Published 2012 by Prometheus Books The Einstein of Money: The Life and Timeless Financial Wisdom of Benjamin Graham. Copyright © 2012 by Joe Carlen. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, digital, electronic, mechanical, photocopying, recording, or otherwise, or conveyed via the Internet or a website without prior written permission of the publisher, except in the case of brief quotations embodied in critical articles and reviews. Trademarks: In an effort to acknowledge trademarked names of products mentioned in this work, we have placed ® or ™ after the product name in the first instance of its use in each chapter. Subsequent mentions of the name within a given chapter appear without the symbol. Cover image © iStockphoto.com/Brian Adducci Cover design by Jacqueline Nasso Cooke Inquiries should be addressed to Prometheus Books 59 John Glenn Drive Amherst, New York 14228–2119 VOICE: 716–691–0133 FAX: 716–691–0137 WWW.PROMETHEUSBOOKS.COM 16 15 14 13 12 5 4 3 2 1 Library of Congress Cataloging-in-Publication Data Carlen, Joe. The Einstein of money : the life and timeless financial wisdom of Benjamin Graham / by Joe Carlen. p. cm. Includes bibliographical references and index. ISBN 978–1–61614–557–6 (cloth : alk. paper) ISBN 978–1–61614–558–3 (ebook) 1. Graham, Benjamin, 1894–1976. 2. Capitalists and financiers—United States—Biography. 3. Investment advisors— United States—Biography. 4. Investment analysis. I. Title. HG172.G68C37 2012 332.6092—dc23 [B] 2012013317 Printed in the United States of America on acid-free paper Acknowledgments Introduction Chapter 1. Losing It All Chapter 2. The Margin of Safety Chapter 3. Top of the Class Chapter 4. Numbers Don't (Usually) Lie Chapter 5. The Original Security Analyst Chapter 6. All or Nothing—Investors as Business Owners Chapter 7. Dizzying Heights and Shuddering Depths Chapter 8. The Folly of “Mr. Market” Chapter 9. New Beginnings Chapter 10. Keynes, Hayek, and Graham? Chapter 11. An Eager Young Student from Omaha Chapter 12. Disciples of Value Chapter 13. Stranger Than Fiction Chapter 14. The Ethics of Money Chapter 15. Of Perpetual Value Appendix Glossary Notes Index F irst, I'd like to acknowledge my parents, Peter and Sarah, and my brother Amos. Second, I'd like to thank Steven L. Mitchell, the editor-in-chief of Prometheus Books, both for recognizing (along with others at Prometheus) the merit of a modern biography of Benjamin Graham and for his editorial assistance with The Einstein of Money. I would also like to thank Brian McMahon, Jill Maxick, Catherine Roberts-Abel, Melissa Shofner, Jade Zora Ballard, Lisa Michalski, and the entire staff at Prometheus Books for help with various aspects of this project. Mindy Flanagan, manager of business programs for international students at UCSD Extension, also deserves thanks for facilitating the internships of Jisun Park, Yumi Nishizawa, and Christine Xie. The aforementioned students assisted with research for this project, and Ms. Park deserves special acknowledgment for her help with some of the current investment examples. Yuki Kato, another intern from that program, assisted with promotional efforts for this project. I'd like to thank Warren Buffett for granting me an interview in which he provided invaluable insight into “Ben”—the man who is still Buffett's primary business/investment mentor (and a dear friend for whom he still holds great admiration and affection). I would also like to extend my gratitude to Mr. Buffett's son (and the acclaimed musician) Peter Buffett for his pivotal role in connecting me with his father. I am also greatly indebted to Graham's children, Benjamin Graham Jr., MD, and the late Marjorie Graham Janis—both were most generous with their time, and Dr. Graham also provided some outstanding interview contacts and family photos. Marjorie's daughter Charlotte Reiter, as well as Charlotte's cousin Pi Heseltine (another of Graham's granddaughters), provided excellent insights and photos for which I'm very grateful. I'd also like to extend special thanks to other personal and professional associates of Graham who shared their remembrances with me: Charles Brandes; Irving Kahn; Thomas Kahn; Dr. Robert Hamburger and his wife, Sonia; the late Dr. Bernie Sarnat and his wife, Rhoda; and the late Professor Fred Weston of the UCLA Graduate School of Business. Their interviews provided a rich layer of additional detail and anecdotes regarding Graham's towering intellect and eccentric personality. I would also like to thank the other prominent value investors and academics who were interviewed for this project. These include Mark Russo, Pat Dorsey, Professor Richard Roll, Andrew Kahn, Mitsunobo Tsuruo, Hideyuki Aoki, Robert Hagstrom, David Poulet, and Raphael Moreau. Most of those interviews were made possible by the 2011 Value Investor Conference organized by the renowned Buffett/Berkshire expert Robert Miles. I would also like to thank my friends and colleagues: Robert Bell, Nathan Stinson, Jeremy Tiefenbrun, David Kanoa Helms, Russ Weinzimmer, Hannah Bui, Max Rizzuto, Simon Eisner, Tom Flaherty, John Friar, Ieden and Harlan Wall, Jon Davis, Elizabeth Shulman, Ron Hall, Lynn Whitmire, Cheri Hill, Mary Anne Andrews, Sergio Fernandez, Shefali Kumar, Karen Messenger, Michael Weitzman, and the late Eric Leonard. I would also like to acknowledge my Uncle Bob, Aunt