In the second part of a two-part series, notes from Benjamin Graham’s lectures between September 1946 and February 1947 at the New York Institute of Finance are presented.Â
The series of lectures was titled "Current Problems in Security Analysis," and it gives a great insight into Graham’s process and investing mentality.
On making sensible earnings projections:
“It is not, I assure you, admissible security-analysis technique to say, 'I don't like this company, so I will multiply the future earnings by four; but I do like the other company so I will multiply the future earnings by 40.' You will not get a passing grade on a security-analysis test if you do anything of that kind.”
“For even if we knew what was going to happen to a company, in terms of its business and its earning power, we might not be able to make too good a prediction as to what was going to happen to it in the market price, which interests us a good deal. That is just an added reason for being either as cautious as possible in regard to our own decisions on security purchases.”
On the advantages of using a well diversified portfolio in bargain hunting:
“When we talk about buying bargain issues, for example, the emphasis on group operation becomes even greater, because you then get into what could practically be know as an insurance type of operation. Here you have an edge, apparently, on each individual company. That advantage may conceivably disappear or not be realized in the individual case; but if you are any good at all as an analyst you ought to realize that advantage in the group.”
On the process of finding bargain issues:
“The first question you ask is, of course: 'How do you know that the market price is low?' That can be answered pretty well, I think. The analyst identifies low market levels in relation to the past pattern of the market and by simple valuation methods such as those that we have been discussing. And bear in mind that the good analyst doesn’t change his concept of what the earnings of the next five years are going to be just because the market happens to be pessimistic at one time, or optimistic at another. His views of average future earnings would change only because he is convinced that there has been some change of a very significant sort in the underlying factors.”
On investment versus speculation:
“Speculative operations are all concerned with changes in price. In some cases the emphasis is on price changes alone, and in other cases the emphasis is on changes in value which are expected to give rise to changes in price. I think that is a rather important classification of speculative operations. It is easy to give examples.”
“If the probabilities, as measure by our mathematical test, are definitely in favor of the speculation, then we can transform these separate intelligent speculations into investment by the simple device of diversification. That, I think, is a clue to the most successful and rewarding treatment of speculation in Wall Street. The idea, in fine, is simply to get the odds on your side by processes of skillful, experienced calculation… Very little has been done in Wall Street to work out these arithmetical aspects of intelligent speculation based on favorable odds. In fact, the very language may be strange to most of you. Yet it oughtn’t to be. If we are allowed to commit some misdemeanor by making some mild comparisons between Wall Street and horse-racing, the thought might occur to some of us that the intelligent operator in Wall Street would try to follow the technique of the bookmaker rather than the technique of the man who bets on the horses. Further, if we assume that a very considerable amount of Wall Street activity must inevitably have elements of chance in it, then the sound idea would be to measure these chances as accurately as you can, and play the game in the direction of having the odds on your side.”
“It is a great mistake to believe that a speculation has been unwise if you lose money at it. That sounds like an obvious conclusion, but actually it is not true at all. A speculation is unwise only if it is made on insufficient study and by poor judgment. I recall to those of you who are bridge players the emphasis that the bridge experts place on playing a hand right rather than on playing it successfully. Because, as you know, if you play it right you are going to make money and if you play it wrong you lose money -- in the long run.”
On the problems with market forecasting (it is all but impossible):
“The trouble with market forecasting is not that it is done by unintelligent and unskillful people. Quite to the contrary, the trouble is that it is done by so many really expert people that their efforts constantly neutralize each other, and end up almost exactly in zero.
The market already reflects, almost at every time, everything that the experts can reliably say about its future. Everything in addition which they say is therefore unreliable, and it tends to be right just about half the time. If people analyzing the market would engage in the proper kind of self-criticism, I am sure they would realize that they are chasing a will-o’-the-wisp.”
Â
