Bruce Greenwald, the value investing professor at Columbia University's Graduate School of Business, has written about Benjamin Graham, the father of “value investing.” Some key points in the article should be highlighted as there some valuable learning there.
Benjamin Graham came to Wall Street in 1914. During that time, speculation was the dominant factor in the stock markets. Graham had written: “In 1914, a mass of financial information was largely going to waste. What counted most was inside information of various kinds, some of it relating to business operations… but more of it to the current activities and plans of market manipulators, the famous “they” who were responsible for all significant moves, up and down.”
Nevertheless, not being affected by the crowd, Graham began by searching for where the value of the stock could be calculated with some precision. A position was found in 1915. Guggenheim Exploration Company planned to dissolve and distribute its holding to its shareholders. The assets comprised shares in other copper mining companies, which were listed in NYSE. He calculated the value of those copper mining companies held by Guggenheim as exceeding the value of Guggenheim stock. So buying Guggenheim was effectively the cheap way to obtain assets that Guggenheim was holding. Moreover, if we sold the appropriate amount of the shares of the constituent holdings (or even short sell the stock), the gain would have been locked in.
For another case, he would examine the balance sheet items very carefully, giving each individual asset in the balance sheets some certain values. For cash, account receivables and other current assets, the value could be close to officially published figures. To plant and equipment, less tangible assets, the conservative values below the published figures should be assigned, combining with his knowledge of the industry. Then the published value of total liabilities was deducted from the asset value to come to “net asset value.” Then a comparison between the “net asset value” and the market price is necessary to see whether the company was undervalued.
In the later phase of his life, Graham had learned to cross-check these asset-based valuations with earnings valuations. Bruce has given the example: “If Graham thought the company’s net asset were worth $8 million and an appropriate return on those assets was 10% (based on what investors were earning in other comparable investments), then he looked at the company’s published income statements to verify that future earnings were likely to exceed $800,000 per annum. If the earnings picture satisfied this criterion, then when the company was selling in the stock market for $4 million, Graham would buy its stock with redoubled confidence.”
For discussion on Mr. Market, he wrote in the memorable passage: “Imagine that in some private business you own a small share. One of your partners, named Mr. Market, is very obliging. Everyday he tells you what he thinks your interest is worth and offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible. 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. If you are a prudent investor, will you let Mr. Market’s daily communication determine your view of the value of the enterprise? You may be happy to sell out to him when he quotes a ridiculously high price and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to value your holdings based on full reports from the company about its operation and financial position.”
After going through his contributions to investing and the different stages in his life, Bruce has concluded that Graham’s general contributions had been absorbed that they are “bred into the bone of basic investment practice.”
Truly, listening and digging in the thinking process to see how Benjamin Graham valued a position will give us a lot of valuable lessons. In some other articles, I will share the key insights of Benjamin Graham on various positions in the stock market via his old writings.
Benjamin Graham came to Wall Street in 1914. During that time, speculation was the dominant factor in the stock markets. Graham had written: “In 1914, a mass of financial information was largely going to waste. What counted most was inside information of various kinds, some of it relating to business operations… but more of it to the current activities and plans of market manipulators, the famous “they” who were responsible for all significant moves, up and down.”
Nevertheless, not being affected by the crowd, Graham began by searching for where the value of the stock could be calculated with some precision. A position was found in 1915. Guggenheim Exploration Company planned to dissolve and distribute its holding to its shareholders. The assets comprised shares in other copper mining companies, which were listed in NYSE. He calculated the value of those copper mining companies held by Guggenheim as exceeding the value of Guggenheim stock. So buying Guggenheim was effectively the cheap way to obtain assets that Guggenheim was holding. Moreover, if we sold the appropriate amount of the shares of the constituent holdings (or even short sell the stock), the gain would have been locked in.
For another case, he would examine the balance sheet items very carefully, giving each individual asset in the balance sheets some certain values. For cash, account receivables and other current assets, the value could be close to officially published figures. To plant and equipment, less tangible assets, the conservative values below the published figures should be assigned, combining with his knowledge of the industry. Then the published value of total liabilities was deducted from the asset value to come to “net asset value.” Then a comparison between the “net asset value” and the market price is necessary to see whether the company was undervalued.
In the later phase of his life, Graham had learned to cross-check these asset-based valuations with earnings valuations. Bruce has given the example: “If Graham thought the company’s net asset were worth $8 million and an appropriate return on those assets was 10% (based on what investors were earning in other comparable investments), then he looked at the company’s published income statements to verify that future earnings were likely to exceed $800,000 per annum. If the earnings picture satisfied this criterion, then when the company was selling in the stock market for $4 million, Graham would buy its stock with redoubled confidence.”
For discussion on Mr. Market, he wrote in the memorable passage: “Imagine that in some private business you own a small share. One of your partners, named Mr. Market, is very obliging. Everyday he tells you what he thinks your interest is worth and offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible. 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. If you are a prudent investor, will you let Mr. Market’s daily communication determine your view of the value of the enterprise? You may be happy to sell out to him when he quotes a ridiculously high price and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to value your holdings based on full reports from the company about its operation and financial position.”
After going through his contributions to investing and the different stages in his life, Bruce has concluded that Graham’s general contributions had been absorbed that they are “bred into the bone of basic investment practice.”
Truly, listening and digging in the thinking process to see how Benjamin Graham valued a position will give us a lot of valuable lessons. In some other articles, I will share the key insights of Benjamin Graham on various positions in the stock market via his old writings.
