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42 Pages·1991·3.2 MB·English

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FRIENDS OF FINANCIAL HISTORY
MESSAGE FROM THE EDITOR by Jason Zweig 2
ALEXANDER HAMILTON: THE MAN AND THE MYTHS 4
by Joanne B. Freeman. In the second ofa two-part series, Ms. Freeman
explores the myths behind our first Secretary ofthe Treasury, deciphering
fact from fiction.
BENJAMIN GRAHAM: THOUGHTS ON SECURITY ANALYSIS 8
An interview with Professor Pat Ellebracht. The late “dean ofthe security
analysts and money managers” reveals his life-long experiences to the
investors of tomorrow.
“BACK TO BASICS: FOCUS ON THE CUSTOMER” 12
William H. Donaldson, the new Chairman and CEO ofthe NYSE, reflects
on the future ofthe securities industry.
BOAS ON BOOKS Enjoy the first ofwhat is to become a regular feature 14
in Friends Ray Boas writing on the many business and financial histories
:
and biographies ofthe past and present. This first review tells ofthe
exciting tales in The Age of the Moguls.
THE BUDAPEST STOCK EXCHANGE RE-OPENING
16
byArthur W. Samansky.
THE DETLEF TSCHOPE AWARD presented by the International Bond 19
& Share Society.
STRASBURG
1991 - Notes and Photos from the 4th Annual Strasburg 22
Stock & Bond Auction & Show.
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THECOVER: SurrenderofCornwallisatYorktown, byJohnTrumbull,oil-on-canvas(detail),ca. 1797.
CourtesyofArchitectofthe Capitol.
Hamilton, underthecommandofGeneral Washington, standsdirectlytotherightofthewhitehorse.
FRIENDS OF FINANCIAL HISTORY
Published 1978-1990byR.M.Smythe&Co.,Inc.
EDITOR
JasonZweig
MANAGINGEDITOR
AnneT.Keane
Copyright1991bytheMuseumofAmericanFinancialHistory,thepublisher,26Broadway,Room200,NewYork,NY10004-1763
Telephone[phone].Fax[phone]. Allrightsreserved.
PermissionisgrantedtoreprintwithpropercredittoFriendsofFinancialHistory.
PFaoyumrenWtoiAmlnudnsTutrabaledsemuabCsedcnertieiprnt,idoPolnlla$azr2as5,LioenvneUla.,SN.NeeawnwdYYoCorarkkn,aodrNaUY.S$13b00a0n4ak8i,,rmAoarBiblAyE#bura0on2pk6e-,w0i0Ur4.e8K2.t8o,SRiAencpgculboelucinoctpNy#a$t45i5o6n-a0l22B4a30n.k
"ALEXANDER HAMILTON:
THE MAN AND THE MYTHS'
"*
PART
II
By Joanne B. Freeman
Within Hamilton’s lifetime, many ofhis with nothing. It is no wonder that Hamilton was silent
opponents made great efforts to invent highly unflatter- about his origins.
ing stories about him. Even some well-meaning
friends, lacking knowledge about parts of Hamilton’s Regarding George Washington’s supposed
life, contributed to the many myths that exist about parentage of Hamilton, this stems from Washington’s
him. Over the years, as Thomas Jefferson has grown to presence in the West Indies in the period that Hamil-
become America’s god of democracy, Alexander Hamil- ton was born. Washington, however, was never in the
ton, Jefferson’s political opponent, has been cast in the part ofthe West Indies where Rachel lived. This myth
role ofthe “villain,” a man without scruples, an elitist probably gained popularity because it explained, in
who hated “the people.” Hamilton’s tendency to try too some people’s minds, why George Washington thought
hard, say too much, and push too far alienated many, so much ofthe supposedly corrupt, self-serving Hamil-
making these myths more believable. But buried ton; Hamilton was, after all, Washington’s son. Others
beneath the legends and stories lies the real Alexander might have looked wistfully toward this myth as a
Hamilton. means ofendowing Hamilton with a “great man” for a
father.
The first myth concerns Hamilton’s birth.
