Book Review Corner - Security Analysis by Benjamin Graham and David Dodd
Benjamin Graham and David Dodd
1934 McGraw Hill
It is instructive to go back and read financial books written at a time of economic trouble and hardship. Benjamin Graham was a stock and bond investor who suffered losses as a result of the Great Depression. I think it safe to say that he was a thoughtful man, who obviously wanted to learn from his financial errors.
The result was the publishing of Security Analysis. He was an Investment Fund Manager and a lecturer in finance at Columbia University in New York City. David Dodd was an associate professor of finance at Columbia. By writing this book, they formulated an approach to investing that became known as “Value Investing.”
If you look at the 1920-1930 period in America and then compare it to the 2000-2010 period, you see a lot of parallels. Just like today, investors were rocked by unexpected financial events. For most investors, losses were suffered. In the real estate market of the 1920s, there was a speculative attitude to some degree. In the 1930s, home lenders reacted by restricting mortgage underwriting, much like today.
The problem is the fear of deflation. What is a parcel of real estate truly worth? What is its value?
In Chapter 10 ‘The Relation of the Value of the Property to the Funded Debt’ Graham and Dodd define in detail their approach to analyzing and valuing real estate as security for a mortgage. I have read this chapter many times. I find it basic yet so revealing in truth. The truth of valuing an investment is analyzing the income or projected income of that investment.
In a financial bubble, this basic truth is going to be abandoned because it is impossible to justify escalating prices with income. It is as though people delude themselves into thinking that these escalating prices are real and that this market is real. It never is.
Warren Buffet studied at Columbia University in New York City in the early 1950s with Graham and Dodd. He learned the concept and adopted the philosophy of value investing. In 1999, Buffet was at an Investment Conference in Sun Valley, Idaho. It was a heady time for the dot.com stock market. Buffet was being criticized for not being invested in the dot.com stock market; some felt that he had lost his investment touch and had missed a great market opportunity. At this conference, he stated that he just didn’t understand the dot.com market; this was partly true. What he was really thinking is that this dot.com market was a bubble market and contrary to everything Graham and Dodd had taught him.
The dot.com stocks, you recall, had no historic earnings. There was no way to intelligently value these stocks without a history of profits and earnings. It was an easy call for Buffet to make; no earnings mean price speculation.
A similar situation existed in the housing market in the 2000s. There was a disconnection between earnings and price. When that happens, the market goes into a speculative state which will lead to a drop in price.
In today’s real estate market that is the security for the Mortgage Notes you are trying to sell, valuation is all about rental income. It is not about price comparison. In a real estate market that is deflating, this is an unwise approach to take.
If you read this book within the larger context of investing, you will see the wisdom of Graham and Dodd and apply it to your investing approach. Warren Buffet did and not only did he make money for his investors and himself, but he had fun doing it because he was sure that this approach was financially sound and wise. At Brownstone, we concur. It is this book and its investment philosophy that has kept us buying Mortgage Notes through the worst down turn since the Great Depression.
Email me at firstname.lastname@example.org with your thoughts and comments. Enjoy.