In numerous respects, Benjamin Graham transformed the investment profession. For decades a superstitious trade practiced by mystics believing the strangest of strategies would bestow them with riches, managing money has become a mathematical profession perhaps excessively at odds with human irrationality. It was Graham, more than anyone else, who made investing and security analysis systematic. Though his own career ended in the middle of the last century, his approach has lived on in the curriculums of finance and valuation programs and the investment philosophies of many famous money managers. Benjamin Graham became famous for both his academic work and his investment record. This account tells of both and outlines his contribution to modern finance and his illustrious career.
Columbia
Born in London in 1894 as Benjamin Grossbaum, Graham grew up in New York after his father relocated to expand the family business, a kitchenware import firm, to America. In his childhood, he was met with financial hardship following his father’s death and the decay of the family business. His family was practically ruined by other bad business ventures and his mother’s attempt at investing on margin. They had gone from great comfort to living beneath the poverty line. However, his experience following the market in the newspapers as a boy turned into a scholarship and an education at Columbia University, where he studied mathematics.
Financial hardship in his youth and following the whims of the market fostered a conservative attitude to investing; a disposition revealed in his writings and in the investment firm he co-founded while in his early 30s. Following the Great Crash of 1929, Graham returned to Columbia. His firm had almost been destroyed by the stock market crash where its losses early on were much larger than the market’s as a whole. He reluctantly took the teaching job for financial security. However, it was there that some of his most lasting contributions to modern finance were conceived.
In 1934, Benjamin Graham published his first of two major works on investments, Security Analysis, with David Dodd another academic at Columbia. The book has influenced many, from small individual investors to legendary fund managers. Many have called it the “bible of value investing,” though this honorific is also often lavished on his later work, The Intelligent Investor. The book was built around Dodd’s notes on Graham’s lectures and had a focus on intrinsic value and margin of safety, ‘Grahamisms’ that have guided his and others’ investment success for decades.
“Security Analysis is extremely thorough and detailed, teeming with wisdom for the ages. Although many of the examples are obviously dated, their lessons are timeless. And while the prose may sometimes seem dry, readers can yet discover valuable ideas on nearly every page.” –Seth Klarman, Preface to the Sixth Edition of Security Analysis
In 1949, the second of Graham’s great works, The Intelligent Investor, was published. It also expounded on the same Grahamisms as Security Analysis but is judged to be more approachable. The work introduced the colorful character of Mr. Market, an erratic fellow who offers to buy and sell shares at seemingly random prices every day. The example of Mr. Market was meant to show that markets are meant to serve the investor and not to rule over him.
Graham-Newman
For thirty years, Graham practiced what he preached at the investment firm he formed with a former broker named Jerome “Jerry” Newman. Graham’s colleague at Columbia, David Dodd, was also made a director at the firm which was founded in 1926. It was a rough start; the Graham-Newman Corporation, as it was called, was almost ruined in the 1929 crash. The firm underperformed the market on the way down; the Dow Industrials sank 15% and 29% respectively in 1929 and 1930 but Graham-Newman was down 20% and 50.5% respectively. However, adopting a more conservative approach meant they performed better on a relative basis as the Great Depression got underway.
Part of the disastrous performance was due to the mistaken belief that the more ‘bond-like’ preferred shares would be safer, and perhaps even rise, in the event of a market downturn in common stock. This relation held in the smaller contractions of the 1920s but did not withstand the Great Crash. Nonetheless, the near failure of the firm brought Graham back to Columbia and the experience shaped his investing philosophy before either Security Analysis or The Intelligent Investor were written.
Graham-Newman left a strong mark on the career of Graham’s most famous disciple. Warren Buffett, who studied under Graham in the early 1950s, worked at Graham-Newman for a year before the firm closed on Graham’s retirement. Buffett was turned down the first few times he asked for a job there. Graham-Newman’s investments even included a sizable position in GEICO, now a Berkshire-Hathaway company, and Graham referred clients to Buffett when he closed his firm.
The fund, occasionally referred to as the first hedge fund, was unrestricted in its investments; everything from corporate and government bonds to preferred and common stock in all sorts of industries filled their portfolio. The composition would change sharply through time. For example, Graham-Newman’s investments in 1946 were about evenly split between stocks and bonds with railroad bonds and industrial stocks making up the largest components. By 1950, the firm had bet big on industrial shares, with investments in the common stock of industrial firms totaling more than $3.5 million; the firm had little more than $5.5 million invested at the time. The makeup would shift back towards bonds as the firm was wound down.