Hamilton’s childhood invites myth, because we know Although Hamilton almost never referred to
very little about it; Hamilton himselfalmost never his childhood or family during his lifetime, some few
referred to it. Myths contend that Hamilton was black, facts about his origins did become common knowledge,
or Jewish, or the illegitimate son ofGeorge Washing- much to his humiliation. By the mid-1790’s, when the
ton. Jefferson/Hamilton political struggle was at its height,
Jeffersonian newspapers were full of descriptions of
None ofthese suggestions is true. Myths about Hamilton as a bastard, and repeated highly unflatter-
Hamilton being black or Jewish stem from confusion ing comments about his mother. John Adams, who
surrounding Hamilton’s mother. Rachel Faucette was grew to detest Hamilton, often referred to him as “the
an independent, strong-willed woman, born to French creole bastard” or the “bastard brat ofa Scots peddler.”
Huguenot parents who had fled France to settle in the It is this truth - the memory ofhis youth spent in
West Indies. Her birth in the West Indies leads many relative poverty, and the knowledge ofhis illegitimacy -
to assume that she was black, although she wasn’t. that made Hamilton so sensitive about his status as a
She was married at a young age to a man named gentleman and led him to crave acceptance by high
Levine, who was probably Jewish. (This is at the heart society.
ofHamilton’s supposed Jewish background.) Levine
mistreated Rachel; he had her imprisoned for whoring Myth number two once again involves George
(although we have no clue as to whether Rachel was Washington, who was perhaps the most significant
indeed guilty ofthe crime.) When she was released, figure in Hamilton’s life. During Hamilton’s life and
she fled Levine, moved to another island, and soon met after, stories circulated that Hamilton had palmed
James Hamilton, the fourth son ofa Scottish lord. He himselfoffon Washington, flattering his way into
had come to the West Indies to make his fortune in Washington’s military family, but that Washington
trade. Rachel and James lived together for many years soon grew tired ofthe young man and threw him out of
in increasing poverty. On one rare occasion, Hamilton his military family in frustration. This myth stems
describes his father as being somewhat lazy; he failed from Hamilton’s notorious fight with General Washing-
miserably in his attempts at business. Rachel and ton. During the Revolutionary War, Hamilton became
James had two sons, James and Alexander; they may extremely frustrated with Washington. After repeat-
even have considered themselves legally married. edly asking Washington for a command over the course
However, in the years following Rachel’s flight from her ofa year, and repeatedly being turned down, Hamilton
husband Levine, he had obtained a conditional divorce grew frustrated and insulted at not getting what he felt
that prohibited Rachel from remarrying. So, ifshe had he deserved. One day, Hamilton was on his way to
married James Hamilton, it was not binding. Ifshe deliver a dispatch. Washington, meeting him on the
hadn’t, the result was the same. Their two children, stairs, told Hamilton he needed to see him immedi-
James and Alexander Hamilton, were illegitimate. The ately. Hamilton assured Washington that he would be
elder James Hamilton later abandoned his family for right there, continued down the stairs, handed the
unknown reasons, and Rachel died shortly thereafter. dispatch to another aide with his instructions, and was
Rachel’s meager belongings were claimed by the son of then accosted by the ever-earnest Marquis de Lafay-
her first husband, Levine, and the two boys were left ette. Lafayette burst into a stream ofconversation,
4
"
which Hamilton later said he interrupted almost Throughout his life, Hamilton was constantly
rudely, so he could return to Washington. Turning being accused ofbeing completely self-serving, as the
from Lafayette, Hamilton found Washington glowering previous myth seems to imply. He was certainly highly
at him from the top ofthe stairs. Washington repri- ambitious and always concerned with himself, his
manded Hamilton, saying, “Col. Hamilton, you have importance and his reputation. But he was also
kept me waiting at the head ofthese stairs these ten completely committed to the American nation, and in
minutes. I must tell you, Sir, you treat me with his eyes his actions were, above all, for the public good.
disrespect.’’ The touchy and frustrated Hamilton Washington, when confronted by the accusation that
responded, “I am not conscious ofit, Sir, but since you Hamilton was dangerously ambitious, replied, “By
have thought it necessary to tell me, so we part,” and some, he is considered as an ambitious man, and
he left. Washington soon sent an offer ofreconciliation therefore a dangerous one. That he is ambitious I shall
to Hamilton, but Hamilton took their minor disagree- readily grant, but it is ofthat laudable kind which
ment as his opportunity to leave what had become a prompts a man to excel in whatever he takes in hand.”
