4. I was working at Bankers TrustCompany. In those days, you started at $25 a week, and they assuredyou that you were being grossly overpaid because they really didn’tneed your services very badly. They were carrying old time employeesout of a sense of loyalty, but they did venture to take on three traineesin June 1932, instead of the usual 30, and I was, happily, able to getone of those spots.
Tanous:At this point you had just graduated from Yale, correct?And with obvious academic distinction, since you were one of onlythree trainees hired just as the depression was about to start. That,in itself, is quite an achievement.
Murray: Well, I was certainly very hesitant when I asked the senior
272INVESTMENT GURUS
officer in the bank if it would be all right if I took two days off aftergraduation before I reported for work. I didn’t want to appear casualabout starting to work. He assured me it was all right.
Tanous:A lot of your classmates didn’t find work, I suppose.
Murray: That’s right. One of my very good friends, a very fine-looking colleague, who had been very active in drama and the artsat Yale, was selling neckties at Macy’s. Whenever | visited Macy’s,I'd make sure that I didn’t go through the necktie department. I didn’twant him to see me coming by because he hardly needed recognitionin that kind of position.
Tanous:Perhaps you could tell us about your transition frombanking to academia.
Murray: Well, I had earned my graduate degrees and worked myway up the ladder. I was the youngest vice president in the historyof Bankers Trust, and J had a very fine career there. But, for manyyears | had known Courtney Brown, who had become the dean ofColumbia Business School. He had been a colleague in my early daysat Bankers Trust Company. One day he invited me to become associatedean, to be the inside man to his outside dean responsible for fundrais-ing. I, of course, would have to endure the experience of teaching aclass for thirteen weeks. As we all know, you can’t deceive yourself;if you don’t do well in the classroom, you know it.
I went to Columbia Business School as an associate dean. I managedbudgets, and faculty recruiting, and curriculum design, and thosekinds of things, on the condition that I could teach one course. I hadalready signed up to teach the seminar which Benjamin Graham hadtaught for many years. He was retiring to California. I had sat in onthe seminar with him, and I enjoyed it immensely. But that wasn’tthe same as teaching a class. That was just a fun experience -watching and listening to one of the masters of the field.
I had two-and-a-half years to find out the answers to the twoquestions. Could I teach? And, did I really like it, and find it reward-ing? When the answers tummed out to be affirmative, I stood for tenure.I had done a lot of writing as chief economist for Bankers Trust, so Icould meet the publication standard and gain the recognition of col-leagues in the field.
Tanous:!t’s staggering to think that we’re sitting here talking abouttaking classes with Benjamin Graham. What was Dodd’s role at thetime?
273PETER J. TANOUS
Murray: He taught the Security Analysis course. He had done thatfor a couple of decades right from the text. That textbook was an in-teresting joint product. Ben Graham was not addicted to writing aserious text. He was full of ideas, loved to chat, loved to think outloud. Dave Dodd sat in on Ben’s classes and took copious notes. ThenDave Dodd would go dig out and verify the examples that Ben hadused. That’s how the first edition of Security Analysis came about in1934,
That year, the conventional wisdom was that bonds were the onlyinvestment outlet. Stocks were nothing but speculation, pure andsimple. So the mission that Ben and Dave had in writing the firstedition was to say, now really, there is such a thing as investing incommon stocks, contrary to what the standard textbook on investmentin those days said. The standard textbook then was by Chamberlainand Edwards. They made it absolutely clear that stocks were specula-tion, and bonds were the only avenue that could be called investing.After the devastation of the securities markets, nobody, except forGraham and Dodd, was prepared to stand up and say, now just a darnminute. When those prices get low enough, even what you mightthink of as speculative securities do have investment quality, becauseyou are paying a price that provides you with, to use their term, abig margin of safety.
Tanous:That presumably is the value stock thesis.
Murray: That’s right. The value stock thesis.
Tanous:As I understand it, you taught the course after Graham andDodd retired.
Murray: When Dave Dodd retired, after ’d been at Columbia forthree years, I took his class. From then on, I taught the SecurityAnalysis course.
Tanous: You’re also the co-author of the most recent edition of thatfamous book, Security Analysis, right?
Murray: That’s right. I started teaching with the edition of the 50s.For the 1962 edition, | was the publisher’s advisor. So when BenGraham and Sidney Cottle were doing that edition, I had the fun ofbeing the arbiter of debates between them.
