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It is by no means difficult to provide even more harrowing examples taken from the more recent version of “the same old story,” which covered the years 1967–1970. Nothing could be more pat to our purpose than the case of AAA Enterprises, which happens to be the first company then listed in Standard & Poor’s Stock Guide. The shares were sold to the public at $14 in 1968, promptly advanced to 28, but in early 1971 were quoted at a dismal 25¢. (Even this price represented a gross overvaluation of the enterprise, since it had just entered the bankruptcy court in a hopeless condition.) There is so much to be learned, and such important warnings to be gleaned, from the story of this flotation that we have reserved it for detailed treatment below, in Chapter 17.

Commentary on Chapter 6

The punches you miss are the ones that wear you out.

—Boxing trainer Angelo Dundee

For the aggressive as well as the defensive investor, what you don’t do is as important to your success as what you do. In this chapter, Graham lists his “don’ts” for aggressive investors. Here is a list for today.

Junkyard Dogs?

High-yield bonds—which Graham calls “second-grade” or “lower-grade” and today are called “junk bonds”—get a brisk thumbs-down from Graham. In his day, it was too costly and cumbersome for an individual investor to diversify away the risks of default.;1 (To learn how bad a default can be, and how carelessly even “sophisticated” professional bond investors can buy into one, see the sidebar on p. 146.) Today, however, more than 130 mutual funds specialize in junk bonds. These funds buy junk by the cartload; they hold dozens of different bonds. That mitigates Graham’s complaints about the difficulty of diversifying. (However, his bias against high-yield preferred stock remains valid, since there remains no cheap and widely available way to spread their risks.)

Since 1978, an annual average of 4.4% of the junk-bond market has gone into default—but, even after those defaults, junk bonds have still produced an annualized return of 10.5%, versus 8.6% for 10-year U.S. Treasury bonds.2 Unfortunately, most junk-bond funds charge high fees and do a poor job of preserving the original principal amount of your investment. A junk fund could be appropriate if you are retired, are looking for extra monthly income to supplement your pension, and can tolerate temporary tumbles in value. If you work at a bank or other financial company, a sharp rise in interest rates could limit your raise or even threaten your job security—so a junk fund, which tends to outper-forms most other bond funds when interest rates rise, might make sense as a counterweight in your 401(k). A junk-bond fund, though, is only a minor option—not an obligation—for the intelligent investor.

A WORLD OF HURT FOR WORLDCOM BONDS

Buying a bond only for its yield is like getting married only for the sex. If the thing that attracted you in the first place dries up, you’ll find yourself asking, “What else is there?” When the answer is “Nothing,” spouses and bondholders alike end up with broken hearts.

On May 9, 2001, WorldCom, Inc. sold the biggest offering of bonds in U.S. corporate history—$11.9 billion worth. Among the eager beavers attracted by the yields of up to 8.3% were the California Public Employees’ Retirement System, one of the world’s largest pension funds; Retirement Systems of Alabama, whose managers later explained that “the higher yields” were “very attractive to us at the time they were purchased”; and the Strong Corporate Bond Fund, whose comanager was so fond of WorldCom’s fat yield that he boasted, “we’re getting paid more than enough extra income for the risk.” 1

But even a 30-second glance at WorldCom’s bond prospectus would have shown that these bonds had nothing to offer but their yield—and everything to lose. In two of the previous five years WorldCom’s pretax income (the company’s profits before it paid its dues to the IRS) fell short