My Review* of Seth Klarman's Ed. of "Graham and Dodd's Security Analysis 7th Ed."

Learning from the Masters

 

Star value investor Seth Klarman has edited an updated version of Graham & Dodd’s investing classic with help from such luminaries as James Grant, Howard Marks, and Todd Combs. Klarman uses the 1940 edition as the basis for his and the other editorial commentaries on the text’s very detailed discussion on security analysis. For most readers the original Graham & Dodd discussion will seem like ancient history to today’s investing world, but for a history buff like me, I found much of the discussion fascinating. (Also see my prior review of Graham Shulmaven: My Amazon Review of Benjamin Graham's and Jason Zweig's (Ed) "The Intelligent Investor (Rev. Ed.)" )

 

The core lesson of Graham & Dodd is that when one invests in a common stock, he or she owns a proportionate share in a business and the value of that business is dependent upon its net assets (shareholders’ equity) and its underlying earning power. The idea is to be able to buy a stock sufficiently below its value to create what Graham & Dodd call a margin of safety. Also timeless is Graham & Dodd’s holding suspect the use of appraised values in real estate debt securities that were so prominent in the 1920’s and again today.

 

For Graham & Dodd earnings power is measured by the average of earnings over the last five or ten years. The future does not really enter into the discussion except if there is a strong upward trend which might allow an investor to pay modestly higher earnings multiple. The authors were especially critical of the 1928-29 new-era philosophy of valuing equities solely on the basis of future prospects largely because the future is unpredictable. Thus, they are critical of John Burr Williams’ 1938 view that the value of a stock equals the present value of future dividends, because, again, the future is unknowable. Nevertheless, in today’s world investing is all about capitalizing future earnings.

 

You have to remember that Graham & Dodd were writing against the backdrop of the Great Depression of the 1930’s. The new-era philosophy of 1928-29 crashed and burned and what investors had to deal with was the here and now of net asset values and historical earning power. However, they did note the price-earnings ratios in 1936-38 were much higher than they were in 1923-25, which they attributed to much lower interest rates. They also wisely noted that the low interest rates of the 1930’s were sending a negative message about the future growth in the economy. In retrospect the high multiples could be attributed to the fact that corporations were under-earning due to the depression.

 

They also seemed to be puzzled about the return to growth stock investing in the late 1930’s. They listed seventeen stocks that were characterized as growth issues at that time. Several of the names would puzzle today’s investor, but I would point out that there were five chemical stocks on the list. The advances in chemistry and chemical engineering in the 1930’s made them the technology stocks of that day.

 

I enjoyed the essays introducing the chapters of the book. However, my criticism of the essays is that they do not include detailed examples of how a Graham & Dodd investor, like me, would utilize the wisdom presented in the book today. For that I would recommend Bruce Greenwald’s “Value Investing: From Graham to Buffett and Beyond 2^nd Ed.” (See: Shulmaven: My Amazon Review of Bruce Greenwald's et.al. "Value Investing: From Graham to Buffett and Beyond" 2nd. Ed.)

*-Amazon has yet again failed to post this review. Amazon just posted my review on 8/17, see Learning from the Masters (amazon.com)