The_Intelligent_Investor

Appendixes

1. The Superinvestors of Graham-and-Doddsville
by Warren E. Buffett

EDITOR’S NOTE: This article is an edited transcript of a talk given at
Columbia University in 1984 commemorating the fiftieth anniversary of
Security Analysis, written by Benjamin Graham and David L. Dodd.
This specialized volume first introduced the ideas later popularized in
The Intelligent Investor. Buffett’s essay offers a fascinating study of how
Graham’s disciples have used Graham’s value investing approach to real-
ize phenomenal success in the stock market.

Is the Graham and Dodd “look for values with a significant
margin of safety relative to prices” approach to security analysis
out of date? Many of the professors who write textbooks today say
yes. They argue that the stock market is efficient; that is, that stock
prices reflect everything that is known about a company’s
prospects and about the state of the economy. There are no under-
valued stocks, these theorists argue, because there are smart secu-
rity analysts who utilize all available information to ensure
unfailingly appropriate prices. Investors who seem to beat the mar-
ket year after year are just lucky. “If prices fully reflect available
information, this sort of investment adeptness is ruled out,” writes
one of today’s textbook authors.

Well, maybe. But I want to present to you a group of investors
who have, year in and year out, beaten the Standard & Poor’s 500
stock index. The hypothesis that they do this by pure chance is at

537

538 Appendixes

least worth examining. Crucial to this examination is the fact that
these winners were all well known to me and pre-identified as
superior investors, the most recent identification occurring over fif-
teen years ago. Absent this condition—that is, if I had just recently
searched among thousands of records to select a few names for you
this morning—I would advise you to stop reading right here. I
should add that all these records have been audited. And I should
further add that I have known many of those who have invested
with these managers, and the checks received by those participants
over the years have matched the stated records.

Before we begin this examination, I would like you to imagine a
national coin-flipping contest. Let’s assume we get 225 million
Americans up tomorrow morning and we ask them all to wager a
dollar. They go out in the morning at sunrise, and they all call the
flip of a coin. If they call correctly, they win a dollar from those who
called wrong. Each day the losers drop out, and on the subsequent
day the stakes build as all previous winnings are put on the line.
After ten flips on ten mornings, there will be approximately
220,000 people in the United States who have correctly called ten
flips in a row. They each will have won a little over $1,000.

Now this group will probably start getting a little puffed up
about this, human nature being what it is. They may try to be mod-
est, but at cocktail parties they will occasionally admit to attractive
members of the opposite sex what their technique is, and what
marvelous insights they bring to the field of flipping.

Assuming that the winners are getting the appropriate rewards
from the losers, in another ten days we will have 215 people who
have successfully called their coin flips 20 times in a row and who,
by this exercise, each have turned one dollar into a little over
$1 million. $225 million would have been lost, $225 million would
have been won.

By then, this group will really lose their heads. They will proba-
bly write books on “How I Turned a Dollar into a Million in
Twenty Days Working Thirty Seconds a Morning.” Worse yet,
they’ll probably start jetting around the country attending semi-
nars on efficient coin-flipping and tackling skeptical professors
with, “If it can’t be done, why are there 215 of us?”

But then some business school professor will probably be
rude enough to bring up the fact that if 225 million orangutans

Appendixes 539

had engaged in a similar exercise, the results would be much
the same—215 egotistical orangutans with 20 straight winning
flips.

I would argue, however, that there are some important differ-
ences in the examples I am going to present. For one thing, if (a)
you had taken 225 million orangutans distributed roughly as the
U.S. population is; if (b) 215 winners were left after 20 days; and if
(c) you found that 40 came from a particular zoo in Omaha, you
would be pretty sure you were on to something. So you would
probably go out and ask the zookeeper about what he’s feeding
them, whether they had special exercises, what books they read,
and who knows what else. That is, if you found any really extraor-
dinary concentrations of success, you might want to see if you
could identify concentrations of unusual characteristics that might
be causal factors.

Scientific inquiry naturally follows such a pattern. If you were
trying to analyze possible causes of a rare type of cancer—with,
say, 1,500 cases a year in the United States—and you found that 400
of them occurred in some little mining town in Montana, you
would get very interested in the water there, or the occupation of
those afflicted, or other variables. You know that it’s not random
chance that 400 come from a small area. You would not necessarily
know the causal factors, but you would know where to search.

I submit to you that there are ways of defining an origin other
than geography. In addition to geographical origins, there can be
what I call an intellectual origin. I think you will find that a dispro-
portionate number of successful coin-flippers in the investment
world came from a very small intellectual village that could be
called Graham-and-Doddsville. A concentration of winners that
simply cannot be explained by chance can be traced to this particu-
lar intellectual village.

Conditions could exist that would make even that concentration
unimportant. Perhaps 100 people were simply imitating the coin-
flipping call of some terribly persuasive personality. When he
called heads, 100 followers automatically called that coin the same
way. If the leader was part of the 215 left at the end, the fact that
100 came from the same intellectual origin would mean nothing.
You would simply be identifying one case as a hundred cases. Sim-
ilarly, let’s assume that you lived in a strongly patriarchal society

540 Appendixes

and every family in the United States conveniently consisted of ten
members. Further assume that the patriarchal culture was so
strong that, when the 225 million people went out the first day,
every member of the family identified with the father’s call. Now,
at the end of the 20-day period, you would have 215 winners, and
you would find that they came from only 21.5 families. Some naive
types might say that this indicates an enormous hereditary factor
as an explanation of successful coin-flipping. But, of course, it
would have no significance at all because it would simply mean
that you didn’t have 215 individual winners, but rather 21.5 ran-
domly distributed families who were winners.

In this group of successful investors that I want to consider,
there has been a common intellectual patriarch, Ben Graham. But
the children who left the house of this intellectual patriarch have
called their “flips” in very different ways. They have gone to differ-
ent places and bought and sold different stocks and companies, yet
they have had a combined record that simply can’t be explained by
random chance. It certainly cannot be explained by the fact that
they are all calling flips identically because a leader is signaling the
calls to make. The patriarch has merely set forth the intellectual
theory for making coin-calling decisions, but each student has
decided on his own manner of applying the theory.

The common intellectual theme of the investors from Graham-
and-Doddsville is this: they search for discrepancies between the
value of a business and the price of small pieces of that business in
the market. Essentially, they exploit those discrepancies without
the efficient market theorist’s concern as to whether the stocks are
bought on Monday or Thursday, or whether it is January or July,
etc. Incidentally, when businessmen buy businesses—which is just
what our Graham & Dodd investors are doing through the
medium of marketable stocks—I doubt that many are cranking
into their purchase decision the day of the week or the month in
which the transaction is going to occur. If it doesn’t make any dif-
ference whether all of a business is being bought on a Monday or a
Friday, I am baffled why academicians invest extensive time and
effort to see whether it makes a difference when buying small
pieces of those same businesses. Our Graham & Dodd investors,
needless to say, do not discuss beta, the capital asset pricing model,
or covariance in returns among securities. These are not subjects of

Appendixes 541

any interest to them. In fact, most of them would have difficulty
defining those terms. The investors simply focus on two variables:
price and value.

I always find it extraordinary that so many studies are made of
price and volume behavior, the stuff of chartists. Can you imagine
buying an entire business simply because the price of the business
had been marked up substantially last week and the week before?
Of course, the reason a lot of studies are made of these price and
volume variables is that now, in the age of computers, there are
almost endless data available about them. It isn’t necessarily
because such studies have any utility; it’s simply that the data are
there and academicians have worked hard to learn the mathemati-
cal skills needed to manipulate them. Once these skills are
acquired, it seems sinful not to use them, even if the usage has no
utility or negative utility. As a friend said, to a man with a hammer,
everything looks like a nail.

I think the group that we have identified by a common intellec-
tual home is worthy of study. Incidentally, despite all the academic
studies of the influence of such variables as price, volume, season-
ality, capitalization size, etc., upon stock performance, no interest
has been evidenced in studying the methods of this unusual con-
centration of value-oriented winners.

I begin this study of results by going back to a group of four of
us who worked at Graham-Newman Corporation from 1954
through 1956. There were only four—I have not selected these
names from among thousands. I offered to go to work at Graham-
Newman for nothing after I took Ben Graham’s class, but he turned
me down as overvalued. He took this value stuff very seriously!
After much pestering he finally hired me. There were three part-
ners and four of us at the “peasant” level. All four left between
1955 and 1957 when the firm was wound up, and it’s possible to
trace the record of three.

The first example (see Table 1, pages 549–550) is that of Walter
Schloss. Walter never went to college, but took a course from Ben
Graham at night at the New York Institute of Finance. Walter left
Graham-Newman in 1955 and achieved the record shown here
over 28 years.

Here is what “Adam Smith”—after I told him about Walter—
wrote about him in Supermoney (1972):

542 Appendixes

He has no connections or access to useful information. Practi-
cally no one in Wall Street knows him and he is not fed any ideas.
He looks up the numbers in the manuals and sends for the annual
reports, and that’s about it.

In introducing me to [Schloss] Warren had also, to my mind,
described himself. “He never forgets that he is handling other
people’s money and this reinforces his normal strong aversion to
loss.” He has total integrity and a realistic picture of himself.
Money is real to him and stocks are real—and from this flows an
attraction to the “margin of safety” principle.

Walter has diversified enormously, owning well over 100 stocks
currently. He knows how to identify securities that sell at consider-
ably less than their value to a private owner. And that’s all he does.
He doesn’t worry about whether it’s January, he doesn’t worry
about whether it’s Monday, he doesn’t worry about whether it’s an
election year. He simply says, if a business is worth a dollar and I
can buy it for 40 cents, something good may happen to me. And he
does it over and over and over again. He owns many more stocks
than I do—and is far less interested in the underlying nature of the
business: I don’t seem to have very much influence on Walter.
That’s one of his strengths; no one has much influence on him.

The second case is Tom Knapp, who also worked at Graham-
Newman with me. Tom was a chemistry major at Princeton before
the war; when he came back from the war, he was a beach bum.
And then one day he read that Dave Dodd was giving a night
course in investments at Columbia. Tom took it on a noncredit
basis, and he got so interested in the subject from taking that
course that he came up and enrolled at Columbia Business School,
where he got the MBA degree. He took Dodd’s course again, and
took Ben Graham’s course. Incidentally, 35 years later I called Tom
to ascertain some of the facts involved here and I found him on the
beach again. The only difference is that now he owns the beach!

