H I G H POT E N T I A L F O R H Y P E POT E N T I A L

H I G H POT E N T I A L
F O R H Y P E POT E N T I A L
Investors aren’t the only people who fall prey to the delusion that
hyper-growth can go on forever. In February 2000, chief executive
John Roth of Nortel Networks was asked how much bigger
his giant fiber-optics company could get. “The industry is growing
14% to 15% a year,” Roth replied, “and we’re going to grow
six points faster than that. For a company our size, that’s pretty
heady stuff.” Nortel’s stock, up nearly 51% annually over the previous
six years, was then trading at 87 times what Wall Street
was guessing it might earn in 2000. Was the stock overpriced?
“It’s getting up there,” shrugged Roth, “but there’s still plenty of
room to grow our valuation as we execute on the wireless strategy.”
(After all, he added, Cisco Systems was trading at 121
times its projected earnings!)1
As for Cisco, in November 2000, its chief executive, John
Chambers, insisted that his company could keep growing at
least 50% annually. “Logic,” he declared, “would indicate this is
a breakaway.” Cisco’s stock had come way down—it was then
trading at a mere 98 times its earnings over the previous year—
and Chambers urged investors to buy. “So who you going to bet
on?” he asked. “Now may be the opportunity.” 2
Instead, these growth companies shrank—and their overpriced
stocks shriveled. Nortel’s revenues fell by 37% in 2001,
and the company lost more than $26 billion that year. Cisco’s
revenues did rise by 18% in 2001, but the company ended up
with a net loss of more than $1 billion. Nortel’s stock, at
$113.50 when Roth spoke, finished 2002 at $1.65. Cisco’s
shares, at $52 when Chambers called his company a “breakaway,”
crumbled to $13.
Both companies have since become more circumspect
about forecasting the future

HOW DID BENJAMIN GRAHAM RULE WALL STREET??

How did Graham do it? Combining his extraordinary intellectual
powers with profound common sense and vast experience, Graham
developed his core principles, which are at least as valid today as they
were during his lifetime:
• A stock is not just a ticker symbol or an electronic blip; it is an
ownership interest in an actual business, with an underlying value
that does not depend on its share price.
• The market is a pendulum that forever swings between unsustainable
optimism (which makes stocks too expensive) and unjustified
pessimism (which makes them too cheap). The intelligent investor
is a realist who sells to optimists and buys from pessimists.
• The future value of every investment is a function of its present
price. The higher the price you pay, the lower your return will be.
• No matter how careful you are, the one risk no investor can ever
eliminate is the risk of being wrong. Only by insisting on what
Graham called the “margin of safety”—never overpaying, no matter
how exciting an investment seems to be—can you minimize
your odds of error.
• The secret to your financial success is inside yourself. If you
become a critical thinker who takes no Wall Street “fact” on faith,
and you invest with patient confidence, you can take steady
advantage of even the worst bear markets. By developing your
discipline and courage, you can refuse to let other people’s mood
swings govern your financial destiny. In the end, how your investments
behave is much less important than how you behave.

WALL STREET STALWARTS-BENJAMIN GRAHAM

Who was Benjamin Graham, and why should you listen to him?
Graham was not only one of the best investors who ever lived; he was
also the greatest practical investment thinker of all time. Before Graham,
money managers behaved much like a medieval guild, guided largely by
superstition, guesswork, and arcane rituals. Graham’s Security Analysis
was the textbook that transformed this musty circle into a modern profession.
And The Intelligent Investor is the first book ever to describe, for
individual investors, the emotional framework and analytical tools that
are essential to financial success. It remains the single best book on
investing ever written for the general public. Graham came by his insights the hard way: by feeling firsthand the anguish of financial loss and by studying for decades the history and
psychology of the markets. He was born Benjamin Grossbaum on
May 9, 1894, in London; his father was a dealer in china dishes and
figurines.2 The family moved to New York when Ben was a year old. At
first they lived the good life—with a maid, a cook, and a French gov
erness—on upper Fifth Avenue. But Ben’s father died in 1903, the
porcelain business faltered, and the family slid haltingly into poverty.
Ben’s mother turned their home into a boardinghouse; then, borrowing
money to trade stocks “on margin,” she was wiped out in the crash
of 1907. For the rest of his life, Ben would recall the humiliation of
cashing a check for his mother and hearing the bank teller ask, “Is
Dorothy Grossbaum good for five dollars?”
Fortunately, Graham won a scholarship at Columbia, where his
brilliance burst into full flower. He graduated in 1914, second in his
class. Before the end of Graham’s final semester, three departments—
English, philosophy, and mathematics—asked him to join the faculty.
He was all of 20 years old.
Instead of academia, Graham decided to give Wall Street a shot.
He started as a clerk at a bond-trading firm, soon became an analyst,
then a partner, and before long was running his own investment partnership.
The Internet boom and bust would not have surprised Graham. In
April 1919, he earned a 250% return on the first day of trading for
Savold Tire, a new offering in the booming automotive business; by
October, the company had been exposed as a fraud and the stock
was worthless.
Graham became a master at researching stocks in microscopic,
almost molecular, detail. In 1925, plowing through the obscure
reports filed by oil pipelines with the U.S. Interstate Commerce Commission,
he learned that Northern Pipe Line Co.—then trading at $65
per share—held at least $80 per share in high-quality bonds. (He
bought the stock, pestered its managers into raising the dividend, and
came away with $110 per share three years later.)
Despite a harrowing loss of nearly 70% during the Great Crash of
1929–1932, Graham survived and thrived in its aftermath, harvesting
bargains from the wreckage of the bull market. There is no exact
record of Graham’s earliest returns, but from 1936 until he retired in
1956, his Graham-Newman Corp. gained at least 14.7% annually,
versus 12.2% for the stock market as a whole—one of the best longterm
track records on Wall Street history.