Sound investment policy will by its terms yield satisfactory performance over many years and through various market conditions. One of the first books to outline such a policy was Graham & Dodd’s Security Analysis. Some of its key points: (1) fixed income obligations must be viewed “from the standpoint of calamity,” i.e. normalized EBIT should cover interest payments by at least seven times; (2) preferred shares lack both the safety of bonds and the appreciation potential of common shares and should thus be purchased only at large discounts from par, when they are “friendless;” (3) net working capital approximates the minimum liquidating value of a business; thus common stocks selling below net working capital and showing a satisfactory record of earnings are likely to be attractive bargain purchases; (4) common stocks should be valued from the standpoint of a private owner, since companies selling below this value are likely to be purchased by a private owner; (5) hedging and arbitrage commitments fall within the scope of intelligent investment; and (6) the investor should allocate less of his portfolio to common stocks when the market is high, based on various technical standards. These rules have withstood major financial developments over nearly 75 years—due at bottom to Graham’s emphasis on quantity, measurement and utility.

The success of security analysis has led inevitably to its widespread use. Coupled with a tremendous improvement in disclosure (both substance-wise and delivery-wise), this has caused obvious statistical bargains to disappear. Now the soundness of investment depends far more upon expectations of the future, which have always been exceedingly difficult to deal with; from many years’ experience it is known that the predictions of analysts, money managers, OPMIs, etc., tend to be less reliable than the simple tossing of a coin. Benjamin Graham acknowledged the limitations of his approach in 1976:

“I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook ‘Graham and Dodd’ was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent I’m on the side of the ‘efficient market’ school of thought now generally accepted by the professors.”

Again, I must emphasize that Security Analysis (ed. 1-4) has no substantive errors; rather it suffers from the problem inherent to all moneymaking techniques: as acceptance increases, usefulness tends to diminish. It follows logically that some unpopular principles of Security Analysis may still be useful. I have expounded on several of these in previous essays:

Corporate Earning Power & Market Valuation
Discounted Cash Flow Method Defective
Net Working Capital Strategy: Historical Perspective
Statistical Bargains: Historical Perspective
Relative Value Arbitrage
Magic Formula Investing is Unsound (Though It May Have Been Sound Before It Was Discovered)
Unearned Premium Reserve & Associated Valuation Errors

Finally, a word about empiricism. The common person in the aim of maximizing his lifespan will probably seek advice from health experts, nutritionists, doctors, etc. This may be the popular approach, but it is not as rational as studying centenarians. More than anyone else, Ben Graham is the investment profession’s equivalent of a centenarian—he is vindicated by some astounding numbers. From 1936 to 1956 Graham-Newman Corporation averaged +17.6% per annum, and some of Graham’s early arbitrages at N.H.&L. earned more than 50% per annum. Readers of Security Analysis should cogitate over why the techniques worked and why they may fail going forward.

“I want to remind all of you that we are the flowers and Ben is the bee.”
-Warren Buffett