My Review of Jeremy Grantham's "The Making of a Permabear:........."

Regression to the Mean?

 

I met Jeremy Grantham of GMO fame on several occasions many years ago and I had a working relationship with Dick Mayo, the M in GMO. Thus, it was a pleasure to read Jeremy’s autobiography written with the help of Edward Chancellor. Grantham is a value investor’s value investor and as such numerous times in his career he was out of step with a raging bull market, hence the title “Permabear." In the interest of full disclosure, I would characterize myself as a value investor.

 

Grantham was born in Yorkshire, England in 1938, just at the onset of the war that would kill his father. His background was middle class and he attended Sheffield University, a far cry from the Oxbridge of the elite. However, the future Nobel Laureate John Hicks read one of his papers. Nevertheless, by the dint of his efforts and natural intelligence he ended up at Harvard Business School and ultimately into investment management.

 

He broke off from Keystone, a prominent mutual fund manager in the early 1970’s to form Batterymarch Financial where he was a pioneer in the nascent index fund industry. He left them to form his own firm, and Dick Mayo soon joined him. The mid-1970’s was a heyday for value managers as the once exalted nifty fifty cratered and practically everything else moved higher. Simply put, value was having the sale of the century.

 

Like most value managers, Grantham believes that stock valuations and profit margins are mean reverting. Simply put, when the market’s price/earnings ratio gets down to around 7 or 8, the market as a whole is a buy and when the ratio is well into the 20’s on normalized earnings, the market is a sell. Grantham backed up his investment analysis with serious quantitative research that covered international markets as well.

 

The dot.com boom of the late 1990’s tested Grantham like no other. Valuations went to the sky from 1998 to early 2000 leaving GMO’s performance in the dust. Nearly half of its assets when out the door. Here Grantham is very astute in talking about business risk and career risk. Being bearish in a bull market brings with it enormous risks to investment managers and their principals. Trust me, as a sell-side equity strategist at Salomon Brothers I felt the brunt of career risk. Nevertheless, Grantham stuck to his guns and was buying REIT stocks that were yielding up to 9% at the time. I had the same instinct at the time and built a personal portfolio holding a basket of REITs. I later became the REIT analyst at Lehman Brothers. In early 2000 the dot.com boom crashed and burned, but unlike in the mid-1970’s the overall stocks market did not get really cheap.

 

In the early 2000’s GMO recovered dramatically, but by mid-decade Grantham blew the whistle on the unsustainable housing boom. Yet again he was early, but dead right. Although stocks suffered from a vicious bear market in 2008-2009, the averages only stayed cheap for a few short months by Grantham’s reckoning.

 

As I write this Grantham is again calling out what he perceives to be the outlandish valuation of the U.S. stock market. Profit margins are at an all-time high and the cyclically adjusted price/earnings ratio is just a touch away from its 2000 peak. What’s going on? Perhaps, the economy has changed so much that it is now dominated by a few highly profitable tech monopolies that are skewing aggregate profit margins. Furthermore, the emphasis has shifted from tangible capital to intangible capital. That was true until last year when the tech behemoths started to massively spend on data centers to support artificial intelligence. The big question is whether or not those investments will be sufficiently profitable to support today’s valuations.

Grantham, through his foundation, is a very active environmentalist. He almost went to jail in opposition to the Keystone XL pipeline. He rightly worries about climate change and chemical pollution. In his private life he attacks the major oil companies, but my guess is that as a value manager he holds the stock in those very same companies. In his environmental hat he applauds the decline in population growth, but as a money manager, he realizes that might have negative consequences for future profit growth.

 

To sum up, Jeremy Grantham is quite the character. and it comes through in his book. For those readers interested in the stock market, its contrarian take is well worth the read and if you are of value bent, like me, it will gird you for the market that lies ahead.

  

My Review of Brett Gardner's "Buffett's Early Investments"

 A Nerdy Look at Buffett’s Early Investments

Investment analyst Brett Gardner did yeoman’s work in piecing together Warren Buffett’s investment process in the early days of his career, first as an individual investor and later through his partnerships.  He went through contemporaneous annual reports, Moody’s manuals, and news stories from the early 1950’s to the mid-1960’s to understand what information Buffett had available to him at the time he made his investments. 

He also availed himself of previously published biographies of Buffett which brought out the legwork Buffett undertook by going beyond the numbers in talking to the managements, employees, and customers of the firms.  Further, he investigated the history, and the managements of the companies Buffett invested in. His is the work of a truly obsessive finance nerd and the reader is the beneficiary of his work.

Gardner investigated 10 investments a few of which I never heard of, such as Marshall-Wells and Cleveland Worsted Mills and several that I am familiar with including Studebaker, American Express and Disney. We should note that Buffett was and is a generalist. There is no industry theme associated with his investments.

Buffett, being a student of the great Benjamin Graham (See: https://shulmaven.blogspot.com/2023/08/my-review-of-seth-klarmans-ed-of-graham.html) who stressed corporate balance sheets as the central focus of investment analysis. Graham was looking for a margin of safety in buying companies that were trading below the value of their working capital, thereby buying the fixed assets for free. This, of course, was not the only factor, but it was significant.

