As his second semester began at Columbia, Warren hummed with excitement. His father had just been reelected to Congress for a fourth time—by the largest majority yet—and he was finally going to meet his hero.
In his memoir, Ben Graham describes himself as a loner who never had an intimate friend after high school: “I was cut out to be everybody’s friend but no one’s bosom pal or crony.”1 “Nobody cracked his shell. Men all admired him, they all liked him, and they all wanted to be his friend more than he wanted them to be. You came away feeling terrific about him, but you never got to be his pal.” Buffett would later call this Graham’s “protective coating.” Even his partner David Dodd never became an intimate. People found him almost painful to talk to—so cerebral, so erudite, so clever. They had to keep their wits about them all the time in his company. While he was always kind, he quickly tired of conversing with his fellow human beings; the “real friends and intimates” of his life were his favorite authors—Gibbon, Virgil, Milton, Lessing—and their subjects, which, he said, “had far more significance for me and left a greater impression on my memory than the living people around me.”
Born Benjamin Grossbaum,2 Graham passed his first twenty-five years in a period when the country experienced four financial panics and three depressions.3 His family’s fortune dwindled after his father’s death when Ben was nine; his worldly, ambitious mother lost most of her own small stake in the stock-market panic of 1907, and she wound up having to pawn her jewelry. During this time, Graham recalled, the family was saved through the charity of relatives “from misery, though not from humiliation.”4
Nonetheless, Ben excelled throughout his education in the New York City public schools, where he read Victor Hugo in French, Goethe in German, Homer in Greek, and Virgil in Latin. Upon graduation, he wanted to attend Columbia University but needed financial aid. When the scholarship examiner visited the Grossbaums, he turned Ben down. Ben was sure the examiner had detected a “secret deformity” in his soul: “For years I had been struggling against something the French call mauvaises habitudes [bad habits, a euphemism for masturbation], and which a combination of innate puritanism on my part and the hair-raising health tracts prevalent in those days had raised to a moral and physical issue of enormous proportions.”5
Graham and his bad habits wound up at tuition-free City College, bereft and broke, convinced that a degree from this school would not advance him in the snobbish, cultivated world to which he aspired. He dropped out, got a job assembling doorbells, and recited the Aeneid and the Rubáiyát to himself as he worked. Eventually, he reapplied to Columbia and this time was given the scholarship that had earlier been denied him—through a clerical error, it turned out. At Columbia, he became an academic star, even while working at a variety of menial jobs. Checking waybills, he would mentally compose sonnets for distraction. On graduation, he turned down a scholarship to law school as well as offers to teach philosophy, mathematics, and English—in order to follow his dean’s advice and go into the advertising business.6
Graham’s sense of humor always tended toward irony. His first effort at writing a jingle for the nonflammable cleaning fluid Carbona was rejected as too frightening to customers when he produced this limerick:
There was a young girl from Winona
Who never had heard of Carbona
She started to clean
With a can of benzene
And now her poor parents bemoan her.
After this episode, Columbia’s Dean Keppel recommended Graham for a job at the brokerage house Newburger, Henderson & Loeb.
He started in 1914 on the bottom rung of the Wall Street ladder, as a runner, then worked as an assistant board boy, changing stock prices on a chalkboard. Graham parlayed these jobs into a career through a classic Wall Street maneuver: He did research on the side, until one day a floor broker gave a report he had written on the Missouri Pacific Railroad to a partner at Bache & Company, which hired him as a statistician.7 Later, he returned to Newburger, Henderson & Loeb as a partner until 1923, when a group of financial backers, including members of the Rosenwald family (early partners in Sears), lured him away by providing him with starting capital of $250,000, which enabled him to go out on his own.
Graham closed this business in 1925 when he and his backers disagreed over his compensation, and established the “Benjamin Graham Joint Account” with $450,000 from clients and his own money. Shortly afterward, Jerome Newman, the brother of one of his clients, offered to invest in the firm and join Graham as a partner at no salary until he learned the business and added value. Graham insisted on paying him, and Newman brought to the partnership a broad general knowledge of business as well as management skills.