Tanous: You mean, you were the kibitzer!
Murray: Yeah. I was the kibitzer for McGraw Hill. So I stored uplots of ideas from that experience and from my teaching, and had the
274INVESTMENT GURUS
opportunity to develop them further in 1988, when I co-authored thefifth edition.
Tanous:! can’t resist asking you what Graham and Dodd were likeas people.
Murray: Ben was just exactly the way he was pictured - a manwho read for background, a fine classical scholar, a man with an ideaa minute. He had a wonderfully agile mind. Dave Dodd was a wonder-ful gentleman. One of the finest people I have ever met anywhere. Hecould listen to Ben all day long, but he retained a healthy skepticism,and when Ben would launch into one of his ideas, which came alongabout every 30 seconds, Dave would quietly just sit down and say,that’s an interesting idea, Ben. However, do you believe that the factsreally support that strong a conclusion? Then he’d get to work on theserious analysis.
Tanous:So these guys would sit around and come up with invest-ment ideas?
Murray: Sure. They just loved to talk about their experiences withstocks. They were early investors in GEICO. They were always kindof interested in insurance companies, because insurance companieshad portfolios of assets.
Tanous:This reminds me of another investor who went to Columbiaand also likes GEICO.
Murray: Of course. Warren Buffett. Warren generated his assets inthe insurance business. We think it’s Berkshire Hathaway, but, mostof the time, it’s one of their insurance companies that owns a largepart of that portfolio. Again, this lends itself to financial analysisbecause insurance companies manage large amounts of capital.
Tanous:I’m curious about how, from a value investing point ofview, you deal with underwriting risk when you buy insurance com-panies. You know, three or four hurricanes might hit, something youcan’t predict.
Murray: In its most extreme form, Buffett deals with it throughreinsurance.
Tanous:! see. You lay off the risk by selling or syndicating it?
Murray: Yes. You can systematically analyze levels of risk andexposure, but it doesn’t mean you end up with certainty. The idea isthat, if you do your homework, this business is just like managing aportfolio with a margin of safety. That term “margin of safety,” showsup frequently in Graham and Dodd.
275PETER J. TANOUS
Tanous:By reinsuring, you’re basically laying off the risk ontosomeone else.
Murray: Right. You control your exposure.
Tanous:Did you run across Warren Buffett at Columbia?
Murray: He had come and gone before I got there. I didn’t meetup with him until later. One of the good sessions he and | had waswhen we were both on the SEC Advisory Committee on CorporateDis-closure, which was a fun enterprise. Dave Dodd originally intro-duced me to Buffett, but on our committee, we had the opportunityto sit around the table and really discuss things at length.
Tanous:Have you had any other relationship with him?
Murray: He comes back to Columbia on occasion. When | taughtthe class in value analysis year before last, he was one of our guestspeakers. You heard about that class, didn’t you?
Tanous:Remind me, please.
Murray: We did it out of the blue. We decided to give a value in-vesting course, limited to 75 kids, although we had upwards of twohundred applications. You discover now that in our wonderful worldof quantitative methods and financial economics, students don’t havemuch opportunity to explore areas like this.
Tanous:Why not?
Murray: It’s interesting. I’m serving on a group for the CFA[Chartered Financial Analyst] institute. We’re examining the kind oftraining a specialist in equity investing should have. The studentshave finished the CFA, they are still actively engaged in equity securityselection and portfolio management, what should we offer thembeyond what is covered in the CFA program? It’s fascinating. Thereare about a dozen of us working on this; two of us paying attentionto accounting and corporate finance, and what are the rest of themfocusing on? Valuation! | always come back to something Ben Grahamsaid to me. He said, if you give me a reliable estimate of the earningpower of a company, I’ll value it on the back of an envelope.
Tanous:! think even growth managers would agree with that. Now,it’s time to put the boxing gloves on. I'd like to focus our discussionon one of the principal features of this book.
Murray: Okay.
Tanous: What we’re doing is talking to a lot of active managers andalso to some academics all of whom, except for you, happen to be ef-ficient market theorists. It was Mario Gabelli who suggested that I
276INVESTMENT GURUS
was talking to the wrong academics. “You should talk to Roger Mur-ray!” he shouted at me. I said, I’d love to talk to Roger Murray. So,thanks to Mario, I’m here.