Graham-Newman was never a huge operation, total capitalization stood at around $5 million before its liquidation in the mid-1950s after peaking at around $7.5 million earlier in the decade. Small though it may have been, Graham and Newman profited handsomely from it. They each collected a salary of $25,000 from the firm in the mid-1950s; in that era, median family income was not even a fifth of that. They also had substantial personal investments in the firm, a 1951 proxy statement for the Graham-Newman Corporation shows that Benjamin Graham owned 92 shares with a total net asset value of over $110,000, over $1 million in today’s money.
However, most of their compensation was performance-linked. In the fiscal year ending January 1955, Graham and Newman each earned $145,000 in performance-compensation; though this was after several years of making no more than half that amount. However, the outsized pay that year was largely due to a substantial fee-increase rather than better performance.
While the fund was set up as a corporation rather than a partnership, its performance-based fee structure resemblances that of modern hedge funds. In 1950, the performance-linked compensation shared by the directors was 10% of net income over $4 per share per year subject to a cap of 12.5% of the excess of dividends paid over $4 a share. The cap meant the directors would not receive their fee unless the investors received distributions as well. The performance fee towards the end of the firm’s existence doubled to 20% of the net income in excess of $40 per share. The higher threshold was the product of a 10-1 reverse stock split, not due to fantastically more optimistic directors.
The fee structure allowed the directors to profit greatly from the firm’s outperformance, and outperform it did. In the ten years prior to 1946, the average annual return was 17.6%, easily outpacing the 10% average return of the Dow Industrials. Returns were also quite stable over the years. After considering the proceeds from Graham-Newman’s liquidation and all the distributions made to investors before its closing, the annual total return averaged 17% over the company’s existence. Despite the cataclysmic start, Graham’s investment record turned out to be very respectable.
Professionalizing the Investment Business
Benjamin Graham’s contribution to modern finance went beyond his illustrious firm and his influential books. Besides founding Graham-Newman, he was a pioneer in other organizations. Graham was one of the New York Society of Security Analysts’ twenty or so founding members. The organization, today a chapter of the CFA Institute, was notable for its quarterly publication, ‘Financial Analysts Journal,’ which Graham worked on and is still being published today.
His strong interest in the professionalization of finance marked the Journal’s first issue. In it, he wrote a piece called “Should Security Analysts Have a Professional Rating? The Affirmative Case” which essentially envisioned a professional certification for securities analysts. Graham also gave his input on the Securities Act of 1933, which required greater financial disclosures for publicly traded companies in the US. The Securities Act helped make his book Security Analysis a success as many investors needed guidance on working their way through financial statements. Being called the “father of value investing” may seem glorious enough, but for Graham, it almost seems belittling considering the breadth of his contributions to the wider investment industry.
Influence
One of Benjamin Graham’s most significant legacies is the influence his work had on future investors, particularly those with a value orientation. Some of them, like Berkshire-Hathaway CEO Warren Buffett and Baupost chief Seth Klarman have returned the favor by sharing their own thoughts in writing, in addition to writing forwards and prefaces to new print runs of Graham’s books. Buffett’s shareholder letters have become holy epistles to value investors, complementing well with Graham’s value investing gospels. Klarman’s letters to investors are equally well regarded but less well circulated. They are just two of the more notable of Graham’s devotees.
Lesson
Few men, perhaps none at all, have had as sizable an impact on the investment profession as Benjamin Graham. His body of work played a fantastically large role in changing the habits of Wall Street and investors everywhere. The Grahamisms that were introduced in his writing have become such common terms in the language of investing that the fact they originate from one man’s work often goes unrealized and unappreciated. If not quite the locomotive driving the investment industry forward in the 20th century, he was at very least the train operator keeping it safely on track, preserving and growing many fortunes going along for the ride. Few men are as worthy of a spot in the financial services hall of fame.
Further Reading
1. “Benjamin Graham Resource Page: Bio, Books, Lectures, Videos.” Valuewalk.com, Value Walk.
2. Carlen, Joe. The Einstein of Money: the Life and Timeless Financial Wisdom of Benjamin Graham. Prometheus Books, 2012.
3. Graham, Benjamin, and David L. Dodd. Security Analysis. McGraw-Hill, 2009.
4. Graham, Benjamin. The Intelligent Investor. Harper, 2006.
5. Lane, Randall. “Warren Buffett’s $50 Billion Decision.” Forbes, Forbes Magazine, 4 Feb. 2014.
6. Norris, Emily. “Benjamin Graham: The Intelligent Investor.” Investopedia, 22 May 2018.