Monica, Aunt Eliane, Mark and Jennifer, Al and Daphne, and other extended family members. As well, Frank Scatoni deserves thanks for encouraging me to follow through with a modern biography of Graham. Last, but certainly not least, thanks to Benjamin Graham himself for having left an extraordinary legacy that is “rich” in both financial wisdom and human insight. F orbes’s 2011 ranking of the world's billionaires places Carlos Slim at number one, Bill Gates at number two, and Warren Buffett at number three.1 The subject of this book, Benjamin Graham, is cited by Buffett (and those who study and write about the Buffett phenomenon) as the most profound influence on his investment approach and, by extension, the one to whom the most credit is owed for Buffett's success as the greatest investor in recorded history. However, given the fact that Bill Gates was seen reading Graham's The Intelligent Investor in 1993,2 Graham has long been known to Gates as well. As for Mexico's Carlos Slim, the world's wealthiest individual has frequently spoken of his admiration not only for Warren Buffett but for the writings of Buffett's mentor, Benjamin Graham.3 In his inimitably understated manner, Buffett once said that “no one ever became poor by reading Graham.” Indeed! Fortunately, despite the fact that Graham himself passed away over thirty-five years ago, the engine of wealth creation that he developed in his extensive writings has not gone unnoticed by the three men who now sit atop the Forbes billionaire list. The modern investor community has long taken notice of Benjamin Graham's impact on investment strategy: “Financial Genius,”4 “Investing Legend,”5 “Value Guru,”6 “Path- Breaking Value Investor,”7 “Best Financial Mind of the 20th Century,”8 “High Priest of Value Investing,”9 these are all terms selected by the New York Times, the Wall Street Journal, Bloomberg Businessweek, Kiplinger's, and the Financial Times (UK) to describe him. Notably, these are quotes from articles written between 2005 and 2011 about a man whose Wall Street career began almost a century ago (1914) and ended over fifty-five years ago (1956). In more tangible terms, many of the world's top fund managers, past and present, are directly linked to the “value” school of investing founded by Graham. Aside from Buffett, these include the likes of Charles Brandes and Irving Kahn (both enormously successful and still-active value-fund managers who knew Graham personally), Mario Gabelli, John Bogle, and a host of recently departed value disciples who left behind decades-long records of consistently well-above-average portfolio performance. This group is exemplified by Bill Ruane and Walter Schloss, both Graham aficionados who had considerable personal contact with their investment mentor during the latter part of Graham's life. Not coincidentally, the financial performance of their respective funds was nothing short of legendary and, like Buffett, they attributed much of this success to Benjamin Graham. As one would expect, the value- investing approach has been emulated by many other funds, not only in the United States but throughout the world. This most formidable investment approach was originated by a man born in nineteenth-century Victorian England, who died in France some eighty-two years later, a man who came into the world as Benjamin Grossbaum, the third son in a family of Jewish kitchenware importers, and left the world as Benjamin Graham, the “Dean of Wall Street.” Unlike the market speculators of his day and ours, Graham had both the boldness and the intelligence to originate a more rational and reliable basis for security selection. Through the application of a rigorous academic discipline (the same one with which he graduated second in his class at Columbia University) to the “smoke and mirrors” that is often the stock and trade of Wall Street, he formulated a sound system for investment, which, unlike almost all others, can still be productively and profitably applied seven decades after its inception. The enduring impact of this approach was most apparent at the 2011 Value Investor Conference in Omaha, Nebraska (held just a few days before Buffet's annual Berkshire Hathaway shareholders meeting). Both the prominence and the diversity of fund managers, presenters, and attendees at the Value Investor Conference were remarkable. Some presenters specialized in global value investing while others focused on particular elements of domestic value investing. As for the attending fund managers, they hailed from all corners of the globe and ranged in age from around twenty-five to well over seventy. There was a younger generation of prominent value investors (e.g., the noted author and fund manager Pat Dorsey), those who have excelled in important applications of the field (e.g., the global value specialist Tom Russo), and value-fund managers operating from the financial centers of Asia, Europe, Latin America, and Africa. Moreover, many of them are CFA (Chartered Financial Analyst) charter holders, a designation that, like value investing itself, owes its existence to Graham! The interviews of these professional fund managers, quoted in this book, provide great insight into the ongoing application of Graham's principles and methods throughout the world. As for the lay investor, as Warren Buffett highlighted when I