Here’s our conundrum. These efficient market guys snicker whenyou talk about analyzing companies and figuring out which ones havehidden values that the market hasn’t uncovered. To them, of course,there are no hidden values! Everything about that company is reflectedin the market price. So please help me out, Professor.
Murray: To use the Graham and Dodd terminology, we’re talkingabout the difference between intrinsic value and market value. Marketefficiency purists will tell you that, fundamentally, the only real ex-pression of value that exists is what you read in the marketplace. Andit is the best expression, absent inside information, of the significantevents that are occurring and are about to occur. That’s saying thatmarket price is the best estimate of economic value.
Now, let’s turn to the concept of “intrinsic value” in a Graham andDodd sense. This is the value of an enterprise, not a stock certificate.This is the value of a company based on its earning power. What dowe mean by earning power? It’s what we have a valid reason to expectin terms of the volume and profitability of this business, and thecharacteristics of this line of business. If we can identify those under-lying characteristics, we can reach some reliable conclusions aboutwhat may lie ahead in terms of growth, consistency, and levels ofprofitability. If we can do that, we don’t have a problem on valuation,since all the elements to arrive at a valuation are there. We don’t needto refine that estimate of value to three decimal places. What we’relooking for is under and over-valuation, recognizing that we’ve inev-itably got a margin of error in framing our expectations - becausewe're talking about a future about which we only have vague know-ledge and guidelines.
Tanous:But absent the ability to predict the future, the efficientmarket theorists say that all of the information that leads to a valu-ation comes to rest at one spot - the price at which the security trades.To them, there’s no such thing as overvalued and undervalued, becausethere is no such thing as mispriced securities.
Murray: Which, obviously, is a silly statement. How can you saythere is no evidence of securities being mispriced? Let’s look at ourmost recent history of the most efficient market. Let’s start on January
277PETER J. TANOUS
1, 1995, and all those securities are efficiently priced. And at the endof 1995, they trade at prices 35% higher.
Tanous:Okay. That’s new information coming into the market.
Murray: New information? Was it really? Look at the underlyinginformation. We had a very good year. Was it 17%, depending onwhat measure you use? If you want to talk about new informationyou could say, well, on average, we get only 7% per annum increasesin earnings, and this year it was 17%, so the new information wasthe differential of 10%, right?
Tanous:Okay.
Murray: How do you relate that to a 35% rise in stock prices?
Tanous:! don’t know. How do you?
Murray: If stocks were priced efficiently at the beginning of theyear and they were also priced efficiently at the end of the year, thatwould tell us that a normal growth in the value of American industryis in the range of 35%, which was the rise in value of stocks. Anydifferent answer about the trendline value of American industry leadsus to the conclusion that the market was inefficient at the beginningof the year or at the end of the year.
Tanous:That’s clear. What you’re saying is that earnings may havegone up 17% in 1995, but they sure didn’t go up 35%, which is whatthe stock market went up.
Murray: Right. And that that’s not my idea of efficiency! And itisn’t yours either, if you sold out on the first of January. The otherthing that happened, to your amazement, is that what securities youhad in your portfolio made a difference. If the market is efficient, di-versification shouldn’t matter. You don’t really need to diversify. Youwant to avoid extreme economic and political factors, but, generallyspeaking, if General Motors is priced efficiently it doesn’t matter ifyou buy General Motors or you buy Ford.
Tanous:But then you don’t have the benefit of diversification.
Murray: Okay, I don’t want to stake my whole future on the auto-mobile business, so I will own General Motors or Ford. That way, Iwill not have more than five or six percent of my portfolio in theautomobile business. But now we're talking about diversifying eco-nomic and other factors. These are all elements subject to the analyt-ical process. That being the case, how can market prices be so ineffi-ciently determined in such a highly developed market system?
Tanous:Good question. What’s the answer?
278INVESTMENT GURUS
Murray: For securities to be efficiently priced, there must be adisciplined analytical process by which those prices are reached. Thatdisciplined analytical process takes a lot of hard work by trained andexperienced people. But most of us would rather not do that muchwork. We'd rather find an easy answer if we could. One easy answeris that I buy stocks because they’re going up. That’s now called mo-mentum investing. Some will say, now, that makes sense to me. Thosesecurities that show the best momentum will, of course, have the mostpromising future! Ask yourself, what kind of reasoning is that? Mo-mentum analysis means that you will miss every turning point in thecourse of a company’s history.
