Benjamin Graham spent time throughout the 1940s and 50s lecturing about things he knew nothing about. The speeches came in the disguise of a “Market Outlook.” People wanted to know what would happen next. Graham’s response was typical:
The subject assigned to me for this afternoon is one about which, precisely speaking, I know nothing.
Those were the first words out of his mouth at a lecture given in November of 1952. Then he gave them a history lesson of sorts.
He repeated that in similar fashion in other speeches too. In 1942, inflation worries were the topic du jour heading into WWII. In 1950, people wanted to know how the second half of the century would turn out. In each case, Graham offered some lessons instead.
What follows are a few of those lessons from those three speeches mentioned, mostly without comment.
On being prepared for multiple eventualities:
For even though inflation may not be probable I feel that the prudent investor will take the possibility of inflation into account and adjust his investment policy accordingly. For that view there are a number of reasons.
It seems to me that it is always desirable not to have to make a risky decision if you can follow a course that avoids substantial risk. It is not necessary for the investor to make a flat determination that there will be no inflation and hence that he can continue to hold a 100% bond portfolio. It would be more logical to follow a course which will provide some protection if inflation comes and at the same time need not involve loss should we escape inflation.
Graham’s inference is simple. If you build a portfolio solely to protect against one risk, you open yourself up to the risk of the opposite happening, which may be just as costly. You can substitute the latest worry in the market for inflation and Graham’s quote would still work.
On the most costly mistake for investors and advisors:
I do wish to express my unalterable opposition to that most costly of all financial self-deceptions — namely, calling oneself an investor and acting and thinking as a speculator. The menace of the inflation, while it underlines the logical justification of common stock investment, will tend to increase its psychological hazards. It will take intelligence and self-control on the part of both investors and their advisors to withstand these risks. If you assist your investor clients to remain common stock investors, if you discourage them from changing over into stock speculators, you will act not only in their best interest but your own — for this policy will pay you and them the best dividends over the long pull.
On the source of speculative influence in stocks and how to protect yourself from it:
Most people think of common stocks as speculative media. They are not, in my opinion. Good common stocks are investment media which are subject to speculative influences. The speculative influences are not in common stocks; they are in the minds of the people who buy and sell them. The problem of investment in common stocks is either to insulate yourselves from the speculative influences, or else to adjust your investment policy so that you can take advantage of the speculative fluctuations that are imposed upon the basic investment quality of common stocks.
On economics and the future:
When it comes to statements about the future in the economic realm, none of us actually have knowledge in the scientific sense of the term. What we have is opinions and surmises — let us hope, based upon adequate reflection and study.
Graham takes a few digs at the “unscientific nature of economics,” warning about how two people, with similar facts in hand, can come to completely opposing views on what happens next. In other words, be wary of those spouting opinions as facts.
On the durability of stocks:
…we are back to the old and once well-established thesis that stock prices do have a long-term upward bias, and that their future prospects should be regarded as good for the long pull. This view seems especially plausible to me, because when you study economic history over the last 38 years, you would have to acknowledge that the fabric of equities has been subject to a tremendous strain imposed upon the free-enterprise economy of our nation.
We have had two world wars. We have now what I call World War Two-and-a-Half. We have an unexampled collapse in the economy in 1929. We have had a world-wide tendency against free enterprise, and towards controls and collectivism. One might well say that if stock equities have survived these tests they appear to be a pretty rugged sort of animal and should be able to survive almost anything that the future will have to offer.
Graham wrote that in 1952 and the concept — there’s always something to worry about — has been repeated numerous times since by others. Sometimes the worries get priced in, dragging markets down but not out indefinitely. Businesses recover, economies grow, and markets rise “irregularly” over time:
I believe that the trend of stock equities will continue in the future as it has in the past — and that is irregularly upward, with some emphasis upon the adverb irregularly.
On the risk in lower profit margins:
The effect of the lower profit margin is adverse in two ways. Not only does it naturally reduce the average earnings, but also it makes companies as a whole more vulnerable to adverse developments in the general economy. A medium-sized recession might have as big an adverse effect on the earnings of a typical company as a large recession would have had formerly when the profit margins were greater.
On the effects of corporate taxes on values:
What the corporation tax actually works out as is a dilution of the stock equities. It is the equivalent of a payment of a stock dividend which goes to the government instead of to the stockholders…
What I am driving at is that the increase in corporate income tax is a factor that does not concern so much the operating position of the corporations. It does concern the overall value of the business to the stockholder in terms of the share capitalization, or of the price which he pays for the shares, which amounts to pretty much the same thing.
If you need a reason why prices rise (fall) in anticipation of a tax cut (hike), there you go.
On market pricing, not market timing:
I am an exponent of the philosophy that the main objective of common stock investment should be pricing, not timing; and by pricing I mean the endeavor to buy securities at prices which are attractive, letting timing take care of itself. It is obvious, of course, that when you buy securities at low prices — and if that happens to be a good time in relation to the future action of the market — your pricing and your timing coincide. There can be no objection to that combination. But from the viewpoint that I represent, the first and primary emphasis must be placed upon the endeavor to buy securities at the right prices. I believe that the decision to postpone buying at the right price, because of the thought that some future time may be more propitious will on the whole turn out to be an unsatisfactory policy for the real investor. He may thus buy his shares sooner in relation to the rise that will finally come. But unless he acquires the stock at a considerably lower price than he previously considered, he has made no true gain whatsoever. (Certainly he has lost interest on his money.)
On margin of safety:
The concept of buying securities at less than their indicated value includes what I have always regarded as the most dependable assurance of success in every form of investment — whether it be bonds or stocks — and that is the concept of margin of safety… When you have such a margin on a common stock purchase, then if things do not work out as well as you expected then you still have a cushion to absorb this disappointment. You can end up, if not with a profit, at least with no loss. But that can not be done when you are operating in the stock market either on the basis of anticipating what the market is going to do very soon, or on the basis of how the company is going to fare over the next few years. If you are wrong on either of these approaches then you are almost sure to lose money, because you have no margin of safety to fall back upon.
On the “grocery” strategy:
I had the pleasure last week of talking to a group of ladies only for the first time in my career. Trying to bring this subject home to them by some analogy with a feminine quality, I pointed out to them that there were two ways of buying stocks: either on the basis that they buy groceries, or on the basis that we men buy perfume for them. When you buy stocks on the grocery basis you try to get adequate quality at a reasonable price. When you buy on the perfume basis you try to buy the stock which is most popular and which gives the most prestige; you pay comparatively little attention to price; in some respects, the more the price you pay the better you seem to like it. I suggested to the ladies that if they would take the grocery approach to the selection of securities they would probably do a very substantially better job in investments than we men do, because they are more likely to see, appreciate and take advantage of a true bargain whenever they see one.