I was first introduced to the writings of Benjamin Graham shortly after graduating from college with a finance degree in 1995. I picked up a copy of The Intelligent Investor and found the investment philosophy very compelling and in stark contrast to most of the books I read as part of my finance coursework.
Perhaps because I ended up working in the technology sector for many years and was part of that culture, I did not entirely take value investing to heart during the late 1990s and invested in technology stocks such as Intel that Graham would never have touched. I felt like a genius when my position in Intel tripled in just a few years, yet I kept coming back to the ideas Graham wrote about in The Intelligent Investor. I eventually came to the conclusion that I was just speculating rather than investing.
Fortunately, during this timeframe, I also read Warren Buffett’s shareholder letters and by early 2000, I liquidated my Intel shares and purchased Berkshire Hathaway stock with the proceeds. This was not due to any brilliance on my part and entirely due to the insights provided by Buffett and Graham that I finally decided to put into practice.
Security Analysis: 1934 Edition
I am not sure why it took several years for me to decide to read Security Analysis when I should have pursued this right after reading the Intelligent Investor. In early 2000, I finally decided to read the book and purchased a reproduction of the 1934 edition. I have to admit that while I found the “Survey and Approach” material in Part I very compelling, I started to get the impression that I was dealing with an outdated book by the time I started reading about fixed income securities and railroad bonds. In retrospect, it would have been better to read a later edition of Security Analysis that contained Graham’s experience of the full impact of the Great Depression. I found the book useful but considered The Intelligent Investor to be a far more relevant text for today’s security analyst.
Security Analysis: Sixth Edition
The Sixth Edition of Security Analysis was published in 2008 and is based on Graham’s Second Edition which was published in 1940. I have read most of this new edition and the experience is far different from reading the 1934 reproduction. The editors of the sixth edition have succeeded in keeping the text of Graham’s work completely intact while adding a significant amount of new content that adds context to the book that is very helpful to modern day readers. The fact that Graham’s own text was written in 1940 rather than 1934 allows the reader to benefit from Graham’s observations throughout the Great Depression period which is invaluable in today’s environment.
The foreword, preface, and introductions to each section add great value as well. Warren Buffett provides a brief introduction and tribute to Graham’s impact on his own career, while Seth Klarman and James Grant provide the preface and introduction which places the importance of Graham’s work in context for modern readers. Each of the seven sections of Graham’s text includes an introduction. I found Roger Lowenstein’s introduction to Part I, Bruce Berkowitz’s comments on Part IV, and Bruce Greenwald’s analysis of Part VI to be particularly insightful, although all of the introductions are well worth careful study.
Graham’s Insights are Relevant Today
Anyone who takes the time to carefully read this book will soon discard the notion that a 75 year old textbook would have little to add to the toolkit of a modern security analyst. If an investor does nothing more than read Part I, it is highly unlikely that he or she will be susceptible to the pitfalls that could result in a large permanent loss of capital. Many investors will be surprised to read that Graham would consider much of what they do to be “speculative” based on Chapter 4. Graham sets a very high bar in terms of what it means to be an investor rather than a speculator.
I found the material in Part VI covering balance sheet analysis particularly useful in my attempts to identify bargain priced securities. Graham’s concept of purchasing stocks under net current asset value has become a viable activity for the security analyst in the current bear market. However, it is hardly sufficient to create a computer screen for such securities and to place trades. One needs to approach the activity with the skeptical eye that Graham would have used to search for hidden pitfalls and other dangers. I have found that the search for stocks that truly meet Graham’s criteria is a tiny fraction of what comes up in simplistic screens.
Anyone who thinks that the outrageous accounting scandals of recent years are new innovations will realize that there is nothing new under the sun after reading Graham’s account of income statement manipulation in Part V. Chapter 32 and 33 contain several examples of blatant accounting manipulation that would probably embarrass even the most unrepentant modern day white collar criminal (well, maybe not … these people typically have no shame). For example, read about Park and Tilford’s accounting in 1929 and 1930 that included such innovations as charging current advertising expenses to goodwill without any disclosure to stockholders in an attempt to inflate reported earnings. Graham’s advice to examine reported net income in conjunction with a comparative analysis of the balance sheets at the start and end of the reporting period still holds true today.
Timeless Concepts Lightly Followed
Despite the timeless quality of Graham’s insights in Security Analysis and The Intelligent Investor, practitioners who follow this approach are still in the minority today. Part of this is due to the fact that most investors are ill suited for the profession due to temperament that is overly impacted by the need to obtain peer approval and to see immediate results. For example, it was considered very cool to own Intel and other technology stocks (particularly dot com stocks) in the late 1990s, and very stodgy and old fashioned to invest in a company like Berkshire Hathaway. Human nature probably guarantees that investors who are able to follow Graham’s approach will continue to be in the minority in the future as well.