Benjamin Graham on Long-Term Ownership

Graham narrates the GEICO investment in his memoirs as a near-accidental encounter. The founder of Government Employees Insurance Company had approached Graham-Newman seeking capital; the partnership negotiated the purchase of approximately half the company for around seven hundred thousand dollars. Graham writes that the deal was an unusual step for the partnership, which had historically preferred workouts, arbitrages, and liquid-asset plays rather than building a new insurance franchise. The transaction immediately created a regulatory problem. The Securities and Exchange Commission informed Graham-Newman that an investment fund was not permitted to hold more than a small percentage of an insurance company, and the partnership was required to distribute most of the GEICO stake to its own shareholders. Graham writes that the forced distribution turned out to be one of the most valuable involuntary decisions the partnership ever made, because the recipients held on through the post-war growth years and the position multiplied hundreds of times in value over the following decades. Graham treats GEICO as both a triumph and a paradox. He had paid a price that turned out to be a tiny fraction of what the company would be worth; the analytical framework had identified the underlying low-cost-operator advantage of GEICO's direct-selling model. But he also notes that the magnitude of the gain was not in any sense forecast by the partnership at the time of purchase. The lesson Graham draws is that the analyst can be right about the business and still badly wrong about the size of the payoff.

BENJAMIN GRAHAM THE FATHER OF FINANCIAL ANALYSIS Benjamin Graham died on September 21, 1976 at his home in Aix-en-Provence, France at age 82. When a pioneer in a profession dies at an advanced age, one generally has to go back many decades to find his last contributions. This was not the case with Ben Graham. The cover of the then current issue of the Financial Analysts Journal (the September/October issue had gone to press only shortly before his death) had the portrait that adorns this publication. The lead article ended with Ben's exhortation consistently stressed for half a century: "True investors can exploit the recurrent excessive optimism and excessive apprehension of the speculative public." The profession of financial analysis was built on the pioneering book Security Analysis, published in 1934 and in its fourth edition still is used in the Chartered Financial Analysts Candidate Study Program. More than 100,000 copies of "Graham & Dodd" have brought his concepts about the merits of investment over speculation to two generations of our profession. The financial success of Ben and his clients dramatically demonstrated the practical value of his thorough approach to the evaluation of investments. Students of Security Analysis recognized that the masterpiece did not spring into life in one outburst of genius. Rather it was the result of much hard work and the experience of two decades before the first edition.

Over a year ago The Financial Analysts Research Foundation became interested in the preparation of a biographical sketch of the professional development of Benjamin Graham as a contribution to the history of the development of financial analysis. Ben was most enthusiastic about this project and supplied nearly 200 pages of an unpublished draft of his memoirs written in 1956. The transcript of the March 1976 interview by the Foundation's Research Coordinator, Hartman L. Butler, Jr., C.F.A., helped Ben to review some of the parts in his active life not covered in his memoirs. One of the co-authors of this sketch, Irving Kahn, had the experience of working extensively and teaching under Ben for over four decades. The reader should understand that the enduring portions of this biography are among Ben's many contributions that have both enriched our lives and enhanced our understanding of the early development of the profession of financial analysis.

contribution plus 150 percent in profits. No accounting came with the check, and Ben said he wouldn't have dreamt of asking for one. A third company, Ohio Savold, came the next month, but this was a small one with no room for Ben's group. Then a very large deal was concocted, Pennsylvania Savold. This was to be the last in the series with rights to the process in the remaining 46 states, as it had been decided that more than four Savold companies would be cumbersome. Ben "neither understood nor approved of this artistic restraint, but prepared to profit to the hilt from this last gorgeous opportunity." Ben's circle of friends combined to send in $60,000 for this venture. It is now August 1919, and the bull market continues strong with great emphasis on stocks of the rankest speculative flavor. The original Savold was strong, reaching a peak of 77%. In a week, however, it fell by 30 percent. The group waited for Pennsylvania Savold to begin trading. There was a slight delay. This continued for a few weeks until all the Savold issues collapsed completely, disappearing forever. The friend brought Ben along to a meeting with the Savold promoter, who was pressured into turning over cash and shares in some other promotions that at least gave back to the victims of the Savold Tire promotion one-third of their "investment". Apparently nobody complained to the district attorney's office about this swindle-nor about similar swindles.

The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become exC£ted by sizable advances. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored. Sound generalz"zations can be more dangerous than unsound ones because they lure more people into unwarranted actions. The Intelligent Investor Third Edition, 1959 The post-World War II world has been characterized as 'brave' and 'new.' Brave it is, indeed, but we are not positive that it is equally new. We can be skeptical about a complete break with the past. Security Analysis Fourth Edition, 1962 Common stocks have one important investment characteristic and one important speculative characteristic. Their investment value and average market price tend to increase irregularly but persistently over the decades, as their net worth builds up through the reinvestment of undistributed earnings . ... However, most of the time common stocks are subject to irrational and excessive price fluctuations in both directions, as the consequence of the ingrained tendency of most people to speculate or gamble-i.e., to give way to hope, fear and greed. Financial Analysts Iournal September/October, 1976

Graham endorses dollar-cost averaging for the defensive investor: invest equal dollar amounts at regular intervals into a diversified list of common stocks, regardless of market level. The mechanism is mechanical, removing the temptation to time purchases. Graham argues that this single discipline, applied consistently over decades, produces better results than most investors achieve trying to outsmart the market. The mathematics of dollar-cost averaging favour it because the investor buys more shares when prices are low and fewer when prices are high, lowering average cost per share. Graham does not claim that dollar-cost averaging is theoretically optimal; he claims it is behaviourally robust. Investors who try to time the market routinely underperform the discipline of regular purchases because they hesitate exactly when prices are attractive and lean in exactly when prices are dangerous. Diversification is the partner discipline. Graham requires the defensive investor to hold a meaningful number of issues across industries, so that no single security's failure can permanently impair the portfolio. He treats concentration as a function of conviction and effort: the enterprising investor with strong analysis on a few positions may concentrate, but the defensive investor must diversify, because his lack of comparative edge is exactly what a single-name bet would expose.

The letters record that Graham-Newman's GEICO holding, although reduced by the SEC-mandated distribution, remained a meaningful position and a focus of the partnership's attention. Graham and Newman took board seats and involved themselves in the company's underwriting and finance. The letters describe GEICO's growth in premium volume and policyholder count, and note that the company's direct-to-consumer model was producing underwriting profits that other insurers could not match. The letters are explicit that Graham-Newman did not forecast GEICO's later dominance. The partnership's analytical case at the time of the 1948 investment was that the company was a low-cost operator with disciplined underwriting, in an industry where most operators were neither. The letters do not project the twenty-five-year outcome; they project a sound business bought cheaply. The lesson the partnership drew, in retrospect, was that soundness and price were sufficient and the growth bonus was a free rider. Graham-Newman's letters also disclose the moment in the early 1970s when GEICO's underwriting discipline broke and the company nearly collapsed. Graham writes, in later correspondence, that he had been retired from Graham-Newman by then and was not involved in the rescue, but that the episode confirmed his view that even a low-cost operator can be ruined by underwriting for growth rather than for profit.