Even The Most Intelligent Investors Succumb To Human Frailty – Including Ben Graham

Even The Most Intelligent Investors Succumb To Human Frailty – Including Ben Graham

I’ve just finished a great little book called – Benjamin Graham: The Memoirs of the Dean of Wall Street. It’s a fantastic read about the father of value investing, Ben Graham. While a lot has been written about the investing insights of Graham it was interesting to read the following passage which illustrates that even he was not immune to one of the greatest enemies of investors – Greed.

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Here’s an excerpt from the book:

It’s not undue modesty to say that I had become something of a smart cookie in my particular field. Still, I was capable of doing some foolish things in other areas of Wall Street. One day, when I was chatting with Barnard Powers about an article for The Magazine of Wall Street, he told me he was thinking of retiring soon, as he had just made a killing in a stock called Ertel Oil.

A close friend had invited him in on ground floor. He had been part of the original group which had bought the shares at $3. A few days later trading had begun the Curb Market at $10. The syndicate manager had sold out all the participants’ stock at this figure, and Powers had just received a large check as his share of the profit. I was unduly impressed by this story and may have uttered some words of envy.

Powers good-naturedly offered to let me in on the next deal of this sort, if there was room for my money. Sure enough, another and apparently promising deal did come along soon afterwards, and a limited participation was available. A new company had been formed, called Savold Tire, which had a patented process for retreading automobile tires. Retreading was then a new idea, and was especially attractive because of the relatively high price of tires.

The subscription price of the shares was to be $10, and they were expected to open on the New York Curb at a much higher figure. I think I put up $5,000. As by clockwork or magic, a few days later trading began in the shares at 35, amid considerable excitement.

Before the week was out, I had received a check for some $15,000 in return for my $5,000. In spite of my innate conservatism and commonsense understanding that operations of this kind were essentially phoney, cupidity ruled me. I eagerly sought other deals of this kind, and so did a few friends to whom I had communicated the glad tidings.

The price of Savold Tire kept advancing. A large electric sign quickly appeared on Columbus Circle, which first flashed “SAVE,” then flashed “OLD,” and then deftly combined the two words into “SAVOLD.” Soon I heard some exhilarating news. The parent company had decided to license its process to affiliated companies in the various states, and these companies, too, would have shares on the market.

Barnard Powers promised to put my money in along with his own. Action came fast. Four weeks after the original Savold made its appearance, the second company—New York Savold Tire—was organized, and we invested something like $20,000 in the syndicate.

Our subscription price was $15 or $20 a share. The stock opened on the Curb at 50, and on sales of 96,000 shares advanced immediately to a high of 60. This was the week of May 10, 1919; I celebrated my twenty-fifth birthday in a blaze of excitement. Promptly I received a fat check for our contribution plus some 150 percent in profits. (No accounting came with the check, and we wouldn’t have dreamed of asking for one.)

When I announced their share to each of my friends, they all told me to keep their money for them and be sure to put it all in the next deal. After all, there were forty-eight states in the union, weren’t there?

Disappointment was in store for us. A third company—Ohio Savold—was duly floated in June, but it was a relatively small affair; we were told that there was no room for our money in that one. It came out on the Curb at 28, advanced the next month to 34, but did not imitate the pyrotechnics of the two previous companies. Nevertheless, we were worried. Was our wonderful party at an end? Powers reassured us. A very large deal was cooking, and we would positively be taken into it. But this company—Pennsylvania Savold—was to be the last of the series. It would have production rights for the whole country except New York and Ohio.

Management had decided that more than four Savold companies would be cumbersome and confusing. We neither understood nor approved of this restraint, but we prepared to profit to the hilt from our last gorgeous opportunity.

When funds were called for, I sent over some $60,000, half of which was contributed by three wealthy young brothers named Hyman. Maxwell Hyman had been an old schoolmate, friend, and customer. (Once, when we were still bachelors, we had teamed up to win a tennis-doubles tournament at a weekend party at the large summer home of four sisters named Jacobs.)

