Ben Graham totally discredits value investing at the end of his career?

I'm a pretty serious student of Ben Graham, and just saw this the other day. Pretty disappointed.

"I am no longer an advocate of elaborate techniques of Security Analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook "Graham and Dodd" was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent, I'm on the side of the "efficient market" school of thought now generally accepted by the professors."

So does he totally discredit value investing? I haven't read this in its entire context, so it may not be over. I would love to find out what he actually meant, and how someone like Buffett would respond.

 

Ben Graham has always wavered back and forth on the idea that one really could get superior results. In The Intelligent Investor, he outlines something very much like the Efficient Market Hypothesis, pointing out the difficulty for the average investor of discovering a market inefficiency that all of the research analysts and money managers on Wall Street have missed.

I have read in several other places that late in life he moved further away from the belief that value investing could provide superior returns. Your quotation from Graham does not seem like a big break with his past views, but instead a moderate change in belief brought about by new circumstances.

 

So the father of value investing now believes that value investing doesn't work? That's pretty disappointing to hear. Why isn't this topic blown up more? Everyone talks about how great value investing is, but no one mentions how Graham thinks it is not relevant anymore. I'm assuming it's alive today because of Buffett.

 

I hate EMH and dislike the idea that Ben Graham would discredit the best idea in finance - especially since he came up with the fuckin' thing. Wow, I really hope everyone starts abiding by the EMH principles so I can make some money - it's easy to win a race if no one else even tries.

Some quotes from Warren Buffet that Mr. Graham should read: - "Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing." -"If a business does well, the stock eventually follows." - "Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it." - "Price is what you pay. Value is what you get." - "Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised."

 
eriginal:
I hate EMH and dislike the idea that Ben Graham would discredit the best idea in finance - especially since he came up with the fuckin' thing. Wow, I really hope everyone starts abiding by the EMH principles so I can make some money - it's easy to win a race if no one else even tries.

Some quotes from Warren Buffet that Mr. Graham should read: - "Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing." -"If a business does well, the stock eventually follows." - "Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it." - "Price is what you pay. Value is what you get." - "Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised."

It would actually be almost impossible to win such a race. You can identify the best company in the world, but if no one else knows/cares how good it is, the price is going to say "mehhhh"

 
SlikRick:
BP fell as low as $30 a share after the Oil Spill. Its decline in price was 100% based on market emotion, with no financial analysis justifying the fall in share price. Needless to say, any value investor could have picked up on this. Made a 33% return in about a month.

This. Some of the share prices hit by the financial crisis didn't deserve to be, and there's definitely money to be made in the long-run if you spot them.

Damn you Rodger! My WSO Blog
 
SynergyWeek:
SlikRick:
BP fell as low as $30 a share after the Oil Spill. Its decline in price was 100% based on market emotion, with no financial analysis justifying the fall in share price. Needless to say, any value investor could have picked up on this. Made a 33% return in about a month.

This. Some of the share prices hit by the financial crisis didn't deserve to be, and there's definitely money to be made in the long-run if you spot them.

I wouldn't say it was purely on emotion, there were real concerns that BP could face huge fines and regulatory uncertainty for a long time following the oil spill. No one really knew how long it was going to last and no one really knew what the political reaction would be. Its really easy to look back and think the guys who sold BP were idiots, but history is full of firsts, and there was a possibility it could severely damaged the firm's long term profitability.

 
SlikRick:
BP fell as low as $30 a share after the Oil Spill. Its decline in price was 100% based on market emotion, with no financial analysis justifying the fall in share price. Needless to say, any value investor could have picked up on this. Made a 33% return in about a month.

So you're saying the reaction to the Macondo spill was "100% based on emotion"?

That's quite bold. Considering its still not back to pre-Deepwater price levels.

It's very easy to say something was undervalued or the market overreacted after the fact. Its much more difficult to analyze the financial impact of an event like Macondo in real time. Especially when everyone on the planet is going after BP's head.

 

Why should Graham's view influence yours? If you find yourself profitable following his/your principles, then keep doing it.

The investing/trading game is all about getting in earlier than someone else. What a value investor does is buy when no one has the balls to do it, and sell when everyone believes the stock is God's gift to humanity. That is the key to his superior returns. He makes the decisions the market cannot, before the market decides it's the right thing to do.

In any case, all Graham is really saying is that there is no mechanical solution to the market puzzle. Understand the game, and you'll do fine.

 
JeffSkilling:
There is no value to be found today, it's all HFT bots trading amongst themselves in a sea of liquidity from the Fed. We don't have markets anymore, we have theatre.

