Geoff Gannon

On Ben Graham, Bank Stocks, Jason Zweig and Tom Brown

Alex,

Graham's idea of “new conditions expected in the future” differs considerably from what I think many people today might mean when they use that phrase. Basically, we’re talking about some sort of normal earnings power. That’s why I used a bank like Valley National as an example. It’s not cheap and Ben Graham would never buy it for that reason. However, it is the kind of company where one could believe the past record will help you come up with an idea regarding future earnings. Graham wouldn’t use a single year P/E. He wouldn’t assume ROEs could be what they had been recently. However, he might look at banks with long records of operating in a relatively consistent manner.

My point in this post and the last (responding to Zweig’s article) is that the stumbling block for Graham wouldn’t be the black box nature of financials, or some credit terra incognita, but rather the price. I felt that portraying Graham as avoiding stocks where the internal workings of the business could be glimpsed only dimly at best was inaccurate. If Graham got both a good past record and a good price on a stock, he’d be willing to buy it even if major qualitative concerns were present. He simply wasn’t the kind of investor who would ignore an entire sector because of a major crisis in that industry.

Finally, re-read the quote you used careful. It actually doesn’t refer to future prospects at all. What it refers to is the reliability of the past record in predicting the future. For example, Graham didn’t want to buy a munitions company after years of war and assume it would do what it had in the past. However, and here we may disagree, I think there are banks (not all banks – probably not even most banks, but some banks) that have done business in a relatively consistent way over long periods of time. Eventually, these banks will return to delivering “normal” results that could be gleaned by looking at their past record.

No. Graham wouldn’t look at Washington Mutual and think that he could rely on the past record at all. He would look for banks with long records of operating under a variety of different conditions.
I stand by my statement that: “(Graham) spent almost no time worrying about a business’s management, corporate culture, or future prospects." Countless sources support this statement. Too many people have attributed certain qualitatively conservative stances to Graham that he never possessed. He was a conservative investor; however, he was a quantitatively conservative investor.

For Graham, most bank stocks today fail on quantitative grounds, not qualitative grounds. They lack the combination of a solid past record and a low price-to-book ratio that he would demand if he were to invest in financials.
By the way, I just started doing a weekly chapter-by-chapter commentary / reading group on Graham’s Security Analysis (1940 ed.). Please check out my blog next Monday (or any Monday) and share your thoughts on Graham – I’d love to have a dissenting voice present.