Buffett’s early investments were balance sheet focused. However, he later focused on the importance of controlling the firm’s capital allocation process and the value intangible assets that did not appear on the balance sheet. In the case of American Express it was its brand name which did not take a hit after the company was victimized by the salad oil scandal of the mid-1960’s. In the case of Disney, it was its film library that was carried on the books at close to zero. Thus, instead of buying average companies at cheap prices, Buffett moved on to buying wonderful companies at a fair price. The other thing that Buffett did was to concentrate his investments. He went all in with some investments accounting for a third of his portfolio.

Now the question remains what an investor can do today. The average investor is not plagued by the curse of bigness. It is very difficult for an individual investment to move the needle in a large fund. Buffett himself has admitted that for years. Next the small investor can find unloved and uncovered stocks not on the radar screen of large institutional investors. Of course, this takes a lot digging and a lot of leg work but can be done. However, the one major disadvantage an investor faces today that Buffet didn’t face in the 1950’s is that the overall stock market is trading at levels where there are few companies that offer the margin of safety that Buffett had when he was starting out.

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)

My Amazon Review of Benjamin Graham's and Jason Zweig's (Ed) "The Intelligent Investor (Rev. Ed.)"

 Margin of Safety

 I just finished rereading “The Intelligent Investor,” a book a I read many years ago and much of its investment insights are still very valid for today. I would note that I was weaned on Benjamin Graham’s “Security Analysis, Principles and Techniques” as an undergraduate at Baruch College. I guess you can say that Graham’s ideas are in my blood. Indeed, just as Graham probed the Standard and Poor’s stock guide, so too did I for many years. Today we have computerized databases.

 The most critical ideas that are useful today include:

·       * A stock certificate is more than a piece of paper; it represents an

      ownership interest in a business.

·      *  Investments should only be undertaken with a quantifiable margin of safety.

·     *   “Mr. Market” who on occasion is manic-depressive allows you to express a view on a stock or a bond every day.

·     *   Despite all of your efforts at security analysis the stock market is loosely efficient making it very difficult to outperform a broad index. Investment success flows from a few very special situations.

·      *  Investors can be characterized as defensive or enterprising, but even for the enterprising investor Graham’s rules are designed to minimize losses through diversification and heeding to margin of safety requirements.

 

As the classic value investor, much of Graham’s work is focused on tangible book value. That metric worked well though the middle of the 20^th Century, but that kept Graham and his acolytes away from growth companies who were powered by intangible capital. Thus, it was hard for Graham to get comfortable with owning many of the growth stocks of his era, but his discipline kept him away from the craziness of the bubbles that occurred in 1961 and in the late 1960’s.  Jason Zweig, the editor of this version discusses at the length the extremes of the late 1990’s dot.com bubble.

 

Graham was fond of public utility shares in the early 1970’s because they traded a low price/earnings and price/book ratios. Unfortunately, he did not foresee the debacle that cost over-runs in nuclear power brought on to this sector. Zweig points this out. Also, Graham really didn’t associate the rise in interest rates in the late 1960’s with the rise in inflation. He characterized common stocks as inflation hedges, which in the long run they are, but that is not necessarily true in the short run as rising inflation propels interest rates higher and price/earnings ratios lower.

 

Then there is a short discussion on Graham’s investment in Government Employees Insurance Co. (GEICO). There his partnership broke his diversification rule by investing 25% of its capital in it for 50% of the company. However, its valuation in terms of earnings and tangible equity was very low. It was his best investment and Warren Buffett, his best-known student, followed him into GEICO and as a result Berkshire Hathaway now owns the entire company.

 

Although the book’s examples are dated, the investing rules outlined here are timeless.

For the full Amazon URL see: Margin of Safety (amazon.com)

My Amazon Review of Justyn Walsh's "Investing with Keynes....."

 

Warren Buffett on the Thames

 

Investment banker and now money manager Justyn Walsh has offered up an overview of the investing style John Maynard Keynes where aside from running his own personal portfolio he invested the endowment of Kings College along with several insurance companies. His record as an investor in the troubled 1930’s was phenomenal.

 

Walsh recounts the influence of Edgar Lawrence Smith’s 1924 classic “Common Stocks as Long Term Investments” which became the great intellectual foundation of the 1920’s bull market. In that book Smith recognized that industrial companies by retaining earnings became compound interest machines. During the 1920’s Walsh characterizes Keynes as a momentum investor and in 1929 he paid the price with severe losses.

 

In the early 1930’s similar to Benjamin Graham he became a value investor seeking out individual securities that he believed sold at a discount to their underlying intrinsic value independent of behavior of the overall stock market. This approach is very similar to that of Warren Buffett. Keynes, also similar to Buffett, believed in running a concentrated portfolio where his best ideas would have a real impact. As with Buffett he believed that less than knowledgeable investors should own a broadly diversified portfolio.

 

My main problem with this readable, but somewhat repetitive book, is that there is no data on the year-to-year performance of the portfolios he was managing and there is no inkling of what securities he actually owned. Further he mentions that Keynes had a less than stellar sell discipline but offers no real proof.  Simply put, Walsh over-promises.

For the full amazon URL see: Warren Buffett on the Thames (amazon.com)