The Education of an Investor, Part 4

 

“The concept that all useful information has already been factored into a stock’s price, and that analysis is futile, is know as The Efficient Market Hypothesis.” – William Bernstein.

As discussed in a previous post, I appreciate Benjamin Graham’s contributions, but I do not accept his conclusions.

Times Have Changed

When Graham first wrote The Intelligent Investor, there were no online sources for information, as stock prices were seen on a paper ticker tape with a 15 to 20 minute time delay, not a CRT with near real-time quotations. It took weeks, if not months, to analyze a single company’s balance sheet, using an old fashioned adding machine called a comptometer, They didn’t have multi-function calculators then, much less a spreadsheet program. Someone as smart as Graham could find under-priced securities, even stocks selling at less than liquidating value.

Investment techniques have changed over the last 40 years, and there has been a tremendous amount of research about how markets work. Anyone attempting to identify undervalued stocks is ignoring four decades worth of research, which proved that, because of all of the competition, it is very, very difficult to find the elusive “good bargain” stock.

In an article written for the 1976 Financial Analysts Journal, “A Conversation with Benjamin Graham,” he indicated that he had reached the same conclusion, and acknowledged the difficulty in finding these undervalued stocks.

Question. “In selecting the common stock portfolio, do you advise careful study of and selectivity among different issues?”

Answer. “In general, no. I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook ‘Graham and Dodd’ was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent I’m on the side of the ’efficient market’ school of thought now generally accepted by the professors.”

Since that interview in 1976, mounting evidence has continued to demonstrate that markets are largely efficient, and that the current price of a stock is the “best estimate” of what it is actually worth.

Burton Malkiel’s paper provides a detailed discussion of Efficient Markets.

Conclusion

An intelligent investor should be cognizant of Graham’s contributions to, and impact on, investing theory and practice, but should go beyond his approach to one more appropriate for 21st Century’s equity markets.