McGraw-Hill Professional to Publish 75th Anniversary Edition of Graham and Dodd's Security Analysis

Benjamin Graham and David L. Dodd's Security Analysis, first published by McGraw-Hill nearly 75 years ago, forever changed the theory and practice of successful investing. Written in the midst of the Great Depression and in the wake of the 1929 stock market crash, the book convinced the nation that stocks were still worth buying and became a bible for generations of investors, the most famous being Warren Buffett. Its timeless advice is as relevant today as when it was first published.

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To commemorate the 75th anniversary of the book and to make Graham's work even more accessible to the current generation of investors, McGraw-Hill Professional announces that it will publish SECURITY ANALYSIS: THE 6th EDITION in October 2008. McGraw-Hill has assembled today's most prominent value investors. These practitioners are joined by top value investing academics and authors. They present new commentary that will refresh and update the 1940 edition, which is considered the definitive edition by many Graham aficionados including Buffett. This edition will also include a CD-ROM of the original text.

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Seth Klarman says: "This is a fabulous new edition of Security Analysis. We have retained the integrity of the original text but added new overviews, as well as commentary on each section. Experienced value investors and novices alike will have much to gain from this revised classic. While the world has changed in more ways than they could have imagined, so much of what Graham and Dodd taught is completely relevant today. Their insights still illuminate the way for modern day value investors. It is an honor and real privilege to collaborate on this edition of Security Analysis."

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James Grant states: "Ben Graham could write, and he could invest. He could write about investing. He produced an investing book, Security Analysis that promises to endure for as long as there are stocks and bonds. And he wrote that book while suffering the torments of the 1929-32 bear market. He is my hero."

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Bruce Greenwald says: "More than a half-century after it was written, the classic second edition remains one of the best textbooks for aspiring professional investors currently available. It is a privilege to help reintroduce it to a new generation."

2008 Berkshire Hathaway Annual Meeting Notes

For detailed notes on the whole meeting, go HERE.

Below are some of my notes. I just wrote down a few things I thought were interesting. Much of it has been said before by Mr. Buffett (WB) and Mr. Munger (CM), but good advice is always worth repeating. These are my notes and paraphrasing, not direct quotes from Warren and Charlie.


WB: There should only be 2 investment courses taught in school: (1) How to Value a Business, and (2) How to Think about Market Prices. Option pricing theory, etc. is all nonsense. [added to the etc. that is nonsense are things like Efficient Market Theory, Beta as a measure of risk, and the Capital Asset Pricing Model (CAPM)]

CM: If you have some extreme political ideology, you’re very likely to make some dumb charitable gifts.

WB: Don’t ever trade away reputation for money.

CM: While we don’t like inflation because it’s bad for our country and our civilization, we’ll probably make more money because of inflation.

WB: The most important factor in choosing a career is finding something you’re passionate about.
CM: But you’ll do better if you develop a passion in something you have an aptitude for.

In response to a question from a professor who is writing a book to help people who are introverted:
WB: The ability to communicate, both in writing and orally, is enormously important. It is great for people who have trouble with that [like he said he used to] to get into situations where they have to do it [get up and talk in front of a bunch of people, etc.], preferably with other people having trouble too, at first.
CM: It’s a real pleasure to have an educator come who is doing something simple and important instead of foolish and unimportant.

WB: [After mentioning that he shorted out the market generally while running his partnership] It is really unnecessary to short anything if you have some good long ideas.

CM: [After Buffett discussed the inefficiency in the Municipal Bond Market recently] The dislocation in Muni bonds was very brief and very extreme. You had to be ready to act fast.

CM: We prefer businesses that drown in cash. [Told a story about a friend with construction business whose profit at the end of the year was sitting in the yard] Berkshire prefers those businesses that can write a check at the end of the year.

CM: Because of human nature….we’ll have turmoil [in this world] for as far as you can see. [There will always be something.]

CM: The goal of investment is to find situations where it is safe to non-diversify. This is the opposite of what is taught in school.
WB: There may be situations where by only putting 20% or less of your net worth in an investment, you’ll miss the opportunity of a lifetime.

