Ludwig von Mises, Meet Benjamin Graham: Value Investing from an Austrian Point of View

0:00Thank you Mark for the introduction. Thanks very much indeed for the Mises Institute for inviting me to give a talk and particularly to Pat Barnett who assisted with the presentation or the infrastructure if you like of getting the organization of my presentation going. And thank you particularly for you for attending the conference and listening to my talk. As Mark said, Chris Leithner is my name. I run a couple of businesses in a suburb of Brisbane in Australia. Australia. My job is basically or one of my jobs is to take shareholder's funds which appear if you like as a current asset on a balance sheet to take cash and to invest it to convert it into a non-current asset. My job basically is to allocate capital. Wearing another hat, my job is to take investment institutions funds and to do much the same sorts of things to invest it sensibly. I raise that because my job and my presentation before you today is to talk from a much

0:58and a much more applied point of view about the linkage between one style of investing and the Austrian School. I've chosen the title Ludwig von Mises meets Ben Graham, Value Investing from an Austrian point of view because it struck me for several years, a lot of years I dare say, that when I talk to Austrian School people about investing topics there's not too much about which we disagree when Austrians conversely talk to a particular style of value investors about that there seems to be a fair bit of commonality and I'd go as far to say that and I'm perhaps stretching it but we'll see how far I can stretch it that value investors and Austrian school economists may well have more in common than value investors have with their mainstream and Austrian school people have with the economics mainstream now Now, my purpose today is not to explain that, but perhaps to describe it to show some of the ways in which there are a fair few commonalities.

2:00I've chosen the title almost as if two gentlemen meet at a relatively formal function, two people who might think, gee, these two gentlemen have a fair bit in common, it would be useful to introduce them such that they themselves can perhaps can explore their commonalities to perhaps from first principles to explain why those commonalities might exist. Just a wee disclaimer, my apologies for that. My purpose today is not, N.O.T. is not to sell you any securities, not to provide legal, accounting, financial advice. I've presented or I've prepared a written paper available either from the website towards the bottom or thanks to Pat Binett by way of the Mises Institute. In the time allotted to me, I haven't the time to discuss it in any great detail. Perhaps what I'll give to you is a hitchhiker's guide following the points which I've just now raised. Let me talk to you briefly as an audience by and large of Austrian School economists or people interested in the Austrian School and not so much as value

3:02investors, a couple of points about value investing. Let me talk very briefly about Ben Graham, both an investor and an adjunct academic at the Columbia B School from roughly the mid-1920s to roughly the late 1940s. Graham was born in London at a relatively early age, moved to New York City, was something of a prodigy as a student, graduated from Columbia, was offered three academic posts at Columbia, one in mathematics, two in classics, which was a lifetime passion and interest of his and I confess on the spot off the top of my head the third one might have been English but don't quote me upon that, but a man with a very eclectic, a very wide-ranging set of views throughout his life and indeed, as you read in his autobiography, investing per se was by no means the most important thing in his life, if anything, the study of classics was a greater passion for him than was the allocation of capital.

4:01to give a very brief overview summary what on earth is this thing value investing at least as he described it up one or two other points the Great Depression was very hard on Graham just as it was on many other people he founded an investing investment company in the mid 1920s which did extraordinarily well during the boom of the 1920s like many other investing companies did extremely badly in the early 1930s and that prompted him to go and we'll go back to first principles to explain to themself what went wrong and equally importantly to present some principles to go forward. That book, Security Analysis, is often described as a foundation stone for investing. It's often described that way but I dare say relatively few people these days will read it from cover to cover.

4:49To my knowledge, which admittedly is limited knowledge, certainly in Australia it will never appear on a B-school curriculum and adventure guests in this country as well. It may well be mentioned on occasion but certainly not utilized that extensively even though there have been multiple editions and the book is still in print. Graham retired in around about the mid-1950s among his students and colleagues at Graham Newman Corp, his investment company, was Warren Buffett who obviously went on to much greater and much more prominent things. Graham, if anything, issued publicity. Mr. Buffett, it seems to me, doesn't necessarily attract it, but the publicity comes his way, nonetheless. Right, now having said that in terms of background, according to Graham, investment is most successful when it's most business-like.

5:38An investment operation is one that, upon thorough analysis, promises safety of principle and a satisfactory return, operations not meeting these requirements are speculative. Grahamites, first and foremost, are analysts, as I'll say a fair bit more, are analysts of businesses. What they are not are people who stare at a screen and notice a blip of a price which goes up or down from one hour to the next one day to the next week or month. Their interest is very much in the business that they're looking at. Businesses have securities obviously, but their interest is in the tangible business which underlies security. Their objective, their passion is to analyze that business, to ascertain the value of that business, to compare value to price, hence the label value investing, when their assessment of value is greater than price to buy, if their assessment of value doesn't meet those criteria to step aside.