What does this mean for value and LT investors and students wanting to become one of them? If there's no market anymore, than it would follow that there will be a reduction in jobs. Is this, too, a dying industry?

I can hardly imagine, I think there will always be markets to invest in and I don't believe that HFT will increase long term due to future regulations.

 

Interesting... i have read both the intelligent investor and security analysis and for a time i was the most astute value investor you would ever come across. Fast forward a few years and the portfolio i had constructed based on Graham's rules was still relatively flat, furthermore, Buffet's BRK.A and BRK.B have been under performing the S&P for the past 5 years. I do not discredit Mr. Graham 100% but i do agree with the point he brings up that the markets have changed. You have to take into account that his first book was written based on the performance of his theory dating back to the 1920s. That being said, it isn't impossible to find value stocks, just substantially harder, and takes a lot more effort than it once did.

"Well, you know, I was a human being before I became a businessman." -- George Soros
 

Buffett always talks about value investing but if you look at his investments especially in the last 5 years he has made most of his money through special situations/event based plays

Simplicity is the highest form of sophistication ~ Leonardo da Vinci
 
arant:
Buffett always talks about value investing but if you look at his investments especially in the last 5 years he has made most of his money through special situations/event based plays
Not mutually exclusive. Complicated transactions and poorly understood situations are a common creator or undervalued securities.
There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.
 

Have you guys read Security Analysis? The techniques in that book are things like adding up the liquidation value of inventories, receivables, and cash, and buying the stock when it trades at two thirds of that or less. In the 40's and 50's, Buffett was able to buy a life insurance stock at a P/E of 1. 1! Those bargains disappeared thanks to the resurgence of equity investors, and--especially--the growth of go-go mutual funds and conglomerates in the 60's. Both groups indiscriminately bought small-caps based on fairly simple valuation metrics.

Graham isn't saying value is dead; he's saying that it's harder than it used to be. But the general attitude--that stocks can be underpriced due to non-fundamental reasons, and that it can be fruitful to invest on this basis--is self-evidently sound. Or, at least, it's true to the extent that people don't believe in it.

I think the fairest way to state this is: early in Graham's career, the ROI on fundamental research was insanely high, to the point that lots of fairly ordinary people could earn annual returns in the teens by doing pretty formulaic work. But because that stuff was fairly easy, people invested and then overinvested in research. Now, an ordinary person can't achieve outstanding returns just based on buying quantitatively cheap stocks. But it's still possible to juice your returns by investing in qualitatively superior companies, at sane prices.

Plus, late in his career Graham was depressed due to personal issues, the near-collapse of GEICO, and the fact that he was probably manic-depressive or at least psychologically fucked in some way.

 
bananadine:
Have you guys read Security Analysis? The techniques in that book are things like adding up the liquidation value of inventories, receivables, and cash, and buying the stock when it trades at two thirds of that or less. In the 40's and 50's, Buffett was able to buy a life insurance stock at a P/E of 1. 1! Those bargains disappeared thanks to the resurgence of equity investors, and--especially--the growth of go-go mutual funds and conglomerates in the 60's. Both groups indiscriminately bought small-caps based on fairly simple valuation metrics.

Graham isn't saying value is dead; he's saying that it's harder than it used to be. But the general attitude--that stocks can be underpriced due to non-fundamental reasons, and that it can be fruitful to invest on this basis--is self-evidently sound. Or, at least, it's true to the extent that people don't believe in it.

I think the fairest way to state this is: early in Graham's career, the ROI on fundamental research was insanely high, to the point that lots of fairly ordinary people could earn annual returns in the teens by doing pretty formulaic work. But because that stuff was fairly easy, people invested and then overinvested in research. Now, an ordinary person can't achieve outstanding returns just based on buying quantitatively cheap stocks. But it's still possible to juice your returns by investing in qualitatively superior companies, at sane prices.

Plus, late in his career Graham was depressed due to personal issues, the near-collapse of GEICO, and the fact that he was probably manic-depressive or at least psychologically fucked in some way.

"Well, you know, I was a human being before I became a businessman." -- George Soros
 

http://greenbackd.com/2012/04/25/value-investing-works-so-why-do-value-…

None of this is a rebuttal of Benjamin Graham's claim, of course, but I think there's still alpha to be had in a disciplined value investment strategy.

Why?

Because I think people are naturally impatient, naturally likely to follow along with the herd, and naturally emotional. Even if you're susceptible to all three qualities, following a disciplined value investment approach protects you from your baser instincts.

