Endnotes

 

Introduction: What This Book Expects to Accomplish

1. “Letter stock” is stock not registered for sale with the Securities and Exchange Commission (SEC), and for which the buyer supplies a letter stating the purchase was for investment.

2. The foregoing are Moody’s figures for AAA bonds and industrial stocks.

Chapter 1. Investment versus Speculation:
Results to Be Expected by the Intelligent Investor

1. Benjamin Graham, David L. Dodd, Sidney Cottle, and Charles Tatham, McGraw-Hill, 4th. ed., 1962. A fascimile copy of the 1934 edition of Security Analysis was reissued in 1996 (McGraw-Hill).

2. This is quoted from by Lawrence Chamberlain, published in 1931.

3. In a survey made by the Federal Reserve Board.

4. 1965 edition, p. 8.

5. We assume here a top tax bracket for the typical investor of 40% applicable to dividends and 20% applicable to capital gains.

Chapter 2. The Investor and Inflation

1. This was written before President Nixon’s price-and-wage “freeze” in August 1971, followed by his “Phase 2” system of controls. These important developments would appear to confirm the views expressed above.

2. The rate earned on the Standard & Poor’s index of 425 industrial stocks was about 11½% on asset value—due in part to the inclusion of the large and highly profitable IBM, which is not one of the DJIA 30 issues.

3. A chart issued by American Telephone & Telegraph in 1971 indicates that the rates charged for residential telephone services were somewhat less in 1970 than in 1960.

4. Reported in the Wall Street Journal, October, 1970.

Chapter 3. A Century of Stock-Market History:
The Level of Stock Prices in Early 1972

1. Both Standard & Poor’s and Dow Jones have separate averages for public utilities and transportation (chiefly railroad) companies. Since 1965 the New York Stock Exchange has computed an index representing the movement of all its listed common shares.

2. Made by the Center for Research in Security Prices of the University of Chicago, under a grant from the Charles E. Merrill Foundation.

3. This was first written in early 1971 with the DJIA at 940. The contrary view held generally on Wall Street was exemplified in a detailed study which reached a median valuation of 1520 for the DJIA in 1975. This would correspond to a discounted value of, say, 1200 in mid-1971. In March 1972 the DJIA was again at 940 after an intervening decline to 798. Again, Graham was right. The “detailed study” he mentions was too optimistic by an entire decade: The Dow Jones Industrial Average did not close above 1520 until December 13, 1985!

Chapter 4. General Portfolio Policy: The Defensive Investor

1. A higher tax-free yield, with sufficient safety, can be obtained from certain a relative newcomer among financial inventions. They would be of interest particularly to the enterprising investor.

Chapter 5. The Defensive Investor and Common Stocks

1. Wilfred Funk, Inc., 1953.

2. In current mathematical approaches to investment decisions, it has become standard practice to define “risk” in terms of average price variations or “volatility.” See, for example, by Richard A. Brealey, The M.I.T. Press, 1969. We find this use of the word “risk” more harmful than useful for sound investment decisions—because it places too much emphasis on market fluctuations.

3. All 30 companies in the DJIA met this standard in 1971.

Chapter 6. Portfolio Policy for the Enterprising Investor: Negative Approach

1. In 1970 the Milwaukee road reported a large deficit. It suspended interest payments on its income bonds, and the price of the 5% issue fell to 10.

2. For example: Cities Service $6 first preferred, not paying dividends, sold at as low as 15 in 1937 and at 27 in 1943, when the accumulations had reached $60 per share. In 1947 it was retired by exchange for $196.50 of 3% debentures for each share, and it sold as high as 186.

3. An elaborate statistical study carried on under the direction of the National Bureau of Economic Research indicates that such has actually been the case. Graham is referring to W. Braddock Hickman, Corporate Bond Quality and Investor Experience (Princeton University Press, 1958). Hickman’s book later inspired Michael Milken of Drexel Burnham Lambert to offer massive high-yield financing to companies with less than sterling credit ratings, helping to ignite the leveragedbuyout and hostile takeover craze of the late 1980s.

4. A representative sample of 41 such issues taken from Standard & Poor’s shows that five lost 90% or more of their high price, 30 lost more than half, and the entire group about two-thirds. The many not listed in the undoubtedly had a larger shrinkage on the whole.

Chapter 7. Portfolio Policy for the Enterprising Investor:
The Positive Side

1. See, for example, Lucile Tomlinson, and Sidney Cottle and W. T. Whitman, both published in 1953.

2. A company with an ordinary record cannot, without confusing the term, be called a growth company or a “growth stock” merely because its proponent expects it to do better than the average in the future. It is just a “promising company.” Graham is making a subtle but important point: If the definition of a growth stock is a company that will thrive in the future, then that’s not a definition at all, but wishful thinking. It’s like calling a sports team “the champions” before the season is over. This wishful thinking persists today; among mutual funds, “growth” portfolios describe their holdings as companies with “above-average growth potential” or “favorable prospects for earnings growth.” A better definition might be companies whose net earnings per share have increased by an annual average of at least 15% for at least five years running. (Meeting this definition in the past does not ensure that a company will meet it in the future.)

