That was especially true because, at its current price, GEICO was an investment that Ben Graham would not have approved of, even though Graham-Newman had only recently become its largest shareholder. Graham’s idea was to buy stocks trading for less than the value of their assets, and he did not believe in concentrating in just a few stocks. But Warren was amazed by what he had learned from Lorimer Davidson. GEICO was growing so fast that he felt confident of being able to predict what it would be worth in a few years. On that basis, it was cheap. He wrote a report about it for his father’s stockbrokerage firm, saying that GEICO was trading at $42 per share, a multiple of about eight times its recent earnings per share. Other insurance companies, he noted, were selling at much higher multiples of their earnings. Yet GEICO was a small company in a large field, whereas its competitors were companies “whose growth possibilities have largely been exhausted.” Warren then made a conservative projection of the company’s value in five years. He thought the stock would be worth between $80 and $90 per share.27
A less Graham-like analysis could hardly be imagined. Graham’s 1920s bubble and Depression experiences had made him suspicious of earnings projections, so suspicious that while he paid lip service to this method of valuation in his teaching, he never used it himself in valuing stocks to buy for his firm. But Warren was betting three-quarters of his patiently accumulated money on the numbers he had calculated.
In April, he wrote to Geyer & Co. and Blythe and Company, the most prominent brokerage firms specializing in insurance stocks, asking for their research. Next he visited these experts to talk to them about GEICO. After he heard their views, he explained his own theory.
They told Warren he was nuts.
GEICO, they said, could not succeed over the larger, more established companies that used agents. It was a tiny company, with a market share of less than one percent. Huge insurance companies with thousands of agents dominated the industry, and so it would ever be. Yet here was GEICO, growing like a dandelion in June and printing money like the U.S. Mint.
Warren didn’t understand why they couldn’t see what was right before their eyes.
17
Mount Everest
New York City • Spring 1951
As his second semester began at Columbia, Warren hummed with excitement. His father had just been reelected to Congress for a fourth time—by the largest majority yet—and he was finally going to meet his hero.
In his memoir, Ben Graham describes himself as a loner who never had an intimate friend after high school: “I was cut out to be everybody’s friend but no one’s bosom pal or crony.”1 “Nobody cracked his shell. Men all admired him, they all liked him, and they all wanted to be his friend more than he wanted them to be. You came away feeling terrific about him, but you never got to be his pal.” Buffett would later call this Graham’s “protective coating.” Even his partner David Dodd never became an intimate. Graham had great difficulty in understanding and empathizing with others. People found him almost painful to talk to—so cerebral, so erudite, so clever. He was not relaxing to be around; people had to keep their wits about them all the time in his company. While he was always kind, he quickly tired of conversing with his fellow human beings; the “real friends and intimates” of his life were his favorite authors—Gibbon, Virgil, Milton, Lessing—and their subjects, which, he said, “had far more significance for me and left a greater impression on my memory than the living people around me.”
