£ECUR!T!

ES IN m~~~U1rtE W~RLD

,

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oel ;Ve~ed 80

If@W~ lliJ LA1 [6 [1 J>6.&1?£l;f'((i£}( oM

November 15-1963

5ocj; per copy

SECURITY Iy AN INSECUlm WORLD A LECTURE BY

BENJAMIN GRAHAM

Doctor Rappaport has chosen a very intrigu.ing title tor my talk; "SECURITY

IN AN INSECURE WORLD. II I hope that not many of you came under the mistaken impl~eslSlion that I am going to talk about security in generaL I am going to taLl,t: only about financial security, not about physical security, mental security, matrimonial security, or other types. Even as tar as financial security is con~ cerned , I am going to address myself' only to investment policy in stockliland bonds. 'I'he title of this talk might better have beeD. SECURITIES lN AN INSECtJREWORLD, becau8e securities are my field. I am not going to talk about savingi and budget policy, life insurance, home ownership, pension plans and other matters of th.t kind. The rea~on is that I don't consider myself an expert in those areas, and I would rather talk to you about things ! hope I know more about than you do.

This reminds me of the fact that when the New York Society of Security Analysts elBJtablilWhed a journal in 1946 we gave it the simple title liThe An&lyritsJolU'nal." Blll~u; then. we got so m.any inq_uiries an4 even subscriptions from psychoanalysts that

we were forced in self-defense to change the name to the present title "The Fiuanci.~l Analysts" Journal. rj

In the field of financial security, SIB limited to the problelD.iii of investment policy~ I would say there are three kinds of threats or dange~s that investprs

tihould recognize as possibly existJ.lmgat the p~esent timeo .One ofthcm'WPuld 'be

the threat from atomic WAr; thesecbnd would be the threat·f'rom in:tlation; ana. the third would be the threat from severe market fluctuations up i.tidd.Own, arid of course primarily dovn~ Now, I have no prescription tor financial security or·for portfolio policy that could de,al with the possibility of atomic war •. ldon 'tthinke,nyone: else h2ls$ we prefer to sweep that problem 1.Ulder the rug and go forirard to things that W<!il can deal with more effectively. The second danger I mentione.d was inflation. Inflation has been a big factor in investors financial experience going back as far as 1900. Not many people realize that we had more intlation in the first thirty years of this century then in the second. thirty years, as measured by the usual

indices. .

The continuation of som.e degree of inflation is certainly·' probable in the future, and that is the chief re.ason why most intelligent investors how recognize that some common stocks must be included in their portfolio. However, that is only., part of the question of the effect of inflation on investment policy. The tact is . that both the extent of inflation and the investor's reaction to it have varied greatly over the year8~ It is by no mee.ns a straight-line matter. A good example i~ the most recent one. We have had a small inflation in recent years accompanied by a very large increase in stock-tmt.rket prices, which seem to be geared not to

\ the inflation experienced but rather to the expectation ot greater inflation in the i'utwre. You probably know there has been lloincree.se in the wholesale-price \\. ayt!!lrag<!'J glnce 1958. There has indeed been a riae of' 6k per cent in the cost of \ livin.g in the laSlt :five years, which of course is not negligible, but it could

\\. mcarcely in itBeIf be a 80und basis for a 100 per cent rise in stock prices. Con • . versely~ during the years 1945-1949 we did have a rather explosive kind of inflation-~the consumer price index, (that is, the "cost of living") advanced over

\33 per cent--but during that period stock prices actually had. a small decline.

\

My c';'1,rw~Lu~i.on here is that investors'; feelings and. reaction. regarding inf'la.:a.l"'e p::."ob:a.bly more the result of the stock-ma.rket action that they have recent~y ~.';?,:;I':lr'i~ncedthalOL tht! ell.UiIflfjlf' it. Consequently there is great danger of investor .....

-- . . .

" ghrl.n.g 1m-l.tieD too fnu'Ch weight when the market advances and ignoring it entirely p

", SIS! they d;Ld in 1945~9, when the market declinelo This has actually been the history

'ot infl~tion and ~to~k market behavior ever since 1900.

T1tle :problem of price fluctu.ation!!! /I or market fluctuationlJ~ b a very real one for i:n:~rl!ll$J1~or!'i', a~ well as ISlpeculator!tJ J) al thcn'l.gh there has been a t~hdencyirl w .. li Stre~t to d~ny that tor a numb~r of y@ar~ in the pa~t and even currently. Ac~uallyj the re~l pro'ulflm is not whether prictP,J fluctuation!!! are important to thte investor ~

it h rath~;r the oppoat te» that b to tind some good workable distinction between the i:nve&;jt~)r g]:jd th€l 5lpeculator in common stockli. As will be pQ.inted out later that distinction ha~ almost v~~ilhed from Wall street~ a tact which has caused a great d~al ot troubl~ in the paat and will cause a great deal of trouble in the future.

Yet only laSit year» alth'H~gh it tilllleJMi a Long time ago-""market· flUctuations» ail evideln~(~'Hll. by a d<ec:lin~ in t.h1/lJ Dow Jone~ Average from 735 to 535; did loom all ~xtremely important to investors and 8p~~mlator~ &l1keo This tall Of about 27~

in the D01lf'Jonti~ AV{!)1"age WI.ai1 iB,:c:~ompanied by decl~ at betw~!!!In ,0 and 90 per cent

',1" mor~ i.r~ mo~t of th<i!1l :run)' iili!Jcvil!!Jtiel!ll that had beon l~iliiued in th~ preceding two year'!!! and .had played. suca ij, ~perCtll.ew.arpart in thte stock market activity of that p~riodQ A:t tha~t;U.m(!'l tbenp in .May 1962.1' the concept of a one-way market» which could go only upwards with v~ry amall reactions, see~d to be abandoned for good. However, Wall Street; haa;! a v~ry short memory, and now the majority of' fin.ancial authorities !!n\eem to be &lJlipping ba<ek to the concept'tl of 1960 and 1961-

They t!,l'r~ Il"l!l!itlJ'Qr'ning to the idea tha.t for the sma.rt investor the question of

~tock market fluetuatlon.~ doe~ not b.avl!"! to be considered to any great extent.

There i~ a tWo=fold. ~mpb.i!II.:illbl hl!!lr~» which fi>lurl over the reality of stock mark.et fluctuations. Th.e firii!lt :iI thre g~n~ral conviction that the market can be counted on to advanc~ ~o ~mphatical1y through the y8ar~ that whatever declines take place are comparatlvely tmimportan.t,9 hence it you have the true investor '$ attitude you

don i t hay~ to concern YO·IF.@lf' with themo The second claim is a denial that the "stock market" exi;:t" at all; meaning thereby that what the mark.et averages do is

of' no real importanc~ to the intelligent.. well-ad.villed· investor or speculator e It SleeD!Jl! to be a ruling 'tenet ot Wall St:reerc that 1.:f' you practice the proper kind of selectivity in inv~l:tments you don't haVfI to worry about what the stoekrmarket does 8.1 a Whol<!ll, 8.!!ii s110WD. by the averageall!f'or at all times the good stocks will 'b1'going u.p and th<e bad ones will be going down. SI~d all you need to do ill pick the good stocks