In 1968 Tom Knapp and Ed Anderson, also a Graham disciple,
along with one or two other fellows of similar persuasion, formed
Tweedy, Browne Partners, and their investment results appear in
Table 2. Tweedy, Browne built that record with very wide diversifi-
cation. They occasionally bought control of businesses, but the
record of the passive investments is equal to the record of the con-
trol investments.

Appendixes 543

Table 3 describes the third member of the group who formed
Buffett Partnership in 1957. The best thing he did was to quit in
1969. Since then, in a sense, Berkshire Hathaway has been a contin-
uation of the partnership in some respects. There is no single index
I can give you that I would feel would be a fair test of investment
management at Berkshire. But I think that any way you figure it, it
has been satisfactory.

Table 4 shows the record of the Sequoia Fund, which is managed
by a man whom I met in 1951 in Ben Graham’s class, Bill Ruane.
After getting out of Harvard Business School, he went to Wall
Street. Then he realized that he needed to get a real business educa-
tion so he came up to take Ben’s course at Columbia, where we met
in early 1951. Bill’s record from 1951 to 1970, working with rela-
tively small sums, was far better than average. When I wound up
Buffett Partnership I asked Bill if he would set up a fund to handle
all our partners, so he set up the Sequoia Fund. He set it up at a ter-
rible time, just when I was quitting. He went right into the two-tier
market and all the difficulties that made for comparative perfor-
mance for value-oriented investors. I am happy to say that my
partners, to an amazing degree, not only stayed with him but
added money, with the happy result shown.

There’s no hindsight involved here. Bill was the only person I
recommended to my partners, and I said at the time that if he
achieved a four-point-per-annum advantage over the Standard &
Poor’s, that would be solid performance. Bill has achieved well
over that, working with progressively larger sums of money. That
makes things much more difficult. Size is the anchor of perfor-
mance. There is no question about it. It doesn’t mean you can’t do
better than average when you get larger, but the margin shrinks.
And if you ever get so you’re managing two trillion dollars, and
that happens to be the amount of the total equity evaluation in the
economy, don’t think that you’ll do better than average!

I should add that in the records we’ve looked at so far, through-
out this whole period there was practically no duplication in these
portfolios. These are men who select securities based on discrepan-
cies between price and value, but they make their selections very
differently. Walter’s largest holdings have been such stalwarts as
Hudson Pulp & Paper and Jeddo Highland Coal and New York
Trap Rock Company and all those other names that come instantly
to mind to even a casual reader of the business pages. Tweedy

544 Appendixes

Browne’s selections have sunk even well below that level in terms
of name recognition. On the other hand, Bill has worked with big
companies. The overlap among these portfolios has been very, very
low. These records do not reflect one guy calling the flip and fifty
people yelling out the same thing after him.

Table 5 is the record of a friend of mine who is a Harvard Law
graduate, who set up a major law firm. I ran into him in about 1960
and told him that law was fine as a hobby but he could do better.
He set up a partnership quite the opposite of Walter’s. His portfo-
lio was concentrated in very few securities and therefore his record
was much more volatile but it was based on the same discount-
from-value approach. He was willing to accept greater peaks and
valleys of performance, and he happens to be a fellow whose
whole psyche goes toward concentration, with the results shown.
Incidentally, this record belongs to Charlie Munger, my partner
for a long time in the operation of Berkshire Hathaway. When he
ran his partnership, however, his portfolio holdings were almost
completely different from mine and the other fellows mentioned
earlier.

Table 6 is the record of a fellow who was a pal of Charlie
Munger’s—another non–business school type—who was a math
major at USC. He went to work for IBM after graduation and was
an IBM salesman for a while. After I got to Charlie, Charlie got to
him. This happens to be the record of Rick Guerin. Rick, from 1965
to 1983, against a compounded gain of 316 percent for the S&P,
came off with 22,200 percent, which, probably because he lacks a
business school education, he regards as statistically significant.

One sidelight here: it is extraordinary to me that the idea of buy-
ing dollar bills for 40 cents takes immediately with people or it
doesn’t take at all. It’s like an inoculation. If it doesn’t grab a per-
son right away, I find that you can talk to him for years and show
him records, and it doesn’t make any difference. They just don’t
seem able to grasp the concept, simple as it is. A fellow like Rick
Guerin, who had no formal education in business, understands
immediately the value approach to investing and he’s applying it
five minutes later. I’ve never seen anyone who became a gradual
convert over a ten-year period to this approach. It doesn’t seem to
be a matter of IQ or academic training. It’s instant recognition, or it
is nothing.

Appendixes 545

Table 7 is the record of Stan Perlmeter. Stan was a liberal arts
major at the University of Michigan who was a partner in the
advertising agency of Bozell & Jacobs. We happened to be in the
same building in Omaha. In 1965 he figured out I had a better busi-
ness than he did, so he left advertising. Again, it took five minutes
for Stan to embrace the value approach.

Perlmeter does not own what Walter Schloss owns. He does not
own what Bill Ruane owns. These are records made independently.
But every time Perlmeter buys a stock it’s because he’s getting
more for his money than he’s paying. That’s the only thing he’s
thinking about. He’s not looking at quarterly earnings projections,
he’s not looking at next year’s earnings, he’s not thinking about
what day of the week it is, he doesn’t care what investment
research from any place says, he’s not interested in price momen-
tum, volume, or anything. He’s simply asking: What is the busi-
ness worth?

Table 8 and Table 9 are the records of two pension funds I’ve been
involved in. They are not selected from dozens of pension funds with
which I have had involvement; they are the only two I have influ-
enced. In both cases I have steered them toward value-oriented man-
agers. Very, very few pension funds are managed from a value
standpoint. Table 8 is the Washington Post Company’s Pension
Fund. It was with a large bank some years ago, and I suggested that
they would do well to select managers who had a value orientation.

As you can see, overall they have been in the top percentile ever
since they made the change. The Post told the managers to keep at
least 25 percent of these funds in bonds, which would not have
been necessarily the choice of these managers. So I’ve included the
bond performance simply to illustrate that this group has no par-
ticular expertise about bonds. They wouldn’t have said they did.
Even with this drag of 25 percent of their fund in an area that was
not their game, they were in the top percentile of fund manage-
ment. The Washington Post experience does not cover a terribly
long period but it does represent many investment decisions by
three managers who were not identified retroactively.

Table 9 is the record of the FMC Corporation fund. I don’t man-
age a dime of it myself but I did, in 1974, influence their decision to
select value-oriented managers. Prior to that time they had selected
managers much the same way as most larger companies. They now

546 Appendixes

rank number one in the Becker survey of pension funds for their
size over the period of time subsequent to this “conversion” to the
value approach. Last year they had eight equity managers of any
duration beyond a year. Seven of them had a cumulative record
better than the S&P. All eight had a better record last year than the
S&P. The net difference now between a median performance and
the actual performance of the FMC fund over this period is $243
million. FMC attributes this to the mindset given to them about the
selection of managers. Those managers are not the managers I
would necessarily select but they have the common denominator
of selecting securities based on value.

So these are nine records of “coin-flippers” from Graham-and-
Doddsville. I haven’t selected them with hindsight from among
thousands. It’s not like I am reciting to you the names of a bunch of
lottery winners—people I had never heard of before they won the
lottery. I selected these men years ago based upon their framework
for investment decision-making. I knew what they had been taught
and additionally I had some personal knowledge of their intellect,
character, and temperament. It’s very important to understand that
this group has assumed far less risk than average; note their record
in years when the general market was weak. While they differ
greatly in style, these investors are, mentally, always buying the
business, not buying the stock. A few of them sometimes buy whole
businesses. Far more often they simply buy small pieces of busi-
nesses. Their attitude, whether buying all or a tiny piece of a busi-
ness, is the same. Some of them hold portfolios with dozens of
stocks; others concentrate on a handful. But all exploit the differ-
ence between the market price of a business and its intrinsic value.

I’m convinced that there is much inefficiency in the market.
These Graham-and-Doddsville investors have successfully ex-
ploited gaps between price and value. When the price of a stock
can be influenced by a “herd” on Wall Street with prices set at the
margin by the most emotional person, or the greediest person, or
the most depressed person, it is hard to argue that the market
always prices rationally. In fact, market prices are frequently non-
sensical.

I would like to say one important thing about risk and reward.
Sometimes risk and reward are correlated in a positive fashion. If
someone were to say to me, “I have here a six-shooter and I have

Appendixes 547

slipped one cartridge into it. Why don’t you just spin it and pull it
once? If you survive, I will give you $1 million.” I would decline—
perhaps stating that $1 million is not enough. Then he might offer
me $5 million to pull the trigger twice—now that would be a posi-
tive correlation between risk and reward!

The exact opposite is true with value investing. If you buy a dol-
lar bill for 60 cents, it’s riskier than if you buy a dollar bill for
40 cents, but the expectation of reward is greater in the latter case.
The greater the potential for reward in the value portfolio, the less
risk there is.

One quick example: The Washington Post Company in 1973 was
selling for $80 million in the market. At the time, that day, you
could have sold the assets to any one of ten buyers for not less than
$400 million, probably appreciably more. The company owned the
Post, Newsweek, plus several television stations in major markets.
Those same properties are worth $2 billion now, so the person who
would have paid $400 million would not have been crazy.

Now, if the stock had declined even further to a price that made
the valuation $40 million instead of $80 million, its beta would
have been greater. And to people who think beta measures risk, the
cheaper price would have made it look riskier. This is truly Alice in
Wonderland. I have never been able to figure out why it’s riskier to
buy $400 million worth of properties for $40 million than $80 mil-
lion. And, as a matter of fact, if you buy a group of such securities
and you know anything at all about business valuation, there is
essentially no risk in buying $400 million for $80 million, particu-
larly if you do it by buying ten $40 million piles for $8 million each.
Since you don’t have your hands on the $400 million, you want to
be sure you are in with honest and reasonably competent people,
but that’s not a difficult job.

You also have to have the knowledge to enable you to make a
very general estimate about the value of the underlying businesses.
But you do not cut it close. That is what Ben Graham meant by
having a margin of safety. You don’t try and buy businesses worth
$83 million for $80 million. You leave yourself an enormous mar-
gin. When you build a bridge, you insist it can carry 30,000
pounds, but you only drive 10,000-pound trucks across it. And that
same principle works in investing.

In conclusion, some of the more commercially minded among

548 Appendixes

you may wonder why I am writing this article. Adding many con-
verts to the value approach will perforce narrow the spreads
between price and value. I can only tell you that the secret has been
out for 50 years, ever since Ben Graham and Dave Dodd wrote
Security Analysis, yet I have seen no trend toward value investing
in the 35 years that I’ve practiced it. There seems to be some per-
verse human characteristic that likes to make easy things difficult.
The academic world, if anything, has actually backed away from
the teaching of value investing over the last 30 years. It’s likely to
continue that way. Ships will sail around the world but the Flat
Earth Society will flourish. There will continue to be wide discrep-
ancies between price and value in the marketplace, and those who
read their Graham & Dodd will continue to prosper.