In 1932, Graham wrote a series of articles in Forbes, “Is American Business Worth More Dead Than Alive?” in which he chastised company managements for sitting on troves of cash and investments, and investors for overlooking this value, which was not reflected in the prices of stocks. Graham knew how to dislodge the value, but his problem was capital. Through its stock-market losses, the firm’s account was down from $2.5 million to $375,000.* Graham felt responsible for recouping his partners’ losses, but that meant he would have to more than triple their money. It would take some doing even to keep the Joint Account alive. Jerry Newman’s father-in-law saved it by putting in $50,000. And by December 1935, Graham did triple the money, and earned the losses back.
For tax reasons, in 1936 Graham and Newman reorganized the Joint Account into two businesses—Graham-Newman Corporation, and Newman & Graham.8 Graham-Newman charged a fixed fee and had issued shares to the public which now traded on an exchange. Newman & Graham was a “hedge fund,” or private partnership with a limited number of sophisticated partners, that paid Graham and Newman based on their performance as managers.
The two men remained partners for thirty years, although in his memoir, Graham cited Jerry Newman’s “lack of amiability,” his demanding, impatient, and fault-finding personality, and his inclination to be “too tough” in negotiation. He and Graham got along because other people’s behavior never seemed to disturb Graham’s equanimity.
The one exception to this was Graham’s penchant for taking on established business figures in a fight. The most famous episode in Graham’s business career consisted of forcing the Northern Pipeline to distribute valuable bonds to shareholders.
Graham went down to the shareholders’ meeting in remote Oil City, Pennsylvania, where he made a motion about the railroad bonds. But the management refused to recognize him because he had brought no one along to second the motion. In its dealings with him, the management also made what he felt were some anti-Semitic innuendos, which hardly inclined him to give up the fight. By the time of the next shareholders’ meeting, he had assembled enough votes to get two additional directors elected to the board, which tilted the balance in favor of distributing the bonds. The company submitted and ended up handing out the equivalent of $110 per share in cash and stock to its shareholders.
The battle became a famous incident on Wall Street, and Graham went on to build the Graham-Newman Corporation into one of the best-known, although far from the largest, investment firms in the business.
He did it even while inflicting a handicap on his own performance. Every time he mentioned a stock Graham-Newman was buying in the classroom, the students ran out and bought it too, pushing up the price and making it more expensive. This drove Jerry Newman crazy. Why let other people in on what they were doing? To make money on Wall Street meant keeping your ideas to yourself. But, as Buffett said, “Ben didn’t really care how much money he had. He wanted to have enough, and he went through that period in ’29 to ’33 that was very rough. But if he had as much money as he felt he needed, anything else was totally immaterial to him.”
Over the twenty-year life of Graham-Newman Corporation, its performance had beaten the stock market’s performance by an average of 2.5 percent a year—a record exceeded by only a handful of people in the history of Wall Street. That percent might sound trifling, but compounded for two decades, it meant that an investor in Graham-Newman wound up with almost sixty-five percent more in his pocket than someone who earned the market’s average result. Much more important, Graham had achieved this superior performance while taking considerably less risk than someone who simply invested in the stock market as a whole.
And Graham did it mainly through his skill at analyzing numbers. Before him, assessments of a security’s value were largely guesswork. Graham developed the first thorough, systematic way of analyzing the value of a stock. He preferred to work by studying only publicly available information—usually a company’s financial statements—and rarely attended even public meetings with a company’s management.9 Although his associate Walter Schloss had been at the Marshall-Wells meeting, it was his own idea to go, not Graham’s.
Ben’s third wife, Estey, drove her husband up to Columbia from the Graham-Newman Corporation’s office at 55 Wall Street every Thursday afternoon after the market closed to teach his “seminar on common stock valuation.” This course was the culmination of the Columbia finance curriculum, so highly regarded that men who were already working in money management signed up for it, sometimes more than once.