Zd forget about the ~tock-market av.rag~s~

How valid are th~l~ two argument~? The fir.t one~- the argument that common iii OCkil are and a.lwaYif!l will be attrac;tiv~j) including the present timeT becaus~ of

/ th~ir exc~11~nt record ~dLnce 194'9-- involves in those terms a very lud.umental and. I important fallacy. TJ::d~ 11 the idea that the better the past record of the stock

f

mark~t a~ such the more certain it ii that common stocks are .ouod inveatments for

th~ future. Now we all know that if a corporation h&8 had a very ~ood record

over th<tJ I1al!lt years that is .. fair ind.ication (but no guarantee) that its record is liktely to be good in th~ future ~ bee .. UIM~ it has certa.in business advantag4!!s which ilfr moet Ca.!i~iii ought; to {'lcl'ltinue. But you cannot 5ay that the fact that the 9tock mar~~t hag rilen continuously (or slightly irregularly) over a long period in the pa~~ i~ ~ guarante~ that it will continue to act in the same way in the futur~. Aft I st:.~e it~ the l'~al truth iilll exactly the opposlt(!J, ~or th.e higher the ~tock mark~t advances the more reason there! is to mbtrulllt its future action if' you ar<!!l going to consddez- orJ.y the mexket! s internal behavior. WJe all know that

· /~or m:a;r.,.y if.~(!ltI.d.®:® th® i.ypice.l hhtor;y ot ·th~ stock ma.rket has been a sueceasdon ot l:~uC'g~ !"i,~M» irt goodL par"t ~:pectGativet0l.lm.red inevitably by substantial falls .. Co,n8l~qu@ntly 5th,\') @ub~'J.antial upl!lweeps of the past have always carried with them WB.rniD.g ~ig), ... l$ tJtvJn..h1l.:PPY consequences to come. It doe. not neceuarily tollow

that a lall'g® l"il!ll~ in 't}:l~ pric~ of a individual stock or in the market "verages MU1ilt "b@i'oll(ir.l'~tl by a &~~lin"» bu"t the only reason to view with confidence the

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Ui~\.t}X .. ~ •. ' j~',:'!!:i.(\'.:~ Of:, ;a ~®'~"l1Z'i'ty that hl.iS 1.1r~ad, s advanced !Jub.tantia~y in the. pre. sence

t!'l:K·t~lt'!~Ql ::;>ll'lMCtll'lI!ll» other than th~ actual price movement itself, which woUld Justify

uch c,,)JO£id®1Dvr:~. Hen©~ a llU'ge a(Q:va.n.ce in the Iltock market is basically a ,1gn

or ,:;;.rs.'!ltio;o, gs;nC!. ;not I. ::"®!I.!ion tor confidenee.

L~it; U8!!i diil>lI(';1L~[@ th~ IlMlrket is po~dbilitieil from present levels interm~ first

of th<l!,lor~tical :If®Mo:rr.d)'tLg md th~n in t~:rm!l!1 of lome practical condderation.. !

woullii lik~to ];lJr@51®litt ttXfl~ pOileibilitieil; edoubtably there are a great many more. one po~~ibility.l> \Whi~mi i:~ .. VI/fJry' popular one in present thought, ill that the riu

that hafj 'tUll:lll :v;:b.dtl'lJ fiid.l:".J.CI!J 1949~= from abou.t 163 in the Dow Jones Average,to 750 at thif'j Pll:"®~~llmt tim.1I!I =~ lr'@tl<\!llc:t@l a n~'iW and a muveloullly imprClJ'V"ed chal's.oter of common sto©k~ p :ll1l1.d th@jll:"~f'o;g'® C~1!"~ bll!l ®xpectl!!Jd to continu.e more or less at "the Blame J'lI.te in the fUt~lX<!J.. Only I@l'lch\ a point ot ~:f'i.~ C'M inU<e liense o'at ot the prt1R)fJ..n't p~a.etice of calcu..l:.l:ti:!lg th~ gai1ffiiS~h\!tt i)tr'W~~toI"" could have M.d.. in mutual-f'udr.1b.fQ". or in similar ];i~JJ.t'<r,ha:i"®@ ~)l'.,.®r i:h<11l la.!I!lt 14 y~ar" 1.11\ a balli~ f'or'~:i.ng to~rBuade them to

buy Il!uc:h ll'&®tC{writi~,1l'& ~~, t).m~il" pI"~/I~nt advanlC:ed prices. As yo1I1 ~ ~ thi, k:I.n(i ot cal .. eulation li!!l done a21 -th@ <tim~ by mTht·aal"*:"1~~J.le(Jm<exi"to impress inve$ltorll~ The

SEC r(lqu:J..r~!i it to hi§! accom.paniedby apelr'f'unctOry statement that the calcul .. tion carries no 'W'arrwtly :for the future ~ but itdOrl·'t think very much emphasis is placed u.pon th.at Q.ulJlliti~atir,Hllo

___ »>: The [Second p01>ltiibility i~ t;h.at a good put of the rislIt I 1ipoke of va. an ad."

.' jt1.Stment from an und.®rv:Mu~d l·svel in 1949 to a proper leVI!!!4- on .lome n~\f balli. of valuatiol.Jl.~ If that i~ ~©.l> (8. go©d part of' the 1949 .. 1963 ria" coul.d not be expected

to br!ll repl!at<l!l«1 f:rolill. a 1~1r(I)J1 which ill JQi.W a cOI'rflcted one. However, we «zow.dhave a sati,d'ac:toJzy' aOl':"i11IThC@l on th~ &v~r$l,gce p fi!lay 4~ pttllr ann:uJll, from whatever lev.l turns out to be abc,ut :rig.h:t f07f today. It 150 111\ about the right present level then the investor might PQ~~ibly ~x~~ct a more or l(I)J~s standard 4~ advance from this level, year by year J) subject i~(j moo,®:rate dO'lInlW1lrd fluctuations.

But the thil'd pO!\iJ!iilibility ill that thil nature Of the market has Xl,at changed trom its (f!jar1i(I)J~t tim®l~.I' lUll IIhrnm in O'Ul" recordll that go back at least to the South Be.iii Bubble in 1120p :prati~ally 200 ye&rl. WE have also very detailed dataQ1l, stock priM~ in the ~(Jnitl!d Statreg since 1871, which were incorporated in the Cowles and the Sta.ndarda:r.Ml Po<g:il."r.~ I rec©rd:i _ It may well be that we .hall still have the all-too-familiar altt!ll" nati:r:Jins: ofexceslJ1ive optimism and excealJive pessimism. The most reJcent eJxample of ~x!C<!II\~iw® PflllUlJimilim 1. the very period which wall a starting one for thb iU.rkl!t" D,ll'ing 1949~50 the market had th.e lowest peace..;time priceearnings lL'atio in ifc:!!) hilitcry. Stock1il I!'!old a.t only about 1 times their earning., in the marke't av~ri!l.g!!'l~ I am talking abO'l.ll.t" as compared with about 20 times at the present time. Th~ implication here ill that jUilt u stocks were evidently undera valued at leven tim~~ th~ir earnings they might ~ery well be overvalued at twenty 'Gimes tel1lrningl!l1 or at !i:OID.<!Z high®l' mul'tiplier that will be estabIISh.ed later inthili market and will I'~pt'~t$i~nt a l®vltll of: exc<e'ssive optimism.