Tanous:So when you ask the question, how can market prices beso inefficiently determined in a fully developed market system, theanswer you just gave is, they aren’t efficient because, for them to beefficient, people would have to do all this work all the time. Theydon’t.
Murray: That’s right. It is a disciplined, even burdensome undertak-ing. You really want to have the capacity to identify corporate change,departures from the past pattern. One thing you know about the pastpattern of published financial statements is that companies have achief financial officer who monitors the value of the enterprise. Heknows how to do that. One of his functions is to smooth out as manyof the financial bumps as he can, and provide as much continuity inthe pattern of growth as he can. Now, we're talking about people whoobey the law, we’re not talking about fraud. We’re talking about thetechniques within the range of generally accepted accounting prin-ciples that permit you to change the timing of the recognition of gainsand losses. That’s neat. Now you can fuss around with this stuff, buteventually the whole story will show up in those financial statements.
Tanous:This presumably is the hard way. You have to do the workto find the true underlying data to make a good investment decision,right?
Murray: Exactly. Think of that financial statement as a publishedphotographic portrait - the financial guy has touched it up, taken outthe blemishes. He’s removed the worry lines, and gives you that lovely,smooth picture. That’s what the chief financial officer’s assignmentis. That’s what he wants you to see.
What I have said for years and years, until I’m tired of hearingmyself say it, is that every large corporation should have on the
279PETER J. TANOUS
payroll a highly skilled security analyst. Put him to work, give himfull access to all of the financial information being generated. Havehim do a very down-to-earth careful analysis, where you don’t haveany of the sugar coating, or painting out of blemishes. Have him workin secret. You, as the chief executive of this company, keep his ana-lytical results locked in your bottom desk drawer. Look at them insteadof what those wonderful financial people are saying, what the investorrelations people are saying, and what your public relations peopleare saying. You would make very much better decisions for yourcompany if you see it as it really is, instead of as it’s been touchedup.
Tanous: Well, what’s the role of the auditor in all this?
Murray: The auditor? He has no basis for complaint. You're stillwithin the range of generally accepted accounting principles. Justthink of the financial statements we have been reading in the lastfive years. This is after one of the great inflationary periods inAmerican economic history. This is after a major change in pricelevels has had an opportunity to work its way through the system.Under these circumstances, we should be looking at huge amountsof realized capital gains on capital assets. What do we read instead?You don’t find any unusual gains realized. All you read about is un-usual capital losses.
Tanous: Well, the assets are valued at cost, right. And if they’re notsold, they’re just there on the balance sheet.
Murray: They’re just there, and if you do sell them they shouldshow a big profit. Yet you and I look at those restructuring write-offs,and now we have this new one about how you write down long-livedassets that seemed to have lost value, and that creates a huge write-off. What does that tell you? It tells you that we have had a hugeoverstatement of corporate earning power.
Tanous:Why is that?
Murray: Because there has been a totally inadequate level of depre-ciation, or even the expiration of, economic value. We have failed torecognize the reality that sometimes we don’t have to use up capitalassets, they simply lose value because of obsolescence.
In determining the intrinsic value of an enterprise, we must try toget at the real earning power. Not reported earning power, but theactual economic value of a company, which the market may or maynot perceive correctly. We can say, with a high degree of certainty,
280INVESTMENT GURUS
that the market is going to be right in lots of valuations of lots ofcompanies.
One of the things that the trained security analyst has to do is todevelop a willingness to throw away his work. For example, you goto work and you think you have uncovered a scent of undervaluation.You immediately do all your work and, after all that effort, your bestconclusion is, no, it’s not undervalued. In fact, it’s fairly valued inthe marketplace. And now you say, I just learned something, but isn’tthis terrible! You and I know that a lot of analysts who come up withthat answer won’t admit it. Instead they'll say, you know, I must havemissed something in my analysis.
Tanous:! know. They can’t accept that all that work went to waste,so they look for a reason to recommend it anyway!
Murray: Absolutely!