hated position. Still seething and resentful, Hamilton Indeed, it was blind ambition in Aaron Burr that led
sent back a stiff, cold reply, stating that his resolution Hamilton to fear and oppose him. Hamilton recognized
was “not to be revoked,” and that in Burr the same driving ambitions
an interview with Washington that he recognized in himself. But
would be “mutually disagreeable.” to Hamilton, Burr only did what
After waiting for a replacement for served Burr best. As Hamilton put
himself at headquarters, he left. it, Burr “is for or against nothing,
'By some, he is considered as but as it suits his interest or
It is clear from this story a?i ambitious man, and therefore ambition. Determined to climb to
ltehaavteHaatmiWlatsohinncgetrotna’isnlryeqduiedstn.otHe a dangerous one. That he is tahnedhaisghmeuscthhohniogrhserofasthceirSctuatme-,
was actually all that Washington ambitious I shall readily grajit, stances may permit, he cares
could want in an aide - he was but it is ofthat laudable kind nothing about the means of
Fquriecnkc,hhfeluwernottlye,wheell,cohueldspenotkeertain which prompts a man to excel in erfefleicgitoiunsg hdiustyputropoospep.os..eI fheiesl it a
visiting dignitaries, and he was whatever he takes in hand. career.”
capable oftaking in the whole of
the American campaign and Myth number three is per-
offering sound advice to his haps the most accepted myth
General. What drove Hamilton to concerning Alexander Hamilton
leave headquarters was his craving that he was a monarchist, anxiou:s
for glory on the battlefield. When Hamilton later heard to establish the equivalent ofa king in America.
ofthis rumor ofhis being cast out ofWashington’s During the Federal Convention, Hamilton was outnum-
family, he wrote to Washington, asking him to correct bered in the New York delegation by two decidedly
this falsehood in writing, and confessing “that anti-national delegates. Rendered essentially useless
this...hurts my feelings.” Washington replied, with by their opposing votes, Hamilton remained uncharac-
admirable restraint, that “your quitting was altogether teristically silent for much ofthe Convention. But on
the effect ofyour own choice.” June 18, with the Convention seemingly hesitating to
An engraving ofa bust by Cerachi
idealizes the American
founding father.
Courtesy of Museum of
American Financial History
A 1, K X I fAIM I LTON.
5
create a strong national government, Hamilton rose which are essential to public strength and private
and delivered a marathon six-hour speech detailing his security and happiness.” Doubts he may have had, but
thoughts on a new government for the American he never sought to do anything but preserve the
nation. He openly professed his admiration for the American republic, no matter what he saw as its flaws.
British system ofgovernment - its balance, its strength,
and its structure. He recognized, however, that the Myth number four involves two statements
American people would only accept a republican model that Hamilton supposedly made. The first one occurred
ofgovernment - a government deriv- ing its authority during the Federal Convention, after Benjamin Fran-
from the people, and in which no one would hold politi- klin suggested that each session begin with a prayer - a
cal office as a matter ofright or ownership. His pro- suggestion on Franklin’s part probably meant to cool
British statements were risky after America’s recent some rather heated tempers and put the Convention’s
war against what was perceived as a tyrannical king. proceedings in perspective. Supposedly, Hamilton rose
He made matters worse by advocating the creation of at this point, and opposed Franklin’s suggestion, con-
an executive who served for life; to him, this would cluding that “he did not see the necessity ofcalling in
promote stability and would prevent the executive from foreign aid.” James Madison, although Hamilton’s
having to continually pander to the public to win re- political opponent, later denied that this ever occurred -
election. and he was the Convention’s unofficial secretary,
noting down all the proceedings in his meticulous
In later years, when Hamilton became a more notes. Hamilton, however, was certainly capable of
controversial political figure and a recognized advocate making scandalous and ill-thought- outjokes. In a
ofa strong national government and a strong executive, letter I recently discovered in the Hamilton papers,
political opponents, and even friends, used this evi- Hamilton is writing to Gouverneur Morris, a friend
dence, combined with Hamilton’s continued skepticism who had a renowned wit, which often strayed towards
about the durability ofthe American republic, to accuse the scandalous. Hamilton, when writing to Morris,
him ofbeing a monarchist. Hamilton fought this per- always assumed a witty, slightly scandalous tone. In
ception throughout his life. To him, ifthe executive this particular letter, Hamilton states that he is writ-
was elected, could be removed by the people’s represen- ing on a Sunday, a day when he should be in church.