My ovn opinicm. <!I.ibou.t thetal~ three choices ill that the :first possibility is rea.lly out of: th~ (p.l!.e,~t:t<on. It ~~r~;"Tl~",~he nature of economic reality to perm.it net gains at th~. ~hOW1:li rate~ tr(om 1949 to 63--ISQ~tlling like 14,% per annum in ... eluding thl!! di ~li81<!nd r~tllll'n.I$-- to continue ind~f~ly .... n the' futUre~ .... We , jUlt . don it hAve a rinaIDlciaJi. and economic IYiltem that ~an operaj;e on that basis. If that vere tlMJ1e nobody wo1llld have to work for a 11v:tngo I remember very well the

.,

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nu.mb~J;· of p<!()!p'l~ in th9 late ~920 's wbo gct a correllpondlng view of the stock markert, gav~ 'npth®ir ,job~ and plunglJd into Wall Street to take advantage of it!Jl wonderful :rut·ux~. T,b,~ ~~'Clorld pOiiElibility--which 1a that the market will advance pretty steadily :from I.pproximatfily th~ prehlent level, but will not have the advAntage of IJte.rting from it. v~ry liG~ l®'IJ'®lg= il Mmillrdble in theory. But the grea.t problem, one that I will talkabCj'iUlt 1f,t®X' J ~I how can you detllrmine the proper new buis' :to'l,"cO!llinon 13"t(/J~k[Q val'J..;.at.i(('JKl\~ and th!lll'~:rort! hw aan. you determine the ~t,or lfIIsilptopjr~~l.¢vel fior now?' Id:liI~~1~1®:9i~d thb qU~1$ltion in til pa.per read to the American lI'l!la.nceAss In,

in December' 1961~ and S:Aid then that the market wa. reaUy adritt. ona •• aof· un-, uttled !frt·a:nrtl.alr:1.~. The old Iltmdardl of value, which had been well established for decades and IJ'(~lrh.ap~ g~n<ll"ationtl p no longer !!ie.m to be tenaQlfll, as muchtQG¢Ollservat i V~ J) butt lli.n® prop<'!ll" new ~tand,a:rdil of' value could certainlY not be . YOl;'ked out either by ~oml~ib<0Jdy g ~ :i.:nnel"-<col'lllci01WJneu or by mathematical ealoUlatlOXL*.. W"

shall have to Wl!it!l plrobably tor a eonlliderable length of time bd'oreweq det~rm;tne d~:p@ljndll.bl~ n:lJ!W Ita.ndl.rdS. In the mean time it seemed to methl;t.the

stock mlllrk®"t ';1I:!LJll havilt© cur,. ~:n i til eale1!llat:tona by a precess of tr1alb.<i error, which;;;(')Iw.d l®M to l<li.rg~ fluctul.t;l.on. arotl1J.ld. what in the end will turn ou.t to be the new c~ntral '\i7l!.1~1JJ,~. I think what happened ,iinee December 1961 bears Qut t~. inte.rpr'l'!rtat1on to !ll©m~ d@grt!~. C~lftll:1111y the 'big decline in 1962 npr ••• :nte4,a.]aitrp f'luetulltion <:;f on~ kind, ilW.d tbe impI'<1IliiiJivifil lrifllcovery sinee June 1962 _;yrepresent

a tluctlwation ot th~ other kindo

No d.oubt y~m 'W'o'11JLd 'be intifllre$tild to know wlaat I mean by the ti!~ "Old and

new sta.ndard~ ot value II as appliiflld to the i'tou market lev.J.~ The old atandardll of value~=vhich '!l~;;ril!J pretty w~ll accepted up to aay 1955 "r. r •• cl'uDd. by a.munber of .. ditf'er®nt approilq;;h:!$ ballf§d on rea~oning or experience.. TAt oit.I.li.~e bes~ of.·' cour-se wa; my ow." which has be<!ln know:O, all the "Graham." It v .... d,.ri.veq,f'l"omthe Central Va1u~ I::r~rail!li <!'!1arningl of the 30 Iiltocks in the DOW Jone.I:nd'lurt:rial

Average for 't®ny~wrl!!l paIaltj) ~ .. pitalized at twice the intel,"e.t rat. on :Q.:l,gh grad. bonds 0 For eXl.mpl~ !Itt the p:!:"flsent t1mte the average earnings tor the last ten yearlll I.r~ abou.t $33 oro, th~ Dov"Jones unit and the present ,rate on higla:grade bonds is 4.3 per cent. If you capitalize $33 at8.6%-- which isamtUt:tp11erot abou.t 12 you would get a C<entral Val'U~ on the old bitlis of about 380, as compa;J."ed'W'i th the present pric;e of about 750.

,.lIp early 1955 when I testif'i~d before the Fulbright Committee the stock market WIlS then about 400J my central val~:lI.e was al$O arotmd 400 and thevaluationll of other "experts" utling other metho~~ all seemed to come to about that level.. The action of the stock market 1Jili.\!;.then WOuld appear to demonltratethat thea. Jllethods of val-

uationS! are ultra-coniiflrvative 'and mu~h ,too low, although they did work out extreme .. ly well thro'!JlgcQ the Iltock ma.rket tlmetuatlona from 1.871 to about 1954, which is an exceptionally long period of t1metor a te~t. Unfortunately in this kind of work, where you are trying to detf:rminfl relationshiplI based upon pa.t behavior, the

almolJt invariable exp~riiflnc<! iii that by the time YOlit have had a long enough period to giyct you fSluf'fiiCli:ent confidence in YOrJr form of measurement just then new con .. ditions :!iluper:!iede and the meag''tllr<!lment :11 no longer dependable .for the ;f'ut\U'e.

We had, to d~ .. l with this problem in the f'~h edition of, "Sectl.l'ity Analysis" published, la.st yea:r.9 and to recognize the probability that stocks should be valued more liberally now than in the pall'!;, 'Our chief !'e".Oll for that, ineidentalj.y,,~,~·not becaul;el th~ govill!lrnm~ntilil commitment to prevent la;rge .cue depressions has changed the climate of c:orporate earning, trom Yhat it n. prior to the Employment. Act

of 1946. We think thb new inllQanee against a v.tV .evere falling off in the earnings ot ~orporation. generaiiy would justify a higher valuation of these earning~ than in tormer year.. Renc~ we have added an arbitrary 50 per cent to

the va.luation bas~d upon our old method. '!'hat would give U nov .. value of About

':t'Q!, ·'G.b,,,, Dow Jones Average, and a corresponding value of about 5, tor the Standard Poo:r~ ,S:OO=&:tock average" Let me point out that the two aV"'~ages stand so closer togetl1.~J(o on ,'I. ten-to~one basis in their price level, dividends and earnings" that you can l1J.iS>~the Jt;'Wo figures almost interchangeably tor purposes of description or an-

... ly~h.

