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Benjamin Graham and His Discussion About IBM

June 12, 2011

During a luncheon in 1958, Ben Graham told the story of one stock that he had involved in his early life, to expose the audience to the development through time of the importance of long-term prospects for investments.

In 1912, he left college for the term to take part in a research project for US Express Co. The research team set out to find the effect on revenues of a revolutionary new system of computing express rate. So Hollerith machines, which were leased out by the Computing – Tabulating – Recording Co., (CTR) were used. They had card-punches, card-sorters and tabulators. At that time, only a few businessmen had ever used these tools before. Ben entered Wall Street in 1914. One year later, he saw this company listed on the NYSE.

At that time Ben was quite emotionally interested in this company, as he was one of the few financial guys who had seen and used them. He thought quite highly of the company’s products and potentials. In early 1916, he recommended this stock to his boss. At that time, the stock was selling in the mid-$40s (for 105,000 shares). Earnings in 1915 was $6.5; its book value including some intangibles was $130, with starting $3 dividends. His boss replied “Ben, do not mention that company to me again. I would not touch it with a ten-foot pole. Its 6% bonds are selling in the low $80s and they are no good. So how can the stock be any good? Everybody knows there is nothing behind it but water.”

Ben was so impressed with the bosses’ condemnation of CTR that he decided he would never buy a share of it in his life, not even after it has changed its name to IBM in 1926. And I think we all know that was not a very good decision.

After the new name was adopted in 1926, it began to reveal the first goodwill item in the balance sheet, $13.6 million. His boss was right; nearly every dollar of the equity behind the common had been nothing but water in 1915. Nevertheless, under the leadership of Sir Thomas Watson for 11 years, its net income had increased from $691,000 to $3.7 million, and the stock was split 3.6 for 1. An earning for new stock was $6.39 and the dividend was $3.

Those are the impressive growth figures. How about the market reaction? Ben described that for that year, the stock price was between the low of $31 and in the high of $59. At the average price of $45, it sold at 7 P/E and dividend yield of 6.7%, the same as in 1915. And we should remember in 1926 the market was at a high and kept rising until the beginning of the Great Depression at the end of 1929.

Fast forward to the future — Ben has summarized using 10 year intervals for the history of IBM. In 1936, the income doubled compared to 1926 figures. The average multiples rose from 7 to 17.5. From 1936-1946, the gain was 2.5 times, and the average multiples in 1946 stayed at 17.5. From that time, it began to race up. The 1956 earning was four times that of 1946, and average multiples doubled to 32.5. One year after that, with further gain in net earnings, the multiples increased to the average of 42.

When the recent figures were examined to compare with 40 years earlier, he commented, “the one-time scandalous water, so prevalent in the balance sheets of industrial companies, has all been squeezed out – first by disclosure and then by write offs. But a different kind of water has been put back into valuation by the stock market – by investors and speculators themselves. When IBM now sells at 7 times its book value, instead of 7 times earnings, the effect is practically the same as if it had no book value at all.”

He recalled it was like when the old-speculator bought Woolworth or U.S. Steel common entirely for their earning power and future prospects. Ben concluded that the speculative aspects of large industrial companies seemed to diminish significantly when they have a strong balance sheet, conservative capital structure and expert management.

About the author:

Money manager in global equities, especially in U.S. and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam.

Visit Anh HOANG's Website

Rating: 4.8/5 (31 votes)


Vuasu - 6 years ago    Report SPAM
Wonderful article!

Anh, you beat the author of this article to it: http://blogs.wsj.com/totalreturn/2011/11/14/what-buffetts-mentor-thought-of-ibm/?

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