tatives, and could not pass his office on to his descen- He then obviously proceeds to make some sort ofjoking
dants, he was not a monarch. And although he con- comment about God - a comment which, unfortunately,
tinually fought to strengthen the powers ofthe govern- anxious Hamilton descendants ripped offthe page to
ment, Hamilton never felt that he strayed from the protect his reputation for posterity.
principles ofa republic. To his friends, he admitted
having some doubts. He once wrote, “I said that I was Hamilton’s other supposed comment is better
affectionately attached to the republican theory. This known. At one point in his career, in response to
is the real language ofmy heart, which I open to you in someone’s comment in favor ofthe “people,” Hamilton
the sincerity offriendship; and I add that I have strong supposedly responded, “the people? Your people, sir,
hopes ofthe success ofthat theory; but in candor, I are a great beast!” This comment has been cited as
ought also to add that I am far from being without proofofHamilton’s desire to remove the government
doubts. I consider its success as yet a problem. It is from the reach ofthe people and as proofofhis interest
yet to be determined by experience whether it be in nothing but himselfand the American elite. Hamil-
consistent with the stability and order in government ton certainly considered himselfto be ofthe upper
(CONTINUEDONPAGE25)
An engraving ofthe 1787 Federal Convention at Philadelphia by Elkanah Tisdale, the site ofHamilton's six hour
speech detailing his thoughts on a new government for the American nation.
Courtesy ofLibrary ofCongress.
6
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York
New
1990
©
BENJAMIN GRAHAM:
THOUGHTS ON SECURITY ANALYSIS
A visit back in time with Benjamin Graham the man whom Forbes
,
magazine called "the dean ofthe security analysts and money
managers," and a business school class at Northeast Missouri State
University conducted by Professor Pat Ellebracht in March of1972
.
Individuals in financial circles regard Graham's knowledge of
securities and his ability to write about them as unparalleled.
Sharing this time together is our once in a lifetime opportunity.
Teacher: Welcome to our tele-lecture series and we Student: What is your definition of an investment and
certainly appreciate your spending time to talk with us. how does it differ from a speculation?
Graham: It is a new experience for me and I hope it Graham: Thatappearsveryearlyinourbookon security
works out well for all ofus. analysis and is supposed to be very formal. It says “an
investment is an operation in securities, which, upon
Teacher: What are the personal characteristics an indi- careful analysis, promises safety of principal and an
vidual must have if he is to be a successful long term adequate return.” All other operations are speculations.
investor?
Teacher: Doyou think that the investor’s overall invest-
Graham: Investment is most intelligent when it is most ment philosophy is influenced too much by what hap-
businesslike. I should add thatitis most successful when pened to him in one stock rather than by a more realistic
itis mostbusinesslike. The simple answertothequestion approach to the market in general?
is that one needs the characteristics of a good business-
man, which would make for long-term success in busi- Graham: I would say that there is a more universal
ness. Knowing what he is doing, having sufficientjudg- approach to the market than the single influence. In the
mentto do sensible things rather than sillyones. Beyond interview with Forbes, I said that people who bought
that, I wouldn’t say that any particular characteristics IBMatanextremelylowpricemighthavebeenspoiledbe-
are required. A man who has a special flair or intuition causeofthatsuccessful one-timeinvestment. Theymight
presumablywould do better than one withoutit, buteven have thought that it was quite easy to find another IBM.
that is somewhat doubtful in Wall Streetbecause one can And so they might have wasted their investment lives
carry one’s confidence, and his flair and his intuition, too looking for a second IBM. To that extent a man’s view-
far and lose out in the end. So I’ll stick to my statement point maybe influenced by his own few experiences.
that one has to be an intelligent businessman.
Student: Would you please comment on the statement
Student: What characteristics do individuals generally you made in The IntelligentInvestor: “Ifyou merelytry to
lack that keep them from being successful long-term bringjustalittle extra knowledge orclevernesstobearon
investors? your investment program you might actually do worse
than before.”