Tables 1–9 follow:

TABLE 1 Walter J. Schloss

S&P WJS Ltd WJS
Partnership
Overall Partners
Overall
Gain, Overall Gain

Including Gain per year
(%)
Dividends per year
6.8
Year (%) (%) –4.7
54.6
1956 7.5 5.1 23.3 Standard & Poor’s 281⁄4 year compounded gain 887.2%
1957 –10.5 –4.7 9.3
1958 42.1 42.1 28.8 WJS Limited Partners 281⁄4 year compounded gain 6,678.8%
1959 12.7 17.5 11.1
1960 –1.6 7.0 20.1 WJS Partnership 281⁄4 year compounded gain 23,104.7%
1961 26.4 21.6 22.8
1962 –10.2 8.3 35.7 Standard & Poor’s 281⁄4 year annual compounded rate 8.4%
1963 23.3 15.1 0.7
1964 16.5 17.1 34.4 WJS Limited Partners 281⁄4 year annual compounded rate 16.1%
1965 13.1 26.8 35.5
1966 –10.4 0.5 WJS Partnership 281⁄4 year annual compounded rate 21.3%
1967 26.8 25.8
1968 10.6 26.6 During the history of the Partnership it has owned over 800 issues
and, at most times, has had at least 100 positions. Present assets under
management approximate $45 million. The difference between returns
of the partnership and returns of the limited partners is due to alloca-
tions to the general partner for management.

TABLE 1 Walter J. Schloss (continued)

S&P WJS Ltd WJS

Overall Partners Partnership

Gain, Overall Overall

Including Gain Gain

Dividends per year per year

Year (%) (%) (%)

1969 –7.5 –9.0 –9.0
–8.2 –8.2
1970 2.4 25.5 28.3
11.6 15.5
1971 14.9 –8.0 –8.0
–6.2 –6.2
1972 19.8 42.7 52.2
29.4 39.2
1973 –14.8 25.8 34.4
36.6 48.8
1974 –26.6 29.8 39.7
23.3 31.1
1975 36.9 18.4 24.5
24.1 32.1
1976 22.4 38.4 51.2
0.8 1.1
1977 –8.6

1978 7.0

1979 17.6

1980 32.1

1981 6.7

1982 20.2

1983 22.8

1984 1st Qtr. 2.3

Appendixes 551

TABLE 2 Tweedy, Browne Inc.

Period Ended Dow S&P TBK TBK
(September 30) Jones* 500* Overall Limited
(%) Partners
(%) (%)
(%)

1968 (9 mos.) 6.0 8.8 27.6 22.0
1969 –9.5 –6.2 12.7 10.0
1970 –2.5 –6.1 –1.3 –1.9
1971 20.7 20.4 20.9 16.1
1972 11.0 15.5 14.6 11.8
1973 2.9 1.0 8.3 7.5
1974 –31.8 –38.1 1.5 1.5
1975 36.9 37.8 28.8 22.0
1976 29.6 30.1 40.2 32.8
1977 –9.9 –4.0 23.4 18.7
1978 8.3 11.9 41.0 32.1
1979 7.9 12.7 25.5 20.5
1980 13.0 21.1 21.4 17.3
1981 –3.3 2.7 14.4 11.6
1982 12.5 10.1 10.2 8.2
1983 44.5 44.3 35.0 28.2

Total Return

153⁄4 years 191.8% 238.5% 1,661.2% 936.4%
7.0%
Standard & Poor’s 153⁄4 year annual compounded rate 16.0%
20.0%
TBK Limited Partners 153⁄4 year annual compounded rate

TBK Overall 153⁄4 year annual compounded rate

* Includes dividends paid for both Standard & Poor’s 500 Composite Index and
Dow Jones Industrial Average.

552 Appendixes

TABLE 3 Buffett Partnership, Ltd.

Overall

Results Limited
Partners’
From Partnership Results

Dow Results (%)

Year (%) (%) 9.3
32.2
1957 –8.4 10.4 20.9
1958 38.5 40.9 18.6
1959 20.0 25.9 35.9
1960 –6.2 22.8 11.9
1961 22.4 45.9 30.5
1962 –7.6 13.9 22.3
1963 20.6 38.7 36.9
1964 18.7 27.8 16.8
1965 14.2 47.2 28.4
1966 –15.6 20.4 45.6
1967 19.0 35.9 6.6
1968 7.7 58.8
1969 –11.6 6.8 9.3
44.5
On a cumulative or compounded basis, the results are: 74.7
107.2
1957 –8.4 10.4 181.6
215.1
1957–58 26.9 55.6 311.2
402.9
1957–59 52.3 95.9 588.5
704.2
1957–60 42.9 140.6 932.6
1403.5
1957–61 74.9 251.0 1502.7

1957–62 61.6 299.8 23.8

1957–63 94.9 454.5

1957–64 131.3 608.7

1957–65 164.1 943.2

1957–66 122.9 1156.0

1957–67 165.3 1606.9

1957–68 185.7 2610.6

1957–69 152.6 2794.9

Annual Compounded Rate 7.4 29.5

Appendixes 553

TABLE 4 Sequoia Fund, Inc. Annual Percentage Change**

Year Sequoia S&P 500

1970 (from July 15) Fund Index *
1971
1972 (%) (%)
1973
1974 12.1 20.6
1975 13.5 14.3
1976 3.7 18.9
1977 –24.0 –14.8
1978 –15.7 –26.4
1979 60.5 37.2
1980 72.3 23.6
1981 19.9 –7.4
1982 23.9 6.4
1983 12.1 18.2
1984 (first quarter) 12.6 32.3
21.5 –5.0
Entire Period 31.2 21.4
Compound Annual Return 27.3 22.4
Plus 1% Management Fee –1.6 –2.4

Gross Investment Return 775.3% 270.0%

17.2% 10.0%

1.0% 10.0%

18.2%

* Includes dividends (and capital gains distributions in the case of Sequoia Fund)
treated as though reinvested.
** These figures differ slightly from the S&P figures in Table 1 because of a differ-
ence in calculation of reinvested dividends.

TABLE 5 Charles Munger Mass. Inv. Investors Lehman Tri–Cont. Dow Overall Limited

Year Trust (%) Stock (%) (%) (%) (%) Partnership (%) Partners (%)

Yearly Results (1) –9.8 –13.4 –14.4 –12.2 –7.6 30.1 20.1
1962 20.0 16.5 23.8 20.3 20.6 71.7 47.8
1963 15.9 14.3 13.6 13.3 18.7 49.7 33.1
1964 10.2 9.8 19.0 10.7 14.2 8.4 6.0
1965 –7.7 –9.9 –2.6 –6.9 –15.7 12.4 8.3
1966 20.0 22.8 28.0 25.4 19.0 56.2 37.5
1967 10.3 8.1 6.7 6.8 7.7 40.4 27.0
1968 –4.8 –7.9 –1.9 0.1 –11.6 28.3 21.3
1969 0.6 –4.1 –7.2 –1.0 8.7 –0.1 –0.1
1970 9.0 16.8 26.6 22.4 9.8 25.4 20.6
1971 11.0 15.2 23.7 21.4 18.2 8.3 7.3
1972 –12.5 –17.6 –14.3 –21.3 –23.1 – 31.9 –31.9
1973 –25.5 –25.6 –30.3 –27.6 –13.1 –31.5 – 31.5
1974 32.9 33.3 30.8 35.4 44.4 73.2 73.2
1975

Compound Results (2) –9.8 –13.4 –14.4 –12.2 –7.6 30.1 20.1
1962 8.2 0.9 6.0 5.6 11.5 123.4 77.5
1962–3 25.4 15.3 20.4 19.6 32.4 234.4 136.3
1962–4 38.2 26.6 43.3 32.4 51.2 262.5 150.5
1962–5 27.5 14.1 39.5 23.2 27.5 307.5 171.3
1962–6 53.0 40.1 78.5 54.5 51.8 536.5 273.0
1962–7 68.8 51.4 90.5 65.0 63.5 793.6 373.7
1962–8 60.7 39.4 86.9 65.2 44.5 1046.5 474.6
1962–9 61.7 33.7 73.4 63.5 57.1 1045.4 474.0
1962–70 76.3 56.2 72.5 1336.3 592.2
1962–71 95.7 79.9 119.5 100.1 103.9 1455.5 642.7
1962–72 71.2 48.2 171.5 142.9 77.2 959.3 405.8
1962–73 27.5 40.3 132.7 91.2 36.3 625.6 246.5
1962–74 69.4 47.0 62.2 38.4 96.8 1156.7 500.1
1962–75 112.2 87.4
3.8 2.8 5.0 19.8 13.7
Average Annual Compounded Rate 5.5 4.6

556 Appendixes

TABLE 6 Pacific Partners, Ltd.

