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How does the foregoing inquiry apply to the enterprising investor who would like to make individual selections that will yield superior results? It suggests first of all that he is taking on a difficult and perhaps impracticable assignment. Readers of this book, however intelligent and knowing, could scarcely expect to do a better job of portfolio selection than the top analysts of the country. But if it is true that a fairly large segment of the stock market is often discriminated against or entirely neglected in the standard analytical selections, then the intelligent investor may be in a position to profit from the resultant undervaluations.

But to do so he must follow specific methods that are not generally accepted on Wall Street, since those that are so accepted do not seem to produce the results everyone would like to achieve. It would be rather strange if—with all the brains at work professionally in the stock market—there could be approaches which are both sound and relatively unpopular. Yet our own career and reputation have been based on this unlikely fact.*

A Summary of the Graham-Newman Methods

To give concreteness to the last statement, it should be worthwhile to give a brief account of the types of operations we engaged in during the thirty-year life of Graham-Newman Corporation, between 1926 and 1956.† These were classified in our records as follows:

Arbitrages: The purchase of a security and the simultaneous sale of one or more other securities into which it was to be exchanged under a plan of reorganization, merger, or the like.

Liquidations: Purchase of shares which were to receive one or more cash payments in liquidation of the company’s assets.

Operations of these two classes were selected on the twin basis of (a) a calculated annual return of 20% or more, and (b) our judgment that the chance of a successful outcome was at least four out of five.

Related Hedges: The purchase of convertible bonds or convertible preferred shares, and the simultaneous sale of the common stock into which they were exchangeable. The position was established at close to a parity basis—i.e., at a small maximum loss if the senior issue had actually to be converted and the operation closed out in that way. But a profit would be made if the common stock fell considerably more than the senior issue, and the position closed out in the market.

Net-Current-Asset (or “Bargain”) Issues: The idea here was to acquire as many issues as possible at a cost for each of less than their book value in terms of net-current-assets alone—i.e., giving no value to the plant account and other assets. Our purchases were made typically at two-thirds or less of such stripped-down asset value. In most years we carried a wide diversification here—at least 100 different issues.

We should add that from time to time we had some large-scale acquisitions of the control type, but these are not relevant to the present discussion.

We kept close track of the results shown by each class of operation. In consequence of these follow-ups we discontinued two broader fields, which were found not to have shown satisfactory overall results. The first was the purchase of apparently attractive issues—based on our general analysis—which were not obtainable at less than their working-capital value alone. The second were “unrelated” hedging operations, in which the purchased security was not exchangeable for the common shares sold. (Such operations correspond roughly to those recently embarked on by the new group of “hedge funds” in the investment-company field.* In both cases a study of the results realized by us over a period of ten years or more led us to conclude that the profits were not sufficiently dependable—and the operations not sufficiently “headache proof”—to justify our continuing them.

Hence from 1939 on our operations were limited to “selfliquidating” situations, related hedges, working-capital bargains, and a few control operations. Each of these classes gave us quite