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between the usual objectives of security analysis and those we deem dependable and rewarding. Most security analysts try to select the issues that will give the best account of themselves in the future, in terms chiefly of market action but considering also the development of earnings. We are frankly skeptical as to whether this can be done with satisfactory results. Our preference for the analyst’s work would be rather that he should seek the exceptional or minority cases in which he can form a reasonably confident judgment that the price is well below value. He should be able to do this work with sufficient expertness to produce satisfactory average results over the years.

Commentary on Chapter 18

The thing that hath been, it is that which shall be; and that which is done is that which shall be done: and there is no new thing under the sun. Is there any thing whereof it may be said, See, this is new? it hath been already of old time, which was before us.

—Ecclesiastes, I: 9–10.

Let’s update Graham’s classic write-up of eight pairs of companies, using the same compare-and-contrast technique that he pioneered in his lectures at Columbia Business School and the New York Institute of Finance. Bear in mind that these summaries describe these stocks only at the times specified. The cheap stocks may later become overpriced; the expensive stocks may turn cheap. At some point in its life, almost every stock is a bargain; at another time, it will be expensive. Although there are good and bad companies, there is no such thing as a good stock; there are only good stock prices, which come and go.

Pair 1: CISCO and SYSCO

On March 27, 2000, Cisco Systems, Inc., became the world’s most valuable corporation as its stock hit $548 billion in total value. Cisco, which makes equipment that directs data over the Internet, first sold its shares to the public only 10 years earlier. Had you bought Cisco’s stock in the initial offering and kept it, you would have earned a gain resembling a typographical error made by a madman: 103,697%, or a 217% average annual return. Over its previous four fiscal quarters, Cisco had generated $14.9 billion in revenues and $2.5 billion in earnings. The stock was trading at 219 times Cisco’s net income, one of the highest price/earnings ratios ever accorded to a large company.

Then there was Sysco Corp., which supplies food to institutional kitchens and had been publicly traded for 30 years. Over its last four quarters, Sysco served up $17.7 billion in revenues—almost 20% more than Cisco—but “only” $457 million in net income. With a market value of $11.7 billion, Sysco’s shares traded at 26 times earnings, well below the market’s average P/E ratio of 31.

A word-association game with a typical investor might have gone like this.

Q: What are the first things that pop into your head when I say Cisco Systems?

A: The Internet…the industry of the future…great stock…hot stock…Can I please buy some before it goes up even more?

Q: And what about Sysco Corp.?

A: Delivery trucks…succotash…Sloppy Joes…shepherd’s pie…school lunches…hospital food…no thanks, I’m not hungry anymore.

It’s well established that people often assign a mental value to stocks based largely on the emotional imagery that companies evoke.1 But the intelligent investor always digs deeper. Here’s what a skeptical look at Cisco and Sysco’s financial statements would have turned up:

Much of Cisco’s growth in revenues and earnings came from acquisitions. Since September alone, Cisco had ponied up $10.2 billion to buy 11 other firms. How could so many companies be mashed together so quickly?2 Also, roughly a third of Cisco’s earnings over the previous six months came not from its businesses, but from tax breaks on stock options exercised by its executives and employees. And Cisco had gained $5.8 billion selling “investments,” then bought $6 billion more. Was it an Internet company or a mutual fund? What if those “investments” stopped going up?

Sysco had also acquired several companies over the same period—but paid only about $130 million.