Warren, of course, looked up to Graham with worshipful awe. He had read the Northern Pipeline story over and over when he was ten years old, well before he understood who Benjamin Graham was in the investing world. Now he hoped to bond with his teacher. But outside the classroom, he and Ben had few hobbies in common. Graham dabbled in the arts and sciences in a quest for knowledge, writing poetry, failing spectacularly as a Broadway playwright, and puttering around filling notebooks with ideas for clumsy inventions. He also devoted himself to ballroom dancing, clumping around for years at the Arthur Murray studio, where he counted the steps out loud. During dinner parties, Graham often disappeared in the middle of a course to work on mathematical formulas, read Proust (in French), or listen to the opera, rather than suffer the dull company of his fellow man.10 “I remember the things I learn,” he wrote in his memoir, “rather than the things I live.” The one exception where living took precedence over learning was his assignations.
About the only way a human being could compete with the classic authors for Graham’s attention was to be female and beddable. He was short and physically unimposing. There was something elfish-looking about him, and he was not a handsome man. Nonetheless, Graham seemed to be a Mount Everest for women who liked a challenge: They met him and wanted to climb on top.
In his three wives, Graham’s taste had ranged wide: from the passionate, strong-willed Hazel Mazur to Broadway showgirl Carol Wade—eighteen years his junior—to his third wife and former secretary, the intelligent, lighthearted Estelle “Estey” Messing. Complicating all these marriages was his complete indifference to monogamy. Graham later wrote a memoir11 in which he begins, “Let me describe my first extramarital affair in the soberest fashion,” a sobriety he giddily abandons six sentences later as he explains the recipe for his liaison with the sharp-tongued, “by no means beautiful” Jenny: “one part attraction and four parts opportunity.” If more attraction was present, he needed less opportunity, making him shameless, even annoying, in his sexual advances toward women. Combining two of his hobbies, Graham might dash off a seductive little poem to a woman he fancied on the subway. Yet he was so cerebral that it must have been a challenge for his lovers to hold his attention. The darting from amour to business in the following passage of the memoir is pure Graham:12
I have a sentimental memory of the last hour we spent together in the cabin of her Ward Line steamer. (Little did I think then that my firm was later to control that old-established steamship company.)
But Warren at the time knew nothing about Graham’s personal life and was focused only on what he could learn from the brilliant teacher. On the first day of Graham’s seminar in January 1951, Warren walked into a classroom containing a long rectangular table. In the middle sat Graham, surrounded by eighteen or twenty men. Most of the other students were older, some of them war veterans. Half were businessmen who were auditing the course. Once again, Warren was the youngest—yet also the most knowledgeable. When Graham asked a question, inevitably he “would be the first one to have his hand up and immediately start talking,” recalls a classmate, Jack Alexander.13 The rest of the class became the audience to a duet.
In 1951, many American businesses were still worth more dead than alive. Graham encouraged his students to use real-life examples from the stock market to illustrate this, down-and-dirty companies such as Greif Bros. Cooperage, a barrel maker whose stock Warren owned. Its main business was slowly disappearing but its stock was trading at a substantial discount to the cash that could be netted if its properties and inventory were simply sold off and its debts repaid. Eventually, Graham reasoned, that “intrinsic” value would surface the way a river-tossed barrel, trapped under winter ice, pops to the surface in a spring thaw. You had only to interpret the balance sheet, decoding the numbers that proved there was a barrel of money trapped under the ice.
Graham said that a company is no different than a person, who might think that her net worth was $7,000, comprising her house, worth $50,000, less her mortgage of $45,000, plus her other savings of $2,000. Just like people, companies have assets that they own, such as the products they make and sell, and debts—or liabilities—that they owe. If you sold all the assets to pay off the debts, what would be left was the company’s equity, or net worth. If someone could buy the stock at a price that valued the company cheaper than its net worth, Graham said, eventually—a tricky word, “eventually”—the stock’s price would rise to reflect this intrinsic value.14
It sounded simple, but the art of security analysis lay in the details—playing detective, probing for what assets were really worth, excavating hidden assets and liabilities, considering what the company could earn—or not earn—and stripping apart the fine print to lay bare the rights of shareholders. Graham’s students learned that stocks were not abstract pieces of paper, and their value could be analyzed by figuring what the whole pie of a business was worth, then dividing it into slices.
