Graham the Stock Analyst
Among Ben Graham’s early tasks as a partner was the production of statistical reports of stock analysis. For example: comparisons of differing railroad companies, and detailed statistical comparisons of all tire and rubber stocks. The latter task taught Ben the importance of meeting or talking a with company’s top management before publishing his comparisons or setting his results in stone, as the top pick in his list (a firm named Ajax Tire) went bankrupt shortly after publication.
As taxation and tax laws became more and more complex, Ben started to study them more and more. He was sure that knowledge of the intricacies of taxation would better allow him to analyze their ramifications as far as corporate results were concerned. This intense study allowed him to devise complex formulae for the calculation of goodwill, and his results were formidably accurate; in particular as reported on page 187 of Security Analysis, Ben discovered that a total of $769 million of the U. S. Steel plant account was “water”. As a result of this, U. S. Steel was forced to write down a large portion of its intangibles over the next few years using retained earnings.
As his success with value arbitrage and hedging due to his development of analytical methods spread, Ben was approached by clients and friends to manage their money with a share in the profits. In 1923 Ben started working as a Portfolio Manager via a new entity named Grahar Corp, taking both a salary and a percentage of the profits. One of his most successful stock positions for Grahar was a purchase of Du Pont while shorting seven times as many shares of GM (Du Pont itself having a large holding in GM while itself selling for no more than the value of this holding). Ben recognized that the market was undervaluing Du Pont and overvaluing GM, and the position was designed to take advantage of an eventual return to rational valuations of the two stocks. This, of course, eventually happened and Ben was able to close out the position with a large profit.
After failing to renegotiate a larger share of the profits of Grahar Corp with the largest investor, Ben wound up and closed the business at the end of 1925, intending to start a new managed account in 1926 on the improved profit-sharing terms that had originally been rejected. Starting with $450,000 capital at the beginning of 1926, the account grew to $2.5M by 1929, the majority of the gain coming from capital appreciation. It was during this time that Benjamin Graham joined forces with Jerome Newman, and formed the beginning of their long association (later in the Graham Newman Corporation).
One of Ben’s successes that contributed to the growth of this account was purchasing stock in a pipeline company, Northern Pipeline, that he had discovered was holding a significant investment of investment-grade railroad bonds with a value far in excess of the company’s revenue. Ben purchased 2000 shares at around $65, and then prodded and probed the management to redistribute the capital to shareholders, insisting that there was no reason for a company to have on its books bond investments that were 10 times its revenue. Eventually the management saw the light, and made two distributions of capital of $50 and $20 per share, Ben effectively receiving more in cash than he paid for the shares, while still maintaining a full holding (Security Analysis p. 502)
The account (“Benjamin Graham Joint Account”) did so well, that larger premises were taken over and after a while the operation caught the eye of celebrated sugar speculator and financier Bernard Mannes Baruch. Baruch invited Ben to be his partner but, although flattered, Ben was having none of it. He was now a success in his own right and felt no compunction to be a junior partner.