interviewed him for this book, Graham's The Intelligent Investor (originally published in 1949 and intended primarily for the nonprofessional investor) consistently ranks in the top 300 (number 247 as of this writing) of the more than 7 million unique books sold on Amazon.com. In a publishing world where this week's bestseller is often all but forgotten months if not weeks later, such strong sales over several decades is almost unparalleled. (Mr. Buffett said that the Bible might come close!) Graham's earlier, lengthier, and more technical investment tome (cowritten with David Dodd) titled Security Analysis (published in 1934), is still referred to as “The Value Bible” by many professional investors and is reported to have sold over 750,000 copies to date. In fact, a later edition of this classic was featured in the 2006 Academy Award–nominated hit film The Pursuit of Happyness. It was the book that a struggling Chris Gardner (played by Will Smith) was required to study as part of his 1981 internship at Dean Witter (presently Morgan Stanley Dean Witter). The phenomena highlighted above are only the most apparent expressions of Graham's formidable and enduring legacy. However, as impressive as these examples are, they compose a surprisingly incomplete reflection of the intellectual powerhouse that was Benjamin Graham. Perhaps this is best illustrated with an example supplied by Graham himself: writing in 1957, he stated that “if my name has any chance of being remembered by future generations…it will be as inventor of the commodity reserve currency plan.”10 This was not false modesty about his contributions to investment finance; from his perspective at that time, this seemed quite plausible. After all, how many noneconomists (Graham had no formal training in economics) in the 1930s and 1940s developed economic proposals that were seriously considered not only by the Roosevelt administration but also by economic theorists the stature of John Maynard Keynes and Friedrich Hayek? Furthermore, those words were written a number of years before Warren Buffett became the household name that it is today. So, from the vantage point of 1965, it was not at all certain that Graham's investment philosophy would ever gain the level of attention that Buffett's record-shattering investment approach has helped bring to it. And yet, in 2012, for the vast majority of those who are aware of him at all, Graham is only known as the author of The Intelligent Investor and/or as Buffett's mentor. Of course, value investing is the most significant aspect of his professional life and legacy. However, as with Graham the economist, Graham the business ethicist, Graham the inventor (he had several innovative patents pertaining to such fields as mathematics and Morse-code systems), and even Graham the literary professional (a play that he cowrote actually made it to the Broadway stage, and his English translation of a favorite Spanish novel was considered to be of the highest caliber), Graham the investor is the expression of an intellect of almost unparalleled breadth and depth. Those who have read many investment books would agree that Greco-Roman philosophy, Elizabethan poetry, and frequent forays into behavioral psychology are hardly standard fare for such volumes. However, these find ample expression in investment and economics books authored by Graham, the only person ever to be offered professorships in three different departments (Mathematics, English, and Philosophy) upon completing his undergraduate degree at Columbia University. Moreover, his posthumously published (and only partially completed) memoirs reveal a man who thought deeply and critically (including considerable self-criticism) about all aspects of the human condition: psychology, friendship, romance/sexuality, philosophy, and other deeply personal and controversial aspects of life. High finance is hardly known as a breeding ground for such reflection, but Graham never felt compelled to conform to the “Wall Street Way” either in deed or in thought. Such was the context for the value-investing paradigm that germinated from the seeds of Graham's “Renaissance Man” imagination to become the governing philosophy behind the allocation of what has now become hundreds of billions of dollars (with no small measure of pounds, euros, yen, yuan, rupees, and other currencies as well). Graham experienced the trauma of a riches-to-rags existence firsthand as a child, due in part to his mother's enormous losses in the stock market “Panic of 1907.” Later, he would suffer considerable losses himself during the Great Depression after scaling the heights of the Roaring Twenties (Graham's personal income in 1928 was $600,000—the equivalent of over $7.5 million in today's currency). As such, to really internalize Graham's primary investment concepts, it is instructive to learn them in the context of his life experiences. Furthermore, the high volatility and tremendous uncertainty of today's economy have rendered this context more relevant than it has been for several decades. That is why this book is structured semichronologically. Each chapter that describes a particular period of Graham's life is followed by a chapter dedicated to a particular investment concept that is linked in important and relevant ways to Graham's experiences highlighted in the previous