Born Benjamin Grossbaum,2 Graham passed his first twenty-five years in a period when the country experienced four financial panics and three depressions.3 His family’s fortune dwindled after his father’s death when Ben was nine; his worldly, ambitious mother lost most of her own small stake in the stock-market panic of 1907, and she wound up having to pawn her jewelry. One of Graham’s earliest memories was standing at a bank teller window, trying to cash his mother’s check as the teller audibly asked a colleague whether Mrs. Grossbaum was good for five dollars. During this time, Graham recalled, the family was saved through the charity of relatives “from misery, though not from humiliation.”4
Nonetheless, Ben excelled throughout his education in the New York City public schools, where he read Victor Hugo in French, Goethe in German, Homer in Greek, and Virgil in Latin. Upon graduation, he wanted to attend Columbia University but needed financial aid. When the scholarship examiner visited the Grossbaums, he turned Ben down. Ben’s mother was convinced that he did so because the family still clung to a few Louis XVI chairs and some other fine pieces of furniture, despite its reduced circumstances. Ben, however, was sure the examiner had detected a “secret deformity” in his soul: “For years I had been struggling against something the French call mauvaises habitudes [bad habits, a euphemism for masturbation], and which a combination of innate puritanism on my part and the hair-raising health tracts prevalent in those days had raised to a moral and physical issue of enormous proportions.”5
Graham and his bad habits wound up at tuition-free City College, bereft and broke, convinced that a degree from this school would not advance him in the snobbish, cultivated world to which he aspired. The last straw came when two borrowed books were stolen from his locker and he had to pay to replace them. He had no pocket money at all. He dropped out, got a job assembling doorbells, and recited the Aeneid and the Rubáiyát to himself as he worked. Eventually, he reapplied to Columbia and this time was given the scholarship that had earlier been denied him—through a clerical error, it turned out. At Columbia, he became an academic star, even while working at a variety of menial jobs to help pay his expenses. Checking waybills, he would mentally compose sonnets for distraction. On graduation, he turned down a scholarship to law school as well as offers from three different departments—to teach philosophy, mathematics, and English—in order to follow his dean’s advice and go into the advertising business.6
Graham’s sense of humor always tended toward irony. His first effort at writing a jingle for the nonflammable cleaning fluid Carbona was rejected as too frightening to customers when he produced this limerick:
There was a young girl from Winona
Who never had heard of Carbona
She started to clean
With a can of benzene
And now her poor parents bemoan her.
After this episode, Columbia’s Dean Keppel recommended Graham for a job at the brokerage house Newburger, Henderson & Loeb. Graham said of Wall Street, “I knew it only by hearsay and in novels as a place of drama and excitement. I felt the urge to participate in its mysterious rituals and momentous events.”
He started in 1914 on the bottom rung of the Wall Street ladder, earning $12 a week as a runner. Then he worked as an assistant board boy, scurrying to and fro in a customer’s room, changing stock prices on a chalkboard. Graham parlayed these jobs into a career through a classic Wall Street maneuver: He did research on the side, until one day a floor broker gave a report he had written—negatively appraising the bonds of the Missouri Pacific Railroad—to a partner at Bache & Company, which hired him as a statistician.7 Later, he returned to Newburger, Henderson & Loeb as a partner, where he remained until 1923. Then, a group of financial backers, including members of the Rosenwald family (early partners in Sears), lured him away by providing him with starting capital of $250,000, which enabled him to go out on his own.
Graham closed this business in 1925 when he and his backers disagreed over his compensation, and established the “Benjamin Graham Joint Account” on January 1, 1926, with $450,000 from clients and his own money. Shortly afterward, Jerome Newman, the brother of one of his clients, offered to make an investment in the firm and join Graham as a partner at no salary until he learned the business and added value. Graham, however, insisted on paying him, modestly at first, and Newman brought to the partnership a broad general knowledge of business as well as management skills.
In 1932, Graham wrote a series of articles in Forbes, “Is American Business Worth More Dead Than Alive?” i
n which he chastised company managements for sitting on troves of cash and investments, and investors for overlooking this value, which was not reflected in the prices of stocks. Graham knew how to dislodge the value, but his problem was capital. Through its stock-market losses, the firm’s account was down from $2.5 million to $375,000.*13 Graham felt responsible for recouping his partners’ losses, but that meant he would have to more than triple their money. It would take some doing even to keep the Joint Account alive. Jerry Newman’s father-in-law saved it by putting in $50,000. And by December 1935, Graham did triple the money, and earned the losses back.
For tax reasons, in 1936 Graham and Newman reorganized the Joint Account into two businesses—Graham-Newman Corporation, and Newman & Graham.8 Graham-Newman charged a fixed fee and had issued shares to the public which now traded on an exchange. Newman & Graham was a “hedge fund,” or private partnership with a limited number of sophisticated partners, that paid Graham and Newman based on their performance as managers.
