Benjamin Graham is known as the father of value investing, but this really understates how much of an impact he had on the world of fundamental investing.
Graham was one of the few analysts on Wall Street to actually begin using fundamental analysis with equities rather than bonds, although he first began to hone his skills in the world of bond investing as Irving Kahn and Robert Milne describe in this paper on Graham’s life:
“One of his earliest studies was an analysis of the Missouri Pacific Railroad. Its report for the year ended in June 1914 convinced him that the company was in poor physical and financial condition and that its bonds should not be held by investors. He showed the report to a friend who was a floor broker on the Exchange. The floor broker, in turn, showed the report to a partner In Bache & Co. As a result, Ben was asked to become a 'statistician'-as security analysts were then called--at a salary of $18 per week, a 50 percent raise.”
In the early 1900s, virtually all analysis was focused on bonds. Stocks were thought of as only speculative instruments, where people like Jesse Livermore could make or lose a fortune in a day. Even when financial information started to become widely available, investors still ignored it, leaving the door open for people like Graham to take advantage:
“Operating and financial information was supplied by corporations, either voluntarily to attract investors, or else to conform with stock exchange regulations. The financial services took advantage of this information, reprinting it in convenient form in their manuals and current publications….Most of this financial information, however, was neglected in common stock analysis. The figures were considered to have limited current interest. What really counted was "insider information"-some of it related to a company's operations, but much relating to the plans of stock market pools.”
Wall Street became a “virgin territory for exploitation by genuine, penetrating analysis of security values” in the 1920s thanks to this unique environment, and Graham was able to put his statistical mind to work uncovering bargains:
“Ben's career as a distinctive professional Wall Street analyst dates back to the 1915 plan for the dissolution of the Guggenheim Exploration Company. This holding company had large interests in several copper mining companies actively trading on the New York Stock Exchange. When Guggenheim Exploration proposed to dissolve and to distribute its various holdings to its shareholders on a pro rata basis, Ben calculated the arbitrage values...these calculations meant an assured arbitrage profit of $ 7.35 for each share of Guggenheim Exploration purchased, provided that simultaneous sales were made of the underlying copper companies.”
At the time, Guggenheim was trading at $68.88. Graham calculated that each share was worth $76.23 in breakup value. As there were no other analysts covering such opportunities, the arbitrage opportunity was not widely known, allowing Graham and his firm to make an impressive profit:
“The risks lay in the possibility that the shareholders might not approve the dissolution, or that litigation might delay it. Another potential problem might arise in maintaining a "short" position in the copper stocks until the distribution was made to Guggenheim shareholders. Because none of these risks appeared substantial, the firm arbitraged a large number of shares. One of Ben's associates proposed that he manage his venture in Guggenheim in return for a 20 percent share in the profits. When the dissolution went through on January 17, 1916, Ben's reputation and his net worth both grew.”
This was just the start of Graham’s Wall Street career and the beginning of the building of his reputation. It’s interesting to learn about how he started out in his career as it shows the man who became to be known as the father of value investing had a bit of help when it came to beating the market -- the competition was extremely limited. Over the years, Graham became highly adept at using this to his advantage.