6:31You can see a commonality though. I put a quote from Human Action from von Mises. Stock exchange transactions produce neither profits nor losses, but are the consummation of profits and losses arising in commerce and manufacturing. I take that quote to be, look at the underlying economic, tangible economic activity. The market exists in order to make transactions, but the financial market per se, the blips on the screen, are not the be all and end all. and all, in actual fact, it's businesses producing ultimately goods and services for consumers, that is the be all and end all of investing. The final point then, on a day-to-day basis, the operations of a business are much more stable than any assessment of its value. Assessments of value will change virtually instantaneously, but it seems to be certainly in with respect to relatively well-established businesses, they're much more stable.

7:21and that's an insight it seems to me that Graham was properly able to take advantage of during his career, certainly Mr. Buffett's done so since then. Just another couple of points in terms of overview. Focusing on that distinction between price and value, it's certainly not a mainstream sort of a notion, repeating a point I made at the outset to talk to Austrian School economists about the distinction between price and value, to say that price is what's paid, value is what's received, that elicits little if any descent, no arguments there. Second point, Graeme observed that over time, price and value tend to gravitate towards one another, sometimes it can take a fair while to do so. At any given point, they may well diverge, sometimes by quite a wide margin, and indeed from one minute to the next, they may well diverge.

8:11They'll eventually converge, but they won't instantaneously do so, they won't necessarily do so from one moment to the next. Graham also lamented that most people rarely recognize, very few willfully, and a few, sorry, more than a few will willfully ignore, that fundamental distinction between price and value. That's certainly not a mainstream notion, price and value are synonyms, according to the mainstream, in terms of the catechisms taught in business school, and people will scratch their heads, where mainstream people will scratch their heads if you put these points to them. Final point on that slide, value investors, investors seeking value, which may well, and often does, differ from price, will reject the mainstream view that these two things, price and values, necessarily coincide at all times.

8:59There's a fair bit of commonality, it seems to me, between Graham and I selected Mises as a relatively accessible source on investing risk, on what investing risk is. For mainstream or for MBAs taught in these schools, the risk of an investment is the price volatility or the risk of a listed investment, which is the overwhelming concentration, is volatility. The more volatile it's been in, say, the recent past, what's that, a week, a month, a year, the more volatile it is, the riskier it is. For Graham, that's patently absurd. Risk resides in a tangible business, the degree of success in the past currently under plausible assumptions how successful it's likely to be going forward largely on the basis of accounting criteria, return on capital, etc, etc, etc.

9:47But the price or the volatility from one moment to the next is of virtually no interest to Graemeites with the one exception if it enables them to buy a quality asset at a decent price. A couple of other points on that and I'll just read from Mises and it struck me because it's something that Graham could easily have written. I dare say he wished that he had written. According to Mises, I'll quote, a popular fallacy considers entrepreneurial profit a reward for risk taking. It looks upon the entrepreneur as a gambler who invests in a lottery after having weighed the favorable chance of winning a prize against the unfavorable chance of losing his stake. This operation manifests itself most clearly in the description of stock exchange transactions as a sort of gambling, which is very similar to what, if you like, a typical newspaper account will be if prices are rising today, falling today, back garden conversation in terms of my investments are doing well, they're not doing so well and so on.

10:48Mises continues quote every word in this description is false the owner of capital does not choose between more risky less risky and safe investments he's forced by the very operation of the market economy to invest his funds in such a way as to supply the most urgent needs of the consumers to the best possible extent the success or failure of the investment in stocks bonds etc etc depends ultimately upon the same factors that determine success or failure of the Capital Invested. And as I say, that's something that Graham could use. The thought is a very Grahamite thought. I dare say he wished he'd expressed it that eloquently. Risk then has to do with tangible businesses, their operations. It has to do not with squiggles on a line from one moment to the next.

11:36I haven't the time to go through the paper point by point, which is just as well, and I certainly shan't read from it or quote from it, but there are eight points of commonality I put up in my paper. I've mentioned two of them thus far. a distinction between price and value, conception of risk. A third point of commonality I put within parentheses that Graemites are methodological individualists. I dare say I stretch the point slightly. The individualists in this sense that their relentless focus, the concentration, their passion is in the individual business which is being analyzed, individual business which has individual securities. Their interest is not in the market or not in a market average, a market aggregate, be it the Standard and Poor's 500, the All-Ordinary's Index, any of many other indices. They're not looking at that aggregate level rather at the more within quotations individual business level.