Graham: The primary cause offailure is that they pay
too much attention to what the stock market is doingcur- Graham: People seem to think that ifyou just know a
rently. They feel that what’s going on now will continue little more than the average person about securities,
indefinitely or long enough for them to benefit substan- you’ll dobetterthantheaverageperson. Nowtheaverage
tially. They wantto make more money than they deserve person we’ll assume, if he is not led astray, will get
to, and because ofthat, frequently lose out. They do not average results in the stock market. Ifyou are trying to
match theirexpectations to theirknowledge and capabili- getbetterthan averageresults,you’regoingtovery likely
ties. rely on whatyou think is sufficient extra knowledge to do
that, you don’t have the sufficient extra knowledge to do
Teacher: In your writings, you use many quotations better than average and verywell may do worse. You are
from the classics. May we ask how have the classics trying to be smart, but you are not going to be smart
influenced your view of human nature and your invest- enough. This is whathappens to a majorityofpeople who
ment philosophy? are playingthe market, the ones that spend agood deal of
time on Wall Street, in brokerage houses and so on,
Graham: It hasn’t had any significant influence on my thinking that they can outsmart the other fellow or the
career. I just use the classics more out of vanity than averages themselves. One has to be very smart to be
anything else because it shows that I really know some- smarter than the experts who make up the stock market,
thingabout them. They have helped me to look at things, that is to be smart enough to outperform the averages.
as Spinoza put it, from the standpoint ofeternity, rather
than day-to-day. I think that has been of considerable Student: If you had to look at the 1970’s and choose
value. either high-grade common stocks or high-grade bonds,
which would you select?
8
Graham: This is an artificial question since my basic Graham: That is discussed at some length in The Intel-
philosophyis notto choose one ofthem exclusively. Ifyou ligent Investor. The margin of safety is the difference
wasokulmdecewrhtiacinhlyonseayItwhoeuhlidghf-avgorradneowb,onadtscsuirnrceentthleeyveylise,ldI basettwheeepnritcheeyopuerpcaeyntfaogreitraantde tohfethreateeaorfniinntgesreosntotnhebosntdosc,k
twice as much as high- grade stock and more. and that margin of safety is the difference which would
absorb unsatisfactory developments. At the time the
Student: If your main interest with respect to invest- 1965 edition of The Intelligent Investor was written the
ments was protecting yourselffrom inflation, how would typical stock was selling at 11 times earnings, giving
you do it? about 9% return as against about 4% on bonds. ItNthoawt
caseyou had a margin ofsafetyofover 100 percent.
Graham: Well, I would just make the best judgment I there is no difference between the earnings rate on stocks
could as to the expected rates of inflation, and then I and the interest rate on bonds, and I say there is no
wouldmaketheverybestdecision Icouldtodeal withthis margin of safety. So instead of having the effective
expectation. My best view over the next ten years about margin of safety obtained in 1965, you have a negative
the rate ofinflation, is a rather modest 3 per cent. I don’t margin ofsafety on stock, which I consider a very impor-
try to make up my mind as to the future in tant negative factor in connection with buy-
termsofrecentexperience. Thatis acommon ing stocks at these levels (1972).
error that leads to badjudgment all over the
place in finance. The Conference Board hap- Student: In The Intelligent Investor, you re-
pened to have a 3 per cent estimated price People seem to fer to a different kind ofwater that has been
increase for 1972, and I have made a projec- think that ifyou putbackin thestockmarketbyinvestors and
tsieovnenofyetahres.same amount for about the next know a little tshpiescunleatworksintdheomfswealtveers?. Would you discuss
more than the
Teacher: In the Forbes article you suggest averageperson Graham: In the old days, what was known
thatthe stockmarketis likelytobe subjectto as water represented a secret mark-up ofthe
wide swings in theyears ahead. Isthereason about securities, valueofthe company’sassets, chieflyitsfixed
forthisbehaviorthe government’s attemptto you'll do better assets, above their actual cost and above
control the business cycle or the public’s be- than the average their replacement value so when a stock
liefthat fast profits can be made in the stock seemed to be worth $100 a share on the
market, as in the late 1960’s? person. balance sheet, actually it was only worth $20
based on value behind it. Now those semi-
Graham: Well, I don’t believe the govern- fraudulent balance sheets have been cor-
ment’s attempt to control the cycle would or rected. Instead of them, the stock market
should necessarily lead to wide swings. Long experience itselffools with the prices the investor pays. We will put
in the stock market indicates that the public always a price of$100 on a stock that has only $20 offixed value
thinks itcan makefastprofitsin one direction oranother. or cost values behind it and the difference between the
It seems that human nature requires that stock price stockmarket’s valuation as againsttruebookvalue corre-
movements be carried too far. Too far means that there sponds to that other difference which was definitely rec-
are going to be corresponding movements in the other ognized as the watered stock phenomenon. People are
direction. And what we’ll have in the future, I assume, is paying $100 for a $20 stock in the same way as in the old
pretty much of what we’ve had in the past, the kind of days a stockthatwasreallyworth only $20 wasvalued on
thing that you’ve seen in the last two years when the the balance sheet at $100.
