June 20, 2005
Quick notes to reading "The Rediscovered Benjamin Graham" . This link currently gives the unabridged lecture notes:
This was an excellent 10 part lecture series given by Benjamin Graham. Here is how Wiley Publishers introduce it:
" These lectures are from the series entitled Current Problems in Security Analysis that Mr. Graham presented at the New York Institute of Finance from September 1946 to February 1947. The book provides an abridged version of this content. The full text of the transcripts are contained within this website."
I only had a few notes from this. Graham is one of my most admired investors and teachers. Actually, him and Warren Buffett are my top 2.
1. In lecture number 1 he states, " The correct attitude of the security analyst toward the stock market might well be that of a man toward his wife. He shouldn't pay too much attention to what the lady says, but he can't afford to ignore it entirely. That is pretty much the position that most of us find ourselves vis-à-vis the stock market." I can't tell you how much I love that paragraph, but please don't tell my wife ;-).
2. The most important part of all the lectures I experienced, was the reiteration of careful analysis. He mentions in Lecture 1, page 7, the following:
"During the last war, when you were just beginning with airplanes, the Wright Aeronautical Company was the chief factor in that business, and it did pretty well in its small way, earning quite a bit of money. In 1922 nobody seemed to have any confidence in the future of the Wright Aeronautical Company. Some of you will remember our reference to it in Security Analysis. That stock sold then at eight dollars a share, when its working capital was about $18 a share at the time. Presumably "the market" felt that its prospects were very unattractive. That stock subsequently, as you may know, advanced to $280 a share.
Now it is interesting to see Curtiss-Wright again, after World War II, being regarded as presumably a completely unattractive company. For it is selling again at only a small percentage of its asset value, in spite of the fact that it has earned a great deal of money. I am not predicting that Curtiss-Wright will advance in the next ten years the way Wright Aeronautical did after 1922. The odds are very much against it. Because, if I remember my figures, Wright Aeronautical had only about 250,000 shares in 1922 and Curtiss-Wright has about 7,250,000 shares, which is a matter of great importance. But it is interesting to see how unpopular companies can become, merely because their immediate prospects are clouded in the speculative mind.
I want to say one other thing about the Curtiss-Wright picture, which leads us over into the field of techniques of analysis, about which I intend to speak at the next session. When you study the earnings of Curtiss-Wright in the last ten years, you will find that the earnings shown year by year are quite good; but the true earnings have been substantially higher still, because of the fact that large reserves were charged off against these earnings which have finally appeared in the form of current assets in the balance sheet. That point is one of great importance in the present-day technique of analysis.
In analyzing a company's showing over the war period it is quite important that you should do it by the balance sheet method, or at least use the balance sheet as a check. That is to say, subtract the balance sheet value shown at the beginning from that at the end of the period, and add back the dividends. This sum -- adjusted for capital transactions -- will give you the earnings that were actually realized by the company over the period. In the case of Curtiss-Wright we have as much as $44-million difference between the earnings as shown by the single reports and the earnings as shown by a comparison of surplus and reserves at the beginning and end of the period. These excess or unraveled earnings alone are more than six dollars a share on the stock, which is selling today at only about that figure."
I put the above into context, when I was working with the technology industry in 1998 - 2002. I could not understand how many of the companies, such as Cisco, Ciena, Lucent and JDSU could carry such high market capitalizations. I am often not concerned with high earnings multiples, unless of course, I feel as though the companies could never grow into those multiples. That type of analysis enabled our clients to preserve capital during the crash years. Since the crash of the Tech's , we have certainly accumulated positions in a few of these companies. We are hoping that our analysis of these companies generates future wealth for us. Yet, there are no guarantees for the future.
Based on the above, investors need to extrapolate future revenues, conditions, demands, costs, etc. One must differentiate profits during a boom, and losses during a depression. Investors must take those periods, and attempt to attach a normalized environment to them. Investors of course need to evaluate earnings quality, along with cash flow quality.
3. In lecture 7, Graham discusses investing in Growth Stocks:
" Investors do not make mistakes, or bad mistakes, in buying good stocks at fair prices. They make their serious mistakes by buying poor stocks, particularly the ones that are pushed for various reasons. And sometimes -- in fact, very frequently -- they make mistakes by buying good stocks in the upper reaches of bull markets."
" The successful purchase of growth stocks requires two rather obvious conditions: First, that their prospect of growth be realized; and, second, that the market has not already pretty well discounted these growth prospects."
4. In Lecture number 10, Graham puts it all together. I have included the text of that lecture at this link www.rbcpa.com/lecture10_graham.html