When the topic of investing comes up in conversation, I'm often asked to recommend an investment book. Since I'm biased toward the value investing philosophy, one of Benjamin Graham's books always comes to mind. But what if I were to tweak the question a bit and not recommend an investment book, but only a particular page of an investment book? What single page above all other pages from a book on investing would I recommend?
One page immediately leaps to mind, but first, allow me to set the stage for this page's publication. Before the author put pen to paper, the Dow Jones Industrial Average collapsed from peak to trough 89% over the recent past. Many on Wall Street lost their jobs, and those who speculated on margin were completely wiped out. Social mood in the country was deeply negative, and many people lost their homes in tax foreclosures. Families were forced to move around the country in a nomadic lifestyle desperate to find work where they could.
The time period is the years following the great stock market crash of 1929 and the start of the Great Depression. In 1934, shortly after this economic catastrophe, Benjamin Graham wrote the first edition of his textbook, Security Analysis. This bookwas put together from notes taken by David Dodd, a young instructor at Columbia University, who sat in on Benjamin Graham's class and recorded his class lectures. These notes became the basis for Security Analysis, which has sold more than a million copies in various editions over the years.
If I had to recommend a single page of an investment book, it would be the first page of Chapter 43 of the Graham and Dodd textbook, Security Analysis. The page lists three points describing the current-asset value selection criterion used to purchase common stocks. The bullet points on this one page read as follows:
- "The current-asset value is generally a rough index of the liquidating value.
- A large number of common stocks sell for less than their current-asset value, and therefore sell below the amount realizable in liquidation.
- The phenomenon of many stocks selling persistently below their liquidation value is fundamentally illogical."
Using data taken from a company's balance sheet, determining the current-asset value or liquidation value of a company is a simple mathematical calculation. The current assets (the most liquid assets on a company's balance sheet) are subtracted from all liabilities, including preferred stock. This calculation is then converted to a per-share figure. The investment strategy involves purchasing only shares of stock trading below the current-asset value per share calculation.
Is the stock selection criterion he wrote about in 1934 an old, washed-up strategy, or is it still useful to this day? Let's assume an investor followed a strategy of purchasing stocks trading below 75% of current-asset value at the end of every year. Assume further that no more than 10% was invested in any one stock. During sparse years where few stocks can be found meeting this value-investing criterion, the balance of cash sits idle in Treasury Bills. Benjamin Graham died I n the year 1976. The graph below shows the performance of stocks trading below current-asset value over three decades since Benjamin Graham's passing.
Since the original text of Security Analysis was written, not all future time periods resulted in a large number of stocks trading below liquidation value. I can't imagine how different the investment world looks today on a valuation basis relative to when Benjamin Graham wrote Security Analysis. In 1932, at the bottom of the worst bear market in U.S. history, more than 40% of all stocks on the New York Stock Exchange traded below their liquidation value.¹ Today, very few stocks trade below current-asset value. Despite time periods where funds sit idle in Treasury Bills because of a lack of candidates trading below current-asset value, the graph above shows Benjamin Graham's stock selection criterion outperforming the S&P500 over the last three decades.
Screening a universe of stocks for ones that trade below current-asset value is not difficult today when compared to the laborious number-crunching Benjamin Graham had to do in the 1930s. With the use of computer filtering, investors can screen stocks without the hassle of digging through corporate balance sheets for the few gems that meet the stringent value-investing criterion. This greater ease of workload does not seem to negate the superior results of buying stocks trading below current-asset value, even if the performance is handicapped by some years of not being fully invested.
Why aren't more investors following this value-investing strategy outlined on a tattered page from an old investment textbook? It could be the patience required of an investor that implements the strategy in real time. The chart above shows superior performance over a 30-year period if one followed the value-investing rule, but that is an incomplete picture. Unfortunately, a portfolio of stocks trading below liquidation value lags an index fund approximately 60% of the years over the long study period. How many investors can endure temporary poor performance if a streak of bad years rolls in? Is that a good career move for a fund manager to lag behind his peers for multiple years in a row? Many financial advisors claim to embrace a value-investing philosophy, but few are willing to endure a long stretch of dismal performance before capitulating and window dressing their portfolio with the latest growth stocks that everyone is talking about. Provided an investor can endure the performance isolation for years in a row that will seem like eternity as you pass through it in real time, choosing the road less traveled by following page 495 of Graham's original Security Analysis text is the way to go.
The website, Abebooks.com, has a listing of rare books that can be purchased from booksellers around the country. A first edition of Security Analysis by Benjamin Graham goes for the bargain basement price of $22,000.00. The book is 725 pages long, so the one page I'm recommending averages out to a retail price of around $30.00. What a bargain in order to achieve superior investment results over the long term.
¹Benjamin Graham and David L. Dodd, Security Analysis, 1st ed. (New York: McGraw-Hill, 1934), 498.
