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Benjamin Graham was the author of many influential investment books, including the classic Security Analysis, now in its sixth edition. The first proponent of the value school of investing and founder and former president of the Graham-Newman corporation investment fund, Graham taught at Columbia Universitys Graduate School of Business from 1927 through 1957.

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Most famous for his investing classic Security Analysis, first published byMcGraw-Hill in 1934, Benjamin Graham wrote for The Magazine of WallStreet between 1917 and 1927. It was in these early articles that Graham began fleshingout what would eventually become some of the most influential investmenttheories in history.

Now, for the first time, Graham’s early writings areavailable exclusively in a single volume.

Benjamin Graham on Investing is a rare presentation of the legendary investor’s uniqueanalytical style and methods for determining a company’s true value. Writing fromthe last two years of World War I through the years leading up to the crash of 1929,Graham’s articles are not only indicative of the economic turbulence of the periodbut also serve as timeless pieces of wisdom for any investor.

Edited and featuring a preface by Rodney G. Klein, a former student of the legendaryvalue investor, and with detailed commentary by asset allocation expert DavidM. Darst, this collection is a prized volume for any fan of Benjamin Graham.

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BENJAMIN GRAHAM on INVESTING

The McGraw-Hill Companies, Inc.

Contents

Chapter One

Issues That Sell on Illogical Bases— Misconceptions of Investors— Some Foreign Issue Anomalies

The test of the market, like that of Barrie's policeman, is popularly supposed to be "infallible." Economists picture a thousand buyers and sellers congregating in the market place to match their keen wits and finally evolve the correct price for each commodity. In the securities market particularly, the word of the ticker is accepted as law, so that one often thinks of prices as determining values, instead of vice versa.

But accurate as markets generally are, they cannot claim infallibility. While vagaries are to be found in both the stock and bond lists, the latter offers the better field for study since direct comparisons are easier, especially where two issues of the same company are selling out of line. The recent universal readjustment of bond prices has produced more than the usual number of such discrepancies, so that there are many opportunities for investors to exchange their holdings for issues "just as good," and returning a higher yield. Several of these anomalies will be discussed in the following paragraphs.

Let us first consider the case of Lorillard 7s, due 1944, and 5s, due 1951. The 7s are senior to the 5s in their claim on the company's assets, yet they are offered at 118, to yield 5.62 per cent., while par is bid for the 5s—a 5 per cent. basis.

AN INVESTMENT MISCONCEPTION

Here then is an issue yielding five-eighths per cent more than a directly junior security. Moreover the 7s are a smaller issue, of nearer maturity. Of course the explanation of this discrepancy lies in the general prejudice against bonds selling at a high premium. The investor apparently imagines that by paying $1,180 for a $1,000 bond, he must eventually lose $180. The fallacy of this argument is well illustrated by this very example. For it would require only $59 a year to yield a straight 5 per cent on the $1,180 investment—the rate of the junior issue. But since the 7s pay $70 per bond, there is a surplus of $11 per year, which if simply accumulated without interest would at the date of maturity amount to about $300—fully $120 per bond more than the premium paid. If interest is compounded on these surpluses, the gain over the 5 per cent bond would be considerably more.

A REVERSED CASE

The reverse side of the prejudice against premium bonds is found in the instance of Baltimore & Ohio convertible 4½s, due 1933, compared with the Refunding and General 5s of 1995. Both issues are secured by the same mortgage, but the 4½s sell at 87½, yielding 5.70 per cent, while at 963/4 the 5s return only 5.16 per cent. This is all the more peculiar because the 4½s have a conversion privilege which may conceivably become valuable; their maturity is much nearer, making for greater stability in market price; and their amount is limited to the bonds now outstanding, while the Refunding 5s may be increased almost indefinitely—in fact, the 4½s are to be retired by an issue of Refunding 5s.

The cause of this discrepancy is probably twofold. In the first place, investors seem to prefer a 5 per cent coupon to any other. This is absolutely illogical, since a 4 per cent coupon on a bond bought at 80 is certainly no less attractive than 5 per cent on an issue costing par. Secondly, the public is wont to disregard that portion of the yield represented by the redemption at par of a bond purchased at a discount. The usual argument is that they don't expect to hold the bond to maturity, and therefore cannot count on receiving par for it.

This reasoning is fallacious, because it is not necessary to hold an issue until the due date in order to recover at least part of the discount. Each year as the maturity approaches, the market value of the bond should grow closer to par—unless its yield is increased as the result of general or special conditions. In the case of long term bonds the annual advance is imperceptible, but in short or medium maturities it is very evident. So with these Baltimore & Ohio 4½s, their appreciation of 12 points to par will be spread over the comparatively short space of 13 years, adding a substantial amount to their yield.

The peculiar aspect of this question is the fact that the same investor who completely ignores the additional yield contained in a discount price is extremely adverse to buying a bond quoted at a premium. He is obsessed by the idea that the $180 premium on Lorillard 7s will have disappeared by 1941, but he pays little attention to the fact that by 1933 he will recover the $120 discount on Baltimore & Ohio 4½s.

As it happens the straight yield on this latter issue at 87½, considered as a stock, is practically equal to that of the General 5s, so that their other advantages described above render them a far more desirable security, even eliminating the discount element.

The Baltimore and Ohio new two-year notes, secured by 120 per cent in these Refunding 5s and Reading stocks, yield 5.73 per cent, against 5.17 per cent for the longer maturity. Their security is at least as good as that of the 1995 issue, and in the present unsettled bond market they can be relied on to display greater price stability because of their early redemption at par.

THE ST. PAUL ISSUES

Almost the identical situation as in the B. and O. issues is presented by Chicago, Milwaukee and St. Paul convertible 4½s of 1932, and convertible 5s of 2014. The 1932 maturity sells at 88¼ to yield 5.65 per cent., as against 97¼ and 5.14 per cent, respectively, for the long term issue. Both maturities are secured by the same mortgage, and in this case they are both convertible into common stock at par. The 5s of 2014 have some advantage in that their conversion privilege extends to 1926, four years longer than that of the 1932 issue. This feature is probably neutralized by the nearer redemption and limited amount of the latter bonds, so that the additional yield of more than one-half per cent makes these much more attractive.

There are three other St. Paul issues secured by the same mortgage as the foregoing, but not convertible. The 4½s of 2014 sell at 93½ and yield 5.39 per cent; the 4s, due 1934, yield 5.45 per cent at their present price of 84, while at 89¼ the 4s of 1925 return fully 5.65 per cent.

OTHER DISCREPANCIES

Similar discrepancies in bonds of the same mortgage are afforded by three newly reorganized roads—St. Louis and San Francisco, Pere Marquette and Missouri Pacific. In the case of the Frisco 4s and 5s of 1950, the 4s at 61 yield 7.05 per cent against only 6.48 per cent for the 5s at 80—a difference of .53 per cent. Even figuring the straight yields as stocks, the 4s return 6.57 per cent, the 5s only 6.25 per cent.

This difference is probably caused by the much larger amount of 4s outstanding—a circumstance which explains, but does not justify the variance. But there are fewer Pere Marquette 4s than 5s of 1956, yet the 4s at 71 yield 5.92 per cent, against 5.76 for the 5s at 88.

The Missouri Pacific consolidated 5s present an even more glaring discrepancy. This issue is divided into three series, due 1923, 1926 and 1965, respectively. One would naturally expect the nearer maturities to sell at a lower basis—as is usually the case; e. g. the B. and...