market declined from 995 on the Dow Jones to 630 and
come back to 940, and it has been fluctuating since. Student: How is the new edition of The Intelligent
Investor different from the previous edition?
Student: Do you think the bear market of 1969-70 is
over? Graham: The basic advice and conclusions about invest-
ment procedurehave notbeen changed to any substantial
Graham: Well, technically I would say yes. You have a degree. The underpinning has been strengthened by my
sufficient recovery from the 680 low on the Dow to over experience with inflation in the last four years, as a jus-
900. The movementthatwearein rightnow is not simply tification for the principles I have been pronouncing since
a minorortemporaryrecovery. Ifyouwanttobotherwith 1949 in thefirstedition ofThe Intelligent Investor. These
thebull andbearmarkets,you mightas well considerthat principles seem to have been set aside by an almost
wehavebeen havinganotherbull marketsinceMay 1970. continuous rise in the stock market from 1939 to 1968.
But the experience since 1968 seems to me to give confir-
Student: Do you make a distinction between earning mation to the reasoning expressed in the earlier editions.
powerandcurrentearnings? How doyou measurequality Naturally, I gave more attention to the question ofinfla-
of earnings? tion in the new edition than I did previously, because sig-
nificant inflation took place since the last edition. But as
Graham: Quality of earnings is not so much related to you know, I do not accept it as an indication ofwhat the
this distinction between earning power and current earn- future holds for us. I don’t consider that five and six
ings. Historically, itis based on the two points ofstability percent inflation is likely over the long term. I also pay
of earnings, the lack of any significant downtrend, plus attention tothechangein interestrates, which isverysig-
the question ofwhether there is a pronounced and well- nificant. I think that because of the adverse change in
maintained upward movementover theyears. The better interest rates from the standpoint ofthe stock buyer, the
the stability, the better the upward movement, the better value ofthe Dow Jones average is no greater now than it
the quality ofearnings. was five or sixyears ago. Any other reasons forincreased
value have been offset bythe increase in the interest rate
Students: Please explain what margin ofsafety means factor.
with respect to common stock.
Student: If we were successful in controlling the busi-
9
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WGIoarramlhdsauWmrae:rwWeIeIh,llaw,vheithcbahettitanegriatcisonenltfirswoaoluoplvadretrmlbyaukasreitnifefoisrcsifacllyucqcluteeussattsiiioonnnc.se tadtihthfeeefdyeqruhbeaanelvttietwfyevrieoornfmtuea3aal0rlpnyuiabnnnlgoidscea2wurthinirliecincthgeysnw,tielnayv.nwedestrtmTehehentatatp.lrkiiicsInetgchhoaaambssopnulf’tletu.tcegtlouyt-
in stock prices. But the public has offset that by its crazy
idea that once business cycles are under reasonably good Student: How do you go about determining the intrinsic
control, no price is too high for common stocks, so it’s value ofa natural resource stock?
because ofthat confidence that you’ve had a more or less
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in the future, but it is not an easy thing to find outjust of value for oil resources, like $1 a barrel for developed
whereyou can expectto buylow and at what point should resources, 40 cents a barrel for probable reserves, and 10-
you sell. However, the program I propose with 25 percent 20 cents a barrel for possible reserves. That can be done,
ofthe portfolioin stocks and 25 percent in bonds, allowing but the results are not especially useful. If somebody
the other 50 percent to fluctuate in accordance with the asked me to put a value on a natural resource company,
I
market, could be operated pretty well over the future, don’tthinkthatIcould doitwell,andthenIwouldnotlike
whether the business cycle is under better control or not. to do it at all.
