1955

The 1955 Graham-Newman annual report, the partnership's report for the year ended January 31, 1955, is the document in which the partnership records its most explicit discussion of the difficulty of finding bargains in a rising market. The report notes that the bull market of the early 1950s had narrowed the universe of undervalued common stocks, and that the partnership's undervalued category had become a smaller fraction of the partnership's total assets as the market's re-rating of the structural discounts had proceeded. The 1955 report's analytical contribution is to make explicit the tension between the partnership's analytical method and the market's general direction: in a rising market, the structural discounts the partnership identifies close more quickly, and the partnership's analytical edge is correspondingly reduced. The report is candid that the narrowing of the edge is the analytical wage for the market's advance, and that the partnership must accept the narrowing as the structural condition of a bull market. The report's discussion of the difficulty of finding bargains is its most instructive passage. Graham-Newman records that the partnership's undervalued positions had been bought at prices the partnership estimated to be below the working-capital value of the underlying businesses, and that the rising market had lifted many of the partnership's holdings above the working-capital floor at which the analytical edge had been identified. The report's instruction is that the partnership's analytical edge in the undervalued category is not a permanent feature of the market; it is a feature of the market's particular condition at the time of purchase, and the partnership must accept that the edge narrows as the market rises. The report is candid that the narrowing of the edge is the analytical wage for the market's general advance, and that the partnership cannot expect to find the same density of structural discounts in a market that has already re-rated them away. The 1955 report's other instructive passage is the partnership's discussion of the special-situations category as the partnership's hedge against the narrowing of the undervalued category. Graham-Newman records that the special-situations positions, held for the closing of defined catalysts, were less affected by the market's general direction than the undervalued positions, because the catalyst's closing was the analytical event the partnership had identified, not the market's general re-rating. The report's instruction is that the special-situations category is the partnership's structural response to the narrowing of the undervalued category in a rising market: when the structural discounts close, the partnership shifts its analytical effort to the catalysts whose closing is not dependent on the market's direction. The 1955 report is, in this sense, the document in which the partnership's working method is most clearly shown to be a response to the market's general condition, and not a fixed recipe that the partnership applies regardless of the market's state.

Graham's 1955 testimony before the U.S. Senate Banking Committee's Stock Market Study is the document in which Graham, summoned to Washington to discuss the state of the equity market, gave his most direct assessment of the market's structure and of the regulator's proper role in it. Graham's testimony opens with the observation that the equity market of 1955 had recovered substantially from the troughs of the 1930s and 1940s, and that the market's recovery had been accompanied by an increase in participation by individual investors who had been absent from the market in the immediate postwar years. Graham's instruction to the Committee is that the market's recovery is, on the whole, a healthy development, and that the regulator's proper role is not to constrain the market's general direction but to ensure that the market's participants are operating honestly, with adequate disclosure, and without the manipulative practices that had disfigured the market in earlier eras. Graham's testimony on the question of market forecasting is the document's most instructive passage. Graham tells the Committee that he does not regard market forecasting as a respectable analytical activity, and that the analyst who claims to forecast the market's general direction is, in his view, claiming a knowledge the analyst does not have. Graham's instruction is that the analyst's proper work is to estimate the value of individual securities, not to forecast the market's direction, and that the analyst who confines himself to the former activity will, over a long horizon, do better than the analyst who attempts the latter. Graham's testimony is, in this sense, an early statement of what later generations would call the efficient-market critique of market forecasting: the market's direction is a function of the aggregate expectations of all participants, and the analyst who attempts to forecast the aggregate expectations is attempting to forecast a forecast. Graham's testimony on the question of margin and leverage is the document's other instructive passage. Graham tells the Committee that the use of margin and leverage by individual investors had, in the 1920s, contributed substantially to the severity of the 1929 crash, and that the regulator's proper role in the postwar market was to maintain margin requirements at a level that would prevent the leverage cycle from repeating. Graham's instruction is that the regulator's margin requirements are the structural protection against the leverage cycle, and that the regulator should resist the pressure to lower margin requirements in periods of market enthusiasm. The 1955 testimony is, in this sense, the document in which Graham's views on the market's structure, the regulator's role, and the proper discipline of the analyst are most directly recorded, and it is the document on which subsequent generations of value analysts have drawn for Graham's most direct statements on the market as a system rather than as a collection of individual securities.

Fisher's Motorola position, begun in 1955 after researching the company's engineering culture through his scuttlebutt network, was held for the rest of his life and became the canonical proof of his method. The initial decision rested less on the numbers of the moment than on what customers, engineers, and competitors said about the firm's product quality and research pipeline.

Fisher also made an early investment in Texas Instruments when it was still a young semiconductor company, having concluded through industry interviews that its technical talent gave it a long runway of growth. The position, held through enormous swings, illustrated his willingness to pay a seemingly high price for a business whose sales could compound for decades.

Fisher described what he looked for in the people running technical companies: executives who understood engineering well enough to choose the right projects, a research organization with genuine freedom to look years ahead, and a sales force able to explain complex products to customers. He judged that in technical businesses, the gap between the best-run and average firms compounds just as powerfully as the financial results.