Tanous:Let’s look at investing from an individual investor’s pointof view. After a year like 1995, when most of the mutual funds andmoney managers did not do as well as the market, the investor mightjust throw in the towel and say, you know, what the hell, why don’tI buy an index fund, or a combination of index funds, rather than tryto do all this myself. What advice would you have for this investor?
Murray: I would say, go ahead and buy that diversified index fundportfolio. Make your choice about the type of asset allocation youwant. Focus on asset allocation, because for most of us, the big differ-ence in returns will come from asset allocation decisions, unless youhave real investment skill and you're really ready to work.
Tanous:So you're saying it’s okay for an investor to buy marketsrather than stocks or managers?
Murray: Yes I am. I think that because, on a part-time basis, thosepeople don’t have the time or the expertise to make informed choices.
Tanous:Good point. But, on the other hand, I interviewed PeterLynch and he says, do a little research, keep your eves open, and youmight find a great company.
Murray: What Peter says about that makes perfectly good sense.This is one of the oldest dimensions of security analysis. Where doyou begin your security analysis? By looking at the company, whatits competitive position is, what the costs of entry are, all of thosefactors. But that doesn’t take you the last mile. Suppose you gothrough that kind of process, and you say to yourself, I’ve studied
281PETER J. TANOUS
retailing intensively and I believe that the discount store is here tostay. So, I’m going to make my long term investment in Kmart.
Tanous: Yeah. Bad choice.
Murray: Now I did everything right up to the point of analyzingKmart versus Wal-Mart.
Tanous:Okay. Let’s say I’m the investor, professor, and I reallyappreciate your advice. You’re right. My odds aren’t too good outthere since I’m not a professional investor. Maybe I should just buythese index funds. But I really am prepared to do the work. I’m reallyinto this! Give me some advice on beating the markets and selectingand buying some of those undervalued securities.
Murray: Okay. First, you sit down and think about identifying youruniverse. You’ve heard Warren Buffett say many times, I don’t makemy choices in fields I don’t understand. That’s very good advice. Stayaway from activities that are unfamiliar to you and will continue tobe unfamiliar to you. That’s the first level of advice. The second levelis that by the time a company has its highest level of recognition andpopularity, you can be pretty darn sure that the market valuation hasrun well in excess of the intrinsic value of the company. It’s that well-known and that well-liked.
Tanous:So, you’ve got to find the undiscovered ones. Is that theidea?
Murray: You've got to find the undiscovered ones. Look at a fieldthat makes good sense on business and economic grounds. Then poreyour way through the whole battery of information on companiesthat are in that field, and which have gotten themselves established,to some extent. Next, sit down and do an old-fashioned spreadsheetcomparative analysis. Look at all the companies in this field, andnatrow it down to six established companies. Next, sit down and putthem though your ratio analysis. That starts to give you some insights,assuming that you're satisfied with the data you’re using and it iscomparable enough so that your comparisons have a chance of beingmeaningful. Go down there and see rates of change in sales andearnings, levels of stability in the underlying earning power of thesecompanies. Then, narrow yourself down from six to two.
Tanous: Instead of picking just one, how about buying them both?
Murray: You may do that. Having narrowed them down to two,you may decide that it is too close to call, so you put half your moneyin each.
282INVESTMENT GURUS
Tanous:! want to ask you about your role with the Individual Re-tirement Account.
Murray: I was Gene Keogh’s expert. He was a member of the HouseWays and Means Committee from Brooklyn. He was a fairly seniorguy on the Ways and Means Committee. When he called the chairmanof Bankers Trust Company and said, I need an expert to support meagainst the Treasury’s contention that the Keogh Act will result intoo great a revenue loss, the chairman said, I know just the guy youwant. His name is Roger Murray. So, for ten years, each year whenthe bill would come up - one year in the House, one year in the Senate- I would go and give my testimony stating that the Treasury estimatesof revenue loss were absolutely unreal and outrageous. Anyway, wefinally got it passed.
By then, I was over at CREF [College Retirement Equities Fund]thinking about pension benefits that were completely portable. Oneof the greater assets of academia is that you can change jobs andyour retirement benefits will move with you as long as you are inTIAA-CREF [(Teachers’ Insurance and Annuity Association CollegeRetirement Equities Fund) Virtually all teachers and college professorsin America are participants in this retirement program, which is oneof the largest institutional pools of money in the U.S., with over $160billion under management for 1.8 million participants in 5,800 schoolsand non-profit educational institutions.] That’s because you own thepolicy from day one.