You ImJ\st :recognize that thiil level of 570, which is derived from an arbitrary ffis..rk up of 5~ from the old level, hall no special authority behind it. It was mer~ly 'che b~:/jt judgment that we could g1 ve on a !Ii tuation which does not admit

of any r~ally dependable calculations. As a matter of fact if one is sufficiently optimi~tlc and adroit it is quite possible to develop a method of valuationwh1ch ,1ll0'1\Jk'1lC!.<l!l plaU3ible enough and would justify the present level of 750 for the Dov Jon<'!J!S Ave!'age. Let me show you. how that could be done. You. say ti:r,t that inIN'l§3ltOdrl@ wow.d like to get an over~all 1"I!!t'WC'l'l of 7f!, on their money in :future yearl. T.hat~~ what common stocks have returned on the average- in dividends and price ap]!l"ecia;!~ir.m.-ever since 1871)1 as shown by the Cowles and Molodoraky •. tudies~ Now

if ¥~ can expect a rate of growth ot earnings and dividends ot 4~ a year then all we need. i~ ~ diVidend return of 3% to make up the desired 7f% total. Since the Dow Jone~ an!!t Standard Poor is! dividend return iii j1!lJiit a little more thu 3% right now

on, th~ market price, we could buy these at the present level with confidence, as

W~ voul::l 'then get a 3% rl!turn in divid\lnd~ and a 4~ amltlal return in growth.

M~llY peoplre might think that even lellSl 'than an overall 7~ should liIuff'ice. All that lllIo1Uil'lds fine but if you reflect that by 50me cha.nce.the future growth rate would be 3~ inlitead of 4t,r;- and 3~ WlU!! about thl!! actull annual growth in dividends in the last ten years-- then you get quite a ditfere~eeo For if now you are expecting a 3# growth rate, you will need a. 4% dividend return to millke up the required 7tf,.

On that bash! 'the DoW' Joneli Average is worth ju.st about the 570 which we arbitrarily gave to It&

There is It lot at juggling with figures that can be done novas always; but none of these nethods in itself giV@8 a dependable relult~ To a great extent the f'iguret> IIl!Jllechd are determined by the g~neral attitude of the man who is $el(!!cting them, and that general attitude is very often determined in turn by what the stock market bas been doing. When the ~tock market 1s at 750 you take an optimistic attitude and u~e some favorable tigureg; but :liit shoudd h_ve a severe decline mo~t people would jump back to the older and more conservative evaluation methods.

Let me now point out a striking area in which the uncertainty of the proper valuation of' common stock. i. brought to the fore. That is this very question of the relationship between div14.end rtrl;;urn on stocks and the- interest rate - on bonds. For ..f'ifty YIIlUS or more it was .. tenet in Wall street that stocks should yield considerably more than bonds. In ~peculative markets stocks might rise until their yield became less than that of bonds. But this very development was II. sure lign that you were in a. dangeroull market-= one heading .for a bad fall. A friend of mine, head of' an :importa.nt brokerage house , vas so enamored of that idea he used It*. constantly in hi. market letters. More than that he actually had the relation~ ship b~tveen stock yields and bond yieldll printed in I. nice chart-design on neck ties imported trom Pa.ris, which he distributed to his friends including me. For awhile I wore this tie at some of my lectures, and said that this wa. the first

time that ~ybody had analy1zed the technical p08ition of the stock market from

hia: n(!f;cktime. Well, since 1958 stocks have been yielding considerably less than bonds with no sign of a return to old relation.hips. Hence m,y broker friends

found ,i;ll .. t this concept increadnghard. to !ilti.ck too About two years ago, actually not very long before the big market break., in a huge n6Wspaper advertisement

he abandoned this concept completely, $aid it was all bosh to talk about stock yieldg a~ the basis of evaluation, claimed the main thing was the psychology and attitude of the public; and a&s.~ed this factor was strongly bullish and Justified

-PAGE 6

confid!Jl'lt buying of' i!litocks~ My chief' reason for mentioning this incident is that I had j~lBt spent a lot of time studying the weekly analyses of the Itock market by

one of our oldest financial services which started in 1909 and I found the identical experience took place just 30 years before in this service (whose name I a180 won't mention.) For many years they talked about the ~tanda.rd. :relationship between stock yields and bond yields, and they used it to determine the probable top levels for' the stock market advances. In the great bull market ot the late 1920us this rela., tionship proved to be very unreliable ali a short='term market forecastero So they too~ in III spectacular statement using almoiiit the l1ame language, turned their back completely on the comparison of ~tock yields and bond yields and said that the market 'Si plychology was the best ba~is for forec:as,ting. Tha.t happened sometime

in 1928, and they stick to this viewpoint to the great crash of 1929.

The present relationship gtves con~iderably lower yields on stockl than

on bonds. High grade bonds yield about ~30 per cent while the stocks averages yield a little bit more than 3%. Because that r~lationship has existed for the past five years does' it represent a permanent relatiolllihip for the future" or b it only an indication that the ~tock mark®t has be~n clearly overvalued for five years,!) in the same way that it 'Was clearly 1md.ervalued during the period 1949-1954.7 This is the ffiany-billion-dollar qtlegtion. You. won 7t be able to get the answer

to that by mathematics; you won 9 t be abl@ 'to ge":C it from an expert such u me

or anybody else; so you'll have to an~1ier that ques't Lon for YOl)l.I'IM!J:lf.

, But the thought that thfll stock market may have been o'Ver~jalued in the last :'ive years, just as it was Qudervalued fifteen year$ ago; brings us to the third /pouibility Which I elrtumeratedJ! namely that we are IitHl going to have wide tluctua-

i tions in the :future, -. This I conlider ·the llI.O&!;t probable one, though it is far from //ceI'taino My reason tor thinking that w shall hll.ve these wide f'luctuationllJ- of which / we had it taste in 1962, in May particularly= b U.l.att I don it ue any change in human ': J naturel! vis-a"'vili the stock markflt Which ill ~tlf'f:icient to utabliah mor~ restraint.

II in the public behavior than it Iilhowed over IJO !J)_AXliy dtec.des in the pa.!Ilto The actions

// of the public wi th resp~ct to loW'~grade n~w bliUeliiI d"ll.l·~~ng the 1960-61 extravilgll!l.nza in

/' that :field are an indiC$,tion of: it~ inh~r'~mt Lack of r'~tra1nt. You ouglrt to remember abo, that many of the higheiilt grade connnon !"lltock,~'issues were forced up

to exceuive level~ by WI. !l15.rketenthu~ia8m. which produced large subsequent declines. Let me give you some exampllllt The m~t :'Lmpr~i!i\:I!live to w."y mind was that of Inter= na.tional Busd.ne aa Ma.chines which i~ undoubtably th<!!l Lead lng common stock in the (. entire market. Specu.lative enth~l,5ia~m pushed it up to 607 in December 1961~ ;from

'; which it declined to 300 in June 1962-- a. tall of mor-e than 5~ in the Slhort period \\ of 6 months. General Electric, which iii! the oldLest high grade investment common

\ stock, declined from .. high of 100 in 1960 to 54 in 1962.. Dow Ch~mical; one of our

\ best chemical companies, fell from a high ot 101 to .. low of 40, and UoS. Steel which \1& an old leader, shrank from 109 in 1959 to a lov of 38 in 1962. These very

\wide swings underline the fact that the ~tock m&r'k.et il!! ba~ically the same now as it ~lwa.ys was, in the senu it iii still 09JubJect to yery ~ubliitantial over-evajluation at \,lometim6S and'lundoUbtably subiitantial under evaluation;;! at others.

