The interview named “An hour with Mr. Graham”, attracted legion of investors awaiting what will the dean comment about the current screen play of the market and throw some bones for the tail wag-ers. The interview happened 20 years after dissolving the investment firm Graham Newman corp. which overrode the 1929 crash, the Great Depression, World War II, and the Korean war. Obviously, the bone of grouping stocks methodology was out to the world which is similar to present day’s index following.
According to Benjamin Graham, selecting stocks should be made simpler by grouping them under a constrain based on exploration and experimenting the condition with the help of historical data. The investing world knows how did the Graham-Newman corporation operated, it’s based on two conditions:
- Get to a stock which is trading below two-third of it’s net asset value. The short and long term liabilities are comfortably neglected. This is famously known Net-Net.
- Go for cheaply trading businesses. As far as the S&P 500 is concerned 10 is what the average PE is and the spread is +5 to the average nothing more than that.
He never considered any of the management traits, way of operation, what business they are in?, what is the next quarter’s earning? and so on which now-a-day analysts scuffle to predict. Graham reasoned a margin of safety exists if the stock qualifies both the criteria and an investment is made. This method of investing was thought to be fool proof which turned to be fallacious when markets kicked off with increasing efficiency and in the world of investing what seems to work in the short term will cease to work if everyone starts to initiate it.
Let’s commence what Hartman L. Butler (the interviewer, CFA) and Benjamin Graham had left for us to learn from the hour of talk.
HB: Mr. Graham, I do appreciate so much being able to come and visit with you this afternoon. When Bob Milne learned that Mrs. Butler and I would be in La Jolla, he suggested that I not only visit with you but also bring along my cassette tape recorder. We have much I would like to cover. First, could we start with a topical question-Government Employees Insurance Company-with GEICO being very much in the headlines.
Graham: Yes, what happened was the team came into our office and after some negotiating, we bought half the company for $720,000. It turned out later that we were worth-the whole company–over a billion dollars in the stock market. This was a very extraordinary thing. But we were forced by the SEC to distribute the stock among our stockholders because, according to a technicality in the law, an investment fund was not allowed more than 10 percent of an insurance company. Jerry Newman and I became active in the conduct of GEICO, although we both retired a number of years ago. I am glad I am not connected with it now because of the terrific losses.
HB: Do you think GEICO will survive?
Graham: Yes, I think it will survive. There is no basic reason why it won’t survive, but naturally I ask myself whether the company did expand much too fast without taking into account the possibilities of these big losses. It makes me shudder to think of the amounts of money they were able to lose in one year. Incredible! It is surprising how many of the large companies have managed to turn in losses of $50 million or $100 million in one year, in these last few years. Something unheard of in the old days. You have to be a genius to lose that much money.
HB: Then with roughly a 50 percent dividend payout, you can take half of the earnings yield to estimate a substainable dividend yield.
Graham: Yes. Basically, I want to double the interest rate in terms of earnings return. However, in most years the interest rate was less than five percent on…..
Since the conversation is too long to read, listen to the audio. (Attached above and below)