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responsible investment houses be honor-bound to refrain from identifying themselves with such enterprises, nine out of ten of which may be foredoomed to ultimate failure? (This was actually the situation when the author entered Wall Street in 1914. By comparison it would seem that the ethical standards of the “Street” have fallen rather than advanced in the ensuing 57 years, despite all the reforms and all the controls.) Could and should the SEC be given other powers to protect the public, beyond the present ones which are limited to requiring the printing of all important relevant facts in the offering prospectus? Should some kind of box score for public offerings of various types be compiled and published in conspicuous fashion? Should every prospectus, and perhaps every confirmation of sale under an original offering, carry some kind of formal warranty that the offering price for the issue is not substantially out of line with the ruling prices for issues of the same general type already established in the market? As we write this edition a movement toward reform of Wall Street abuses is under way. It will be difficult to impose worthwhile changes in the field of new offerings, because the abuses are so largely the result of the public’s own heedlessness and greed. But the matter deserves long and careful consideration.*

Commentary on Chapter 17

The wisdom god, Woden, went out to the king of the trolls, got him in an armlock, and demanded to know of him how order might triumph over chaos. “Give me your left eye,” said the troll, “and I’ll tell you.” Without hesitation, Woden gave up his left eye. “Now tell me.” The troll said, “The secret is, ‘Watch with both eyes!’”

—John Gardner

The More Things Change…

Graham highlights four extremes:

an overpriced “tottering giant”

an empire-building conglomerate

a merger in which a tiny firm took over a big one

an initial public offering of shares in a basically worthless company

The past few years have provided enough new cases of Graham’s extremes to fill an encyclopedia. Here is a sampler:

Lucent, Not Transparent

In mid-2000, Lucent Technologies Inc. was owned by more investors than any other U.S. stock. With a market capitalization of $192.9 billion, it was the 12th-most-valuable company in America.

Was that giant valuation justified? Let’s look at some basics from Lucent’s financial report for the fiscal quarter ended June 30, 2000:1

FIGURE 17-1 Lucent Technologies Inc.

All numbers in millions of dollars. * Other assets, which includes goodwill.

Source: Lucent quarterly financial reports (Form 10-Q).

A closer reading of Lucent’s report sets alarm bells jangling like an unanswered telephone switchboard:

Lucent had just bought an optical equipment supplier, Chromatis Networks, for $4.8 billion—of which $4.2 billion was “goodwill” (or cost above book value). Chromatis had 150 employees, no customers, and zero revenues, so the term “goodwill” seems inadequate; perhaps “hope chest” is more accurate. If Chromatis’s embryonic products did not work out, Lucent would have to reverse the goodwill and charge it off against future earnings.

A footnote discloses that Lucent had lent $1.5 billion to purchasers of its products. Lucent was also on the hook for $350 million in guarantees for money its customers had borrowed elsewhere. The total of these “customer financings” had doubled in a year—suggesting that purchasers were running out of cash to buy Lucent’s products. What if they ran out of cash to pay their debts?

Finally, Lucent treated the cost of developing new software as a “capital asset.” Rather than an asset, wasn’t that a routine business expense that should come out of earnings?

CONCLUSION: In August 2001, Lucent shut down the Chromatis division after its products reportedly attracted only two customers.2 In fiscal year 2001, Lucent lost $16.2 billion; in fiscal year 2002, it lost another $11.9 billion. Included in those losses were $3.5 billion in “provisions for bad debts and customer financings,” $4.1 billion in “impairment charges related