Examining Benjamin Graham’s Record: Skill Or Luck?

http://greenbackd.com/2013/01/09/examining-benjamin-grahams-record-skill-or-luck/

Two recent articles, Was Benjamin Graham Skillful or Lucky? (WSJ), and Ben Graham’s 60-Year-Old Strategy Still Winning Big (Forbes), have thrown the spotlight back on Benjamin Graham’s investment strategy and his record. In the context of Michael Mauboussin’s new book The Success Equation, Jason Zweig asks in his WSJ Total Return column whether Graham was lucky or skillful, noting that Graham admitted he had his fair share of luck:

We tend to think of the greatest investors – say, Peter Lynch, George Soros, John Templeton, Warren Buffett, Benjamin Graham – as being mostly or entirely skillful.

Graham, of course, was the founder of security analysis as a profession, Buffett’s professor and first boss, and the author of the classic book The Intelligent Investor. He is universally regarded as one of the best investors of the 20th century.

But Graham, who outperformed the stock market by an annual average of at least 2.5 percentage points for more than two decades, coyly admitted that much of his remarkable track record may have been due to luck.

John Reese, in his Forbes’ Intelligent Investing column, notes that Graham’s Defensive Investor strategy has continued to outpace the market over the last decade:

Known as the “Father of Value Investing”—and the mentor of Warren Buffett—Graham’s investment firm posted annualized returns of about 20% from 1936 to 1956, far outpacing the 12.2% average return for the broader market over that time.

But the success of Graham’s approach goes far beyond even that lengthy period. For nearly a decade, I have been tracking a portfolio of stocks picked using my Graham-inspired Guru Strategy, which is based on the “Defensive Investor” criteria that Graham laid out in his 1949 classic, The Intelligent Investor. And, since its inception, the portfolio has returned 224.3% (13.3% annualized) vs. 43.0% (3.9% annualized) for the S&P 500.

Even with all of the fiscal cliff and European debt drama in 2012, the Graham-based portfolio has had a particularly good year. While the S&P 500 has notched a solid 13.7% gain (all performance figures through Dec. 17), the Graham portfolio is up more than twice that, gaining 28.5%.

Reese’s experiment might suggest that Graham is more skillful than lucky.

In our recently released book, Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, Wes and I examine one of Graham’s simple strategies in the period after he described it to the present day. Graham gave an interview to the Financial Analysts Journal in 1976, some 40 year after the publication of Security Analysis. He was asked whether he still selected stocks by carefully studying individual issues, and responded:

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.

Instead, Graham proposed a highly simplified approach that relied for its results on the performance of the portfolio as a whole rather than on the selection of individual issues. Graham believed that such an approach “[combined] the three virtues of sound logic, simplicity of application, and an extraordinarily good performance record.”

Graham said of his simplified value investment strategy:

What’s needed is, first, a definite rule for purchasing which indicates a priori that you’re acquiring stocks for less than they’re worth. Second, you have to operate with a large enough number of stocks to make the approach effective. And finally you need a very definite guideline for selling.

What did Graham believe was the simplest way to select value stocks? He recommended that an investor create a portfolio of a minimum of 30 stocksmeeting specific price-to-earnings criteria (below 10) and specific debt-to-equity criteria (below 50 percent) to give the “best odds statistically,” and thenhold those stocks until they had returned 50 percent, or, if a stock hadn’t met that return objective by the “end of the second calendar year from the time of purchase, sell it regardless of price.”

Graham said that his research suggested that this formula returned approximately 15 percent per year over the preceding 50 years. He cautioned, however, that an investor should not expect 15 percent every year. The minimum period of time to determine the likely performance of the strategy was five years.

Graham’s simple strategy sounds almost too good to be true. Sure, this approach worked in the 50 years prior to 1976, but how has it performed in the age of the personal computer and the Internet, where computing power is a commodity, and access to comprehensive financial information is as close as the browser? We decided to find out. Like Graham, Wes and I used a price-to-earnings ratio cutoff of 10, and we included only stocks with a debt-to-equity ratio of less than 50 percent. We also apply his trading rules, selling a stock if it returned 50 percent or had been held in the portfolio for two years.

Figure 1.2 below taken from our book shows the cumulative performance of Graham’s simple value strategy plotted against the performance of the S&P 500 for the period 1976 to 2011:

Amazingly, Graham’s simple value strategy has continued to outperform.

Table 1.2 presents the results from our study of the simple Graham value strategy:

Graham’s strategy turns $100 invested on January 1, 1976, into $36,354 by December 31, 2011, which represents an average yearly compound rate of return of 17.80 percent—outperforming even Graham’s estimate of approximately 15 percent per year. This compares favorably with the performance of the S&P 500 over the same period, which would have turned $100 invested on January 1, 1976, into $4,351 by December 31, 2011, an average yearly compound rate of return of 11.05 percent. The performance of the Graham strategy is attended by very high volatility, 23.92 percent versus 15.40 percent for the total return on the S&P 500.

The evidence suggests that Graham’s simplified approach to value investment continues to outperform the market. I think it’s a reasonable argument for skill on the part of Graham.

It’s useful to consider why Graham’s simple strategy continues to outperform. At a superficial level, it’s clear that some proxy for price—like a P/E ratio below 10—combined with some proxy for quality—like a debt-to-equity ratio below 50 percent—is predictive of future returns. But is something else at work here that might provide us with a deeper understanding of the reasons for the strategy’s success? Is there some other reason for its outperformance beyond simple awareness of the strategy? We think so.

Graham’s simple value strategy has concrete rules that have been applied consistently in our study. Even through the years when the strategy underperformed the market  our study assumed that we continued to apply it, regardless of how discouraged or scared we might have felt had we actually used it during the periods when it underperformed the market. Is it possible that the very consistency of the strategy is an important reason for its success? We believe so. A value investment strategy might provide an edge, but some other element is required to fully exploit that advantage.

Warren Buffett and Charlie Munger believe that the missing ingredient is temperament. Says Buffett, “Success in investing doesn’t correlate with IQ once you’re above the level of 125. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

Was Graham skillful or lucky? Yes. Does the fact that he was lucky detract from his extraordinary skill? No because he purposefully concentrated on the undervalued tranch of stocks that provide asymmetric outcomes: good luck in the fortunes of his holdings helped his portfolio disproportionately on the upside, and bad luck didn’t hurt his portfolio much on the downside. That, in my opinion, is strong evidence of skill.

Who are the Five Best Financial Bloggers? - Joshua M Brown

Who are the Five Best Financial Bloggers?

• Joshua M Brown

A kid in college emailed this to me over the weekend:

Hey JB,
I'm a big fan of the blog, I told everyone in my finance courses to start reading it. Anyway, I'm double-majoring and barely have time to read things that aren't part of my coursework but I want to make sure I have the pulse of the markets too, was hoping you could help me narrow down my daily reading to the best five or so financial bloggers.

Thx and also I disagree with you on Grizzly Bear, they're genius and you just are out of touch maybe.

He asked that I not use his name for this public response so let's just call him Dick. As in Dick who thinks Grizzly Bear is a cool band even though they clearly make sad bastard music and their core fan base is Brooklyn hipsters pretending to like them so they can act all superior to everyone else.

Anyway, here's my answer to Dick's query:

Hi Dick,

The best five bloggers in finance are the guys who are consistent and smart and well-rounded enough that they could serve as your only daily read and you would be totally up to speed. In my opinion, the best five financial bloggers at the moment (of the hundreds I know of) are:

(no particular order)

1. Joe Weisenthal (Business Insider)

2. Tadas Viskanta (Abnormal Returns)

3. Cullen Roche (Pragmatic Capitalism)

4. Felix Salmon (Reuters)

5. Barry Ritholtz (The Big Picture)

There are hundreds of good financial bloggers and dozens of great financial bloggers (I hope that I myself belong to one of those groups) but these five are the best.

The bloggers in the above list, if you could only follow their posts and the things they link to, would give you everything you'd need on a daily basis. If you could follow all five, you'd probably be more well-versed about the economy and markets than 99% of the investing public.

Joe and Tadas were no-brainer choices. There's almost nothing important that escapes Tadas six days week and on the seventh day he does not rest - he posts a killer long-reads general interest linkfest of all the stuff he's saved for you. The dedication and work ethic on display at AR just blows my mind, he's like a machine that makes you a smarter investor and asks nothing in return.

As far as Joe, there's no one faster on the web as news breaks - and not just fast with the headline but with the context you need to process what's happening. He has also led the charge in the democratization of Wall Street research. You take it for granted that there's a guy ripping 20-page big firm research reports off a Bloomberg and delivering you just the filet mignon portion, cut away from the bone and fat and gristle. All day long. Anyone else offering you that for free? It's insane.

A year or so ago Cullen was still anonymously updating PragCap each day, but I'm really glad he came out of his shell because the man really deserves credit for what I consider to be some of the strongest, most high quality market writing on the web. He is immune to political influence in his outlook and unafraid to bash an economic meme into tiny bits if it offends his sensibilities. It was tough to choose between Cullen and Bill McBride at Calculated Risk for this slot, to be honest, but Cullen wins as a function of utility - Bill's blog has the intel, but Cullen's has the reasons for why that intel may or may not matter.

Choosing Felix was tough - not because he's not great (he is) - but because there are so many other journalists from the mainstream media who also blog that could be in that slot too (Mark Gongloff at HuffPo, Steven Russolillo at WSJ MarketBeat. everyone at FT Alphaville, etc). But Felix is terrific, just the right mixture of wonkiness, acerbity and skepticism. And a great nose for interesting stories and the right angles to cover them from.

As for Barry, let me simply mention that he was blogging finance before there was a such thing as a blog - in 1998, he'd spend an hour writing a post and then an hour coding it on Geocities. He gave us a running record of the dot com boom/bust. Then he blogged 9/11 from a trading desk in real-time. After that, a live accounting of the entire credit boom, credit crash and market comeback as it happened while concurrently writing the definitive book on bailouts and bank excess. How many bloggers have been through all of that over so much time (over 20,000 posts) and have remained relevant? I can't think of even one other, can you?

So that's my list. And then the next phase would be to follow the blogs that these guys read into the specialized areas you're interested in: Meb Faber or Erik Falkenstein for quantitative research, Market Folly for a window into what the pros are buying, JC Parets and Chess and Greg Harmon for trading ideas and perspective, Tom Brakke, David Merkel and Bob Seawright for investment process, Bess and Matt at Dealbreaker for hedge fund scoops and i-bank gossip, Tyler Durden for the reality checks etc etc etc.

Following the right bloggers is a hack, a time saver. The "news" itself is cheap, repetitive and mostly useless - it's the interpretation of this news that we rely on blogs for. If I were limited to checking just one blogger each day, any of these five would do the trick.

Good luck in school and stop listening to weepy, obtuse indie rock before your roommate steals your chick, bro.

- Downtown

http://www.thereformedbroker.com/2012/10/09/who-are-the-five-best-financial-bloggers/ 

HUL's Nitin Paranjpe: How to Make Friends and Win

HUL's Nitin Paranjpe: How to Make Friends and Win

HUL’s Nitin Paranjpe is rewiring his organisation for the digital marketing era. And he’s leading from the front

Award: Best CEO MNC
Name: Nitin Paranjpe, CEO, HUL
Age: 49
Why He Won: For resurrecting HUL’s position as a premium multinational, after almost a decade in the wilderness. And for bringing the focus back on execution and profitable growth with a significant expansion of its distribution system.


When I met Nitin Paranjpe early in December last year, he very clinically dissected the difference between a successful entrepreneur and a manager. He told me, “The only difference is the relationship between ambition and resources.” 

It was something, he said, that was drilled into his head by legendary management thinker CK Prahalad, who was brought in by the board in 1999 to mentor a few people destined for larger roles at Hindustan Unilever (HUL). “Managers,” Paranjpe learnt from Prahalad, “have a mindset... where ambition (A) equals resources (R), a steady state condition. There are no entrepreneurs who start off believing A=R. They have virtually no resources, but dream big.”

To understand how the insight Prahalad offered played out during the course of Paranjpe’s career, it is important to put a few numbers into perspective. Since the time he took over as CEO four years ago, sales jumped 45 percent to Rs 22,800 crore; growth in profits averaged an eye-popping 25 percent; the company’s market capitalisation zoomed 60 percent to over Rs 1.14 lakh crore; and in January this year, the Nielsen Campus Track reported HUL had reclaimed its spot as the most preferred employer among B-School grads.

Compare this to what things were like when Paranjpe was offered the corner office four years ago. He was 44 then and the youngest chief executive HUL ever had. Growth in sales and profits were stagnant. Its stock had stayed around Rs 200 for eight years. The company had lost its position as the recruiter of choice at premier B-Schools. For an entity that once used to be known as the training ground for future CEOs in the country, this was as humiliating as it could get. 

After architecting a now well-documented and dramatic turnaround, it is easy therefore to imagine a smug 49-year-old man on the lecture circuit telling people how things ought to be done. What you have instead is a man back to school. Why? Because by his own admission, he couldn’t understand the brave new world his children inhabit. What the hell are they doing spending all their time on social networking sites like Facebook and Twitter? In any case, what are these places all about?

As he looked around, he realised his kids aren’t the only ones who live in this world. There are 121 million internet users in the country—the third largest user base in the world. Not surprisingly, their media consumption patterns are changing dramatically. It is only a matter of time, he figured, before their numbers overtake that of those who consume media on print and television. If that be true, he argued, HUL would have to work at moulding itself as the largest digital marketing firm in the country.

“Most people say we either need to do short-term or long-term. I say we have to run the business with a bifocal lens. Part of it is looking at this week, this month and this quarter and the other part is how do I shape this business and make it ‘future-proof’ five years from today. Both have to be done,” he argues.

While dealing with the short term part of the business is now easy for him, it is the long term he was beginning to get paranoid about. If HUL had to maintain the lead he had managed to create in his four years at the helm, both the company and he would have to change. “At a consumer goods company, if the consumer is moving in a certain direction, how can the head of the company say he doesn’t get it?” he asks rhetorically. 

So, he got himself a ‘reverse mentor’. A young 25-year-old at the firm was put in charge of tutoring the CEO on how to navigate the social media. How do you tag a person on Facebook? How do you write on somebody’s wall? How do you tweet? Most people at his level lead seminars. But he figured if he had to participate in the world his children were now a part of, he’d have to “go back to school” and attend digital workshops led by his brand managers, read the materials they insisted he read, and submit assignments they asked him to complete. When we last checked, he had 251 friends on Facebook; on Twitter though, he remains a passive participant.

Even as he embarked on this personal exercise, he initiated discussions with the management committee, an eight-member body that runs the day-to-day affairs of the company. At these meetings, he communicated how paranoid he was that HUL maintains its lead in the market place.

Marketing Director Hemant Bakshi says Paranjpe was clear the strategies that helped them win so far may not necessarily be what will help them win tomorrow. “Because the skills and capabilities with which I grew up as a marketer are dramatically different from the skills and capabilities needed in the future,” Paranjpe explained.

These arguments eventually won over the other members on the committee. Some chose the path of reverse mentoring like Paranjpe; others struck out on their own. On his part, Paranjpe reckoned it was time he dived headlong into uncharted waters. He moved on to plan his own online advertising campaigns, allocating budgets for them and seeing how the efficacy of such ads among audiences is measured. That, in a nutshell, is how HUL got into the digital marketing journey.

That done, he got into an agreement with Google to train the 100 senior most managers at HUL in the ways of the digital world by the end of this year. ‘Digitally certified’ is what they’re called. Eventually, he wants every employee in the company to be digitally certified. Says Leena Nair, executive director, human resources, “You may question why somebody in the supply chain needs to be digitally certified. But Nitin was clear that every employee in the firm has to be.”

For now though, the company is working hard at learning the new rules of this medium. The hardest one to absorb is that advertising cannot be intrusive and interruptive the way television advertising is. Instead it has to engage and integrate with whatever the customer is doing at any given moment. For instance, pop up ads on web pages are intrusive and drive people away. 

“So, all the work we are doing on digital—the certification process, the reverse mentoring—is to say this is a new medium and until we get educated in its ways, we won’t be able to create interesting options for our consumers,” says Bakshi.

Advertising agencies have been roped in as well to help navigate this landscape because nobody knows which way it is headed. 

All of the work the team at HUL is putting in is generating new lessons for their marketing teams. To cite just one instance, they quickly figured that the rules of engaging with consumers on the internet and mobile phones are very different from the worlds they grew up in. But there was a paradox.
While the younger employees understood this world, the purse strings were controlled by older people who were not always on the same wavelength. Simply put, the bosses lacked the judgement to decide if allocating resources to digital media would be wise.

That is also the reason why HUL’s marketing department is going deeper to understand what works in this world. On his part, Bakshi has set aside a corpus of Rs 10 crore as a ‘Digital Experimentation Fund’. 

The aim is to encourage employees to come up with interesting ideas. If it passes scrutiny, money from this corpus will be used to fund the idea and figure out if it works. “If you have to fail, fail early, before it becomes too expensive. If you have to fail and not make the same mistake again, then the failure is well worth it. But we don’t encourage failure. I encourage winning,” says Paranjpe. The first sets of pitches are expected to come in later this month. Every year, Paranjpe intends to double the resources allocated for projects like these. “It doesn’t matter how much it costs. This company can afford it,” he says.

The seeds to this corpus were planted when the senior team at HUL lent an ear to an unlikely quarter. Sometime last year a brand manager at Wheel, a detergent powder brand in the company’s portfolio, proposed what came to be known within the company as the ‘missed call’ campaign. The manager had observed that many Indians avoid placing a call on their cellphones because it cost them money. Instead, they place a call to the person they intend to speak to and hang up before the call is received. Inevitably, they would get called back. What if, the brand manager suggested, all sachets of Wheel had a message printed on them: “Missed call dijiye, muskurate rahiye [Give a missed call and stay smiling].” The message was accompanied by a number.

The idea was that if somebody indeed placed a ‘missed call’, the company would call back and regale the individual with an interesting anecdote that contained a message around the Wheel brand. From a marketer’s perspective, it sounded like an interesting proposition: Permission marketing. The idea was given the go-ahead and the outcome astonished the bosses. In three months, they received 15 million calls.

The numbers reinforced Paranjpe’s belief that digital will cause a tectonic shift in the years to come and he had to be prepared for it. The Rs 100 crore HUL now spends on digital marketing, may look like chump change in the future. (The company has Rs 2,634 crore at its disposal.) 

That said, Paranjpe also knows throwing money at the problem, just because HUL has enough of it, isn’t good enough. “So you either starve resources or create an ambition that is greater than the resources you have on hand. The bigger the gap, the better it is…because there the trick is, you suspend all room for rational dialogue.” 

Which is why, Paranjpe is insisting HUL becomes the biggest and most successful digital marketing company in a world where the rules are still unclear. As ambitions go, it is an incredibly tough one for a consumer marketing company. He knows that in spite of all the resources the firm has in terms of money, the only resource that will matter the most is ingenuity. Ingenuity of that kind cannot be drilled down from the top. Instead, it will have to be stoked from all quarters until everybody goes ballistic and all room for rational dialogue is closed.