What a difference five words make

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Dawkins dates earth, says God created it... Before I bashed the Efficient Markets Hypothesis again last week. I looked it up in what must surely be the ordinary investor’s efficient markets bible, Burton Malkiel’s A Random Walk Down Wall Street. The book is in its ninth edition, and my copy has ‘Over 1 Million Copies Sold’ emblazoned across the top of it. It must have spawned thousands of passive investors. Within it I read something extraordinary: Even the legendary Benjamin Graham, heralded as the father of fundamental security analysis, reluctantly came to the conclusion that fundamental security analysis could no longer be counted on to produce superior investment returns. Shortly before he died in 1976, he was quoted in an interview in the Financial Analysts Journal as saying, "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 Graham and Dodd was first published; but the situation has changed... [Today] I doubt whether such extensive efforts will generate sufficiently superior selections to justify their cost… I'm on the side of the 'efficient market' school of thought." By way of background, the Efficient Market school of thought describes how stockmarkets fluctuate. It proposes that markets adjust instantaneously to new information and therefore it is not possible to profit from, say, analysing a company’s finances. There’s no point in trying to buy a share you think is cheap because before you can place that order, quicker, wiser, better connected investors will have beaten you to it and increased demand for the share will have driven the price up to a reasonable value. Malkiel thinks the hypothesis is true enough to dispense with analysing individual companies. Instead he promotes passive investments like index trackers and exchange traded funds that capitalise on the theory by capturing the market return, the best you can achieve according to the EMH, at the cheapest cost. Today, I’m not going to bash the EMH again. I did it here, and here, and on Graeme Pietersz’s Moneyterms blog here (see the comments). Instead I want to examine Benjamin Graham’s change of heart. He’s a hero of mine, and of many an investor who thinks he can beat the market including Warren Buffet, who probably needs no introduction. Benjamin Graham wrote the textbook on financial analysis, called Security Analysis, which has been continuously in print even longer than Malkiel’s book. Its first edition, published in 1934, predates the Efficient Market Hypothesis by about thirty years. The notion that, towards the end of his life, Graham might have embraced EMH is as unlikely to me as Richard Dawkins proclaiming God created the World in 4004BC on his deathbed. Unfortunately, Janet Lowe’s magnificent anthology of Graham’s writings and interviews, which I keep on my desk with A Random Walk and Security Analysis, doesn’t include the interview Malkiel refers to. But it includes others, published around the same time, in which he describes a very different change of heart. I believe I have found the actual interview, though. From it, I have extracted the complete quote including information that had been replaced in Malkiel’s book with ellipses (...). I’ve marked the bits of the original quote that Malkiel, or his editors, cut in red: 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. “To that very limited extent.” What a difference five words make. All writers, and most readers, and anybody who has been quoted extensively will know how dangerous the ellipsis is. Take certain words out of a quotation and it can change the entire sense. I urge you to read the rest of the interview, because Graham didn’t embrace the EMH or think investors couldn’t beat the market average. It’s true he didn’t think the style of fundamental analysis conducted by professional investors, focused on forecasting future profits, was worth the trouble. But he thought an investor could capture the inefficiencies of the market with a few simple variables, notably the price earnings ratio: We are just finishing a performance study of these approaches over the past half-century--1925-1975. They consistently show results of 15 per cent or better per annum, or twice the record of the DJIA for this long period. I have every confidence in the threefold merit of this general method based on (a) sound logic, (b) simplicity of application, and (c) an excellent supporting record. At bottom it is a technique by which true investors can exploit the recurrent excessive optimism and excessive apprehension of the speculative public. And he thought private individuals, ironically the intended audience of Malkiel’s book, not professionals, were well placed to do it. Graham detailed his technique in an interview published in Medical Economics also in 1976, which I summarised in this blog post: The simplest way to select bargain stocks. - Since I used Graham’s system as a template for the Thrifty 30 model portfolio, I’m keen to put the record straight. Graham thought investors could get a 15% average annual return by screening the market for shares on low PE ratios with sound finances. I use the 10 year PE and Piotroski’s F_Score from the Sharelockholmes database every week to produce this table of Thrifty 30 candidates in the hope it’s of interest to fellow efficient market sceptics: I am going to put the notes explaining the column headings on a special page, but until then they’re at the bottom of this post.


Very good post. This was something I overlooked, and I'm really glad you found it. Now I see how cleverly Graham concealed his true meaning behind a few words. I was slightly disheartened, to say the least, that Graham was skeptical of his own approach. Apparently, keeping in mind the way he adapted to changes, he wasn't, and as can be seen from his various "offspring" his method proved to work.

Good job!

(A private investor, having read Security Analysis 1934, Intelligent Investor and now reading 2008 ed.)

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