Limited Overall
Partnership
S & P 500 Partnership Results (%)

Year Index (%) Results (%) 32.0
36.7
1965 12.4 21.2 180.1
1966 –10.1 24.5 171.9
1967 23.9 120.1 97.1
1968 114.6 –7.2
1969 11.0 64.7 16.4
1970 –8.4 –7.2 17.1
1971 3.9 10.9 –42.1
1972 14.6 12.8 –34.4
1973 18.9 –42.1 31.2
1974 –14.8 –34.4 127.8
1975 –26.4 23.4 27.1
1976 37.2 127.8 37.9
1977 23.6 20.3 48.2
1978 –7.4 28.4 24.1
1979 6.4 36.1 8.0
1980 18.2 18.1 32.0
1981 32.3 6.0 24.8
1982 –5.0 24.0
1983 21.4 18.6 316.4%
22.4 5,530.2%
22,200.0%
Standard & Poor’s 19 year compounded gain
Limited Partners 19 year compounded gain 7.8%
Overall Partnership 19 year compounded gain 23.6%
Standard & Poor’s 19 year annual compounded rate 32.9%
Limited Partners 19 year annual compounded rate
Overall Partnership 19 year annual compounded rate

TABLE 7 Perlmeter Investments

PIL Limited
Year Overall (%) Partner (%)

8/1–12/31/65 40.6 32.5 Total Partnership Percentage Gain 8/1/65 through 10/31/83 4277.2%
1966 6.4 5.1
1967 73.5 58.8 Limited Partners Percentage Gain 8/1/65 through 10/31/83 2309.5%
1968 65.0 52.0
1969 –13.8 –13.8 Annual Compound Rate of Gain Overall Partnership 23.0%
1970 –6.0 –6.0
1971 55.7 49.3 Annual Compound Rate of Gain Limited Partners 19.0%
1972 23.6 18.9
1973 –28.1 –28.1 Dow Jones Industrial Average 7/31/65 (Approximate) 882
1974 –12.0 –12.0
1975 38.5 38.5 Dow Jones Industrial Average 10/31/83 (Approximate) 1225
1/1–10/31/76 38.2 34.5
11/1/76–10/31/77 30.3 25.5 Approximate Compound Rate of Gain of DJI including dividends 7%
11/1/77–10/31/78 31.8 26.6
11/1/78–10/31/79 34.7 28.9
11/1/79–10/31/80 41.8 34.7
11/1/80–10/31/81 4.0 3.3
11/1/81–10/31/82 29.8 25.4
11/1/82–10/31/83 22.2 18.4

TABLE 8 The Washington Post Company, Master Trust, December 31, 1983

All Investments Current Quarter Year Ended 2 Years Ended* 3 Years Ended* 5 Years Ended*
Manager A % Ret. Rank % Ret. Rank % Ret. Rank % Ret. Rank % Ret. Rank
Manager B
Manager C 4.1 2 22.5 10 20.6 40 18.0 10 20.2 3
Master Trust (All Managers) 3.2 4 34.1 1 33.0 1 28.2 1 22.6 1
Common Stock 5.4 1 22.2 11 28.4 3 24.5 1 ——
Manager A 3.9 1 28.1 1 28.2 1 24.3 1 21.8 1
Manager B
Manager C 5.2 1 32.1 9 26.1 27 21.2 11 26.5 7
Master Trust (All Managers) 3.6 5 52.9 1 46.2 1 37.8 1 29.3 3
Bonds 6.2 1 29.3 14 30.8 10 29.3 3 ——
Manager A 4.7 1 41.2 1 37.0 1 30.4 1 27.6 1
Manager B
Manager C 2.7 8 17.0 1 26.6 1 19.0 1 12.2 2
Master Trust (All Managers) 1.6 46 7.6 48 18.3 53 12.7 84 7.4 86
Bonds & Cash Equivalents 3.2 4 10.4 9 24.0 3 18.9 1 ——
Manager A 2.2 11 9.7 14 21.1 14 15.2 24 9.3 30
Manager B
Manager C 2.5 15 12.0 5 16.1 64 15.5 21 12.9 9
Master Trust (All Managers) 2.1 28 9.2 29 17.1 47 14.7 41 10.8 44
3.1 6 10.2 17 22.0 2 21.6 1 ——
2.4 14 10.2 17 17.8 20 16.2 2 12.5 9

* Annualized
Rank indicates the fund’s performance against the A.C. Becker universe.
Rank is stated as a percentile: 1 = best performance, 100 = worst.

TABLE 9 FMC Corporation Pension Fund, Annual Rate of Return (Percent)

Period ending 1 Year 2 Years 3 Years 4 Years 5 Years 6 Years 7 Years 8 Years 9 Years

FMC (Bonds and Equities Combined)

1983 23.0 *17.1

1982 22.8 13.6 16.0 16.6 15.5 12.3 13.9 16.3

1981 5.4 13.0 15.3 13.8 10.5 12.6 15.4

1980 21.0 19.7 16.8 11.7 14.0 17.3

1979 18.4 14.7 8.7 12.3 16.5

1978 11.2 4.2 10.4 16.1

1977 –2.3 9.8 17.8

1976 23.8 29.3

1975 35.0 * 18.5 from equities only

Becker large plan median

1983 15.6 12.6

1982 21.4 11.2 13.9 13.9 12.5 9.7 10.9 12.3

1981 1.2 10.8 11.9 10.3 7.7 8.9 10.9

1980 20.9 NA NA NA 10.8 NA

1979 13.7 NA NA NA 11.1

1978 6.5 NA NA NA

1977 –3.3 NA NA

1976 17.0 NA

1975 24.1

TABLE 9 FMC Corporation Pension Fund, Annual Rate of Return (Percent) (continued)

Period ending 1 Year 2 Years 3 Years 4 Years 5 Years 6 Years 7 Years 8 Years 9 Years
15.6
S&P 500 22.8
1983
1982 21.5 7.3 15.1 16.0 14.0 10.2 12.0 14.9
1981
1980 –5.0 12.0 14.2 12.2 8.1 10.5 14.0
1979
1978 32.5 25.3 18.7 11.7 14.0 17.5
1977
1976 18.6 12.4 5.5 9.8 14.8
1975
6.6 –0.8 6.8 13.7

7.7 6.9 16.1

23.7 30.3

37.2

Appendixes 561

2. Important Rules Concerning Taxability of Investment
Income and Security Transactions (in 1972)

Editor’s note: Due to extensive changes in the rules governing such
transactions, the following document is presented here for historical
purposes only. When first written by Benjamin Graham in 1972, all the
information therein was correct. However, intervening developments
have rendered this document inaccurate for today’s purposes. Follow-
ing Graham’s original Appendix 2 is a revised and updated version of
“The Basics of Investment Taxation,” which brings the reader up-to-
date on the relevant rules.

Rule 1—Interest and Dividends

Interest and dividends are taxable as ordinary income except (a)
income received from state, municipal, and similar obligations,
which are free from Federal tax but may be subject to state tax, (b)
dividends representing a return of capital, (c) certain dividends
paid by investment companies (see below), and (d) the first $100 of
ordinary domestic-corporation dividends.

Rule 2—Capital Gains and Losses

Short-term capital gains and losses are merged to obtain net
short-term capital gain or loss. Long-term capital gains and losses
are merged to obtain the net long-term capital gain or loss. If the
net short-term capital gain exceeds the net long-term capital loss,
100 per cent of such excess shall be included in income. The maxi-
mum tax thereon is 25% up to $50,000 of such gains and 35% on the
balance.

A net capital loss (the amount exceeding capital gains) is
deductible from ordinary income to a maximum of $1,000 in the
current year and in each of the next five years. Alternatively,
unused losses may be applied at any time to offset capital gains.
(Carry-overs of losses taken before 1970 are treated more liberally
than later losses.)

Note Concerning “Regulated Investment Companies”

Most investment funds (“investment companies”) take advan-
tage of special provisions of the tax law, which enable them to be

562 Appendixes

taxed substantially as partnerships. Thus if they make long-term
security profits they can distribute these as “capital-gain divi-
dends,” which are reported by their shareholders in the same way
as long-term gains. These carry a lower tax rate than ordinary divi-
dends. Alternatively, such a company may elect to pay the 25% tax
for the account of its shareholders and then retain the balance of
the capital gains without distributing them as capital-gain divi-
dends.

3. The Basics of Investment Taxation (Updated as of 2003)

Interest and Dividends

Interest and dividends are taxed at your ordinary-income tax rate
except (a) interest received from municipal bonds, which is free from
Federal income tax but may be subject to state tax, (b) dividends rep-
resenting a return of capital, and (c) long-term capital-gain distribu-
tions paid by mutual funds (see below). Private-activity municipal
bonds, even within a mutual fund, may subject you to the Federal alter-
native minimum tax.

Capital Gains and Losses

Short-term capital gains and losses are merged to obtain net short-
term capital gain or loss. Long-term capital gains and losses are
merged to determine your net long-term capital gain or loss. If your net
short-term capital gain exceeds the net long-term capital loss, that
excess is counted as ordinary income. If there is a net long-term capi-
tal gain, it is taxed at the favorable capital gains rate, generally 20%—
which will fall to 18% for investments purchased after December 31,
2000, and held for more than five years.

A net capital loss is deductible from ordinary income to a maxim-
um of $3,000 in the current year. Any capital losses in excess of
$3,000 may be applied in later tax years to offset future capital
gains.

Mutual Funds

As “regulated investment companies,” nearly all mutual funds take
advantage of special provisions of the tax law that exempt them from

Appendixes 563

corporate income tax. After selling long-term holdings, mutual funds
can distribute the profits as “capital-gain dividends,” which their share-
holders treat as long-term gains. These are taxed at a lower rate (gen-
erally 20%) than ordinary dividends (up to 39%). You should generally
avoid making large new investments during the fourth quarter of each
year, when these capital-gain distributions are usually distributed; oth-
erwise you will incur tax for a gain earned by the fund before you even
owned it.

4. The New Speculation in Common Stocks1

What I shall have to say will reflect the spending of many years
in Wall Street, with their attendant varieties of experience. This has
included the recurrent advent of new conditions, or a new atmo-
sphere, which challenge the value of experience itself. It is true that
one of the elements that distinguish economics, finance, and secu-
rity analysis from other practical disciplines is the uncertain valid-
ity of past phenomena as a guide to the present and future. Yet we
have no right to reject the lessons of the past until we have at least
studied and understood them. My address today is an effort
toward such understanding in a limited field—in particular, an
endeavor to point out some contrasting relationships between the
present and the past in our underlying attitudes toward invest-
ment and speculation in common stocks.

Let me start with a summary of my thesis. In the past the specu-
lative elements of a common stock resided almost exclusively in
the company itself; they were due to uncertainties, or fluctuating
elements, or downright weaknesses in the industry, or the corpora-
tion’s individual setup. These elements of speculation still exist, of
course; but it may be said that they have been sensibly diminished
by a number of long-term developments to which I shall refer. But
in revenge a new and major element of speculation has been intro-
duced into the common-stock arena from outside the companies. It
comes from the attitude and viewpoint of the stock-buying public
and their advisers—chiefly us security analysts. This attitude may
be described in a phrase: primary emphasis upon future expecta-
tions.

Nothing will appear more logical and natural to this audience
than the idea that a common stock should be valued and priced

564 Appendixes

primarily on the basis of the company’s expected future perfor-
mance. Yet this simple-appearing concept carries with it a number
of paradoxes and pitfalls. For one thing, it obliterates a good part of
the older, well-established distinctions between investment and
speculation. The dictionary says that “speculate” comes from the
Latin “specula,” a lookout. Thus it was the speculator who looked
out and saw future developments coming before other people did.
But today, if the investor is shrewd or well advised, he too must
have his lookout on the future, or rather he mounts into a common
lookout where he rubs elbows with the speculator.