 

All of you talking about value vs. growth obviously do not know what value investing is. Value is just a broad framework to buy at a price substantially less than the amount the company can earn back in the long run. Special sits, growth and so on comes under Buffett's definition of value.

 
ggsonny:
All of you talking about value vs. growth obviously do not know what value investing is. Value is just a broad framework to buy at a price substantially less than the amount the company can earn back in the long run. Special sits, growth and so on comes under Buffett's definition of value.

Not trying to have an argument in semantics but value and growth are different approaches, hence why so many mutual exist and the majority of them are classified as one or the other.

Value is a subjective word, but let's say that Buffett dislikes technology companies.... you could have bought AMZN after the tech bubble very cheaply but you were still buying a company with negative earnings. Whether that constitutes value at that time is subjective... based on fundamental ratios that's more of a growth play.

You can't just call high P/E relative to their industry stocks (yes I know Buffett dislikes this ratio) value because you think that future earnings will justify the current price. That's growth.

 
Best Response

There have been a lot of ideas thrown around here so I'm not sure about the most logical way to address all of them but here goes:

-Graham blew up very bad at one point in his career. I can't find the actual dates, returns, etc, but he was down well over 50% (I think it may have been 70-80%). The only reason he became so cheap was because he got torched so bad. It is hard to lose money on a classic "Net-Net" (100% of cash, 75% of A/R, 50% of inventories less liabilities). These opportunities were actually around in the 30's and 40's and he made money off of them. A generation long bull market got started in 1949 and these opportunities dried up, only to reappear amidst the "death of equities" in the 70's. Even at the very bottom in March 2009, stocks weren't as cheap then as they were in much of the 30's, 40's, or 70's.

-I believe the OP's quote comes from an interview Ben Graham did with a the Financial Analyst Journal in 1976 right before he passed away. I can't find the actual journal PDF but this is a presentation he gave around the same time that covers the same topic.

http://www.grahaminvestor.com/wp-content/uploads/2010/01/graham-seminar…

Graham goes onto say that

"To that extent I share the skepticism expressed by the "efficient market" theoreticians as to the ability of all but very superior security analysts to do a good job of individual stock selection. But this is far from saying that I think that individual stock prices reflect in general and under most conditions the "fair value" of each issue. On the contrary, my present emphasis on the tendency of most stocks to fluctuate widely and often wildly in price over the years should show my conviction that stock prices are often out of line with their fair or intrinsic values."

He admits that both it is very hard to pick individual stocks and make money but at the same time there are many mispriced securities.

Graham goes on in the paper linked above to talk about how he tested three different strategies, systematically applied, that generated excess returns (Low P/E, Low P/B, and a price more that 50% below the high of the past two years). All three of them worked well, with the low P/E working the best. Graham was not completely writing off all of the work he had done for the past decades or the validity of fundamental analysis, but rather saying there might be easier, more effective ways to make money. Security analysis can be difficult work and with the proliferation of information, just about anybody can do it. That doesn't change the fact that it is important to buy stocks that are cheap, but it might be a lot easier to just buy a basket of cheap stocks rather than picking through all of the cheap stocks and finding the best ones.

I think about Value Investing the same way Winston Churchill described democracy: It's the worse form except for all of the others that have been tried." Graham was on to something 80 years ago and much of it still rings true today. It doesn't mean it is a bullet-proof Bible to profits. Value stocks did very well once the tech bubble popped all the way up until the credit bubble popped. They have not done much of note in the past three years with correlations through the roof. The fact that a lot of the big name guys have done so well since 2001 have made it a crowded field - there are a lot of charlatans. Stock picking is tough when markets are totally driven by central banks in the short term. It creates opportunities but a lot of pain in the interim.

I could ramble on and on, but that is enough for now.

 
Gray Fox:
There have been a lot of ideas thrown around here so I'm not sure about the most logical way to address all of them but here goes:

-Graham blew up very bad at one point in his career. I can't find the actual dates, returns, etc, but he was down well over 50% (I think it may have been 70-80%). The only reason he became so cheap was because he got torched so bad. It is hard to lose money on a classic "Net-Net" (100% of cash, 75% of A/R, 50% of inventories less liabilities). These opportunities were actually around in the 30's and 40's and he made money off of them. A generation long bull market got started in 1949 and these opportunities dried up, only to reappear amidst the "death of equities" in the 70's. Even at the very bottom in March 2009, stocks weren't as cheap then as they were in much of the 30's, 40's, or 70's.