My basic conolusion is that investors as well a~ ~pecu~ators must be prepared in their thinking and in their policy for wi.de price movementi in eitht!r direction. They should not be taken in by soothing lI·t .. tement~ that a real investor doe sn It have to worry about the fluctuatioll!J ot the ~tock market.

It is time now to say what lit'tle I can ~ay about the probable cour-se of the stock ma.rket from the present levelo No doubt that i~ th~ point which wOlud interest the audience most and on which I can be the least !!lnlig.b:I .. entng, In my view there

is an important difference between the prellen't; stock. market and the market at more or lesa the same level in December 196L At that ti,m~ I had no hesitation about predicting that then there would have to be III fairly near~term collapae of the newi.sue market, which had passed all bound$ in ~peculative excesseso And if that

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co.l.l.apsed it voul.d li.Jurely~ttect in some SJerious way the general level of .took prices» it mlg,ht pO~ilibly Uflher in the bur m.a.rket which inwa.rdly I have been expecting for ~ome tim~ pastQ Th~ new i~sue collapse came per schedule and it did have a major adyer~e ~f:fect on the relt of the market 0 But II. recovery began in

<II. compardi'nly IS\hort time_p and it has carried the market averages to new height., .. which werilll (contrary to my inward e:xpectati,ons but not to any IIpecific prediction. which r made. I would like to point out that the Ialt time I made any atook

market ~rediction~ W~~ in the year 1914~ when my firm judged, me qualified to

write their daily market letter» ba~~d on the fact that I had one month's experience in Wall Str~~t. Since then I have given up making prediction ••

The important point now ill 'thlJ.t the cll!JC'rent high lteV'el" of the market are

not accompanied 'by thcle !!l%CIIs,:$ie9J in 'the n<!lw=i..l)llue market and in lome other direction" which ud~ it app~al" so ruLu.erablf: in 19610 It il the general view in Wall Street that such characteristic abuBu mu~'t develop again before the stock market can have anoth~r collap~e,==or before a true bear market can begin (if it isn't Ill,gain8t thl!! lay to use the dirty word§i u~ market"). These abU8es 'Would include Iargfl public participation by :!!lmal! people-w:ho don It !mow what they ~e doing" high borl"O'Wingl!il OIl mll.rgiI!." th~ r~:nerW:l.l ot the n~w=iiilIJHleS li_prelS and 110 on. Now this contention ~ound~ plauidbl@ ®nou,gh ba~(I!li on o!ixperi~nc~ s and so one might gueu that

the market could lJ'<ell con,tinl)),fj geIl.t!ll'ally upward, tor quite a while" But let me point' out lifor the record" thlftt it i/iID not impo~lllible in theory that the market '81 high level alone eoutd PJOOI~,~r or .l:l,t~r prl\!iciJPitat~ ill. collap!!l~ 'i!IT:tthout the"'ne'c~gflllity for these technical weakn~iII1iIer,!I1 to ®.how thelXJ.tlelvf!l. The collaplJe might be triggered by some untoward economi~ or political d~v<elopmento But if thing. do happen that way it

will be the firillt time in market hi~tory» I believe~ that we would have the end of

it bull market without the ~xce$l$I!J" and &btl18'!~ of th~ 101"t I have mflntioned~ But there is alwaYI a tir~t time for ~v~rythingQ

My opinion then r~g*rding th~ :pli."ef$~nt lll!I.Jtktlt levfll mu~t be rather 1nconcludve, and I :$hall baril!" my' l&t~l" pl"fJ!!lcription of' policy on thfJ auumption that investors cannot haYfl Ii, dependabill w-i(!iw on 'i;,htl!! muket j Ii future action in the next year or SOl, but that iB. large and di!'lJt1U!l'bing decline ill likely ,to tUtI! place ~ain som.ettme'in th~ future s and that <W"~ shoul.d be prepared in thought and action tor it, 1s a necessary a~lumption tor investorl to make» and for .eulible speculators too if there ar!!ll,my such,

Thtl!! second claim which b that t.h~re ill no real ".tock market" but only, ... the Wall str~e't people like to ~ay, only VIa market of: stock.n-~ deserves a moment or

two of dilc'lBlliono What they mean. by laying thiil is that investment ruult.depend only on what happ:en$to individual i'!le0tl.I'itiltl!il~ lIome ot which will go up and other •

. down, and that it 1; illu~ol"Y to talk about what happenl to 'the market alJ a whole as having" major b~aring on how the inv~stor fare~o I disagree with that point of view on thre~ grounds 0

Thti firlt is that I doubf that the market irf!l r~ally !OlO much different in this respect from v,hat it alw.:y~ wa~ in the pute I have some recollection of the market in 1928 and 1929} and I am "wre that the disparity and diversity of stocks between tholle that acted w~ll and tholie that acted poorly was almost a~ great then a.s we see now. But del!lpit<! that tact it wall ~a:llential :for investors to be guided by a view &1; to thl!!l general le'fel of 'th~ l!ltock market. It is luprising to me that Wall street p~opl~ haVfJn2t taken th~ time to make a study of the spread in price movement; betwl!ifJin indivi.dual stockll! in re(';flnt yea;r8 as compared with what happened in former y~ar!lio (I hav~ a IlIt'Ud(!llIlt a:t UCL.A. who i~ going to mue thil stu.dy

and it may prov~ quite il11~in.tory)o

, . The second !'tl!lason i[i that there :ts act1.lally .. considerable underlying consi!itency in the st.ock markllllt if' you mea~n~l'e its movemerrcs by comparing two averages which IJtlem to be qui'te different. One of th~m i~ the Dow Jones Industrial Average, which con8ist~ of only 30 Stock8~ and the other is the Standard & Poor's Composite Aver-age which conoii:it~ of 500 stockB. You might well assume that if there

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.L<$ ;/lI.0. r~na,erlyiJ:lg d,i yer~i ty of price mo·;rements then an a:nrage including only 30 stocks \m"0ill·:c(~r{!;,ltir.!l::r behave dii'fere:IJ:~ :from one embracing 500" :But if you observe the

in both ayerage~J now given by most newspa.periJ you get V'irtually a 'ten="to=Ol1l'l change s 'W"hich meane a parity change, almost day by day and certainly month

by m.Olntba:nd year :'ry year. In th.e pa&>t ten years the Dew Jones Average 1"0'1. ;from .!Ii. 275 m:.d .... po Irrt Ln 195~,. to 750:J while the Standard. Poor I s index rose from 24!7tq."

"5. An interecg-[,il1g ~oil1t is that the apparentl:r miscellan5lOUS group a# :5pO'isll1lli:;ls . actl11al.l;y had a slig,,"ltly better advance than thei1:it",edge or blue-chip stocks in the Dow Jane;,;; Ayerage. This indicates that yon cannot tell a priorit)'lhw.lItat,n~zr~~p:f'6f stiocks is. going to do Olver the future years in comparison with any Qtl1e.1",,' \."