chapter. In this manner, each of the primary principles will be given sufficient attention to be understood reasonably well while the chronological chapters maintain the thread of Graham's compelling life story. Certainly, his personal life did not lack for drama. Along with a certain measure of domestic tranquility and prosperity, the man bore his share of stinging blows (most notably, the tragically premature deaths of his two sons). Moreover, his somewhat unrestrained romantic appetites were a destabilizing factor in three unsuccessful marriages (the first of which was particularly stormy) and eventually led to a deeply controversial yet successful long-term romance during the final stages of his life. As I learned from interviews with Graham's surviving children and other friends and family, his personality was a curious one in many ways: Warren Buffett, among others, was mystified and impressed by his unusual generosity (e.g., Graham's decision to use current stock selection examples at his finance courses, essentially giving away his trade secrets to his own financial detriment), while others close to him were mystified and dismayed by some aspects of his romantic conduct. Nonetheless, he was universally respected and mostly admired. After all, the enormity of his positive qualities—his legendary intelligence, discipline, generosity (both financial and otherwise), and, above all, his impeccable professional ethics—outweighed his personal shortcomings. Furthermore, it seems that he did succeed in maintaining high personal integrity in many aspects of his personal life but, unlike his professional life, there were some exceptions. Unfortunately, for him and for some of those with whom he was close, the sheer weight of his intellect and drive, among other factors, led to certain personal and interpersonal complications. Personality quirks and all, the story of his meteoric rise from poverty to prominence, during some of the most significant events in Wall Street (and world) history, is unusually inspiring. Since Graham lived and prospered during a momentous time in American history (1894–1976), our discussion will span his involvement in two world wars, the “Jazz Age,” the Great Depression, the post–World War II boom, and the tumultuous era of the 1960s and early 1970s. Indeed, Graham's life is one of those rare biographical narratives that carry both immense historical significance and dynamic personal drama. However, first and foremost, Graham was a man of ideas. Consequently, this book has been structured to serve the dual purpose of providing the reader with an understanding of the man himself as well as a solid grasp of his most essential ideas. As indicated in the subtitle, it is an integrated exploration of Graham's life and wisdom, both of which are rich with meaning and practical relevance for the modern reader. B enjamin Grossbaum was born in London, England, in 1894, toward the end of the reign of Queen Victoria. Grossbaum was his legal surname until his family “Americanized” it to Graham roughly twenty-three years later (for the sake of clarity and consistency, our subject will generally be referred to as Graham throughout the book). His father, Isaac, was born in Britain and was proud of his British upbringing (a pride that, apparently, was never diminished by the family's subsequent emigration to the United States) while his mother, Dora, originated from Poland. Isaac Grossbaum, along with his five brothers and his father, Bernard, owned and operated a business that imported china, bric-a- brac, and related merchandise from Austria and Germany to the United Kingdom. The Grossbaums were able and industrious merchants, Isaac being especially gifted in this regard. The Grossbaum family was also strictly orthodox in its practice of the Jewish faith. Isaac was one of eleven children. Among the devoutly religious (Jewish or otherwise), such large families were (and are) not unusual. What was somewhat unusual, even in an orthodox context, was the extent of discipline that Isaac's father imposed upon his children. Because he was so fearful of any “ungodly” influence, he enforced a draconian code of conduct upon his household so severe as to prohibit such “sinful debauchery” as whistling! According to his memoirs, Graham recalls his paternal grandfather, nicknamed “Old Grossbaum,” in fairly stark terms: “A man with a square, expansive, grey-black beard, a skull cap, a severe expression, and a fanatical gleam in his eyes.”1 However, considering that Benjamin grew up in a home where he was exposed to French lessons and other secular/non-Jewish activities, it seems that, while officially orthodox (at least while Isaac was still alive), the family Graham was born into was somewhat less pious than that of Bernard Grossbaum. Moreover, despite being a young and presumably fertile couple, Isaac and Dora had quite a number of childless years between Benjamin's birth and Isaac's death. Such a gap is rare among the most pious practitioners of Orthodox Judaism. As Graham writes in his memoirs, “Out of delicacy or a lack of the inquisitive sense, I never asked mother how it came about that there were none after me.”2 Regarding Benjamin's mother, Dora, her family was also comprised of highly devout Orthodox Jews. This family was known as the Gesundheits. Graham recalls his maternal grandfather