Complicating matters was that word “eventually.” Stocks often traded at odds with their intrinsic value for long periods of time. Even if an analyst figured everything right, he could still appear wrong in the eyes of the market for the investing equivalent of a lifetime. You had to build in what Graham and Dodd called a MARGIN OF SAFETY—that is, plenty of room for error.
Graham’s method struck people who studied it in one of two ways. Some grasped it immediately as a fascinating, all-consuming treasure hunt and others recoiled from it as a dreary homework assignment. Warren’s reaction was that of a man emerging from the cave in which he had been living all his life, blinking in the sunlight as he perceived reality for the first time.15 His former concept of a “stock” was derived from the patterns formed by the prices at which pieces of paper traded. Now he instantly grasped that the patterns formed by trading these pieces of paper did not signify a “stock” any more than those childhood piles of bottle caps had signified the effervescent, sweet-sour-spicy taste of soda pop that made people crave it. His old notions dissolved in an instant, conquered by Graham’s ideas and illuminated by the way he taught.
Graham used all kinds of nifty, effective tricks in his class. He would ask paired questions, one at a time. His students thought they knew the answer to the first, but when the second came along, it made them realize that maybe they didn’t. He would put up descriptions of two companies, one in terrible shape, practically bankrupt, another in fine form. After asking the class to analyze them, he would reveal that they were the same company at different times. Everyone was surprised.
Along with his Company A and Company B teaching method, Graham used to talk about Class 1 and Class 2 truths. Class 1 truths were absolutes. Class 2 truths became truths by conviction. If enough people thought a company’s stock was worth X, it became worth X until enough people thought otherwise. Yet that did not affect the stock’s intrinsic value—which was a Class 1 truth. Thus, Graham’s investing method was not simply about buying stocks cheap. As much as anything it was rooted in an understanding of psychology, enabling its followers to keep their emotions from influencing their decision-making.
From Graham’s class, Warren took away three main principles:
Of these points, the margin of safety was most important. A stock might be the right to own a piece of a business, and the intrinsic value of the stock was something you could estimate, but with a margin of safety, you could sleep at night. Graham built in his margin of safety in various ways. He never forgot the danger of using debt. And although the 1950s had become one of the most prosperous eras in American history, his early experiences had given him the habit of assuming the worst. He looked at business through the lens of his 1932 Forbes articles—as worth more dead than alive—thinking of a stock’s value mostly in terms of what the company would be worth if dead—that is, shut down and liquidated. Implicitly, Graham was always looking over his shoulder at the 1930s, when so many businesses went into bankruptcy. He kept his firm small in part because he was so risk-averse. And he rarely bought more than a tiny position in any company’s stock, no matter how sound the business.16 This meant the firm owned a large array of stocks that required much tending. While plenty of stocks did sell at prices below the businesses’ liquidation value, which made Warren an enthusiastic follower of Graham, he disagreed with his teacher about the need to buy so many stocks. He had cast his lot with one stock: “Ben would always tell me GEICO was too high. By his standards, it wasn’t the right kind of stock to buy. Still, by the end of 1951, I had three-quarters of my net worth or close to it invested in GEICO.” And yet Warren “worshipped” his teacher, even though he had strayed so far from one of Graham’s ideas.
As the spring semester wore on, Warren’s classmates gradually accepted the routine of the classroom duet. Warren “was a very focused person. He could focus like a spotlight, twenty-four hours a day almost, seven days a week almost. I don’t know when he slept,” says Jack Alexander.17 He could quote Graham’s examples and come up with examples of his own. He haunted the Columbia library, reading old newspapers for hours on end.