WB: WB read the annual report for PetroChina [without talking to management or anyone else] and thought it was worth about $100 billion. He then checked the price and it was trading for $35 billion. The basic business was easy for him to understand and there was a big margin of safety, so he bought. When oil was at about $70-75 he thought it was worth $275-300 billion which is where it was trading, so they sold.

WB: Most big food businesses are good businesses in that they earn good returns on tangible assets. You can feel good about branded products when they’re runaway leaders in their field. If you buy good branded products and don’t pay too much, you should do okay – but you won’t do exceptional because that fact is well known. A brand is a promise.

CM: A risk officer is often just a guy who makes you feel good while you do dumb things. Models and things that make you feel good and have confidence in an investment often just clobber up your head.

WB: There’s no reason to be exposed to ruin and disgrace for something that doesn’t matter that much.

There are a lot of things WB and CM can make quick decisions about because there are a whole lot of things they won’t allow themselves to take the time to think about.

CM: I would argue there’s an environmental reason for using coal. [Explained something along the lines of using those (coal) hydrocarbons so that we can save food producing hydrocarbons – oil, gas – for food production]. Most people don’t think that way, but I do.

WB: You can become, to an enormous degree, the person you want to be.

CM: Avoid being manipulated by vendors and lenders by using their own tricks. [Recommended Robert Cialdini’s book Influence, and his new book, Yes!.]

WB: Americans have an aversion to mass transit. I don’t think this view will change anytime soon.

CM: Agrees with Al Gore that we shouldn’t be burning hydrocarbons, but they have different reasons. “My brain works differently than Al Gore’s. You’ll have to decide which you prefer.”

CNBC - LIVE BLOG ARCHIVE: Warren Buffett News Conference

Asked about the partnership, Buffett says the two hit it off from the start, "rolling on the floor, laughing at their own jokes" and have "had a lot of fun ever since." They disagree sometimes, but they have never had an argument since 1959. Buffett says Charlie has taught him a lot about how to value a business and about human nature. Charlie has pushed him to buy into strong, solid businesses rather than be tempted by cheap "cigar butts."

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Munger says Buffett has influenced his life far more than he has influenced Buffett, especially since Buffett convinced him to give up his law practice. "We both like learning." Berkshire is an example of an "ever-learning machine." "The best thing a human being can do is to help another human being know more." They say they are blessed to know each other and to be able to work with such talented managers throughout Berkshire.

Inside Wall Street's Black Hole by Michael Lewis

In my opinion, one should just file Black-Scholes in the same category as the Efficient Market Hypothesis/Theory, the Capital Asset Pricing Model (CAPM), Beta, etc. That category, to borrow a term from Charlie Munger, should be labeled TWADDLE. But let's hope 99+% of colleges/universities continue to teach them so that value investors can have some limit to competition.

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For years, investors have relied on a complex formula to manage risk. But what happens if the Black-Scholes model is wrong—and we're in bigger trouble than ever?
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Oddly, this failure of financial theory didn't lead Wall Street to question Black-Scholes in general. "If you try to attack it," says one longtime trader of abstruse financial options, "you're making a case for your own unintelligence." The math was too advanced, the theorists too smart; the debate, for anyone without a degree in mathematics, was bound to end badly. But after the crash of 1987, individual traders at big Wall Street firms who sold financial-disaster insurance must have smelled a rat. Across markets—in stocks, currencies, and bonds—the price of insuring yourself against financial disaster rose. This rise in prices and the break with Black-Scholes reflected two new beliefs: one, that huge price jumps were more probable and likely to be more extreme than the Black-Scholes model assumed; and two, that you can't manufacture an option on the stock market by selling and buying the market itself, because that market will never allow it. When you most need to sell—or to buy—is exactly when everyone else is selling or buying, in effect canceling out any advantage you once might have had.

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"No one believes the original assumptions anymore," says John Seo, who co-manages Fermat Capital, a $2 billion-plus hedge fund that invests in catastrophe bonds—essentially bonds with put options that are triggered by such natural catastrophes as hurricanes and earthquakes. "It's hard to believe that anyone—yes, including me—ever believed it. It's like trying to replicate a fire-insurance policy by dynamically increasing or decreasing your coverage as fire conditions wax and wane. One day, bam, your house is on fire, and you call for more coverage?"