I think the third and most important r"ason why the investor ahould not be

Ileid to emphasi::(;6 hia: iJlel<ection of .i.n ... di.'fidUal stocks, and to neglect .. the g.ene.ra.l level of' the ISt,;ock market is the fact that there La no indication that the investor ean do j'

better than the msrke't ayeragea by making his own selections or by taking expert .

ai"li('~e. '].the outstanding s,u.pport t,~f that pessimistic statement is found 'in the

/ r~cord. of the investment :funds, which represent a. combination of about the best

, financial brai!l:fff. in the country & and a tremendo'Wll -e.xpenditure~ of money , time.? and··c~e.fuly directed ~ff'ort. The record shows that the fund.s have had great difficulty as a'whole in <equaling 'th~ performance o:.f the 30 stocks in the Dov Jones

A ver'ages or the 500 Standard & Poor 1 a Lndex, If' an investc!;f. had been able.v by some

\ roug.l:l acrmHi!=the""board divers~.'1ca'tion to make up a portfQ}:t'9'apprOXimat*,pg these averagi!1l6 he would nave had every z-eascn to expsct about as 'good :results its' 'Were." \ shown by the very intelligent and ea;refuJ. stock selections by the investment..;t~A"'>

\managerf\9,. But th.e great Justification tor the mutual :funds is that ver! few in";;' '

'vag'tors actually do follow such a Bound and simple policy.

I must reluctantly e¥1presg ~ome skepticism about the general efficacy ot. economic forecasting, of ~tock market forecasting, and of expert selection of common lSl'tocks, in their :relation ,to th.<1JJ investment and specula.tive profits which can

be made th~r~from. Let me give you my reasonst I say first that to the extent that an ~conomic for~cast appear$ dependable-~and it is generally so only tor the short term--its effect is lik~ly to 'be alr~ady reflected ~n the ~ket lev~lp and there

is no way to mak:~ money t:::'om ~tt. Fe:)!' example ~ we cannot; say because t;l:u'J forecast for 1964 :ta favorable thatrc01l!)1li!!llO:n stocks shoul.d be botllght today. The price of common stockrm todaY:J as everybody shoukd :lmow reflects the general expectation of a good 1964. On the other hand, longer term business forecasts have proven'um:'iHia1itle on the whole.

Similarly, take the case where an individua.l stock is favored by one or my

own fraternity of secu;rity analysi~ i~ because he is optimistic about its future ea.:nings and gener-aL prol::j:pect~?o;i To the lI!:li;tent that in~estora generally agree that thJ.s company has good fut11l"e pr6gJpectll! to.;:~',t~hat extent J.ts prospects are alac likely to be fully reflect~d and perhaps (1)ver=rreflected in the market price. Sometimes you find "the contrary case wherttl a Wall Street man may Bay "Nobody likes this stockp nobody has confidence in 1t~ but I have confidence in it and I know its results are going to btlll bertt':J:;:'''' in the future." That Vii an interesting and valu.able conclusion if true. The trouble is that in most cases you can't rely on it~ de= pendabilityq The man may be right or he may be wrong in saying that !'I9me 1.Ul~ popukar stock Ls going to have a very good future. That is 'the dill!rr.ma,. all ii.n~ vestors'i'ace in trying ,to make money out ot :f'orecaat~ as to the future prospects

of any individual security.

No"loY s with respect to stock mark~t forecasting as such, as a sepa},"ate occupation or amusement, I don't think there is any good ~vid~nce that $. recognized and publicly u~ed method of stock market foreca~tir~ can be relied upon to be pro~

t:!i.tabl®o Le,t me illu3!trate what I mean by r~fi!r<snce to the famo1.!.S "Dow Theory" 'i:.::.:L(!ll i,1ij th~ be~t known of th<e methodll used tor forecasting the stock market. I nladlfJ snm..e ®lahm:"Er~e ~tudieiSl of the reEtults of applying the mechanical concepts oftk16 Dml Them:})l in '1fhich you have vell .. de:f'ined signals to buy and sell stocks by ithe !tj!)v~ment of the average through resistance points upward or downward. I f'o·w.d that whl!:ln :r studied the record from 1898 to 1933, a period of about 35 years- .. thiS' l'l'slSultSl from fc.llow:itJ.g this m:echooi.c-a:l me.t4od :were~':1i'emarltably' good. Alo()'Uxt 1933,1> the time when the Dow Theary had: show itself a very useful method

:tor d.eEling ~iith th.<e mark<f:lt action in the 19.201s and early 1930ts~ the publicts :L1"t<ex'<e2l~~ in thtS Theory increaliled ~normQusly e P"viou~ly it had been a. kind of eJ~oteric pre®!crip'tion f:J11owed only by a few d!l!lvoted adhert!nts; and about which <5lverybod.y <elfl1~ had b~(~n pretty sk~ptical. TIle Dow Theory became extremely popular a.f'ter 1933. I !t!tud:lL<!ld. the ccnsequences of u~ilmg exactly the same method in

the mJa.rkltt after 1933» and I found peculiarly enough tha.t in no case in the

next 25 j1'@!Iat"al d.id one b<ln~fit thrOltgh following 'the Dow $ignals mechanically.

By tlc.J .. ® I ll1l"lalllthat one Tial\lJ never able to buy hi$ f!Jtock~ back a.t a lower price than h~ ~old th~m foro

.A81 you krmow J! the Dm'il' Theory i8 (!$jt:ill pfilrj;n.r.ed by a J:1'l\lmber of practi tionflrs and s~rii(jl~~~ I th.ink all of' th~m will t~ll YOll that :it ial not a m<!!lchanical

th<eory now p 800. the/c a lal"g~ ~l~m~)Q,t of judgmen.t 11'8.0$ "1;;0 ~nto!ir in the interpretation of th~ signa.li€l 0 Bl[t once you introduce that Iltlll!mllflrrt you don. it have a true theory a:nymoJr'@ s you JUt£j't,; hav~ a c-ertain 6lxpertili!® whi,;;J.l mayor may not b<e dependable and usefu.l.

Lli'lit illif!l now mak~ a general observatiOilc For obvious reasons it is impouible

!;or irJv~gtor:g; as a whole» and th<5r~for<e fclt" the average invl!li!!itor or speculator s

o do blJ:tt!'Jrthan th® g®nil1Jral markets The! E\l!la~On is that you 8JC'®;',the general market and Y0',ll can 'i!j "iob(~rt·t<!1Jr than yOill,;Z"iS<!ilv~~o I do o@li®v(!1l it is possible tor a

/ ull.n.ority of ilnrel'Eto:r~ '~(B g@1it d.gni:fic;antly b~tt~:r !"<l!5j'w,ts than the average. Two

condiJ'~ioniSi a:r~ n<F!lc('iJg,)~8Jf'y for t.hato One 112\ that th@y mMt folloW' some sound prin"

ci:ple:l':o1 of hSlell.;1lc'tion Whir;;;h ar@ r<l'&la't~d. to t,he value of th<1!! "'liecu.ritieSl and not to

\ their marke·t p:r::'x~® actiono Th!'!! oth~I" iilil that their m~thod of operation must be baSically diff<!!:r@!Hl~G than. that of thilll majority of security buyerB. They have to

, cut thl!lmr&JelY~1i!l off' trom the geul!lra1. pUbl:i.c and put th~H1l8elves into a sp~cial catal"" .

. gary. I will 'toiJlch mO:l:"e 'briefly on that pain:t later 0 +-;

Novs l~t m~ iSiummariz~ up thi~ stag~o The inve~tor ne~ds common stocks in his)

port.folio 3 but thflS~ in:troduci! hazards of wid,fl flu:;tuations which he cannot (

expect to avoid more $llCC~$!!!lt1illy than others unless perhaps he thinks Lndepen- i,

d~ntly from the crowd; that b >Cll.nles$ he is consut tu.tionally different :from the~_/ average.

