, in the context of his many achievements, largely inconsequential. The personal side of his life, at least by his telling, was a different story. In Memoirs, Graham repeatedly bemoaned his inability to make personal connections. He was a selfless teacher and mentor and a faithful and honest steward of the money entrusted to his care as a money manager; he was not an observant Jew, but taught a children’s worship class in his synagogue; and Warren Buffett—who bestowed a grand compliment on his mentor by naming his first child Thomas Graham Buffett—said that Graham embodied “an absolutely open-ended, no-scores-kept generosity of ideas, time, and spirit … if encouragement or counsel was needed, Ben was there.”40
But Graham, by contrast, thought that his first wife, Helen Mazur, probably got it right when she sized him up as being “humane, but not human,” and a sense of estrangement nagged at him for the duration of his life. His regret for not joining a college fraternity served as just one of the examples he enumerated of his emotional coldness; he confessed that he could be everybody’s friend but never one’s bosom buddy. “Something within me rebels at the idea of exclusiveness or monopoly in human relations. This makes me, if not a bad friend, at least an impossible crony—and, I must add, a fundamentally unsatisfactory lover.”41
His history of three unsuccessful marriages—to Carol Wade and Estelle Messing, after Helen Mazur—and a little-disguised string of dalliances would lend credence to that self-professed rebellion against much exclusiveness in the area of human relationships. As Buffett recounts, “It was all open and everything that Ben liked women. And women liked him. He wasn’t physically attractive—he looked like Edward G. Robinson—but he had style.”42 In the latter part of his life, however, he formed what appeared to be a long-term, satisfying, and monogamous relationship with a French citizen, Marie Louise “Marlou” Amingues, and, for some twenty years, they divided their time between California and France.
The twenty-year relationship with Amingues roughly corresponded to his time away from Wall Street following his closing the Graham-Newman operation, and from all indications his sunset decades with her were the most satisfying of his life. He continued to write and speak occasionally on financial topics, but in retirement he devoted much more of his time to the intellectual pursuits that had captured his youthful passions. In an address to his friends and family at his eightieth birthday party, he said,
At least half of all the pleasures that I have enjoyed in life have come from the world of the mind, from things of beauty and culture, especially literature and art. These things are available to everybody, virtually free of charge; all one needs is the interest to start with and a minimal effort to appreciate the riches spread out before us. Once you have found it—the life of culture—never let it go.43
Graham’s remarks serve as a useful reminder that the man who literally wrote the book on security analysis—and who is arguably the greatest intellect to have worked on Wall Street—did not hold an MBA or a PhD in economics or finance. Rather, he was a classically trained scholar who, after transforming the world of investing, returned to his ultimate passions. There may be a lesson somewhere in that.