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THE PROBLEM

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 This is interesting: The very theory underlying all insurance against financial panic falls apart in the face of an actual panic. A few smart traders may have abandoned the theory, but the market itself hasn't; in fact, its influence has mushroomed in the most fantastic ways. At the end of 2006, according to the Bank for International Settlements, there were $415 trillion in derivatives—that is, $415 trillion in securities for which there is no completely satisfactory pricing model. Added to this are trillions more in exchange-traded options, employee stock options, mortgage bonds, and God knows what else—most of which, presumably, are still priced using some version of Black-Scholes. Investors need to believe that there's a rational price for what they buy, even if it requires a leap of faith. "The model created markets," Seo says. "Markets follow models. So these markets spring up, and the people in them figure out that, at least for some of it, Black-Scholes doesn't work. For certain kinds of risk—the risk of rare, extreme events—the model is not just wrong. It's very wrong. But the only reason these markets sprang up in the first place was the supposition that Black-Scholes could price these things fairly."

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Black-Scholes didn't work; trillions of dollars' worth of securities may have been priced without regard to the possibility of crashes and panics. But until very recently, no one has bitched and moaned about this problem too loudly. Lay folk might harbor private misgivings about the clergy, but as lay folk, they are reluctant to express them. Now, however, as the subprime market unravels, the beginnings of a revolt against the church seem to be taking shape.

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One of the revolt's leaders is Nassim Nicholas Taleb, the bestselling author of The Black Swan and Fooled by Randomness and a former trader of currency options for a big French bank. Taleb can precisely date the origin of his own personal gripe with Black-Scholes: September 22, 1985. On that day, central bankers from Japan, France, Germany, Britain, and the United States announced their intention to torpedo the U.S. dollar—to reduce its value in relation to the other countries' currencies. Every day, Taleb received a list of his trading positions from his firm and a matrix describing his risks. The matrix told him how much money he stood to make or lose, given various currency fluctuations. That September 22, when the central bankers announced their plan to lower the dollar's value, he made money but didn't know it. "I didn't know what my position was," he says, "because the movement was outside the matrix they'd given me." The French bank's risk-analysis program assumed that a currency crash of this magnitude would occur once in several million years and therefore wasn't worth considering.

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Taleb made a killing that day, but it wasn't thanks to a grand plan and it wasn't happy money. "People in dark suits started coming from Paris," he says. "They said that the only way I could have made that much was to have taken far too much risk." But he hadn't. They had simply failed to account for the true nature of risk in financial markets. "Then I started looking at the history of markets," he says. "And I saw that these sorts of things happened all the time." Taleb became obsessed with the way prices in the options market, based on the famous Black-Scholes model, underestimated the risk of extreme and rare events. He set up his trading to profit from such events by buying up disaster insurance that would, according to Black-Scholes, be considered overpriced. When October 19, 1987, arrived, he was prepared. "Ninety-seven percent of all the returns I ever made as a trader, I made on that day," he says.

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THE SOLUTION

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 In the past two years, Taleb has co-authored a pair of papers that have appeared in the sort of academic journals that originally published the Black-Scholes model. He and his co-author attack the model head-on in its own language (math), and as much as call for a retraction of the Nobel Prize awarded to Myron Scholes and Robert Merton for their work in creating the model. "This is what I'm saying to Merton and Scholes," Taleb says. "You guys are just parasites. You're not bringing anything useful to the market. You are lecturing birds on how to fly. You're watching them fly. And then you're taking credit for it."

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He's saying more than that, actually. He's saying that the academics, in lecturing the birds, have made flying more difficult.