3. See Table 7-1.

4. Here are two age-old Wall Street proverbs that counsel such sales: “No tree grows to Heaven” and “A bull may make money, a bear may make money, but a hog never makes money.”

5. Two studies are available. The first, made by H. G. Schneider, one of our students, covers the years 1917–1950 and was published in June 1951 in the The second was made by Drexel Firestone, members of the New York Stock Exchange, and covers the years 1933–1969. The data are given here by their kind permission.

6. See pp. 393–395, for three examples of special situations existing in 1971.

Chapter 8. The Investor and Market Fluctuations

1. Except, perhaps, in dollar-cost averaging plans begun at a reasonable price level.

2. But according to Robert M. Ross, authority on the Dow theory, the last two buy signals, shown in December 1966 and December 1970, were well below the preceding selling points.

3. The top three ratings for bonds and preferred stocks are Aaa, Aa, and A, used by Moody’s, and AAA, AA, A by Standard & Poor’s. There are others, going down to D.

4. This idea has already had some adoptions in Europe—e.g., by the state-owned Italian electric-energy concern on its “guaranteed floating rate loan notes,” due 1980. In June 1971 it advertised in New York that the annual rate of interest paid thereon for the next six months would be 8 1/8%.

       One such flexible arrangement was incorporated in The Toronto-Dominion Bank’s “7%–8% debentures,” due 1991, offered in June 1971. The bonds pay 7% to July 1976 and 8% thereafter, but the holder has the option to receive his principal in July 1976.

Chapter 9. Investing in Investment Funds

1. The sales charge is universally stated as a percentage of the selling price, which includes the charge, making it appear lower than if applied to net asset value. We consider this a sales gimmick unworthy of this respectable industry.

2. The Money Managers, by G. E. Kaplan and C. Welles, Random House, 1969.

3. See definition of “letter stock” on p. 579.

4. Title of a book first published in 1852. The volume described the “South Sea Bubble,” the tulip mania, and other speculative binges of the past. It was reprinted by Bernard M. Baruch, perhaps the only continuously successful speculator of recent times, in 1932. That was locking the stable door after the horse was stolen. Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds (Metro Books, New York, 2002) was first published in 1841. Neither a light read nor always strictly accurate, it is an extensive look at how large numbers of people often believe very silly things—for instance, that iron can be transmuted into gold, that demons most often show up on Friday evenings, and that it is possible to get rich quick in the stock market. For a more factual account, consult Edward Chancellor’s Devil Take the Hindmost (Farrar, Straus & Giroux, New York, 1999); for a lighter take, try Robert Menschel’s Markets, Mobs, and Mayhem: A Modern Look at the Madness of Crowds (John Wiley & Sons, New York, 2002).

Chapter 10. The Investor and His Advisers

1. The examinations are given by the Institute of Chartered Financial Analysts, which is an arm of the Financial Analysts Federation. The latter now embraces constituent societies with over 50,000 members.

2. The NYSE had imposed some drastic rules of valuation (known as “haircuts”) designed to minimize this danger, but apparently they did not help sufficiently.

3. New offerings may now be sold only by means of a prospectus prepared under the rules of the Securities and Exchange Commission. This document must disclose all the pertinent facts about the issue and issuer, and it is fully adequate to inform the as to the exact nature of the security offered him. But the very copiousness of the data required usually makes the prospectus of prohibitive length. It is generally agreed that only a small percentage of buying new issues read the prospectus with thoroughness. Thus they are still acting mainly not on their own judgment but on that of the house selling them the security or on the recommendation of the individual salesman or account executive.

Chapter 11. Security Analysis for the Lay Investor:
General Approach

1. Our textbook, by Benjamin Graham, David L. Dodd, Sidney Cottle, and Charles Tatham (McGraw-Hill, 4th ed., 1962), retains the title originally chosen in 1934, but it covers much of the scope of financial analysis.

2. With Charles McGolrick, Harper & Row, 1964, reissued by HarperBusiness, 1998.

3. These figures are from Salomon Bros., a large New York bond house.

4. At least not by the great body of security analysts and investors. Exceptional analysts, who can tell in advance what companies are likely to deserve intensive study and have the facilities and capability to make it, may have continued success with this work. For details of such an approach see Philip Fisher, Harper & Row, 1960.

5. On p. 295 we set forth a formula relating multipliers to the rate of expected growth.

6. Part of the fireworks in the price of Chrysler was undoubtedly inspired by two two-for-one stock splits taking place in the single year 1963—an unprecedented phenomenon for a major company. In the early 1980s, under Lee Iacocca, Chrysler did a three-peat, coming back from the brink of bankruptcy to become one of the best-performing stocks in America. However, identifying managers who can lead great corporate comebacks is not as easy as it seems. When Al Dunlap took over Sunbeam Corp. in 1996 after restructuring Scott Paper Co. (and driving its stock price up 225% in 18 months), Wall Street hailed him as little short of the Second Coming. Dunlap turned out to be a sham who used improper accounting and false financial statements to mislead Sunbeam’s investors—including the revered money managers Michael Price and Michael Steinhardt, who had hired him. For a keen dissection of Dunlap’s career, see John A. Byrne, Chainsaw (HarperCollins, New York, 1999).