Now let me come to part tvm what investment policy to follow under the conditionB a.i&lCUI38~d? My views thl!'lreOll are and def'inJ.te and ~trong~ In my nearly tift;)?' ;VearOi of exper-Ience in Wall S·treet lIve t'm.1l.nd that I know l~!Hui and less about what th~: ffilltock ma:rket ill!l going to do but I know mOI'e and more about what investors ought to dOjj and thatqs a pretty vital change in attitude. The first point

~k~:, is tha.t the inveli>tor i~ requir~d by the very in~ecurity ruling in the world of

l·· ·today to maintain at all timtla !lJom~ divb10n or hi!lll :f!lllds bl!!tween bonds and IJtocks (ca&1h and variml!'ll types of interteiEt=beaxing deposi tiS may \e viewed ali bondequivaltlnt~.) My ~uggestion i~ that the minimum po~ition of thi9 portfolio

held in common :sltoekSl shoukd btl 25'1> and th~ maximum sho'Lud be 75~Q Conseq'llen=

tly the maxrmum holding of bonds would btl 7510 and "the minimum 25%- the figures being I'ilSytlI'Bsdo Any varia:tions made in hi~ portfolio mix snoul.d be held within these 2510 and 7:;;'% figlU'~$. Any such val'iationg ~hlQ\!lld. btl clearly based on val.ue consideratiOlll1l p ,!!'hich would lead him to otm more common ~toc:ks when the mBJ:'ket aeems low 1.10:. relation to value and l~ss common $tock~ whe:n the market seems high

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1;'AGE 10

in relation to value.

Now while this is the classic language of investment authorities, it is amazing how many people think in exactly opposite termsQ That was brought home to me shortly after the May 1962 break when a savings=and-loan company representative came to me with questionsq The first question he asked me

was "Don't you think that common stocks now are less safe than before because of the decline in the market?" That hit me between the eyes. Here were financial people who could I!!eriousl.y consider that stocks less safe because they have declintJ.d' in price than they were after they had advanced in price 0 The policy I pnopoae to have more common scocke when the market seeme to be Lov and less when it seems to be high by value sbandaz-da is obv Lous Ly opposed to the psychology

of investors generally and to that of speculators always. It is particularly true now because of the great confu~ion between investment and speculation which I shall refer to later. I suppose the idea of having more common stocks at low levels than at high levels is a. "counsel of perfection" for most investors. But it could be followed by many investors to the extent of a.n inflexible rule that they should not increase the percentage of common stocks in their portfolio as

the market advances, except of course through the rise in the market itself. However, a more sophlsticattd application9 vhich ·would take advantage of' a rise in the market level for sal~~.9could be something .likethii'Sl<> Use a fixed 50-50 division between bonds and mtocks. When the ma.rket level of the s cocss rises <to a point where they con~titute 55% of the total or maybe 60%~ you would. then sellout enough to bring your pr opoz-t ton back to 50%09 putting the proceeds back into bonds or irito sa.vings bankso And conver~ely when the mar~~t went down ~o that your common stock proportion had fallen 45% or 40%, you "Tould\u~t some of your bond money to buy common stocks and bring it back to the 50%0 Thcr<G was the fa.mous Yale Un.iversity system, which was on'&'l;)f the e8.rlie!!lt formula methods knoVIlo They used a 35% basis for common stocks, a percentage which at that time was regarded alE pretty rash

:for an institution of Learnfng , When a ma.rket rise bz-ougrrt it up to 40% they sold out one eighth of their holdingsp to get back to 35%<~ Ii .. hen it went down to 30% they P.9ught one sixth to bring the'ra.tio up aga Ln to 35%. It was a good system until the mal-kef-ran away on the upside J and then t.hey dec Lded they had too little in common stocks. Now they are up to' a, 50 to 55% rat::ioj like the other universitie8~ I think, and they don't follow the formula anymore.

Another approach that ial practicable J but from a .different point of' view s is the "Do.Ll.ar' Averaging" method, in which you .put t.he aame amount of money in common stOcks year after year, or quarter af'ter quar-cez-, In that way you buy more shares .9~ stocks when the market level. iill low and fewt!!lr' shares when i tm high. That ~thod has worked out extremely well tor thoa:e who have had. (a) the money, (b) the time, and (0) the character nece saaz-y to per-sue a cons Lsterrt policy over the years

regardless of whether the market has been going up or down. If you can do that you are guaranteed satisfactory success in your inve~tment3o

Let me add that there are count Leas var ranns of this ·type J; which are called "formula pla.ns. II The main. need here is for thte irnrestor to 5Ielect some rule which seems to be suitable for hie: point of view s one lfhich will keep him out of mis"," chief, and one, I insi.!!lt» which will always maintain some interest in common stocks regardless of how high the market level gou. For :if you had follOwed one of

these older formulas Which took you out of common gtockB entirely at some level of the market, your disappointment would have been ~o great because of the ensueing advance as probably to ruin you from the etan.dpoint of' irrtelligent investing for the rest of your life,

Now let me come to the problem~ of security gelectiono We have talked about a bond component (and/or a. ca!!lh=equivalent compon~nt) and a common stock com= ponent. There's a wide choice In the bond component» but the decision is not of

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too much importance in most cases. In the taxable list; you can put your money in U.S. Savingm Bonds at 3~; which you can redeem at will; you can buy long term U.S. Government Bonds at about 4.10% taxable; you can buy high grade, longterm corporate bonds at 4.30%, or 4~ if you do a little selecting, you can have savings deposits in commercial banks which give you up to 4t% if held for one year; you can buy savings-and loan shares (bear in mind that they are not deposits but sbar-e s ) which now yield up to 5% in California. Another choice of great importance are tax~free state and municipal bonds, which yield up to about 3~ for good quality and long maturity. For most investors who are in a tax bracket of more than 30%, tax~free bonds have been the most attractable for

many years. They actually were in part a gift to the investor of which he didn't take advantage up to the extent he should have as against taxable bonde. That advantage has diminished, because tax free bonds have advanced relative to others, but it is still per-suas rve for people of subatiarrt i al, means. I would like to point out that in 1953 municipal bonds yielded 2.93~ and U.S. Government taxable bonds 3008%, nearly the same return despite the full tax on the governments~ In October 63 the municipal average was 3028% and that of U.S. Government bonds 4.0~, so

you see the advantage that has ~ue.a to the past holder of tax-free bonds as compared with U.S. government~

One que$tion for the investor which I won't go into, and I am glad I havn't got the time to do it, is whether he E1hould take advantage of the 5% rate offered by some of the sav mgs and loan associations in California. Let me say that I am not an expert on !'.Iavinglll- and loan associations, and I don't want to get drawn into the controversy that has now begun as to whether their methods are completely sound and their prospects are completely dependable. I just want to say in general terms that nobody can assume that he can get exactly the same degree of safety and dependability in a standard type of invel!)1tm~'ll!t yielding 5% as in one yielding 4%.