So I looked around the landscape and said, we’ve got a fine organ-ization here that covers academia, and others are covered by theircompany or their union. But the people in the workforce who don’thave a comparable opportunity are those who have a lifetime of work,where their economic asset is their skill and professional ability, butwho do not have continuity of specific employment. What we oughtto do is fill that gap by having an individual retirement account,where an individual could sign up with a financial institution andhave a part of his pay go into a lifetime savings account. It wouldthen be possible to make it tax deductible, just as it is for everybodyelse.
The beauty of this is that it becomes a wonderful asset for financialinstitutions, and they will promote it because they will gain a longterm depositor. Furthermore, here is the ideal place for people to buystocks and make long term equity investments, because they will have
283PETER J. TANOUS
locked themselves into this program. The one thing we know aboutstocks is that if you give me 15 or 20 years, I’ll give you a superiortate of return, which is what you need for your retirement savings.
Tanous:How did you get from cogitating about this idea, to the IRAas we know it?
Murray: There was a hearing in Washington. They were kindenough to invite me to come and talk about retirement income. I gavewhat I thought was expert testimony, but nobody gave me the timeof day. I got nowhere. However, the Hunt commission was appointedto study our financial institutions, and they invited me to write aposition paper to address fiduciary standards for the protection ofpensions. I said, I’m delighted, and I’m just the right guy to do that.But, curiously enough, as you get about two-thirds through the paper,there is a slight departure. We talk about the gap in the availabilityof pension plans for the individual who is not part of a significantgroup. The potential remedy for this is something called the IndividualRetirement Account. They said, hey, you’ve really got something!You're absolutely right!
Out of the Hunt Commission report comes the Employment Retire-ment Income Security Act [ERISA]. Where do you find a tax benefitfor the self-employed? Answer: in ERISA. It’s ERISA that providesyour deductibility for a contribution to your IRA. We got this in abill that has to do with the careful inspection and auditing of pensionplans. Never happened before. The magic here was that this couldhappen, not in ten or twelve years like the Keogh Act, but in threeor four.
Tanous:So we have you to thank for it.
Murray: We got it in the side door.
Tanous:Tell me, Professor, the coincidence of the signing of thisbill, just as we came to the end of the ’73-’74 bear market, is a bitstriking, don’t you think?
Murray: It’s a sheer coincidence. I had done work on pension reformway back in the ’60s. The appointment I had was when Kennedy wasin office. I worked on one of the task forces that addressed pensionreform. But it took a long time, and a series of hearings.
In September 1974, while we were preparing the annual report ofthe Common Fund [a large mutual fund and investment group whichaddresses the specific needs of educational institutions], we had haddiscussions about the fact that colleges were withdrawing their parti-
284INVESTMENT GURUS
cipation in the equity fund and putting the funds into high-yieldbonds. We decided we had to do something like write a statement [indefense of equities]. My colleagues said, Roger, you write the firstdraft. I wrote the first draft. We had a meeting of the investmentcommittee. They said, gee, we like this and we kind of agree with it,but we think you're taking too strong a position. My position wasthat this was an opportunity of a lifetime to buy equities.
Tanous:This is in 1974?
Murray: September 1974.
Tanous:Talk about timing!
Murray: They all wanted to tone it down. I listened patiently andsaid, I'll tell you what. I’ve got a deal you can’t refuse. I'll write adisclaimer and say this is not really an expression of the CommonFund. We observe freedom of thinking and speech, which is commonto academia. This is one man’s opinion, not necessarily endorsed bythe trustees. My offer was that, if this turns out to be right, it will bethe Common Fund’s statement. If it turns out to be wrong, it can beRoger Murray’s statement.
Tanous:Did it work?
Murray: It worked. I went back to my original draft and didn’thave to modify the conclusions. It was illustrative of the conventionalwisdom. I never had more invitations to speak than I did in the fallof 1974. They couldn’t get anybody else to constructively talk aboutbuying equities. | had never spoken at the Chicago Analysts Societyand I got an invitation to talk to them. | said I'd be delighted. Thatwas the only time I ever used the word “never.” The old saying isnever use the word “never” in relation to equities. And I used theword by saying you'll never have an opportunity to buy stocks ascheap as they are now. I said it and I