7. Note that we do not suggest that this formula gives the “true value” of a growth stock, but only that it approximates the results of the more elaborate calculations in vogue.

Chapter 12. Things to Consider About Per-Share Earnings

1. Our recommended method of dealing with the warrant dilution is discussed below. We prefer to consider the market value of the warrants as an addition to the current market price of the common stock as a whole.

Chapter 13. A Comparison of Four Listed Companies

1. In March 1972, Emery sold at 64 times its 1971 earnings!

Chapter 14. Stock Selection for the Defensive Investor

1. Because of numerous stock splits, etc., through the years, the actual average price of the DJIA list was about $53 per share in early 1972.

2. In 1960 only two of the 29 industrial companies failed to show current assets equal to twice current liabilities, and only two failed to have net current assets exceeding their debt. By December 1970 the number in each category had grown from two to twelve.

3. But note that their combined market action from December 1970 to early 1972 was poorer than that of the DJIA. This demonstrates once again that no system or formula will guarantee superior market results. Our requirements “guarantee” only that the portfolio-buyer is getting his money’s worth.

4. As a consequence we must exclude the majority of gas pipeline stocks, since these enterprises are heavily bonded. The justification for this setup is the underlying structure of purchase contracts which “guarantee” bond payments; but the considerations here may be too complicated for the needs of a defensive investor.

Chapter 15. Stock Selection for the Enterprising Investor

1. Mutual Funds and Other Institutional Investors: A New Perspective, I. Friend, M. Blume, and J. Crockett, McGraw-Hill, 1970. We should add that the 1966–1970 results of many of the funds we studied were somewhat better than those of the Standard & Poor’s 500-stock composite and considerably better than those of the DJIA.

2. Personal note: Many years before the stock-market pyrotechnics in that particular company the author was its “financial vice-president” at the princely salary of $3,000 per annum. It was then really in the fireworks business. In early 1929, Graham became a financial vice president of Unexcelled Manufacturing Co., the nation’s largest producer of fireworks. Unexcelled later became a diversified chemical company and no longer exists in independent form.

3. The Guide does not show multipliers above 99. Most such would be mathematical oddities, caused by earnings just above the zero point.

Chapter 16. Convertible Issues and Warrants

1. This point is well illustrated by an offering of two issues of Ford Motor Finance Co. made simultaneously in November 1971. One was a 20-year nonconvertible bond, yielding 7½%. The other was a 25-year bond, subordinated to the first in order of claim and yielding only 4½%; but it was made convertible into Ford Motor stock, against its then price of 68½. To obtain the conversion privilege the buyer gave up 40% of income and accepted a junior-creditor position.

2. Note that in late 1971 Studebaker-Worthington common sold as low as 38 while the $5 preferred sold at or about 77. The spread had thus grown from 2 to 20 points during the year, illustrating once more the desirability of such switches and also the tendency of the stock market to neglect arithmetic. (Incidentally the small premium of the preferred over the common in December 1970 had already been made up by its higher dividend.)

Chapter 17. Four Extremely Instructive Case Histories

1. See, for example, the article “Six Flags at Half Mast,” by Dr. A. J. Briloff, in January 11, 1971.

Chapter 18. A Comparison of Eight Pairs of Companies

1. The reader will recall from p. 434 above that AAA Enterprises tried to enter this business, but quickly failed. Here Graham is making a profound and paradoxical observation: The more money a company makes, the more likely it is to face new competition, since its high returns signal so clearly that easy money is to be had. The new competition, in turn, will lead to lower prices and smaller profits. This crucial point was overlooked by overenthusiastic Internet stock buyers, who believed that early winners would sustain their advantage indefinitely.

Chapter 19. Shareholders and Managements: Dividend Policy

1. Analytical studies have shown that in the typical case a dollar paid out in dividends had as much as four times the positive effect on market price as had a dollar of undistributed earnings. This point was well illustrated by the public-utility group for a number of years before 1950. The low-payout issues sold at low multipliers of earnings, and proved to be especially attractive buys because their dividends were later advanced. Since 1950 payout rates have been much more uniform for the industry.

Chapter 20. “Margin of Safety” as the Central Concept of Investment

1. This argument is supported by Paul Hallingby, Jr., “Speculative Opportunities in Stock-Purchase Warrants,” third quarter 1947.

Postscript

1. Veracity requires the admission that the deal almost fell through because the partners wanted assurance that the purchase price would be 100% covered by asset value. A future $300 million or more in market gain turned on, say, $50,000 of accounting items. By dumb luck they got what they insisted on.

Appendixes

1. Address of Benjamin Graham before the annual Convention of the National Federation of Financial Analysts Societies, May 1958.

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