With respect to pref'ered stocks the import point is that they do not· belong

in the individual investor's portfolio. The reason is they have a great tax advantage for corporate owners which they donit have for individual owners. Corporate owners 8Rve 85% of the tax on these dividen~s) individual owners save

It very small amount, which may disappear pretty soon in the new law. It should

be obvious that preferred stocks should be bought only by corporate investors just as tax=free bonds should be bought only by people who pay income tax. You may have noticed last week that one of the public utility companies offered a bond issue and a preferred~stock is~ue at practically the same yield; although hitherto preferred "tock~ have alway 6'1 yielded quite a bit more than the bonds to Which they wne junior. The great tax advantage of preferred stocks to corporate buyers is now

be atedly showing its t!!ffect on relative yd.elds.

We come finally to common~stock investment. My recommendation is that the inV8fll\tor choose either his own limt of, say, 20 or 30 representative and leading companies, or el~e put his money in several of the wellcestablished mutual funds. (There is uiually an advantage for the shrewd investor in buying shares of the clO$ed~end inve$tment companies on the New York Stock Exchange, when obtainable at discounts from net asset value, rather than paying the premium added on to the price of most open=end shares.)

Many inve~tors would think my prescriptioh too $imple. If they can get re~ ~ult~ equal to the averages in this easy way why Qhouldnit they try to get a $ubstantially higher return by careful and compet~ntly=advised selection? My short anlwer has already been given: If the investment founds as a whole can't beat the av~rages~ even pretty clever investors as a whole can't do it either. The underlying problem of selection is that the "good ~tocks==chiefly the growth stockm with b~tter than average prospectl=~tend to be fully priced and

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often overpriced." At the other extreme new stock offering., when the craze i. one, are likely to combine fourth-rate quality with abaurdly high price-earnings ratio •• There a.re better opportWlitieill in b.,tween th ••• extreme., but moat innltorl don't look for them there.

As I lee it, the fundamental problem in common stock. i. the market'. injection of a large Ipeculative element into the strongest and best companies by establishing an untenably high price for them. (The rise ot IBM or 607, soon followed by a fall to 300, il the best illustration of my point.) This haa addedgreatly to the contu.ion between inveltment and .peculation, bec.Ule it is ea8Y to tell onuelf' that the .har'lI of a good company are a.lway. a. lound inveltment", rega.rdl~.IIIS of price. From this it Wa.1 an easy .tep to calling everyone an in .. vestor who bought hi. share. outright~ and finally to calling every Wall Stre.t customer an investor--period.

My recent crulade haa befll!n to perluade Wall Street that it ha.. made a mbtake, and harmed it.elf J in IlJ,pprusing the word "lIIpeculationlt from itllll vocabulary. Speculation is not bad in it.elf; over.peculation ia. It ia important that the public should ~ave a ta¢rly good idea of the extent to which it 18 speoulating,

not only when it busy .""hot bauer! at a completely Dilly price, but even w~ it buy. into a wonderful concern such •• IBM at 70 time. i til high.lt recorded earning.. To my mind the mo.if valuablecontribut1on that .. curi ty analy.tl could make to the art of invelting would be the determination of the inveltment &nd .peoula-

'."t,,~". compon.n'es in the current price of any gi yen common .tock, 80 that the in-

tending buyer might have lome notion of the rilk. he i. taking. a. well as what profit he might makeo I have pointed out that my own conservative apprats81

put the investment component in IBM', 1961 price at not more than $200 per.hare --about $6 billion for the entire enterprile--the rtmainderof the quotation repre.enting iii. Ipeculative valuatt,pn ot the company's undoubtedly brilliant future. Converlu,ly, I Ita.ted,tha:t at least 8~ of the highest pric,s(55) of International Harv"ter :!.n 19~1 could bl ascribed to its investment value.

Th1. did not prove that Harve.ter W&I a better buy than IBM-wit waa", alit

t).U'ned out .... but it did demonltrate that the rilk. factor involved was much smaller.

. Let me raiae a final question: D •• pi" rather dilcouraging reeults from '.

end.avor. to prld:lcrt market mov .. or to nl.ct the most attractive oompaniee,:, can the intelligent inv •• tor tollow any polioie. ~ oommon-.tock lellction that prom1,., better than average result.? I thi:qk it 11 po.sible for some strong .. minded inv •• torl to do thil, by buying value rather than prolpects or pop-

ularity. Some example. ot thil approach: (1) Select stocks .of important com-

" pani •• which •• 11 on iii. no-glamour .be..i.- .... g. I International Harvester. Some extraordinary relultl could have b.,n obtained lince 1933 by buying 18.Qh year

the .hare. ot the lix compani,. in the Dow Jonel Ind. Average which .old at the lowe.t mll1t1pli.r of their recent laming.. (2) Buy definitely "bargain 1aIUe.. n Typically thlll would bl .hare. that lold tor lell their valul in working~capital alo~., with nothing paid for fixed a ••• t. and goodwill. The •• wert quite numerou. ~p to a. late al 1957, and were oonlilt.ntly profitable when diversi-

\\ tic.tion wa. oblerv,d. Few IUOA opportun1 tie. remainJ perhap. they have bien

'\ lupplanted by .harl. of amaller oampanie •• Illing on a relatively d.pr .... d

\ ba.i, IUld. likely to be taken oVlr by ilL larger oono.rn at a good advanc. in price. \ (3) Finally there 11 the wid. field of u1pecial .1tuat10n."--rlorganization.,9

\ merg,r" take-over., liquidation., eto. Thia il a prot,.,ional area, but it

. \

i. not impol.ibl. tor intelligent invlltor. to profit hand.omely trom it if

\ t~.y approach slcurity operation. all they would .. commercial bUlin •• lo

\, CONCLUSION.

\ The investor must recognize that there al'l unoertain and. hinCI .peculative

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~l~mi>}1Gti'lll inn.E!I"<!IH.1t in any policy he fol1ows--even an all-Government-bond program. E~ ,:ri:;di1,.; :i~al '\WJ'ith theu uncertainties by a policy of continuous compromilll. ba';~'l,l~Jrllj!l. bO!:2d~ and common stocks; and by adequate diver. ificat ion. (Exception:

E~ may puts.nd ksep mOISt of his funds in shar •• of a. promi.ing businelllS with

bJe i~ (,;louly connecbed , ) He must make a .trong effort to have more money ·;.;:,,·f!~'t~d, in common itockii at lower market levels (at lea.t on the basis of cost) c;;}'tan at '\Sihs:!:, b.<e I'<lccgnius to be potentially high level.. Most important, he IT.:U£it m;aintain a philoiiophical attitude towards the inescapable variations in

l"ina,'2cial p05itiollJ. and the inevita.ble "mistakes" lISsociated with these T8.1'ia:tiO:rl:S •

Ae;cord.hAg to an old Wall Street story" when a certa5n broker wits a.ked by a cli~nt to rgcomm~nd ir.sue~ to buy, h~ a.!ways alke~ in ~Jturn, "What is your ,~'1'~f'I,;l:rI~nce7 Do you want to flat 'Well or to ,:J,.t.lep well? J! 1 am optimist enough 'bo b-eli<l!i'\lte that by following sound policies almost any investor--even in this :t:l.li5~C\J!:r~ wO:K'ld==!lihould be able to eat well enough without having t.o lose MY ®;1~~]!4

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