It will still be a feasible program ifa man wants to give it
the time and attention it needs. Student: Do you think corporations should substitute
stock dividends for cash dividends in order to more easily
Student: In the Forbes article, you said you would buy finance long-term growth?
public utility stocks because they are selling around book
value. Are your gains here not going to be limited by a Graham: Yes, by all means. Dividend policy in my own
regulatory environment and high interest charges? opinion has been very unintelligent, especially by public
utilities which pay out the typical 2/3 oftheir earnings in
Graham: Well, that is a good question and I am gladyou cash and then every now and then take back money for
asked it. The gains would be limited by regulations, but new stock, which is greater than the amount of the
there are two things on the plus side. One is previous dividend that they paid out. They
thatthelosses shouldbeverystrictlylimited, could have anticipated that by paying stock
and secondly, that there is a much better dividends in place of cash, and the stock-
promise of gain if you buy these stocks at holderwould bavebeen spared on incometax
book value than for a typical industrial stock I think an onthoseearnings. Hewouldhavebuiltuphis
that you would buy at book value. Utilities investor should equity, by not having to pay taxes on the
have very strong advantages which are not dividendshereceivedincash, sincetheywere
be well satisfied
recognized in the current market. Their addedtohisequity. AmericanTelephoneand
earnings are legally protected. Regulatory with a very good Telegraph couldhave savedbillions ofdollars
bodies must give them adequate earnings to chance ofhaving forits stockholdersifithad developed a stock
support their investment and pick a value a 50% gain on dividend policymoreorlessequivalentin the
and particularly to encourage new invest- final result to its cash dividend plus rights.
ment. That has resulted in a rate structure his investment
which has resulted in stock prices about 50 very quickly, with Teacher: Mr. Graham, I had a questionthat
percent abovecommon stockbookvalue. You came to mindwhileyou were talking. We see
see, it would not be possible to raise substan- very little chance this statement made in textbooks a lot of
tial amounts of money through the sales of ofloss. times and itseems that the marketdisproved
common stockstothe public unless the public itin 1969-70. Itistheblanketstatementthat
had reason to believe that the value of the stocks are an inflation hedge. How do you
stocks they are buyingwould atleastbe worth feel about that?
the price they are paying. Underthose circumstances the
whole history and philosophy ofregulation has virtually Graham: Well, they are a better inflation hedge than
guaranteeda premiumoverbookvalueforcommon stocks bonds, but they certainly are not perfect. You can’t
with thevery minor dangerofdecliningbelow it, and that assume that their earning power will increase to reflect
is a very good combination. I think an investor should be inflation. You might say that historically, stocks have
well satisfied with a very good chance of having a 50 repaid their earnings on your investment capital in spite
percent gain on his investment very quickly, with very ofinflation. Bonds, on the other hand, lost a considerable
little chance ofloss. portion oftheir principal value because ofinflation, so to
the extent that stocks have stood still and bonds have
Student: Why would you select public utilities stocks declined over the last 10 or 20 years, stocks have fared
over natural resource stocks, such as copper, oil, and land much better. The point is that the real earning power of
stocks that are selling for around book value? acompanyis measuredbytherateofearningson its stock
equity. Ifyou double the equity, you would assume that
Graham: First, you don’t find so many natural resource the earnings would double. What has happened over
stockssellingaboutbookvalueunlessthey havehadsome manyyears is that the common stock has built up consid-
real difficulties with theirearnings, the kind ofthingthat erable stock equity, and while earnings have gone up,
has nothappenedtotheutilities. Forutilities, an adverse they have not gone up more than the equity. So that all
situation is one where they earned a few cents less than that has happened is that they are earning a lot less, say
theyear before, instead oftwo or three percent more than 9.5 % for Dow Jones companies where 20 years ago they
they earned the year before. But for natural resource wereearning 12%. Thechangehasbeen downwardinthe
stocks, earnings are subjecttoall sorts offluctuationsand last twentyyears in spiteofinflation so tothatextentyou
conditions. Supposeyou takeAnaconda, subjecttoconfis- cannot say that inflation has benefitted common stocks.
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