Every so often the internet throws up an undiscovered gem from the world of value investing. The latest offering is a selection of articles written by Benjamin Graham in 1919 for the Magazine of Wall Street.
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These articles cover several topics including analysis by Benjamin Graham on several securities, giving us a fascinating insight into the way the Godfather of value investing analyzed securities and how he looked for value.
Q2 hedge fund letters, conference, scoops etc
Today I'm looking at an article Graham wrote called "High Yield and Safe Investments," which considers a selection of investments, stocks, bonds and preference shares for investors looking for yield.
Graham begins his article by acknowledging that the market at the time (towards to end of 1919) offered some great investments for high yield-seeking investors. "This is an excellent opportunity to attack that ancient and deep-rooted misconception -- namely that a high-yield must necessarily signify a greater risk than a low yield," he notes (I should point out that in this scenario a high-yield was considered to be 6%, while low yield is 4%).
The Godfather of value investing then goes on to say that while some issues might come with more risk, the riskiness of each issue should be considered on a case-by-case basis:
"The fact is that whereas ordinarily, a high yield is due to uncertain security, in many particular instances the reason may have no connection with the intrinsic merits of the issue. It is here that the careful investor will find his opportunity and the signs whereby these bargains may be recognized are twofold:
A. Securities safe but unseasoned.
B. Securities safe but affected by investor's prejudice, never or no longer justified."
Benjamin Graham then goes on to recommend a broad selection of selection of securities, including the sovereign debt of Britain and France.
He says that when the United States entered the First World War "two things must have been apparent to every thinking man." Firstly that the "war must be won in the end" and secondly, "as long as the war continued the entire financial resources of the country would stand solidly behind the allies." In this situation, the sovereign debt of Britain and France would, in Graham's opinion, undoubtedly prove to be profitable investments:
"In the long months when the United Kingdom 52s ranged below 90 and the French Municipals sold in the "early eighties," the writer presented these arguments to investors time and time again. Did they dispute his reasoning ? No. But how many took advantage of this extraordinary opportunity? Very, very few. Most of them "did not like foreign bonds"--which meant that the handful of level headed investors who were superior to prejudice were enabled to make a veritable killing."
He then goes on to recommend Virginia-Carolina Chemical:
"Virginia-Carolina Chemical 6% debentures due 1924, also sell at par. Four years of unprecedented prosperity has placed these bonds in the conservative investment class. The issue is small, the equity large, a sinking fund maintains the price, and a conversion privilege into 8% preferred stock at 110 (below the present price) carries prospects of a nice profit."
And a railroad issue, Missouri Pacific:
"In the railroad group, there are not many issues yielding 6% which can stand the acid test of analysis. The Missouri Pacific reorganization has been so skillful and thorough, and the road's recent exhibit so encouraging, that the First and Refunding 5s due 1923 and the Iron Mountain division refunding 4s of 1929 can now be recommended without hesitancy."
The article then moves on to preferred stocks. "Our selection of preferred shares has been arranged in two groups. The first includes the standard seasoned issues, which "in the old days sold around 6%, and which now yield between 6.3% and 6.75%." The second selection is comprised of issues that yield over 7% that "may shock the staid investor. But a careful analysis would demonstrate that every one of these high yields in preferred stocks is well protected by both asset value and earnings power." Graham's highlights three "motor issues" that he believes offered this combination of asset value and earnings power.
"In the same way, the tremendous equities accumulated for the benefit of such stocks as Republic pfd., American Locomotive Pid., and Bethlehem Steel 8% Pfd., in the past three years should carry them safely through a temporary period of depression--if that is in store--and should ultimately be reflected in a permanently increased earnings power behind the senior shares."
The final section of the article is common stocks. Here Graham once again highlights two groups of investments, those for the more conservative investor and those for enterprising investors. Westinghouse falls into the second group. Here's what Graham has to say about the company:
"Westinghouse is in much the same position as General Electric, but belongs rather to the second group because its investment status is of more recent creation. A long article could be written about the transformation wrought in this company's affairs by the prosperity of the war period. With negligible funded debt and preferred stock, with current assets available to liquidate its note issue at maturity, Westinghouse comes into the reconstruction period with practically no charges ahead of its common stock. Its 7% disbursement has been earned with a greater margin than many bond interest requirements, and a plentiful surplus has been set aside to stabilize its dividend policy, should any lean years intervene. Westinghouse like General Electric possesses limitless possibilities, and the stockholder need never fear that the claims of prior issues may at any time endanger his interests."
This originally appeared at ValueWalkPremium.com