The two men remained partners for thirty years, although in his memoir, Graham cited Jerry Newman’s “lack of amiability,” his demanding, impatient, and fault-finding personality, and his inclination to be “too tough” in negotiation. Newman, said Graham, was “far from popular, even among his friends, of whom he had many,” and “had numerous quarrels with close associates,” which he always made up in the end. He and Graham got along because of Graham’s protective coating; other people’s behavior never seemed to disturb Graham’s equanimity.
The one exception to this was Graham’s penchant for taking on established business figures in a fight. Through diligent research digging through a report published by the Interstate Commerce Commission, he had discovered that Northern Pipeline, an oil transmission company whose stock sold for $65, owned railroad bonds worth $95 per share in addition to its pipeline assets. However, the Rockefeller Foundation, which controlled the stock, was doing nothing to release the value of the railroad bonds to shareholders. The stock traded at a depressed price that did not reflect the value of the bonds, so Graham began quietly accumulating shares until his firm became the largest owner after the Rockefeller Foundation. Then he pushed for the bonds to be distributed to the shareholders. Northern Pipeline’s management, who had come from Standard Oil when it was broken up in 1911, gave him a runaround. It said the company needed to keep the bonds in order to be able to pay for replacing the aging pipeline someday. But Graham knew better. Finally, the managers simply said: Running a pipeline is a very complex and specialized business, about which you know very little but which we have done for a lifetime. If you don’t agree with our policies, why don’t you just sell your shares?
But Graham viewed his role as serving all the company’s investors, not just himself, and instead of selling, he went down to the shareholders’ meeting in remote Oil City, Pennsylvania, where he was the only person who attended other than company employees. He made a motion about the railroad bonds, but the management refused to recognize him because he had brought no one along to second the motion. In its dealings with him, the management also made what he felt were some anti-Semitic innuendos, which hardly inclined him to give up the fight. Over the next year, he bought additional shares, teamed up with other investors, and prepared to mount a legal battle with management—a proxy fight. By the time of the next shareholders’ meeting, he had assembled enough votes to get two additional directors elected to the board, which tilted the balance in favor of distributing the bonds. The company submitted and ended up handing out the equivalent of $110 per share in cash and stock to its shareholders.
The battle became a famous incident on Wall Street, and Graham went on to build the Graham-Newman Corporation into one of the best-known, although far from the largest, investment firms in the business.
He did it even while inflicting a handicap on his own performance. His teaching style used examples taken directly from Graham-Newman’s office. Every time he mentioned a stock in the classroom, the students ran out and bought it, pushing up the price and making it more expensive for Graham-Newman to buy. This drove Jerry Newman crazy. Why make the firm’s job harder by letting other people in on what they were doing? To make money on Wall Street meant keeping your ideas to yourself. But, as Buffett said, “Ben didn’t really care how much money he had. He wanted to have enough, and he went through that period in ’29 to ’33 that was very rough. But if he had as much money as he felt he needed, anything else was totally immaterial to him.”
Over the twenty-year life of Graham-Newman Corporation, its performance had beaten the stock market’s performance by an average of 2.5 percent a year—a record exceeded by only a handful of people in the history of Wall Street. That percent might sound trifling, but compounded for two decades, it meant that an investor in Graham-Newman wound up with almost sixty-five percent more in his pocket than someone who earned the market’s average result. Much more important, Graham had achieved this superior performance while taking considerably less risk than someone who simply invested in the stock market as a whole.
And Graham did it mainly through his skill at analyzing numbers. Before him, assessments of a security’s value were largely guesswork. Graham developed the first thorough, systematic way of analyzing the value of a stock. He preferred to work by studying only publicly available information—usually a company’s financial statements—and rarely attended even public meetings with a company’s management.9 Although his associate Walter Schloss had been at the Marshall-Wells meeting, it was his own idea to go, not Graham’s.
