It is always fascinating to hear or read about how Benjamin Graham, possibly the most famous investor to have ever lived, ran his portfolio.
Around the turn of the century, in a question-and-answer session titled “65 Years on Wall Street,” Jim Grant spoke with Walter Schloss, Graham’s former student and later a value investor himself, about the Dean of Wall Street and how he liked to manage his investments.
Speaking about how he was first employee at Graham’s firm, Schloss said that in 1946, “I was out of the Army and Graham hired me to work for him as a security analyst and Graham-Newman was then 10 years old and had a nice record.”
As he went on to explain, one of the reasons why the firm was doing so well at the time is because, “they bought these secondary stocks which had big book values but not particularly good earnings.” Graham was able to profit from these investments because the “excess profits taxes really hurt the companies with small book values.”
He went on to explain, “the big book value stocks were in the war and so they made a lot of money based upon the fact that they didn't have to pay these excess profits taxes. And those stocks went up and he did very well.”
What always surprises me about Graham is the fact that he had such a small equity portfolio. Schloss explained in his Q&A session that Graham had only $1.1 million invested in common stocks in 1946. This balance was spread across 37 positions:
“So, when I came to work for Ben, he had 37 stocks in his common stock portfolio. This was a really big investment company. They had $4,100,000 of which $1.1 million was in common stocks. I looked at the portfolio and I saw that of their 37 stocks that were in the portfolio on January 31, 1946, only two of them are still around. All the others were taken over, merged, disappeared. And the only two; one was Tricontinental Corp and the other one was McGraw Hill. He had very small amounts of these stocks and you figure $1,100,000 with 37 stocks, it wasn't very much.”
Schloss went on to add that the rest of the portfolio was invested mainly in bankrupt bonds and special situations:
“Basically the rest of his portfolio was made up of bankrupt bonds, against which he sold "when-issued” securities, some convertible preferred stocks where he shorted the common stocks against them. In those days, if the stock went up you took a long-term gain on the profit side for the preferred and you took a short-term loss on the short side, which was a pretty good deal for them and, of course, that isn't true anymore.”
As well as using this strategy, Graham also owned deep-value stocks, which he sent Schloss off to find.
However, Schloss told Grant that “my job was to find stocks which were undervalued. And we looked at stocks selling below working capital, which was not very many.”
This seems to explain why Graham only invested 25% of his capital into this bucket. Graham is generally considered to be the father of deep-value investing, but even he struggled to find enough opportunities to devote 100% of his portfolio to deep-value stocks.
Instead, it seems that he devoted most of his time to finding special situations, preferred stocks and bonds, as there were more options in these markets. Graham was well aware that the best way to make money was to take advantage of every opportunity offered rather than sticking to just a handful of undervalued businesses.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Walter Schloss on Buffett's Big Mistake
- Warren Buffett Explains Why Berkshire Does Not Give Analysts Special Treatment
- Warren Buffett's Thoughts on Intrinsic Value and Berkshire's Stock Price
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