Thursday, 28 January 2010

Graham's thinking was original and he preached value.

Graham preached value - the advantage of paying less for stocks than for the value of the current assets after deducting all liabilities.

One of Graham's favourite teaching strategies was to analyse 2 companies side by side, even if they were in different industries, and compare the balance sheets. 
  • He would take Coca-Cola and Colgate, related to one another only by alphabetical proximity, and ask which stock was more of a bargain relative to the net asset values. 
  • Graham's primary concern was the margin of safety, a focus which prevented hm from recognising the great growth potential in Coke.

Not all of Graham's tactics worked out.

1.  He would buy a leading company in an industry, such as the Illinos Central Railroad, and sell short a secondary one, like Missouri Kansas Texas, as a hedge. 
  • As it turned out, the two securities were not correlated, and the hedge did not work.

2.  Another type of hedge that Graham used repeatedly was to buy a convertible preferred stock and short the common. 
  • If the common rose, he was protected by the convertible feature. 
  • If it fell, he made money on the short. 
  • In either case, he collected the dividend. 
  • This approach has become a standard practice in the industry even though it no longer has the tax advantage it once did. 

Graham is seen as a legitimate genius, someone whose thinking was original and often contrary to establish wisdom.  Graham's motivation, was primarily intellectual.  He was more interested in the ideas than in the money, although that too had its rewards.

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