Secondly, we find that, for the most part, companies with the
best investment characteristics—i.e., the best credit rating—are the
ones which are likely to attract the largest speculative interest in
their common stocks, since everyone assumes they are guaranteed
a brilliant future. Thirdly, the concept of future prospects, and par-
ticularly of continued growth in the future, invites the application
of formulas out of higher mathematics to establish the present
value of the favored issues. But the combination of precise formu-
las with highly imprecise assumptions can be used to establish, or
rather to justify, practically any value one wishes, however high,
for a really outstanding issue. But, paradoxically, that very fact on
close examination will be seen to imply that no one value, or rea-
sonably narrow range of values, can be counted on to establish and
maintain itself for a given growth company; hence at times the
market may conceivably value the growth component at a strik-
ingly low figure.

Returning to my distinction between the older and newer spec-
ulative elements in common stock, we might characterize them by
two outlandish but convenient words, viz.: endogenous and exoge-
nous. Let me illustrate briefly the old-time speculative common
stock, as distinguished from an investment stock, by some data
relating to American Can and Pennsylvania Railroad in 1911–1913.
(These appear in Benjamin Graham and David L. Dodd, Security
Analysis, McGraw-Hill, 1940, pp. 2–3.)

In those three years the price range of “Pennsy” moved only
between 53 and 65, or between 12.2 and 15 times its average earn-
ings for the period. It showed steady profits, was paying a reliable
$3 dividend, and investors were sure that it was backed by well
over its par of $50 in tangible assets. By contrast, the price of Amer-

Appendixes 565

ican Can ranged between 9 and 47; its earnings between 7 cents
and $8.86; the ratio of price to the three-year average earnings
moved between 1.9 times and 10 times; it paid no dividend at all;
and sophisticated investors were well aware that the $100 par
value of the common represented nothing but undisclosed
“water,” since the preferred issue exceeded the tangible assets
available for it. Thus American Can common was a representative
speculative issue, because American Can Company was then a
speculatively capitalized enterprise in a fluctuating and uncertain
industry. Actually, American Can had a far more brilliant long-
term future than Pennsylvania Railroad; but not only was this fact
not suspected by investors or speculators in those days, but even if
it had been it would probably have been put aside by the investors
as basically irrelevant to investment policies and programs in the
years 1911–1913.

Now, to expose you to the development through time of the
importance of long-term prospects for investments. I should like to
use as my example our most spectacular giant industrial enter-
prise—none other than International Business Machines, which
last year entered the small group of companies with $1 billion of
sales. May I introduce one or two autobiographical notes here, in
order to inject a little of the personal touch into what otherwise
would be an excursion into cold figures? In 1912 I had left college
for a term to take charge of a research project for U.S. Express Com-
pany. We set out to find the effect on revenues of a proposed revo-
lutionary new system of computing express rates. For this purpose
we used the so-called Hollerith machines, leased out by the then
Computing-Tabulating-Recording Company. They comprised card
punches, card sorters, and tabulators—tools almost unknown to
businessmen, then, and having their chief application in the Cen-
sus Bureau. I entered Wall Street in 1914, and the next year the
bonds and common stock of C.-T.-R. Company were listed on the
New York Stock Exchange. Well, I had a kind of sentimental inter-
est in that enterprise, and besides I considered myself a sort of
technological expert on their products, being one of the few finan-
cial people who had seen and used them. So early in 1916 I went to
the head of my firm, known as Mr. A. N., and pointed out to him
that C.-T.-R. stock was selling in the middle 40s (for 105,000
shares); that it had earned $6.50 in 1915; that its book value—

566 Appendixes

including, to be sure, some nonsegregated intangibles—was $130;
that it had started a $3 dividend; and that I thought rather highly of
the company’s products and prospects. Mr. A. N. looked at me
pityingly. “Ben,” said he, “do not mention that company to me
again. I would not touch it with a ten-foot pole. [His favorite
expression.] Its 6 per cent bonds are selling in the low 80s and they
are no good. So how can the stock be any good? Everybody knows
there is nothing behind it but water.” (Glossary: In those days that
was the ultimate of condemnation. It meant that the asset account
of the balance sheet was fictitious. Many industrial companies—
notably U.S. Steel—despite their $100 par, represented nothing but
water, concealed in a written-up plant account. Since they had
“nothing” to back them but earning power and future prospects,
no self-respecting investor would give them a second thought.)

I returned to my statistician’s cubbyhole, a chastened young
man. Mr. A. N. was not only experienced and successful, but
extremely shrewd as well. So much was I impressed by his sweep-
ing condemnation of Computing-Tabulating-Recording that I
never bought a share of it in my life, not even after its name was
changed to International Business Machines in 1926.

Now let us take a look at the same company with its new name
in 1926, a year of pretty high stock markets. At that time it first
revealed the good-will item in its balance sheet, in the rather large
sum of $13.6 million. A. N. had been right. Practically every dollar
of the so-called equity behind the common in 1915 had been noth-
ing but water. However, since that time the company had made an
impressive record under the direction of T. L. Watson, Sr. Its net
had risen from $691,000 to $3.7 million—over fivefold—a greater
percentage gain than it was to make in any subsequent eleven-year
period. It had built up a nice tangible equity for the common, and
had split it 3.6 for one. It had established a $3 dividend rate for the
new stock, while earnings were $6.39 thereon. You might have
expected the 1926 stock market to have been pretty enthusiastic
about a company with such a growth history and so strong a trade
position. Let us see. The price range for that year was 31 low, 59
high. At the average of 45 it was selling at the same 7-times multi-
plier of earnings and the same 6.7 per cent dividend yield as it had
done in 1915. At its low of 31 it was not far in excess of its tangible
book value, and in that respect was far more conservatively priced
than eleven years earlier.

Appendixes 567

These data illustrate, as well as any can, the persistence of the
old-time investment viewpoint until the culminating years of the
bull market of the 1920s. What has happened since then can be
summarized by using ten-year intervals in the history of IBM. In
1936 net expanded to twice the 1926 figures, and the average multi-
plier rose from 7 to 171⁄2. From 1936 to 1946 the gain was 21⁄2 times,
but the average multiplier in 1946 remained at 171⁄2. Then the pace
accelerated. The 1956 net was nearly 4 times that of 1946, and the
average multiplier rose to 321⁄2. Last year, with a further gain in net,
the multiplier rose again to an average of 42, if we do not count the
unconsolidated equity in the foreign subsidiary.

When we examine these recent price figures with care we see
some interesting analogies and contrasts with those of forty years
earlier. The one-time scandalous water, so prevalent in the balance
sheets of industrial companies, has all been squeezed out—first by
disclosure and then by writeoffs. But a different kind of water has
been put back into the valuation by the stock market—by investors
and speculators themselves. When IBM now sells at 7 times its
book value, instead of 7 times earnings, the effect is practically the
same as if it had no book value at all. Or the small book-value por-
tion can be considered as a sort of minor preferred-stock compo-
nent of the price, the rest representing exactly the same sort of
commitment as the old-time speculator made when he bought
Woolworth or U.S. Steel common entirely for their earning power
and future prospects.

It is worth remarking, in passing, that in the thirty years which
saw IBM transformed from a 7-times earnings to a 40-times earn-
ings enterprise, many of what I have called the endogenous specu-
lative aspects of our large industrial companies have tended to
disappear, or at least to diminish greatly. Their financial positions
are firm, their capital structures conservative: they are managed far
more expertly, and even more honestly, than before. Furthermore,
the requirements of complete disclosure have removed one of the
important speculative elements of years ago—that derived from
ignorance and mystery.

Another personal digression here. In my early years in the Street
one of the favorite mystery stocks was Consolidated Gas of New
York, now Consolidated Edison. It owned as a subsidiary the prof-
itable New York Edison Company, but it reported only dividends
received from this source, not its full earnings. The unreported Edi-

568 Appendixes

son earnings supplied the mystery and the “hidden value.” To my
surprise I discovered that these hush-hush figures were actually on
file each year with the Public Service Commission of the state. It
was a simple matter to consult the records and to present the true
earnings of Consolidated Gas in a magazine article. (Incidentally,
the addition to profits was not spectacular.) One of my older
friends said to me then: “Ben, you may think you are a great guy to
supply those missing figures, but Wall Street is going to thank you
for nothing. Consolidated Gas with the mystery is both more inter-
esting and more valuable than ex-mystery. You youngsters who
want to stick your noses into everything are going to ruin Wall
Street.”

It is true that the three M’s which then supplied so much fuel to
the speculative fires have now all but disappeared. These were
Mystery, Manipulation, and (thin) Margins. But we security ana-
lysts have ourselves been creating valuation approaches which are
so speculative in themselves as to pretty well take the place of
those older speculative factors. Do we not have our own “3M’s”
now—none other than Minnesota Mining and Manufacturing
Company—and does not this common stock illustrate perfectly the
new speculation as contrasted with the old? Consider a few fig-
ures. When M. M. & M. common sold at 101 last year the market
was valuing it at 44 times 1956 earnings, which happened to show
no increase to speak of in 1957. The enterprise itself was valued at
$1.7 billion, of which $200 million was covered by net assets, and a
cool $11⁄2 billion represented the market’s appraisal of “good will.”
We do not know the process of calculation by which that valuation
of good will was arrived at; we do know that a few months later
the market revised this appraisal downward by some $450 million,
or about 30 per cent. Obviously it is impossible to calculate accu-
rately the intangible component of a splendid company such as
this. It follows as a kind of mathematical law that the more impor-
tant the good will or future earning-power factor the more uncer-
tain becomes the true value of the enterprise, and therefore the
more speculative inherently the common stock.

It may be well to recognize a vital difference that has developed
in the valuation of these intangible factors, when we compare ear-
lier times with today. A generation or more ago it was the standard
rule, recognized both in average stock prices and in formal or legal

Appendixes 569

valuations, that intangibles were to be appraised on a more conser-
vative basis than tangibles. A good industrial company might be
required to earn between 6 per cent and 8 per cent on its tangible
assets, represented typically by bonds and preferred stock; but its
excess earnings, or the intangible assets they gave rise to, would be
valued on, say, a 15 per cent basis. (You will find approximately
these ratios in the initial offering of Woolworth preferred and com-
mon stock in 1911, and in numerous others.) But what has hap-
pened since the 1920s? Essentially the exact reverse of these
relationships may now be seen. A company must now typically
earn about 10 per cent on its common equity to have it sell in the
average market at full book value. But its excess earnings, above 10
per cent on capital, are usually valued more liberally, or at a higher
multiplier, than the base earnings required to support the book
value in the market. Thus a company earning 15 per cent on the
equity may well sell at 131⁄2 times earnings, or twice its net assets.
This would mean that the first 10 per cent earned on capital is val-
ued at only 10 times, but the next 5 per cent—what used to be
called the “excess”—is actually valued at 20 times.