as a “stout, jovial man with a white beard,”3 and Grandmother Gesundheit as a “stout, emotional, and domineering lady.”4 Of course, the hilarity of the Gesundheit name did not go unnoticed, and there were many who couldn't quite hold in their laughter after verifying that the Gesundheits were not kidding and it really was their family name. As Graham recounted several decades later in his memoirs, Gesundheit “was a name which was the cause of much amusement for others and embarrassment to us.”5 Not surprisingly, circumstance and common sense intervened to ensure that the name would not last long in the New World. Graham's cousins, who immigrated to America, would eventually change their surname from Gesundheit to Gerard (“for the children's sake,” as one of the surviving Gerards recounted to me). However, behind the amusing name was an intellectual lineage that was anything but laughable. Graham's maternal great-grandfather was a celebrated religious scholar in nineteenth-century Poland and even served as chief rabbi of Warsaw for several years. At the time, that was among the most prestigious positions anywhere for an observant Jew. One had to be extremely learned in many different areas to become a chief rabbi of any Jewish community, let alone what was, by a significant margin, the largest Jewish community in the world at that time (comprising somewhere between 30 and 40 percent of the Polish capital's total population).6 Indeed, from a nineteenth-century Jewish perspective, such a position was almost comparable to the papacy for Polish (and other) Catholics of that era. So it would be difficult to understate the stature of such an honored post and the level of both respect and trust that the world's largest Jewish community must have had for Graham's great-grandfather. Not surprisingly, there is an entry for Graham's maternal grandfather, Jacob Ben Isaac Gesundheit (1815–1878) in the Jewish Encyclopedia. Despite the fact that he died long before Graham was born, the entry for Mr. Gesundheit reveals three remarkable parallels between the two men: Jacob was a noted scholar in his field (Jewish law and religion) and wrote a number of works that were “very highly esteemed by Talmudical scholars of eastern Europe.”7 Apparently, he was also an enthusiastic teacher, having led a yeshiva (a Jewish seminary) in Warsaw for forty-two years. Last, although he was a devoted religious scholar (and, one presumes, an observant Jew), as chief rabbi, he apparently held views on some religious matters that were considered to be excessively liberal by some of the more pious members of his community. This created a stir that ultimately led to his loss of that prestigious post. Revealing another, almost eerie, similarity to his great-grandson Benjamin, whose memoirs remained both unpublished and incomplete when he died, the Jewish Encyclopedia entry notes that Jacob “left several works in manuscript.”8 As will be elaborated in subsequent chapters, Graham, like Jacob Gesundheit, also became known for highly esteemed scholarly written works and many years of teaching in his field of investment finance (thirty-seven years, to be precise). And, of course, he used both the typewriter and the classroom lectern to communicate an investment philosophy that, relative to the accepted “wisdom” of Wall Street at the time, was entirely unconventional. So it seems that thinking outside of the mainstream and being willing to espouse unorthodox views had some relatively recent precedent in the Gesundheit branch of Graham's family tree. Rhoda Sarnat, the daughter of Maurice Gesundheit/Gerard (Rhoda Gesundheit's brother), had extensive contact with Graham throughout much of his life. I interviewed her and her late husband, Dr. Bernard Sarnat (who, prior to his retirement, was a plastic surgeon of some renown), just a few months prior to the latter's passing. Having studied the family tree in some detail, both of them expressed to me that they saw a link between the Gesundheits’ intellectualism and Graham's exemplary success in a highly analytical field. In a recent biography of Dr. Sarnat, the illustrious genealogy of the doctor's wife is highlighted to a considerable extent. While the author concludes that, of the Gesundheit progeny, “the most famous of all was Benjamin Graham,”9 he certainly is not the only great intellect in that gene pool. In fact, Rhoda's own father (and Dora Grossbaum/Graham's brother), Maurice Gesundheit, was a respected intellectual in his own right. Curiously, after several years of rabbinical studies convinced him that he was actually an agnostic, Maurice abandoned religious studies for mathematics. In turn, he became a professor in this field at the University of Manchester. Later, upon leaving the United Kingdom for America, Maurice became, as Graham recalled in his memoirs, “quite a success as one of the earliest of the ‘systematizers’ or ‘efficiency engineers.’”10 To one degree or another, this intellectualism is evident in many of Maurice Gesundheit/Gerard's children, most of whom have excelled in medicine and various other academic disciplines. Perhaps the most significant among these is Ralph Waldo Gerard. A son from Maurice's first marriage (and Rhoda Sarnat's half-bother), Ralph earned his doctorate in neurophysiology, and his research won him two Nobel Prize nominations (but no