Nov 26, 2007

Jim Grant on Benjamin Graham's bullishness in 1932

It might have been for penance that [Benjamin] Graham, with the editorial assistance of David L. Dodd, began to write his magnum opus, "Security Analysis"—for penance and for money. Certainly, there was no money coming in from the money-management business. Graham's fund was down by 20% in 1929, by 50% in 1930 and by 16% in 1931. In 1932, the year the Dow bottomed at 41.22, he managed to achieve a kind of moral victory by losing a mere 2%. Still, there was but 30 cents remaining of each dollar entrusted to his stewardship at the peak only three years before.

Graham was in the throes of composition in the spring of 1932, though he was writing not for his book publisher, McGraw-Hill, but for Forbes Magazine. Under his byline, starting in the issue dated June 1, appeared a three-part series headed, "Is American Business Worth More Dead Than Alive?" To judge by the valuations then prevailing on the New York Stock Exchange, the answer was "yes." More than a third of all listed industrial companies changed hands at less than the companies' own net current assets. In other words, the business values of these companies—as distinct fromo their net cash and other liquid assets—was worth less than zero.

Graham treated this astonishing fact not only with wonder—who could have dreamt it?—but also with a well-reasoned measure of indignation. In the long-vanished boom, companies had raised billions of dollars from the public. Now they were liquid, while the public was struggling to pay the rent and put food on the table. The only rational way to explain the existence of so many cheap stocks, Graham proposed, was that the market, in its wisdom, was discounting operating losses for years to come. But if that were the case, he asked, "should not the stockholder demand liquidation before his money is thus dissipated?"

Well, the market wasn't wise, he judged. It was an ass. How could it be otherwise when the people who bought and sold—especially those who sold—refused even to look at balance sheets? "Much of the past year's selling of stocks has been due to fear rather than necessity," Graham wrote in Forbes. "If these timid holders were thoroughly aware that they were selling out for only a fraction of the liquid assets behind their share, many of them might have acted differently. But since valuation has come to be associated exclusively with earning power, the stockholder no longer pays any attention to what his company owns—not even its money in the bank."

If "earning power" was the boomtime cry, "losing power" was the motto of the bust. "Is it true," Graham posed, "that one out of three American businesses is destined to continue losing money until the stockholders have no equity remaining? That is what the stock market says in no uncertain terms."

And Graham answered his own question: "In all probability [the market] is wrong, as it has always been wrong in its major judgments of the future. The logic of Wall Street is proverbially weak. It is hardly consistent, for example, to despair of the railroads because the trucks are going to take most of their business, and at the same time to be so despondent over the truck industry as to give away shares in its largest units for a small fraction of their liquid capital alone."

~ Jim Grant, "My Hero, Benjamin Grossbaum," speech given in Manhattan before the Center for Jewish History, November 15, 2007

No comments: