The Intelligent Investor: A Comparison of Four Listed Companies

intelligentThis is the fourteenth in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the thirteenth chapter, which is on pages 330 to 338, and the Jason Zweig commentary, on pages 339 to 346.

Over the past few chapters, Graham finally began to lay out some of the specifics of how to implement his concept of value investing.

It only took him ten chapters to reach the supposed “meat” of the book. I wouldn’t hesitate a bit to speculate that Graham’s “slow start” to the book is the reason many people have a hard time picking it up and going with it – it’s simply a slow starter, especially if you just want to know specifically how Graham values stocks.

But that’s not the point of the book.

What does it say on the front? The Intelligent Investor. That doesn’t mean “The Guy Who Can Price Value Stocks Really Well” – and the fact that many people believe that the two are the one and the same is actually a real problem.

Investing isn’t just about knowing how to evaluate a company properly or how to seek out huge values on Wall Street – that’s only one small part of the bigger picture. Investing is about knowing yourself (how much risk you can tolerate, for one), knowing the people around you, setting goals, defining a broader portfolio than just stocks, and so on.

Here’s the problem – those topics are boring to a lot of people. Yet Graham devoted the first nine or ten chapters of The Intelligent Investor to just these issues.

Graham views these elements as the bedrock of what it means to be an intelligent investor, and that’s why he devoted the first third of his book to it. Those who would skip it or not “waste their time” paying attention to it are missing a key part of Graham’s message.

Chapter 13 – A Comparison of Four Listed Companies
This chapter, however, does focus on evaluating companies in terms of finding ones that offer significant value to the investor. Graham does this by actually running through how he would evaluate four different companies given their situation in early 1972 – ELTRA, Emerson Electric, Emery Air Freight, and Emhart Corp.

What companies? If you looked at those names and shrugged your shoulders, there’s good reason – only Emerson still actually exists as a distinct company and brand. The other three were subject to mergers and buyouts from other firms – ELTRA merged with Bunker Ramo and that operation was eventually purchased by Honeywell, Emery Air Freight is now a part of CNF, and Emhart was bought by Black and Decker. Remember, though, the point here isn’t to point out good stock buys. Graham’s discussion here is about how he would evaluate these companies from his position in early 1972.

Graham walks through all four companies, considering their profitability (he looks at the past decade of results), stability (he looks at their worst year over the past decade), growth (compared over multiple time frames, not just the last year), financial position (they must have $2 in assets for every $1 in debt), dividends (years of dividends paid without interruption), and price history (evaluated over the companies’ entire histories).

Graham concludes a few things here: Emerson and Emery are both overpriced – or at least aren’t value stocks at the moment. He thinks Emerson has better long term potential, but seems fairly gold on buying Emery as a value stock. The other two companies, though, are undervalued, and he believes they would be good buys for a defensive investor.

What exactly constitutes a “good buy”? Graham just begins to touch on that, indicating “seven statistical tests,” but then holds off on delving into those tests until the next chapter.

Commentary on Chapter 13
Zweig basically does the same analysis as Graham, except Zweig focuses on four modern companies – Emerson (again), EMC, Expeditor’s International, and Exodus Communications.

Why those four? Together, they actually provide a very nice history of the stock market during the 1980s, 1990s, and early 2000s, highlighting all of the ups and downs along the way.

What did Zweig conclude from his evaluation? Companies that aren’t stable on paper aren’t stable investments. Exodus Communication was his “dot-com” stock and it went belly-up before 2003 was out. On the other hand, Emerson was Zweig’s stable old horse – and it weathered the dot-com bust just fine.

There’s a lesson here – value investors don’t buy the flashy stocks. The flashy stocks are almost always overvalued compared to what the company is really worth on paper. Instead, value investors tend to look for the boring – Emerson’s shop-vacs aren’t glamorous, but the company does provide a good value for the shareholders.

Next Friday, we’ll take a look at Chapter 14: Stock Selection for the Defensive Investor.

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