The Investment Classics

In the middle decades of the 20th century, investment strategy took on a newly serious demeanor. Stock picking began to be something investors could think about rigorously and systematically, rather than relying on hunches, rumors and insider connections.

Three individuals were crucial to this transformation: Benjamin Graham, David Dodd and Philip Fisher. Graham and Dodd pioneered what came to be known as value investing, and Fisher became the guru of growth investing. All three were enormously influential, and their impact plays out to this day. Their ideas are much discussed and debated — and even worshipped and sneered at.

A contentious debate, for instance, arose recently from a Wall Street Journal column on whether Graham, if alive today, would be buying bank stocks. Columnist Jason Zweig, editor of a revised version of Graham’s The Intelligent Investor, argued that financial shares are currently too opaque and risky to meet Graham’s criteria; others contend weakness in such shares has brought the very kind of bargain Graham sought.

Some other disputes are more fundamental, delving into the merits of stock picking itself. The ideas of Graham, Dodd and Fisher run counter to the “efficient markets” hypothesis that by the late 20th century had made many finance theorists skeptical about the relevance of investor skill. But uncertainties about the applicability of that hypothesis have granted the classic stock pickers a degree of academic respect.

Moreover, the embrace of classic ideas by some successful investors — very prominently including Warren Buffett, who has described his philosophy as “15 percent Fisher and 85 percent Benjamin Graham” — ensures that those ideas will continue to exert a powerful influence and appeal on the investment scene. The history of the works of Graham, Dodd and Fisher is thus, in a sense, an ongoing story.

Depression LessonsIt was in the Great Depression’s crucible that the classic theories began to take shape. Graham, who had come to Wall Street in 1914 at age 20, had started a high-flying career as an analyst and money manager but was battered badly by the 1929 Crash. The year before, he had taken up a sideline of teaching at his alma mater, Columbia University, and now his lectures there focused on developing a safer investment strategy. In 1934, Graham and fellow instructor Dodd published Security Analysis, a textbook that soon will be available in a sixth edition issued for its 75th anniversary.

Fisher also got a close-up view of the Crash and its aftermath. He began working as an analyst at Anglo & London Bank in San Francisco in the late 1920s, and was head of the institution’s statistics department when the market plunged. In 1931, he started his own investment firm, Fisher & Company, reasoning that customers still in the battered market might be ready at this point for a new broker. Plus, it was a good time to be doing investment research, since managers at hard-hit companies now had more time to talk.

For Graham and Dodd, the imperative was to find companies that were trading at a discount from what their operations were actually worth. Although assessing such “intrinsic value” was imprecise, they argued it could be done well enough to present opportunities. “To use a homely simile,” the authors wrote, “it is quite possible to decide by inspection that a woman is old enough to vote without knowing her age, or that a man is heavier than he should be without knowing his exact weight.”

“Things happen too fast in the economic world to permit authors to rest comfortably for long,” declared Graham and Dodd in a new preface to the 1940 edition of Security Analysis. The authors indicated in the preface that there were “weaknesses to be corrected and some new judgments to be substituted,” but mainly the second edition expanded the argument of the first, emphasizing careful valuation of individual securities and advising investors to seek a “margin of safety” by buying undervalued stocks.

In 1949, Graham published The Intelligent Investor, aimed at bringing that philosophy to a broader audience. Going on to sell over a million hard-covers, it included what became a famous parable: You own part of a small business and have a partner named Mr. Market, who routinely offers to buy your share (or sell you more) at what he thinks it’s worth, which changes frequently. “Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them,” wrote Graham. “Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.”

You should deal with Mr. Market, suggested Graham, when his assessments of the business are significantly at odds with what your own analysis indicates.

Fisher, meanwhile, was developing a notably different philosophy. Whereas Graham and Dodd emphasized crunching company numbers, Fisher focused in major part on qualitative factors, such as management integrity and workforce morale. And while the value investors sought discounted stock prices, Fisher searched for enterprises with robust growth potential. The greatest investment rewards, he wrote in his 1958 classic Common Stocks and Uncommon Profits, came from finding “the occasional company that over the years can grow in sales and profits far more than industry as a whole.”

In that book, Fisher provided 15 points that investors should take into consideration when choosing stocks. This list, which would become well-known in investment circles, included such items as: “Does the management talk freely to investors about its affairs when things are going well but ‘clam up’ when troubles and disappointments occur?” Such clamming, Fisher observed, likely meant managers had not worked out a response to the troubles, were panicky or lacked an adequate sense of responsibility to shareholders.

Despite the differences between the Graham-Dodd and Fisher strategies, they shared an essentially conservative approach to investment. These strategies involved patience and hard work, sought to reduce risk and avoided in-and-out trading. They were for people who were pretty serious about not just making money but also not losing it.