I wrote a response to Jason Zweig’s column on Ben Graham and bank stocks. Now, Tom Brown of Bankstocks.com has done the same. I have to admit, Tom’s article is better than mine. Both take Zweig to task for his explanation of why Ben Graham wouldn’t be a buyer of bank stocks today. However, Tom’s post does a better job of presenting the opportunities and challenges in analyzing bank stocks today:
Zweig’s premise seems to be that no one inside or outside a financial services company can ever reasonably value the institution’s assets–particularly if the assets are secured by real estate at a time when real estate values are declining on average. The stock’s valuation? Irrelevant. Investor sentiment? Beside the point. Rather, Zweig sees the companies as no more than black boxes. By his logic, Graham-style investors (as opposed to speculators) would never own these companies. But we know as a matter of fact that that is not true.
Graham saw every investment as a black box – and that didn’t trouble him. A lot of investors spend a lot of their time worrying about the inner workings of the companies they own – Graham never did. He didn’t look inside the “system”, i.e. the company itself; instead he looked only at the outputs – the financial statements. He spent almost no time worrying about a business’s management, corporate culture, or future prospects. He didn’t worry about competitive advantages. He looked to the balance sheet first. When he moved on from there to consider earnings, his usual approach was to rely heavily on the past record in an attempt to discover what “normal” earnings might look like.
Graham was a rear view mirror guy. His margin of safety was based on making purchases at prices that would’ve worked well in the past. He liked sure things. For instance, he knew that NCAV stocks were sure things – and subsequent research continues to support that claim. I mentioned NCAV stocks in my previous post, because they are perhaps Graham’s most characteristic investment category. They combine elementary arithmetic and logic in a potentially lucrative but almost certainly safe investment operation. Also, unlike much of what he wrote about in The Intelligent Investor and Security Analysis, Graham actually made NCAV investments during his Wall Street career.
Before we can answer what Graham would do today, we need to know what he did do in his own lifetime. When writing about Graham, one needs to consider three separate categories: what Graham practiced, what Graham preached, and what Graham’s principles were.
What Graham Practiced
In the Intelligent Investor, Graham lists the five successful techniques his partnership employed from 1926 – 1956: arbitrage, liquidations, related hedges, net-current asset issues, and control investments.
Graham does not discuss control investments in any of his books; however, GEICO is a well-known example of a Grahamian control investment.
Buffett has discussed this techniques in some detail. See especially Buffett’s discussion of Berkshire’s purchase of Arcata …