Now there is a logical reason for this reversal in valuation proce-
dure, which is related to the newer emphasis on growth expecta-
tions. Companies that earn a high return on capital are given these
liberal appraisals not only because of the good profitability itself,
and the relative stability associated with it, but perhaps even more
cogently because high earnings on capital generally go hand in
hand with a good growth record and prospects. Thus what is really
paid for nowadays in the case of highly profitable companies is not
the good will in the old and restricted sense of an established name
and a profitable business, but rather their assumed superior expec-
tations of increased profits in the future.

This brings me to one or two additional mathematical aspects of
the new attitude toward common-stock valuations, which I shall
touch on merely in the form of brief suggestions. If, as many tests
show, the earnings multiplier tends to increase with profitability—
i.e., as the rate of return on book value increases—then the arith-
metical consequence of this feature is that value tends to increase
directly as the square of the earnings, but inversely the book value.
Thus in an important and very real sense tangible assets have
become a drag on average market value rather than a source

570 Appendixes

thereof. Take a far from extreme illustration. If Company A earns $4
a share on a $20 book value, and Company B also $4 a share on
$100 book value, Company A is almost certain to sell at a higher
multiplier, and hence at higher price than Company B—say $60 for
Company A shares and $35 for Company B shares. Thus it would
not be inexact to declare that the $80 per share of greater assets for
Company B are responsible for the $25 per share lower market
price, since the earnings per share are assumed to be equal.

But more important than the foregoing is the general relation-
ship between mathematics and the new approach to stock values.
Given the three ingredients of (a) optimistic assumptions as to the
rate of earnings growth, (b) a sufficiently long projection of this
growth into the future, and (c) the miraculous workings of com-
pound interest—lo! the security analyst is supplied with a new
kind of philosopher’s stone which can produce or justify any
desired valuation for a really “good stock.” I have commented in a
recent article in the Analysts’ Journal on the vogue of higher mathe-
matics in bull markets, and quoted David Durand’s exposition of
the striking analogy between value calculations of growth stocks
and the famous Petersburg Paradox, which has challenged and
confused mathematicians for more than two hundred years. The
point I want to make here is that there is a special paradox in the
relationship between mathematics and investment attitudes on
common stocks, which is this: Mathematics is ordinarily consid-
ered as producing precise and dependable results; but in the stock
market the more elaborate and abstruse the mathematics the more
uncertain and speculative are the conclusions we draw therefrom.
In forty-four years of Wall Street experience and study I have never
seen dependable calculations made about common-stock values, or
related investment policies, that went beyond simple arithmetic or
the most elementary algebra. Whenever calculus is brought in,
or higher algebra, you could take it as a warning signal that the
operator was trying to substitute theory for experience, and usu-
ally also to give to speculation the deceptive guise of investment.

The older ideas of common-stock investment may seem quite
naïve to the sophisticated security analyst of today. The great
emphasis was always on what we now call the defensive aspects of
the company or issue—mainly the assurance that it would con-
tinue its dividend unreduced in bad times. Thus the strong rail-

Appendixes 571

roads, which constituted the standard investment commons of fifty
years ago, were actually regarded in very much the same way as
the public-utility commons in recent years. If the past record indi-
cated stability, the chief requirement was met; not too much effort
was made to anticipate adverse changes of an underlying character
in the future. But, conversely, especially favorable future prospects
were regarded by shrewd investors as something to look for but
not to pay for.

In effect this meant that the investor did not have to pay any-
thing substantial for superior long-term prospects. He got these,
virtually without extra cost, as a reward for his own superior intel-
ligence and judgment in picking the best rather than the merely
good companies. For common stocks with the same financial
strength, past earnings record, and dividend stability all sold at
about the same dividend yield.

This was indeed a shortsighted point of view, but it had the
great advantage of making common-stock investment in the old
days not only simple but also basically sound and highly prof-
itable. Let me return for the last time to a personal note. Some-
where around 1920 our firm distributed a series of little pamphlets
entitled Lessons for Investors. Of course it took a brash analyst in his
middle twenties like myself to hit on so smug and presumptuous a
title. But in one of the papers I made the casual statement that “if a
common stock is a good investment it is also a good speculation.”
For, reasoned I, if a common stock was so sound that it carried very
little risk of loss it must ordinarily be so good as to possess excel-
lent chances for future gains. Now this was a perfectly true and
even valuable discovery, but it was true only because nobody paid
any attention to it. Some years later, when the public woke up to
the historical merits of common stocks as long-term investments,
they soon ceased to have any such merit, because the public’s
enthusiasm created price levels which deprived them of their built-
in margin of safety, and thus drove them out of the investment
class. Then, of course, the pendulum swung to the other extreme,
and we soon saw one of the most respected authorities declaring
(in 1931) that no common stock could ever be an investment.

When we view this long-range experience in perspective we
find another set of paradoxes in the investor’s changing attitude
toward capital gains as contrasted with income. It seems a truism

572 Appendixes

to say that the old-time common-stock investor was not much
interested in capital gains. He bought almost entirely for safety and
income, and let the speculator concern himself with price apprecia-
tion. Today we are likely to say that the more experienced and
shrewd the investor, the less attention he pays to dividend returns,
and the more heavily his interest centers on long-term apprecia-
tion. Yet one might argue, perversely, that precisely because the
old-time investor did not concentrate on future capital apprecia-
tion he was virtually guaranteeing to himself that he would have it,
at least in the field of industrial stocks. And, conversely, today’s
investor is so concerned with anticipating the future that he is
already paying handsomely for it in advance. Thus what he has
projected with so much study and care may actually happen and
still not bring him any profit. If it should fail to materialize to the
degree expected he may in fact be faced with a serious temporary
and perhaps even permanent loss.

What lessons—again using the pretentious title of my 1920 pam-
phlet—can the analyst of 1958 learn from this linking of past with
current attitudes? Not much of value, one is inclined to say. We can
look back nostalgically to the good old days when we paid only for
the present and could get the future for nothing—an “all this and
Heaven too” combination. Shaking our heads sadly we mutter,
“Those days are gone forever.” Have not investors and security
analysts eaten of the tree of knowledge of good and evil prospects?
By so doing have they not permanently expelled themselves from
that Eden where promising common stocks at reasonable prices
could be plucked off the bushes? Are we doomed always to run the
risk either of paying unreasonably high prices for good quality and
prospects, or of getting poor quality and prospects when we pay
what seems a reasonable price?

It certainly looks that way. Yet one cannot be sure even of that
pessimistic dilemma. Recently, I did a little research in the long-
term history of that towering enterprise, General Electric—stimu-
lated by the arresting chart of fifty-nine years of earnings and
dividends appearing in their recently published 1957 Report. These
figures are not without their surprises for the knowledgeable ana-
lyst. For one thing they show that prior to 1947 the growth of G. E.
was fairly modest and quite irregular. The 1946 earnings, per share
adjusted, were only 30 per cent higher than in 1902—52 cents ver-

Appendixes 573

sus 40 cents—and in no year of this period were the 1902 earnings
as much as doubled. Yet the price-earnings ratio rose from 9 times
in 1910 and 1916 to 29 times in 1936 and again in 1946. One might
say, of course, that the 1946 multiplier at least showed the well-
known prescience of shrewd investors. We analysts were able to
foresee then the really brilliant period of growth that was looming
ahead in the next decade. Maybe so. But some of you remember
that the next year, 1947, which established an impressive new high
for G.E.’s per-share earnings, was marked also by an extraordinary
fall in the price-earnings ratio. At its low of 32 (before the 3-for-1
split) G.E. actually sold again at only 9 times its current earnings
and its average price for the year was only about 10 times earnings.
Our crystal ball certainly clouded over in the short space of twelve
months.

This striking reversal took place only eleven years ago. It casts
some little doubt in my mind as to the complete dependability of
the popular belief among analysts that prominent and promising
companies will now always sell at high price-earnings ratios—that
this is a fundamental fact of life for investors and they may as well
accept and like it. I have no desire at all to be dogmatic on this
point. All I can say is that it is not settled in my mind, and each of
you must seek to settle it for yourself.

But in my concluding remarks I can say something definite
about the structure of the market for various types of common
stocks, in terms of their investment and speculative characteristics.
In the old days the investment character of a common stock was
more or less the same as, or proportionate with, that of the enter-
prise itself, as measured quite well by its credit rating. The lower
the yield on its bonds or preferred, the more likely was the com-
mon to meet all the criteria for a satisfactory investment, and the
smaller the element of speculation involved in its purchase. This
relationship, between the speculative ranking of the common and
the investment rating of the company, could be graphically
expressed pretty much as a straight line descending from left to
right. But nowadays I would describe the graph as U-shaped. At
the left, where the company itself is speculative and its credit low,
the common stock is of course highly speculative, just as it has
always been in the past. At the right extremity, however, where the
company has the highest credit rating because both its past record

574 Appendixes

and future prospects are most impressive, we find that the stock
market tends more or less continuously to introduce a highly spec-
ulative element into the common shares through the simple means
of a price so high as to carry a fair degree of risk.

At this point I cannot forbear introducing a surprisingly rele-
vant, if quite exaggerated, quotation on the subject which I found
recently in one of Shakespeare’s sonnets. It reads:

Have I not seen dwellers on form and favor
Lose all and more by paying too much rent?

Returning to my imaginary graph, it would be the center area
where the speculative element in common-stock purchases would
tend to reach its minimum. In this area we could find many well-
established and strong companies, with a record of past growth
corresponding to that of the national economy and with future
prospects apparently of the same character. Such common stocks
could be bought at most times, except in the upper ranges of a bull
market, at moderate prices in relation to their indicated intrinsic
values. As a matter of fact, because of the present tendency of
investors and speculators alike to concentrate on more glamorous
issues, I should hazard the statement that these middle-ground
stocks tend to sell on the whole rather below their independently
determinable values. They thus have a margin-of-safety factor sup-
plied by the same market preferences and prejudices which tend to
destroy the margin of safety in the more promising issues. Further-
more, in this wide array of companies there is plenty of room for
penetrating analysis of the past record and for discriminating
choice in the area of future prospects, to which can be added the
higher assurance of safety conferred by diversification.

When Phaëthon insisted on driving the chariot of the Sun, his
father, the experienced operator, gave the neophyte some advice
which the latter failed to follow—to his cost. Ovid summed up
Phoebus Apollo’s counsel in three words:

Medius tutissimus ibis
You will go safest in the middle course

I think this principle holds good for investors and their security
analyst advisers.

Appendixes 575

5. A Case History: Aetna Maintenance Co.

The first part of this history is reproduced from our 1965 edition,
where it appeared under the title “A Horrible Example.” The sec-
ond part summarizes the later metamorphosis of the enterprise.