In August 1919, the world was harassed by a host of problems growing out of the collapse of Germany. But in Wall Street the market continued a headlong advance, especially in stocks of the poorest quality and the rankest speculative flavor. The original Savold was active and strong. In fact, at the beginning of the month it soared to 773/4 but fell back immediately to 53 in the same week. We waited impatiently for Pennsylvania Savold to make its spectacular debut, smacking our lips over our impending killing.

The promised day arrived, but trading didn’t begin. There was a “slight delay” for reasons explained neither then nor later. Suddenly all the Savold issues were acting very badly; we wondered what was wrong. Came September and still no trading in our stock. Suddenly a complete debacle occurred in the Savold markets. The parent issue fell to 12½! A few more trades, and then the coup de grâce was announced: “No bid for any of the Savold issues.” After October 4 all three companies disappeared completely from the records—as if they had never existed.

I had many conferences with Barnard Powers, who had invested most of his own money, and that of his friends, in Savold. He told me that the arch-promoter who had managed all these flotations had diverted our money to other uses. We could put him in jail, but that wouldn’t do us any good. Powers and I formed a committee to represent his victims, and we visited him in his office close to the Curb. I still remember the beautiful blue shirt and expensive cuff links he wore at our meeting.

Powers did all the talking, except once. That was when the promoter asked me if I would like to have a very low number for my automobile license. He could get one for me, since he was a close friend of New York Secretary of State Hugo. I declined with cold thanks.

The upshot was that the promoter turned over about 10 percent of our contributions in cash and certificates for shares of companies he had been promoting. In one way or another we managed to sell some of these, and finally returned about 33 cents on the dollar to our respective groups.

What happened to the Savold companies themselves? I never really knew. Presumably they went into bankruptcy—if they ever really existed. There is no trace of any of them in the financial manuals of the following year. All that we as so-called insiders ever knew about those enterprises was the (supposed) nature of their business and the number of shares alleged to be outstanding. This information appeared in a flimsy “descriptive circular” of unknown origin.

Yet, gullible as we were, we had felt highly privileged to put our money in this manipulative scheme, relying on a speculative public even greedier and more foolish to pay us a huge profit. In the six months between April and September 1919, thousands of shares of the three companies changed hands on the Curb, in trades involving millions of real people’s real dollars. But as far as I know, the only thing real about Savold Tire itself was the electric sign at Columbus Square which bore its name.

Also, as far as I know, nobody complained to the district attorney’s office about the promoter’s bare-faced theft of the public’s money.

Article by Johnny Hopkins, The Acquirer's Multiple

The Acquirer’s Multiple® is the valuation ratio used to find attractive takeover candidates. It examines several financial statement items that other multiples like the price-to-earnings ratio do not, including debt, preferred stock, and minority interests; and interest, tax, depreciation, amortization. The Acquirer’s Multiple® is calculated as follows: Enterprise Value / Operating Earnings* It is based on the investment strategy described in the book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, written by Tobias Carlisle, founder of acquirersmultiple.com. The Acquirer’s Multiple® differs from The Magic Formula® Earnings Yield because The Acquirer’s Multiple® uses operating earnings in place of EBIT. Operating earnings is constructed from the top of the income statement down, where EBIT is constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–earnings that a company does not expect to recur in future years–ensures that these earnings are related only to operations. Similarly, The Acquirer’s Multiple® differs from the ordinary enterprise multiple because it uses operating earnings in place of EBITDA, which is also constructed from the bottom up. Tobias Carlisle is also the Chief Investment Officer of Carbon Beach Asset Management LLC. He's best known as the author of the well regarded Deep Value website Greenbackd, the book Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014, Wiley Finance), and Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012, Wiley Finance). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law. Articles written for Seeking Alpha are provided by the team of analysts at acquirersmultiple.com, home of The Acquirer's Multiple Deep Value Stock Screener. All metrics use trailing twelve month or most recent quarter data. * The screener uses the CRSP/Compustat merged database “OIADP” line item defined as “Operating Income After Depreciation.”
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