-I believe the OP's quote comes from an interview Ben Graham did with a the Financial Analyst Journal in 1976 right before he passed away. I can't find the actual journal PDF but this is a presentation he gave around the same time that covers the same topic.

http://www.grahaminvestor.com/wp-content/uploads/2010/01/graham-seminar…

Graham goes onto say that

"To that extent I share the skepticism expressed by the "efficient market" theoreticians as to the ability of all but very superior security analysts to do a good job of individual stock selection. But this is far from saying that I think that individual stock prices reflect in general and under most conditions the "fair value" of each issue. On the contrary, my present emphasis on the tendency of most stocks to fluctuate widely and often wildly in price over the years should show my conviction that stock prices are often out of line with their fair or intrinsic values."

He admits that both it is very hard to pick individual stocks and make money but at the same time there are many mispriced securities.

Graham goes on in the paper linked above to talk about how he tested three different strategies, systematically applied, that generated excess returns (Low P/E, Low P/B, and a price more that 50% below the high of the past two years). All three of them worked well, with the low P/E working the best. Graham was not completely writing off all of the work he had done for the past decades or the validity of fundamental analysis, but rather saying there might be easier, more effective ways to make money. Security analysis can be difficult work and with the proliferation of information, just about anybody can do it. That doesn't change the fact that it is important to buy stocks that are cheap, but it might be a lot easier to just buy a basket of cheap stocks rather than picking through all of the cheap stocks and finding the best ones.

I think about Value Investing the same way Winston Churchill described democracy: It's the worse form except for all of the others that have been tried." Graham was on to something 80 years ago and much of it still rings true today. It doesn't mean it is a bullet-proof Bible to profits. Value stocks did very well once the tech bubble popped all the way up until the credit bubble popped. They have not done much of note in the past three years with correlations through the roof. The fact that a lot of the big name guys have done so well since 2001 have made it a crowded field - there are a lot of charlatans. Stock picking is tough when markets are totally driven by central banks in the short term. It creates opportunities but a lot of pain in the interim.

I could ramble on and on, but that is enough for now.

What a post.

There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.
 

I think profitability in the stock market game comes from being able to predict. I'm guessing there isn't many ways to make money mechanically anymore unless you have HFT edges. There is just too many people making edges obsolete. Maybe the best things to do is to do nothing at all. Buy the S&P and call it a day.

 

Prediction as in.. you must predict situations such as... I think the deal with company A will go through because of B. With B being unknown to the general public. You have to come up with your own Ideas. I meant making money mechanically as in making money based off of "systems." Such as buying low "valued" stocks which everyone is already doing. Basically anything that is already known or being implemented by a great number of people. The more I learn about investing and the more knowledge I gain from my own endeavors, I seem to think the market is almost completely efficient. This means you must predict a situation or a catalyst which is unknown or not included in the price already.

 
cyoungmark:
Prediction as in.. you must predict situations such as... I think the deal with company A will go through because of B. With B being unknown to the general public. You have to come up with your own Ideas. I meant making money mechanically as in making money based off of "systems." Such as buying low "valued" stocks which everyone is already doing. Basically anything that is already known or being implemented by a great number of people. The more I learn about investing and the more knowledge I gain from my own endeavors, I seem to think the market is almost completely efficient. This means you must predict a situation or a catalyst which is unknown or not included in the price already.

I see but how is this different than any market in history? Isn't it the nature of speculation, and in essence this never changes.

 

Markets oscillate back and forth between value and momentum states. These two strategies are strongly negatively correlated with one another. Read "Value and Momentum Everywhere" by Cliff Asness. All successful professional investors understand the need to have exposure to both market paradigms.

Just buying "cheap" stocks isn't good enough anymore; investors need to be mindful of market sentiment and need to wait until other investors begin to realize that something is indeed cheap before jumping in.

Just screen stocks on trailing 90-day price momentum and discount to consensus price target and weight the two factors equally. Boom, you've got your own market-neutral hedge fund right in your PA. This extremely simple strategy has worked for many years.

Of course there's other stuff that works too, but I can' give that away!

 

^ It depends on your time frame but it seems that even if you hold a stock for a year or two then the game is buy high, sell higher.

Investing in value presents an issue with survivorship bias. You can purchase companies that are "undervalued" b.c of their book ratio or whatever, but you are essentially calling bottoms. A lot of those companies do not survive so it is easier to remember the ones that did... and then attribute their success to the validity of value.

Still, I don't think there's a single best way to extract profits from the market. Sometimes momentum works, other times value, sometimes both, and many times its just the whims of randomness.