We think it might have a salutary effect on our readers’ future
attitude toward new common-stock offerings if we cited one “hor-
rible example” here in some detail. It is taken from the first page of
Standard & Poor’s Stock Guide, and illustrates in extreme fashion
the glaring weaknesses of the 1960–1962 flotations, the extraordi-
nary overvaluations given them in the market, and the subsequent
collapse.

In November 1961, 154,000 shares of Aetna Maintenance Co.
common were sold to public at $9 and the price promptly
advanced to $15. Before the financing the net assets per share were
about $1.20, but they were increased to slightly over $3 per share
by the money received for the new shares.

The sales and earnings prior to the financing were:

Year Ended Sales Net for Earned
Common Per Share
June 1961 $3,615,000
(June 1960)* (1,527,000) $187,000 $0.69
December 1959 2,215,000 (25,000) (0.09)
December 1958 1,389,000 48,000 0.17
December 1957 1,083,000 16,000 0.06
December 1956 1,003,000 21,000 0.07
2,000 0.01
* For six months.

The corresponding figures after the financing were:

June 1963 $4,681,000 $ 42,000 (def.) $0.11 (def.)
June 1962 4,234,000 149,000 0.36

In 1962 the price fell to 22⁄3, and in 1964 it sold as low as 7⁄8. No divi-
dends were paid during this period.

COMMENT: This was much too small a business for public partic-
ipation. The stock was sold—and bought—on the basis of one good
year; the results previously had been derisory. There was nothing in

576 Appendixes

the nature of this highly competitive business to insure future sta-
bility. At the high price soon after issuance the heedless public was
paying much more per dollar of earnings and assets than for most
of our large and strong companies. This example is admittedly
extreme, but it is far from unique; the instances of lesser, but inex-
cusable, overvaluations run into the hundreds.

Sequel 1965–1970

In 1965 new interests came into the company. The unprofitable
building-maintenance business was sold out, and the company em-
barked in an entirely different venture: making electronic devices.
The name was changed to Haydon Switch and Instrument Co. The
earnings results have not been impressive. In the five years
1965–1969 the enterprise showed average earnings of only 8 cents
per share of “old stock,” with 34 cents earned in the best year, 1967.
However, in true modern style, the company split the stock 2 for 1 in
1968. The market price also ran true to Wall Street form. It advanced
from ⁄78 in 1964 to the equivalent of 161⁄2 in 1968 (after the split). The
price now exceeded the record set in the enthusiastic days of 1961.
This time the overvaluation was much worse than before. The stock
was now selling at 52 times the earnings of its only good year, and
some 200 times its average earnings. Also, the company was again to
report a deficit in the very year that the new high price was estab-
lished. The next year, 1969, the bid price fell to $1.

QUESTIONS: Did the idiots who paid $8+ for this stock in 1968
know anything at all about the company’s previous history, its
five-year earnings record, its asset value (very small)? Did they
have any idea of how much—or rather how little—they were get-
ting for their money? Did they care? Has anyone on Wall Street any
responsibility at all for the regular recurrence of completely brain-
less, shockingly widespread, and inevitable catastrophic specula-
tion in this kind of vehicle?

6. Tax Accounting for NVF’s Acquisition of Sharon
Steel Shares

1. NVF acquired 88% of Sharon stock in 1969, paying for each
share $70 in NVF 5% bonds, due 1994, and warrants to buy 11⁄2

Appendixes 577

shares of NVF at $22 per share. The initial market value of the
bonds appears to have been only 43% of par, while the warrants
were quoted at $10 per NVF share involved. This meant that the
Sharon holders got only $30 worth of bonds but $15 worth of war-
rants for each share turned in, a total of $45 per share. (This was
about the average price of Sharon in 1968, and also its closing price
for the year.) The book value of Sharon was $60 per share. The dif-
ference between this book value and the market value of Sharon
stock amounted to about $21 million on the 1,415,000 shares of
Sharon acquired.

2. The accounting treatment was designed to accomplish three
things: (a) To treat the issuance of the bonds as equivalent to a
“sale” thereof at 43, giving the company an annual deduction from
income for amortization of the huge bond discount of $54 million.
(Actually it would be charging itself about 15% annual interest on
the “proceeds” of the $99 million debenture issue.) (b) To offset this
bond-discount charge by an approximately equal “profit,” consist-
ing of a credit to income of one-tenth of the difference between the
cost price of 45 for the Sharon stock and its book value of 60. (This
would correspond, in reverse fashion, to the required practice of
charging income each year with a part of the price paid for acquisi-
tions in excess of the book value of the assets acquired.) (c) The
beauty of this arrangement would be that the company could save
initially about $900,000 a year, or $1 per share, in income taxes from
these two annual entries, because the amortization of bond dis-
count could be deducted from taxable income but the amortization
of “excess of equity over cost” did not have to be included in tax-
able income.

3. This accounting treatment is reflected in both the consoli-
dated income account and the consolidated balance sheet of NVF
for 1969, and pro forma for 1968. Since a good part of the cost of
Sharon stock was to be treated as paid for by warrants, it was nec-
essary to show the initial market value of the warrants as part of
the common-stock capital figure. Thus in this case, as in no other
that we know, the warrants were assigned a substantial value in
the balance sheet, namely $22 million+ (but only in an explanatory
note).

578 Appendixes

7. Technological Companies as Investments

In the Standard & Poor’s services in mid-1971 there were listed
about 200 companies with names beginning with Compu-, Data,
Electro-, Scien-, Techno-. About half of these belonged to some part
of the computer industry. All of them were traded in the market or
had made applications to sell stock to the public.

A total of 46 such companies appeared in the S & P Stock Guide
for September 1971. Of these, 26 were reporting deficits, only six
were earning over $1 per share, and only five were paying divi-
dends.

In the December 1968 Stock Guide there had appeared 45 compa-
nies with similar technological names. Tracing the sequel of this
list, as shown in the September 1971 Guide, we find the following
developments:

Total Price Price Declined Price Declined Dropped from
Companies Advanced Less Than Half More Than Half Stock Guide

45 2 8 23 12

COMMENT: It is virtually certain that the many technological
companies not included in the Guide in 1968 had a poorer subse-
quent record than those that were included; also that the 12 compa-
nies dropped from the list did worse than those that were retained.
The harrowing results shown by these samples are no doubt rea-
sonably indicative of the quality and price history of the entire
group of “technology” issues. The phenomenal success of IBM and
a few other companies was bound to produce a spate of public
offerings of new issues in their fields, for which large losses were
virtually guaranteed.

Endnotes

Introduction: What This Book Expects to Accomplish

1. “Letter stock” is stock not registered for sale with the Securities and
Exchange Commission (SEC), and for which the buyer supplies a let-
ter stating the purchase was for investment.

2. The foregoing are Moody’s figures for AAA bonds and industrial
stocks.

Chapter 1. Investment versus Speculation:
Results to Be Expected by the Intelligent Investor

1. Benjamin Graham, David L. Dodd, Sidney Cottle, and Charles
Tatham, McGraw-Hill, 4th. ed., 1962. A fascimile copy of the 1934 edi-
tion of Security Analysis was reissued in 1996 (McGraw-Hill).

2. This is quoted from Investment and Speculation, by Lawrence Cham-
berlain, published in 1931.

3. In a survey made by the Federal Reserve Board.
4. 1965 edition, p. 8.
5. We assume here a top tax bracket for the typical investor of 40%

applicable to dividends and 20% applicable to capital gains.

Chapter 2. The Investor and Inflation

1. This was written before President Nixon’s price-and-wage “freeze” in
August 1971, followed by his “Phase 2” system of controls. These
important developments would appear to confirm the views
expressed above.

2. The rate earned on the Standard & Poor’s index of 425 industrial
stocks was about 111⁄2% on asset value—due in part to the inclusion
of the large and highly profitable IBM, which is not one of the DJIA
30 issues.

579

580 Endnotes

3. A chart issued by American Telephone & Telegraph in 1971 indi-
cates that the rates charged for residential telephone services
were somewhat less in 1970 than in 1960.

4. Reported in the Wall Street Journal, October, 1970.

Chapter 3. A Century of Stock-Market History:
The Level of Stock Prices in Early 1972

1. Both Standard & Poor’s and Dow Jones have separate averages for
public utilities and transportation (chiefly railroad) companies. Since
1965 the New York Stock Exchange has computed an index represent-
ing the movement of all its listed common shares.

2. Made by the Center for Research in Security Prices of the University
of Chicago, under a grant from the Charles E. Merrill Foundation.

3. This was first written in early 1971 with the DJIA at 940. The contrary
view held generally on Wall Street was exemplified in a detailed
study which reached a median valuation of 1520 for the DJIA in 1975.
This would correspond to a discounted value of, say, 1200 in mid-
1971. In March 1972 the DJIA was again at 940 after an intervening
decline to 798. Again, Graham was right. The “detailed study” he men-
tions was too optimistic by an entire decade: The Dow Jones Industrial
Average did not close above 1520 until December 13, 1985!

Chapter 4. General Portfolio Policy: The Defensive Investor

1. A higher tax-free yield, with sufficient safety, can be obtained from
certain Industrial Revenue Bonds, a relative newcomer among financial
inventions. They would be of interest particularly to the enterprising
investor.

Chapter 5. The Defensive Investor and Common Stocks

1. Practical Formulas for Successful Investing, Wilfred Funk, Inc., 1953.
2. In current mathematical approaches to investment decisions, it has be-

come standard practice to define “risk” in terms of average price varia-
tions or “volatility.” See, for example, An Introduction to Risk and Return,
by Richard A. Brealey, The M.I.T. Press, 1969. We find this use of the
word “risk” more harmful than useful for sound investment deci-
sions—because it places too much emphasis on market fluctuations.
3. All 30 companies in the DJIA met this standard in 1971.

Endnotes 581

Chapter 6. Portfolio Policy for the Enterprising Investor:
Negative Approach

1. In 1970 the Milwaukee road reported a large deficit. It suspended
interest payments on its income bonds, and the price of the 5% issue
fell to 10.

2. For example: Cities Service $6 first preferred, not paying dividends,
sold at as low as 15 in 1937 and at 27 in 1943, when the accumulations
had reached $60 per share. In 1947 it was retired by exchange for
$196.50 of 3% debentures for each share, and it sold as high as 186.

