Book Review: Benjamin Graham And The Power of Growth Stocks by Frederick K. Martin

Benjamin Graham And The Power of Growth Stocks is the most important investment book I’ve ever read. Employing the principles outlined in the book, the author’s firm (Disciplined Growth Investors) has generated exceptional results for his clients. One offers this summary in the book’s foreword:

When Frederick Martin “took over management of the (my firm’s) account in 1980, we had a total of $841,338 in the pension fund. Since then, some money has been added and some has been withdrawn, adding up to a total net addition to the original amount of $967,943. That means that, all in all, we have contributed a net total of about $1.8 million. Under Fred’s management, that sum had grown to $96.9 million as of April 30, 2011 – an increase of more than 5,000 percent.”

–        Craig R. Weflen, Administrator, Noran Neurological Clinic

Benjamin Graham of course wrote Security Analysis and The Intelligent Investor, two books widely considered to be classics of investment literature. He was also Warren Buffet’s professor, employer and mentor for twenty years. While primarily known for the principles of value investing that he developed during the 1930s, Graham’s most successful single investment was a growth stock, GEICO, which yielded a greater return than all of the other investments he made in his career combined. His investment firm put roughly a quarter of its investable assets into GEICO at $27 a share. It rose to the equivalent of $54,000 a share.

The two investment principles in the book that I find particularly fascinating and useful:

1. Growth stocks tend to be more volatile than value stocks because their pricing reflects a prediction of future growth. When investors, in the aggregate, are optimistic, growth stocks trade at big premiums. When pessimistic, growth stocks often trade at values close to those of “value” stocks.
2. Buying high-growth stocks of companies that offer something exceptional to their customers after a 30-50% decline from a market top has historically provided returns to investors way in excess of those of the overall market. Such an investment strategy requires doing battle with one’s own psyche – researching companies for years without investing, investing only every few years, holding for long periods of time, and buying during times of widespread negativity about the economy and the market.

The two investment principles espoused in the book that I find questionable and that I do not incorporate into my investment practices:

1. Valuing a growth stock based on estimating earnings over the next seven to ten years is important to successful growth stock investing. (I don’t believe that most investors can reliably enough estimate future earnings or P/E ratios (which are highly-dependent on future interest rates) to be consistently useful.
2. It is important to growth stock investing to purchase securities at a significant discount to the estimated present value of future earnings to insure a “margin of safety.” (I’m concerned that this rules out growth stocks with the best long-term prospects).

The book also offers:

1. Important perspectives on how to identify companies that have sustainably high growth rates.
2. Fascinating case studies of investments by the author’s firm, including those that worked out fabulously (Apple, for instance), were losers or mediocrities.
3. The entire chapter “Newer Methods for Valuing Growth Stocks” from the 1962 edition of Security Analysis 1962 (a section unfortunately excluded from editions of Security Analysis after 2009). The chapter includes the simple mathematical formula Graham developed to value growth stocks, and a detailed analysis of appropriate P/E ratios for companies growing at various sustainable rates. I find the analysis fascinating, but do not accept the conclusions because I believe it to be too dependent upon future estimates of earnings and interest rates.

I offer this review in order to try to make a contribution to other members-readers of the MicroCapClub during this period when I am reluctant to offer opinions of specific small cap stocks due to concerns over the global economy, and stock market cycle.

For any reader interested in a longer version of this review, including extensive quotes from the book, and from Graham & Dodd’s Security Analysis, please contact me at [email protected].

If you liked this book review, you’ll enjoy I Passed on Berkshire Hathaway at $97 Per Share

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