“I would get these papers from 1929. I couldn’t get enough of it. I read everything—not just the business and stock-market stories. History is interesting, and there is something about history in a newspaper, just seeing a place, the stories, even the ads, everything. It takes you into a different world, told by somebody who was an eyewitness, and you are really living in that time.”
Warren spent hours reading the Moody’s and Standard & Poor’s manuals, looking for stocks. But it was the weekly Graham seminar that he looked forward to more than anything else.
While the chemistry between Warren and his teacher was obvious to everyone else in the class, one student in particular had taken note of him. Bill Ruane, a stockbroker at Kidder, Peabody, had found his way to Graham through his alma mater, Harvard Business School, after reading two important and memorable books—Where Are the Customers’ Yachts? and Security Analysis.18 He and Warren had connected immediately. But neither Ruane, nor any other of Graham’s students, nor Warren himself, ever had the temerity to try to see Graham outside the seminar room. Warren did manage to find reasons, however, to drop in on his new acquaintance, Walter Schloss, down at the Graham-Newman Corporation.19 He got to know Schloss better and learned he was caring for a wife who had been suffering from depression throughout most of their marriage.20 Schloss, like David Dodd, appeared to be remarkably loyal and steadfast, qualities that Buffett sought out in people. He also envied Schloss his job; he would have cleaned the washrooms for free in exchange for one of those gray laboratory-style jackets, made of thin cotton, that everyone at Graham-Newman wore to keep from dirtying their shirtsleeves while they filled out the forms that Graham used to test stocks against his investing criteria.21 Above all, Warren wanted to work for Graham.
As the semester neared an end, the rest of the class was busy finding their futures. Bob Dunn would be heading off to U.S. Steel, possibly the most prestigious corporate job in the United States. Almost every young businessman saw the route to success as working his way up the ladder in a great industrial corporation. In Eisenhower’s postwar, post-Depression America, finding one’s cell inside the institutional beehive and learning how to fit in was the normal and expected thing to do.
“I don’t think there was one guy in the class that thought about whether U.S. Steel was a good business. I mean, it was a big business, but they weren’t thinking about what kind of train they were getting on.”
Warren had one goal in mind. He knew he would excel if Graham would hire him. While lacking self-confidence in many things, he had always felt surefooted in the specialized area of stocks. He proposed himself to Graham for a job at Graham-Newman Corporation. It took audacity to even dream of working for the great man himself, but Warren was audacious. He was, after all, Ben Graham’s star student, the only one to earn an A+ in his class. If Walter Schloss could work there, why couldn’t he? To clinch the deal, he offered to work for free. He went in and asked for the job with far more confidence than he had felt riding up to Chicago for his interview with the Harvard Business School.
Graham turned him down.
“He was terrific. He just said, ‘Lookit, Warren. In Wall Street still, the “white-shoe” firms, the big investment banks, they don’t hire Jews. We only have the ability to hire a very few people here. And, therefore, we only hire Jews.’ That was true of the two gals in the office and everybody. It was sort of like his version of affirmative action. And the truth is, there was a lot of prejudice against Jews in the fifties. I understood.”
Buffett found it impossible to say anything that could be interpreted as criticism, even decades later. Of course, it must have been incredibly disappointing. Couldn’t Graham have made an exception for his star student? Someone it wouldn’t cost him anything to employ?
Warren, who idolized his teacher, had to accept that Graham viewed him impersonally, so much so that he would not overrule a principle even for the best student who had ever taken his class. There was no appeal—at least for now. Chagrined, he stayed through graduation, then once again he pulled himself together and stepped aboard a train.
He had two consolations. He would be back in Omaha, where he felt he belonged. And it would be much easier to pursue his love life there, for he had met an Omaha girl and was now smitten. As usual, the girl he wanted was not smitten with him. But this time, he was determined to change her mind.
*Including distributions, withdrawals, and losses.