3. An elaborate statistical study carried on under the direction of the
National Bureau of Economic Research indicates that such has actu-
ally been the case. Graham is referring to W. Braddock Hickman,
Corporate Bond Quality and Investor Experience (Princeton University
Press, 1958). Hickman’s book later inspired Michael Milken of Drexel
Burnham Lambert to offer massive high-yield financing to companies
with less than sterling credit ratings, helping to ignite the leveraged-
buyout and hostile takeover craze of the late 1980s.

4. A representative sample of 41 such issues taken from Standard &
Poor’s Stock Guide shows that five lost 90% or more of their high
price, 30 lost more than half, and the entire group about two-thirds.
The many not listed in the Stock Guide undoubtedly had a larger
shrinkage on the whole.

Chapter 7. Portfolio Policy for the Enterprising Investor:
The Positive Side

1. See, for example, Lucile Tomlinson, Practical Formulas for Successful
Investing; and Sidney Cottle and W. T. Whitman, Investment Timing:
The Formula Approach, both published in 1953.

2. A company with an ordinary record cannot, without confusing the
term, be called a growth company or a “growth stock” merely
because its proponent expects it to do better than the average in the
future. It is just a “promising company.” Graham is making a subtle but
important point: If the definition of a growth stock is a company that will
thrive in the future, then that’s not a definition at all, but wishful thinking.
It’s like calling a sports team “the champions” before the season is over.
This wishful thinking persists today; among mutual funds, “growth” port-
folios describe their holdings as companies with “above-average growth

582 Endnotes

potential” or “favorable prospects for earnings growth.” A better defini-
tion might be companies whose net earnings per share have increased
by an annual average of at least 15% for at least five years running.
(Meeting this definition in the past does not ensure that a company will
meet it in the future.)
3. See Table 7-1.
4. Here are two age-old Wall Street proverbs that counsel such sales:
“No tree grows to Heaven” and “A bull may make money, a bear may
make money, but a hog never makes money.”
5. Two studies are available. The first, made by H. G. Schneider, one of
our students, covers the years 1917–1950 and was published in June
1951 in the Journal of Finance. The second was made by Drexel Fire-
stone, members of the New York Stock Exchange, and covers the
years 1933–1969. The data are given here by their kind permission.
6. See pp. 393–395, for three examples of special situations existing in
1971.

Chapter 8. The Investor and Market Fluctuations

1. Except, perhaps, in dollar-cost averaging plans begun at a reasonable
price level.

2. But according to Robert M. Ross, authority on the Dow theory, the
last two buy signals, shown in December 1966 and December 1970,
were well below the preceding selling points.

3. The top three ratings for bonds and preferred stocks are Aaa, Aa, and
A, used by Moody’s, and AAA, AA, A by Standard & Poor’s. There
are others, going down to D.

4. This idea has already had some adoptions in Europe—e.g., by the
state-owned Italian electric-energy concern on its “guaranteed float-
ing rate loan notes,” due 1980. In June 1971 it advertised in New York
that the annual rate of interest paid thereon for the next six months
would be 81⁄8%.
One such flexible arrangement was incorporated in The Toronto-
Dominion Bank’s “7%–8% debentures,” due 1991, offered in June
1971. The bonds pay 7% to July 1976 and 8% thereafter, but the holder
has the option to receive his principal in July 1976.

Endnotes 583

Chapter 9. Investing in Investment Funds

1. The sales charge is universally stated as a percentage of the selling
price, which includes the charge, making it appear lower than if
applied to net asset value. We consider this a sales gimmick unwor-
thy of this respectable industry.

2. The Money Managers, by G. E. Kaplan and C. Welles, Random House,
1969.

3. See definition of “letter stock” on p. 579.
4. Title of a book first published in 1852. The volume described the

“South Sea Bubble,” the tulip mania, and other speculative binges of
the past. It was reprinted by Bernard M. Baruch, perhaps the only
continuously successful speculator of recent times, in 1932. Comment:
That was locking the stable door after the horse was stolen. Charles
Mackay’s Extraordinary Popular Delusions and the Madness of Crowds
(Metro Books, New York, 2002) was first published in 1841. Neither a
light read nor always strictly accurate, it is an extensive look at how
large numbers of people often believe very silly things—for instance, that
iron can be transmuted into gold, that demons most often show up on
Friday evenings, and that it is possible to get rich quick in the stock
market. For a more factual account, consult Edward Chancellor’s Devil
Take the Hindmost (Farrar, Straus & Giroux, New York, 1999); for a
lighter take, try Robert Menschel’s Markets, Mobs, and Mayhem: A
Modern Look at the Madness of Crowds ( John Wiley & Sons, New
York, 2002).

Chapter 10. The Investor and His Advisers

1. The examinations are given by the Institute of Chartered Financial
Analysts, which is an arm of the Financial Analysts Federation. The
latter now embraces constituent societies with over 50,000 members.

2. The NYSE had imposed some drastic rules of valuation (known as
“haircuts”) designed to minimize this danger, but apparently they
did not help sufficiently.

3. New offerings may now be sold only by means of a prospectus pre-
pared under the rules of the Securities and Exchange Commission.
This document must disclose all the pertinent facts about the issue
and issuer, and it is fully adequate to inform the prudent investor as to
the exact nature of the security offered him. But the very copiousness

584 Endnotes

of the data required usually makes the prospectus of prohibitive
length. It is generally agreed that only a small percentage of individu-
als buying new issues read the prospectus with thoroughness. Thus
they are still acting mainly not on their own judgment but on that of
the house selling them the security or on the recommendation of the
individual salesman or account executive.

Chapter 11. Security Analysis for the Lay Investor:
General Approach

1. Our textbook, Security Analysis by Benjamin Graham, David L. Dodd,
Sidney Cottle, and Charles Tatham (McGraw-Hill, 4th ed., 1962),
retains the title originally chosen in 1934, but it covers much of the
scope of financial analysis.

2. With Charles McGolrick, Harper & Row, 1964, reissued by Harper-
Business, 1998.

3. These figures are from Salomon Bros., a large New York bond house.
4. At least not by the great body of security analysts and investors.

Exceptional analysts, who can tell in advance what companies are
likely to deserve intensive study and have the facilities and capability
to make it, may have continued success with this work. For details of
such an approach see Philip Fisher, Common Stocks and Uncommon
Profits, Harper & Row, 1960.
5. On p. 295 we set forth a formula relating multipliers to the rate of
expected growth.
6. Part of the fireworks in the price of Chrysler was undoubtedly
inspired by two two-for-one stock splits taking place in the single
year 1963—an unprecedented phenomenon for a major company. In
the early 1980s, under Lee Iacocca, Chrysler did a three-peat, coming
back from the brink of bankruptcy to become one of the best-performing
stocks in America. However, identifying managers who can lead great
corporate comebacks is not as easy as it seems. When Al Dunlap took
over Sunbeam Corp. in 1996 after restructuring Scott Paper Co. (and
driving its stock price up 225% in 18 months), Wall Street hailed him as
little short of the Second Coming. Dunlap turned out to be a sham who
used improper accounting and false financial statements to mislead
Sunbeam’s investors—including the revered money managers Michael
Price and Michael Steinhardt, who had hired him. For a keen dissection
of Dunlap’s career, see John A. Byrne, Chainsaw (HarperCollins, New
York, 1999).

Endnotes 585

7. Note that we do not suggest that this formula gives the “true value”
of a growth stock, but only that it approximates the results of the
more elaborate calculations in vogue.

Chapter 12. Things to Consider About Per-Share Earnings

1. Our recommended method of dealing with the warrant dilution is
discussed below. We prefer to consider the market value of the war-
rants as an addition to the current market price of the common stock
as a whole.

Chapter 13. A Comparison of Four Listed Companies

1. In March 1972, Emery sold at 64 times its 1971 earnings!

Chapter 14. Stock Selection for the Defensive Investor

1. Because of numerous stock splits, etc., through the years, the actual
average price of the DJIA list was about $53 per share in early 1972.

2. In 1960 only two of the 29 industrial companies failed to show current
assets equal to twice current liabilities, and only two failed to have
net current assets exceeding their debt. By December 1970 the num-
ber in each category had grown from two to twelve.

3. But note that their combined market action from December 1970 to
early 1972 was poorer than that of the DJIA. This demonstrates once
again that no system or formula will guarantee superior market
results. Our requirements “guarantee” only that the portfolio-buyer is
getting his money’s worth.

4. As a consequence we must exclude the majority of gas pipeline
stocks, since these enterprises are heavily bonded. The justification
for this setup is the underlying structure of purchase contracts which
“guarantee” bond payments; but the considerations here may be too
complicated for the needs of a defensive investor.

Chapter 15. Stock Selection for the Enterprising Investor

1. Mutual Funds and Other Institutional Investors: A New Perspective,
I. Friend, M. Blume, and J. Crockett, McGraw-Hill, 1970. We should
add that the 1966–1970 results of many of the funds we studied were

586 Endnotes

somewhat better than those of the Standard & Poor’s 500-stock com-
posite and considerably better than those of the DJIA.
2. Personal note: Many years before the stock-market pyrotechnics in
that particular company the author was its “financial vice-president”
at the princely salary of $3,000 per annum. It was then really in the
fireworks business. In early 1929, Graham became a financial vice pres-
ident of Unexcelled Manufacturing Co., the nation’s largest producer of
fireworks. Unexcelled later became a diversified chemical company and
no longer exists in independent form.
3. The Guide does not show multipliers above 99. Most such would be
mathematical oddities, caused by earnings just above the zero point.

Chapter 16. Convertible Issues and Warrants

1. This point is well illustrated by an offering of two issues of Ford
Motor Finance Co. made simultaneously in November 1971. One was
a 20-year nonconvertible bond, yielding 71⁄2%. The other was a 25-year
bond, subordinated to the first in order of claim and yielding only
41⁄2%; but it was made convertible into Ford Motor stock, against its
then price of 681⁄2. To obtain the conversion privilege the buyer gave
up 40% of income and accepted a junior-creditor position.

2. Note that in late 1971 Studebaker-Worthington common sold as low
as 38 while the $5 preferred sold at or about 77. The spread had thus
grown from 2 to 20 points during the year, illustrating once more the
desirability of such switches and also the tendency of the stock mar-
ket to neglect arithmetic. (Incidentally the small premium of the pre-
ferred over the common in December 1970 had already been made up
by its higher dividend.)

Chapter 17. Four Extremely Instructive Case Histories

1. See, for example, the article “Six Flags at Half Mast,” by Dr. A. J.
Briloff, in Barron’s, January 11, 1971.

Chapter 18. A Comparison of Eight Pairs of Companies

1. The reader will recall from p. 434 above that AAA Enterprises tried to
enter this business, but quickly failed. Here Graham is making a pro-