Ben’s third wife, Estey, drove her husband up to Columbia from the Graham-Newman Corporation’s office at 55 Wall Street every Thursday afternoon after the market closed to teach his “seminar on common stock valuation.” This course was the culmination of the Columbia finance curriculum, so highly regarded that men who were already working in money management signed up for it, sometimes more than once.
Warren, of course, looked up to Graham with worshipful awe. He had read the Northern Pipeline story over and over when he was ten years old, well before he understood who Benjamin Graham was in the investing world. Now he hoped to bond with his teacher. But outside the classroom, he and Ben had few hobbies in common. Graham dabbled in the arts and sciences in a quest for knowledge, writing poetry, failing spectacularly as a Broadway playwright, and puttering around filling notebooks with ideas for clumsy inventions. He also devoted himself to ballroom dancing, clumping around for years at the Arthur Murray studio, where he danced like a wooden soldier and counted the steps out loud. During dinner parties, Graham often disappeared in the middle of a course to work on mathematical formulas, read Proust (in French), or listen to the opera in solitude, rather than suffer the dull company of his fellow man.10 “I remember the things I learn,” he wrote in his memoir, “rather than the things I live.” The one exception where living took precedence over learning was his assignations.
About the only way a human being competed with the classic authors for Graham’s attention was to be female and beddable. He was short and physically unimposing, but people had told him that his sensual full lips and penetrating blue eyes reminded them of the actor Edward G. Robinson.11 There was something elfish-looking about him, and he was not a handsome man. Nonetheless, Graham seemed to be a Mount Everest for women who liked a challenge: they met him and wanted to climb on top.
In his three wives, Graham’s taste had ranged wide: from the passionate, strong-willed teacher Hazel Mazur to Broadway showgirl Carol Wade—eighteen years his junior—to his third wife and former secretary, the intelligent, lighthearted Estelle “Estey” Messing. Complicating all these marriages was his complete indifference to monogamy. Graham later wrote a memoir12 in which he begins, “Let me describe my first extramarital affair in the soberest fashion,” a sobriety he giddily abandons six sentences later as he explains the recipe for his liaison with the sharp-tongued, “by no means beautiful” Jenny: “one part attraction and four parts opportunity.�
�� If more attraction was present, he needed less opportunity, making him shameless, even annoying, in his sexual advances toward women he found attractive. Combining two of his hobbies, Graham might dash off a seductive little poem to a woman he fancied on the subway. Yet he was so cerebral that, even for his lovers, it must have been a challenge to hold his attention. The darting from amour to business in the following passage of the memoir is pure Graham:13
I have a sentimental memory of the last hour we spent together in the cabin of her Ward Line steamer. (Little did I think then that my firm was later to control that old-established steamship company.)
He drove his wives to distraction with his philandering. But Warren at the time knew nothing about Graham’s personal life and was focused only on what he could learn from the brilliant teacher. On the first day of Graham’s seminar in January 1951, Warren walked into a smallish classroom containing a long rectangular table. In the middle sat Graham, surrounded by eighteen or twenty men. Most of the other students were older, some of them war veterans. Half were not Columbia students but businessmen who were auditing the course. Once again, Warren was the youngest—yet also the most knowledgeable. When Graham asked a question, inevitably he “would be the first one to have his hand up and immediately start talking,” recalls one of his classmates, Jack Alexander.14 The rest of the class became the audience to a duet.
In 1951, many American businesses were still worth more dead than alive. Graham encouraged his students to use real-life examples from the stock market to illustrate this, down-and-dirty companies such as Greif Bros. Cooperage, a barrel maker whose stock Warren owned. Its main business was slowly disappearing but whose stock was trading at a substantial discount to the cash that could be netted if its properties and inventory were simply sold off and its debts repaid. Eventually, Graham reasoned, that “intrinsic” value would surface the way a river-tossed barrel, trapped under winter ice, pops to the surface in a spring thaw. You had only to interpret the balance sheet, decoding the numbers that proved there was a barrel of money trapped under the ice.
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