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Books:

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Fooled by Randomness

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The Black Swan

The psychology of the housing mess - By Richard H. Thaler and Cass R. Sunstein

With the housing collapse, human decisions — whether on Wall Street or on Main Street — played a critical role. So it's instructive and, indeed, essential that we understand the human decision-making of today's crisis so that we don't veer down this treacherous road again.
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The first problem is that with respect to borrowing, cultural values have radically changed in the past three decades. For most of the 20th century, most American homeowners had a single-minded goal: Pay off the mortgage. Owning a home outright was every family's dream. If a windfall came their way, people would often use it to pay off that damn mortgage.
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But in the 1990s, this principle dissolved under the pressure of temptation. With house prices rising, families started using home equity loans to finance their spending habits. And as interest rates plummeted, many families refinanced their mortgages to finance more lavish lifestyles. Who could resist the combination of lowering the monthly payment and getting an extra $25,000 to use for a new media room?
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A complicated world
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In normal circumstances, all this borrowing might "merely" have cut into savings rates. That would have been bad enough, because savings has been hovering around zero for the past few years. But when real estate prices began to fall, and variable-rate mortgage payments started to reset, families found themselves in deep trouble.
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Why didn't people foresee the dangers? A key reason is that the choice among mortgage options has become impossibly complicated. With all the bureaucratic mandates, the incomprehensible terms and the fine print, even the most sophisticated borrowers are unable to compare plans.
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Borrowers also fell prey to the pervasive failing known as "extrapolation bias," which is the all-too-human tendency to assume that the current trend will continue forever. Remember when Internet stocks were increasing in value? Many people expected that they could count on continued increases. So what did they do? They put most of their money in technology stocks — and got walloped.
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In real estate, countless Americans caught this fever. Not surprisingly, one of the many markets with the biggest foreclosure problems was Las Vegas, which experienced one of the highest rates of price appreciation in real estate over the past decade.
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The unfortunate group includes homeowners who saddled themselves with mortgages they couldn't pay, and speculators who thought that a good way to get rich was to buy several homes with cheap money.
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The crisis is compounded by what psychologists call "loss aversion." The real estate market is by no means immune to this phenomenon. Numerous studies have shown that humans hate losses much more than they like gains. This means that losing $1,000 hurts you about twice as much as winning $1,000 makes you feel good. In the stock market, investors hold on to losers longer than winners, even though there are tax incentives to do just the opposite.
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How does this play out in the housing market? Reluctant to take less for their houses than their neighbor got just a year ago, sellers tend to keep their houses on the market for far too long. So even as the market began to go south, people foolishly failed to budge.
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For the future, an understanding of these problems offers some important lessons for individuals and government alike. Prudent homeowners should start thinking more like their parents' generation. They should plan to pay off their mortgages by the intended date of retirement; that would be a great start on a retirement savings plan.
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New strategies
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Also, homeowners should beware of extrapolating from current trends. When neighbors start to say prices can only go up because everyone wants to live there, stop listening. A red-hot real estate market tends to usher in what former Fed chairman Alan Greenspan famously called "irrational exuberance."
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People who have a house on the market now would be wise to step back and reassess their strategy. If a house has been languishing for months, it might well be time to accept your fate and lower the asking price. Those who have made bad investments are often tempted to wait until they can recoup their purchase price. That's a mistake.
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For government, the best response is to take immediate steps to ensure that borrowers are able to make sensible comparisons among different plans.
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Mortgage providers today tend to deluge people with fine print and confusing details. Government regulation, which mandates endless pages of complex disclosures, makes the situation even worse. Borrowers feel overwhelmed. They agree, often cluelessly, to the terms placed in front of them.

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Related Book: Nudge: Improving Decisions About Health, Wealth, and Happiness

David Einhorn on WealthTrack

David Einhorn on WealthTrack: Video 4/25/08

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Book: Fooling Some of the People All of the Time: A Long Short Story

Speech: "Private Profits and Socialized Risk"

Major Takeaways from a Visit with Warren Buffett

Some notes from University of Western Ontario students' visit with Mr. Buffett on March 31, 2008. The source and a PDF file of these notes can be found HERE.


Life Learning Lessons

1. Using the concept of buying or shorting 10% of one of your friends to identify the things that make people successful in life. You want to add more of the characteristics that make your friends more valuable and remove those characteristics that are devaluing. It’s never too late to change.

2. Being humble gains respect. Check your ego at the door.

3. Try to live within your means.

4. Be loyal to your friends and expect loyalty in return.

5. Be reasonable with your view towards social responsibility. Berkshire would never buy a tobacco company; however, they will invest in retailers that sell tobacco.

