The Intelligent Investor

PrintPrintEmailEmail

Graham didn’t need to know. He simply loaded up on Du Pont while selling an equivalent amount of GM short and waited for the market to notice the discrepancy. When it did, Du Pont rose substantially while GM held steady, allowing him to close his short at no loss while making a bundle on Du Pont.

Both these investments display fully Graham’s technique: Look for undervalued companies, invest, and wait for the market to notice them. He especially looked at working capital and cash—and only then turned his attention to such fixed assets as plant and equipment. He advised investors to be very wary of “intangibles,” such as goodwill. To Graham the most important calculation was net current assets, minus all current liabilities. If this number was high, then the security had a “margin of safety” that limited any downside risk while providing an upside potential. The only other thing needed was patience, a virtue often in short supply on Wall Street, where the measure of eternity is the end of the current quarter.

Some people, especially professional investment advisers, find this technique annoyingly simple. After all, as Warren Buffett explained, “If you’ve gone and gotten a Ph.D. and spent years learning how to do all kinds of tough things mathematically, to have it come back to this—it’s like studying for the priesthood and finding out that the Ten Commandments were all you needed.”

Soon Graham’s reputation as a stock wizard spread, and he was able to open his own investment firm, on January 1, 1926, with $450,000 under management. Three years later he was managing $2,500,000 in what today would be called a mutual fund.

Graham’s technique: Look for undervalued companies, invest, then sit back and wait for the market to notice them.

It was easy to make money on Wall Street in the late 1920s, of course. But Graham consistently beat the Dow Jones Industrial average, which is more than can be said for all too many investment advisers then and now. He did this so well that the legendary investor Bernard Baruch offered him a partnership, an offer Graham had enough self-confidence to turn down.

By the end of the decade Graham and his family were living in a duplex in the majestic Beresford apartment building, overlooking Central Park. The securities under his management grew by 60 percent in 1928, while the Dow Jones average rose 51 percent.

The next four years, however, would be a very different story. Thanks to the huge run-up in stocks in the early months of 1929, the Dow Jones declined only 15 percent for the year as a whole, despite the crash in October. But Graham saw a 20 percent decline in the value of his fund’s investments.

In the early months of 1930 the stock market rallied strongly, and Graham was convinced, as were many others, that the worst was over. He invested aggressively in what turned out to be the greatest mistake of his career. By the end of 1930 the Dow Jones had fallen an additional 29 percent, while Graham’s fund had suffered a staggering 50 percent decline in value. Graham moved to stem the losses, and in 1931 the fund declined by only 16 percent while the Dow Jones fell 48 percent. The following year Graham lost only 3 percent while the Dow Jones went down another 17.

In fact only a timely infusion of cash from his partner’s father-in-law saved the firm from failure. During those years Graham took no salary and moved from the splendor of the Beresford to a much more modest apartment. But when the market finally hit bottom in 1932, stocks that met Graham’s criteria for investment abounded, and by the end of the decade he had earned back all the money lost in the Crash and its awful aftermath.

In the meantime Graham had had to find other sources of income, and this turned out to be fortunate for posterity. He started teaching at Columbia, where his course (which carried the description “Investment theories subjected to practical market tests. Origin and detection of discrepancies between price and value”) soon became legendary, taken as often by Wall Street professionals as by Columbia students.

In 1934 he and his coauthor David L. Dodd published Security Analysis: Principles and Techniques , a college-level textbook. In 1949 he followed that with The Intelligent Investor , intended for its namesake. Both have been in print since they were first published, selling hundreds of thousands of copies each.

The reason for their success, of course, is easy to explain. “No one has ever become poor reading Graham,” Warren Buffett once said.