 

so much talk about value, growth, p/e, p/b etc.

Who cares? I haven't looked at a p/e of a company or p/e comps for any of the companies I've researched.

The only things that matter are: a) Sound business and operating model with catalysts that you can feel confident about b) Strong management who are aligned with shareholders' interests c) Macro-view for the industry the business is operating in

Based on the above, and after you are 100% certain you understand the business almost as good as its managers, you can assess their future trajectory and how that fits with your risk/reward profile. Sometimes it may be a short-term catalyst that works for you, sometimes a long-term one. That will define whether you think it's cheap or not. For example, a strong imminent catalyst could render a company's share price cheap - simply because you expect it to jump fairly soon, you get my point. The investment horizon is very important.

There are many who advocate buying "value" shares and that if you hold them for 10 years you will surpass market returns blahblahblah. Noone's got 10 years in the HF industry, it's all for much shorter-term investments so whether it's best to hold on to something for the end of times it's irrelevant. If you were a pension fund then the argument would be on its head, obviously.

Also, markets have evolved and one needs to follow up with sentiment. Investing based on ratio cut-offs etc. while ignoring the market behaviour and sentiment will always end in tears.

Obviously with the throngs of analysts covering most stocks in the well developed countries it's getting harder and harder to find cheap stocks, however opportunities are out there. Many times market events will cause groups of shares to go down for no good reason. This in turn creates opportunities. But in order to get on that opportunity you'll need to do your work beforehand and wait for the trigger event to exploit it.

Anyway, I'm rambling, just wanted to point out that talking about all these ratios etc. is futile when there are far more important things that define a value/growth stock. Just because many people are looking into the same companies doesn't mean that they understand them (many sell-side analyst examples that were talking pure bullshit). Of course it's a hard game, that's why the very successful HF are relatively few and far between, but the fact that they exist shows that there are always big opportunities that most have missed.

Also, my definitions of these two terms are as follows:

value: a company that you do not think will exhibit strong revenue growth in the future but you do think it's underpriced compared to the opportunities to improve margins and overall financials. I.e. it's rerating will come from better management or market conditions. growth: a company that you expect to grow exponentially (ok, maybe not really exponentially) and while it may seems fully valued, it is actually cheap when you consider you are buying multiples of future growth - which in turn will rerate the stock higher.

 

Wrong - Graham merely pointed out that the advent of technology has made it more difficult to find bargains because of lack of coverage e.g. it's rare to find good companies these days selling below net current assets/liquidation value. This point was stressed multiple times in Security Analysis. He also noted that as long as human beings are prone to mob psychology and herding mentalities that bargains will always present themselves due to market cyclicality.

So no, he didn't discredit value investing - he simply observed how the pragmatic application of the theory has changed -- but the underlying theory behind buying a dollar for $.50 will never change.

 
sofa king smooth:
So no, he didn't discredit value investing - he simply observed how the pragmatic application of the theory has changed -- but the underlying theory behind buying a dollar for $.50 will never change.

Pretty much my thoughts exactly.

 

I came across this article quite a while ago and only thought to come back to it now after reading the context of the quote. I found this article quite saddening at the time, and if you felt the same way, please be sure to read the interview in full to understand what Graham meant. He agrees with part of the efficient theory - but this quote explains it best, from the same year. [when asked about efficient market professors]

"Well, I am sure they are all very hardworking and serious. It's hard for me to find a good connection between what they do and practical investment results. In fact, they say that the market is efficient in the sense that there is no particular point in getting more information than people already have. That might be true, but the idea of saying that the fact that the information is so widely spread that the resulting prices are logical prices-that is all wrong. I don't see how you can say that the prices made in Wall Street are the right prices in any intelligent definition of what right prices would be."

 
Terriers12:
So does he totally discredit value investing? I haven't read this in its entire context, so it may not be over. I would love to find out what he actually meant, and how someone like Buffett would respond.

I think its just a timing thing. There was a point where the academic evidence for EMH was piling up and the access to data for studies the other way just wasn't there. Graham always saw himself as data driven, and may have felt forced to that conclusion. Add in some old fashioned sticker stock (what do you mean this industry output report costs $50,000!) and you can see how he would stray.

Still, I think long-only value investing is less effective in large-cap equities these days, as information is pretty much uniform (unless you are Steve Cohen), with some sectors being notable exceptions. Can still do very well in HY and distressed bond markets though, and in the equities of those names. The successful guys are either small/mi-cap, have tech expertise or are layering on shorts, activism, special situations or something else to create value on top of what they find with the stock screen.

 

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