6. Being an inherent optimist is a key trait to success.

7. When I asked how he balanced his passion for investing with his commitments to his wife and family, he said “never have contracts with your family” meaning that no silly rules or formal routines are necessary if true happiness is involved.

8. A good business partnership evolves into something intuitive over time, when it’s based on the proper balance of trust, humour, accuracy, and friendship

9. Formula for happiness: kids that love you, a job you jump out of bed for and working with people you enjoy being around.

10. Most important choice in life is one’s spouse.

11. Do what you’re best at and then give the fruits of your labour to people who are best at humanitarian work. Don’t muddy the waters with inefficient capital or resources.

12. Do what you love, not for the money, do it because it’s in your heart.

Market Specific Recommendations

1. The 19th century belonged to England, the 20th century belonged to the US and the 21st century belongs to China. Invest accordingly.

2. Have a long term view. Short term events are a good source of experience and learning points, but stick with the end goal and don’t be rattled.

3. Use volatility to your advantage.

4. Buy healthcare stocks in a basket to diversify risks since it is very difficult to decipher which company’s pipeline is most optimal.

5. Vices are a good business because they are human nature.

6. Financial institutions should, in general have more regulations.

7. Markets are not efficient.

8. Read as many annual reports as possible per year without knowing the stock price. Try to value the stock independently of knowing its valuation.

9. Buffett reads “Value Line” (http://www.valueline.com/) to source his information on investing.

10. Highly recommends Katherine Graham’s Autobiography

Quotes

1. “Look to be turned on everyday in life. Doing something solely to build your resume is like saving up sex for your old age.”

2. “Happiness is tap dancing to work every day.”

3. "Wealth allows you to be meaner."

4. "It's hard for a man not to be happy when he comes home to happy family and home."

5. "Surround yourself by people who love you and will support you in life. This support system is integral to happiness."

6. "I do what I do because I love to do it, not because I need the money. It's fun and I surround myself with people I enjoy seeing everyday"

7. “Success begets success and it starts from the inside and flow out.”

8. “Brilliance is the ability to simplify a mass amount of information in to a simple yes/no decision.”

9. "There are many very wealthy people (other billionaires) in this world and they are very unhappy. Money does not buy happiness."

10. "If you ever want to find me on line playing bridge, look for TBONE, that's my name."

11. “Success is getting what you want. Happiness is wanting what you get.”

12. “Giving unconditional love is the best thing you can do. When you give it out you get it back 2x, you can’t get rid of it.”

Giverny Capital – 2007 Letter to Partners

It is not easy to have the right temperament toward market quotes. The vast majority of investors perceive the daily market quotes as an ultimate judge of value. At Giverny Capital, we do not evaluate the quality of an investment this way. In our mind, we are owners of the businesses we invest in. Consequently, we study the growth in underlying earnings of our companies and their long-term perspectives. Every year, we submit a table showing the growth of the intrinsic value of our businesses that we measure using the term invented by Warren Buffett: owner’s earnings.

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We therefore come to an estimate of the intrinsic value increase of our portfolio by adding to the growth in owner’s earnings, our average dividend rate (which is around 1% presently).

Looking Up to Warren Buffett

IT OFTEN SEEMS like every hedge-fund manager is reading from the same playbook about how to look, work and behave. Neatly pressed khakis; thumbs glued to a BlackBerry; slick digs in Greenwich or Manhattan staffed by number-crunching research drones. But apparently, Mohnish Pabrai never got his copy. He wears shorts to his Southern California office, keeps e-mail to a minimum and almost never misses his 4 p.m. nap. And forget goosing returns with fancy computer models or using complex derivatives: Pabrai doesn't even sell stocks short.

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About the only thing slick about this 43-year-old investor is his market-trouncing track record — annualized returns of nearly 25% since he set up shop in 1999, enough to earn him a growing cult following. His "secret"? Probably the most documented investment strategy around — a bare-bones, Warren Buffett style of stock picking. While that description may inspire yawns — sometimes it seems like everybody claims to be a Buffett disciple — Pabrai takes it to an extreme. His office houses an impressive Buffett mini-museum: a wall covered with photos and articles he's amassed over the years. He recently dropped a stunning $650,100 at a charity auction for the privilege of just one lunch with the Berkshire Hathaway guru. Even his minimalist approach to e-mail mirrors the Buffett philosophy of avoiding distractions. And his track record is more than Warren-worthy: A $100,000 investment in his flagship Pabrai Investment Fund 2 in June 2001 would have been worth $465,200 at the end of 2007; the same amount invested in the Dow, only $145,500.

