Sunday, March 22, 2009

Is Benjamin Graham Still Relevant?

A few years ago, Jason Zweig worked with the publisher of The Intelligent Investor in order to update the classic investment book. Zweig made it clear to the publisher that he would not rewrite any of what Graham had written. Zweig outlines some of the thoughts that went into the 2003 update of the Intelligent Investor in a paper titled, Equity Analysis Issues, Lessons, and Techniques.

Graham gets criticized by some analyst because some of Graham's formulas seem outdated. For example, in the late 1990's Jim Cramer commented,
"You have to throw out all of the matrices and formulas and texts that existed before the Web. . If we used any of what Graham or Dodd teach us, we wouldn’t have a dime under management."
It should be noted though, Graham constantly retested and reworked his formulas over time and in subsequent editions of the book. Zweig states in the above noted paper:
"Of course they are! They are the ones he used to replace the formulas in the 1965 edition, which replaced the formulas in the 1954 edition, which, in turn, replaced the ones from the 1949 edition, which were used to augment the original formulas that he presented in Security Analysis in 1934." Graham constantly retested his assumptions and tinkered with his formulas, so anyone who tries to follow them in any sort of slavish manner is not doing what Graham himself would do if he were alive today.
Zweig characterizes Graham's relevance into five factors with detail found in the below link to the article.
  • intellectual brilliance
  • financial brilliance
  • prophetic brilliance
  • psychological brilliance
  • explanatory brilliance.
So why did Graham title his book the Intelligent Investor? In the first edition (1949) of the book, Graham defines what he means by intelligent.
will be used throughout the book in its common and dictionary sense as meaning "endowed with the capacity for knowledge and understanding." It will not be taken to mean "smart" or "shrewd," or gifted with unusual foresight or insight. Actually the intelligence here presupposed is a trait more of the character than the brain.
Zweig expands on the last sentence to mean,
The components that are needed in the character of an intelligent investor are patience, independent thinking, discipline, eagerness to learn, self-control, and self-knowledge.
And many followers of Graham have memorized the one passage on independent thinking that seems to sum up his philosophies:
"you are neither right nor wrong because the crowd disagrees with you. You are right because your data and your reasoning are right."
Warren Buffett recites this phrase at nearly every annual meeting of Berkshire Hathaway (BRK/A). According to Buffett,
Investment managers must be independent. They must tell their clients that worrying about the information ratio and tracking error is not part of their process. If they do not establish the independence of their thinking, managers (and independent investors) will end up turning a basic advantage into a basic disadvantage. They will become trapped in the measurement and benchmarking game, which pretends that managers can outperform the market while maintaining portfolios and strategies that look exactly like the market.
Lastly, what Graham had to say about management and owners as recently as 1972, could apply today's management issues. In the 2003 edition that Zweig participated in, he tried to add back the "lost Ben Graham." Some of the lost Ben Graham in the 1972 addition did appear in the 1949 edition. At the suggestion of Warren Buffet, Zweig added some of the management material.
For example, in the 1972 edition, Chapter 19 was eight pages of perfunctory remarks about dividend policy. When I went back to the 1949 edition (on the suggestion of a certain resident of Omaha), I discovered that one-third of the original book was given over to a discussion of what Graham called "the investor as stockholder."
In these passages, Graham explained the responsibilities that come with owning companies.
"Nothing in finance," he wrote in 1949, is more fatuous and harmful, in our opinion, than the firmly established attitude of common stock investors and their Wall Street advisers regarding questions of corporate management. That attitude is summed up in the phrase: "If you don’t like the management, sell the stock." In the 1934 edition of Security Analysis, Graham reinforced this idea with the following classic formulation, "Certainly there is just as much reason to exercise care and judgment in being as in becoming a stockholder."
And what does Warren Buffet say about Benjamin Grahman's relevence in today's market?
"I read the first edition of this book early in 1950, when I was 19. I thought then that it was by far the best book about investing ever written. I still think it is."
The entire article is detailed below and was obtained via the University of South Dakota.
Lessons Ideas Benjamin Graham

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