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SM: What are some other mistakes investors make?

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MP: Using the market to tell you what a business is worth. If a stock goes from $10 to $3, most people freak out and sell out. You have to have your own internal yardstick. Sell to the market when the price is higher than what you think the business is worth, and buy when the price is lower. Another problem is that our brains are very poorly evolved to deal with the stock market.
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SM: How so?

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MP: Our brains are in sync with the speed at which the market is moving and totally out of sync with the speed at which a business is moving. It seems obvious: The market is repricing a company's stock very quickly. I can process very quickly; therefore, I make decisions based on that. You have to learn to dramatically slow your brain, which is very hard for most people. The reality is that you should make decisions based on how that business is changing, and that's a very slow process.

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SM: What stocks do you like now?
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MP: Pinnacle Airlines. Depending on how things work out, it's anywhere from a double to five or six times return in the next two or three years.
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SM: An airline?
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MP: It's a regional jet company. The large airlines, like Northwest and Delta, outsource the small planes to Pinnacle. Many of the reasons why airlines are so terrible — load factors, price wars — don't matter. The revenue is the same whether there is one passenger or the plane is full and whether Northwest charges $200 or $2,000 round-trip. The contracts are long-term, usually 10 years, and will hold up in the event of a merger. So you can estimate what their cash flows will be many years into the future.
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SM: What's the investment case?
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MP: Pinnacle has more than $10 a share in cash on the balance sheet. In the next few years, free cash flow will be $3 to $6 a share, depending on how much more business they get. With a simple 10 or 15 multiple on those numbers, you end up with $30.
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SM: Why are the shares so cheap?
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MP: One overhang is that they have a past-due contract with pilots. But not a lot of Wall Street analysts follow Pinnacle, and the business itself is changing. The evolution away from hub-and-spoke and toward more nonstop flights is driving demand for their services. When you connect one small city to another directly, you aren't going to run a jumbo or a 737.

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Book: The Dhandho Investor: The Low - Risk Value Method to High Returns by Mohnish Pabrai

Amazon.com's 2007 Letter to Shareholders - Jeff Bezos

We humans co-evolve with our tools. We change our tools, and then our tools change us. Writing, invented thousands of years ago, is a grand whopper of a tool, and I have no doubt that it changed us dramatically. Five hundred years ago, Gutenberg’s invention led to a significant step-change in the cost of books. Physical books ushered in a new way of collaborating and learning. Lately, networked tools such as desktop computers, laptops, cell phones and PDAs have changed us too. They’ve shifted us more toward information snacking, and I would argue toward shorter attention spans. I value my BlackBerry—I’m convinced it makes me more productive—but I don’t want to read a three-hundred-page document on it. Nor do I want to read something hundreds of pages long on my desktop computer or my laptop. As I’ve already mentioned in this letter, people do more of what’s convenient and friction-free. If our tools make information snacking easier, we’ll shift more toward information snacking and away from long-form reading. Kindle is purpose-built for long-form reading. We hope Kindle and its successors may gradually and incrementally move us over years into a world with longer spans of attention, providing a counterbalance to the recent proliferation of info-snacking tools. I realize my tone here tends toward the missionary, and I can assure you it’s heartfelt. It’s also not unique to me but is shared by a large group of folks here. I’m glad about that because missionaries build better products. I’ll also point out that, while I’m convinced books are on the verge of being improved upon, Amazon has no sinecure as that agent. It will happen, but if we don’t execute well, it will be done by others.

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Your team of missionaries here is fervent about driving free cash flow per share and returns on capital. We know we can do that by putting customers first. I guarantee you there is more innovation ahead of us than behind us, and we do not expect the road to be an easy one. We’re hopeful, and I’d even say optimistic, that Kindle, true to its name, will “start a fire” and improve the world of reading.

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Related previous post: Put Buyers First? What a Concept

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The Amazon Kindle - $399.00