12:26So if you like a business analyst is a reasonable handle for them. A fourth point of commonality is a skepticism about mathematical modeling. For Graham in his experience, the more fancy the mathematics, the more arcane the assumptions, The more likely the person doing the assuming, the more likely the person utilizing the mathematics was speculating rather than investing. He was very cautious about anything beyond ordinary arithmetic in terms of the sorts of things one would need to analyze a balance sheet, a profit and loss statement, and so on. It's stretching slightly, but not very much, dare I say it, to say that little more than primary school mathematics is required to be a grey mite investor, which is just as well. Certainly the arcane stuff with which MBAs would be exposed is not just alien to a gray mite but they'd be not just very skeptical about it but I dare say they'd run as fast as a feet can carry them from it.

13:19A fifth point, the future is largely but not radically uncertain. A gray mite would say look, they would be comfortable with the notion there exists laws of economics, there exists historical data and on the basis of those sorts of things, One, they're prepared to look very cautiously into the future, that's not to say that they're making forecasts that the price of a stock will be X in six months' time. They're saying, look, based upon the laws of economics, their analysis of a business, that a reasonable price is likely to be no more than such and such. And if you buy today on the basis of their experience going back now, the better part of three-quarters of a century, one is likely to do reasonably well. But that's not the same thing, if you like, as a point forecast. are much more comfortable saying, look, given this information, we're rather unlikely to end up disastrously wrong.

14:09Sixth point is that value investors are Austrian entrepreneurs in a specific way. In the way that, for example, Israel Kirzner described entrepreneurs. Not so much, not at all in the way that, for example, Joseph Schumpeter might have described entrepreneurs. I'm grateful for Robert Blumen for distinguishing the two more clearly than I would have. Value investors seek to discover things which other people have, for whatever reason, overlooked. They're not the sort of people who, in a sense, are creating utterly and completely new things, engaging in the process of creative destruction, going where no person has gone before. So they're entrepreneurs in that Kirznerian sense as opposed to a Schumpeterian sense.

14:54I'll skip in terms of time available, but I've drawn another distinction in terms of the views about capital goods. goods. I have given an example, Austrians don't use the phrase time preference, to my knowledge it's a the phrase itself isn't used by them. The underlying logic though is something they use virtually on a daily basis. They constantly talk in terms of payback periods. Making an investment today, how long is it likely for the fruits I expect to be generated? They seek the smallest possible payback period, the longer it is, the greater risk becomes in terms of unanticipated things which might occur between now and then. So I'm stretching it a bit, I don't think dramatically so, to say that look, there's not a complete commonality, but a sufficient commonality to be intriguing in terms of the views of time preference and concepts that stem from it, namely interest and an investor's rate of return.

15:50Let me say a few points in terms of, a few points more I should say, a bit of detail, in terms of the distinction between price and value. The price to a gramite is set at the margin, the price is a ratio at which the most eager person, say the most eager buyer and the most eager seller voluntarily exchange some specified goods, service, commodity, stock or bond. A buyer is most eager in the sense that he or she is willing to exchange it for the greatest amount of some other commodity, say money. A seller's most eager in the sense that he's prepared to accept less money for it than any other seller. You might shrug your shoulders and say, well that's elementary, and indeed I agree that it is. Those comments are not from an Austrian School economist, they are from John Burr Williams, his book, The Theory of Investment Value, published in 1938.

16:40The margin, says John Burr Williams, who is a colleague who's pushing it, acquaintance of Graham, in William's words, the margin will fall between owners and non-owners, The ins and the outs, the eyes and the nays, and this margin, opinion, mere opinion, will determine actual price. An opinion is not the same thing as a fact, and Graham Mites, I dare say, are very familiar with the notion that some actors will be better informed than others. The mainstream notion that all buyers and sellers, all market participants have the same information, they would reject. The notion that all buyers and sellers would react in the same way to that information, they'd reject. And with it, comes a rejection of quite a lot of contemporary finance. So in that point, again, an initial point of elaboration.

17:29To say, for example, that SecurityX is selling at such and such a price on this particular Friday in February at this moment, basically has to do with the opinions expressed by, ultimately, two different people. Whether they're well informed, whether there's other information that can be brought to bear, That's a different issue entirely. Prices are neither omniscient nor prescient. Briefly, let me summarize that point, not from Graham, but from Jim Grant, who quotes from Graham occasionally. Grant says this, I quote, to suppose that the value of a common stock is determined purely by a corporation's earnings, discounted by the relevant interest rate and adjusted for the Marginal Tax Rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin and believed Orson Welles when he told them over the radio that the Martians had landed.

18:23Actors and markets are not necessarily well-informed actors. To say that the price of something sells for X today is not necessarily an accurate reflection of underlying value. As a rule, disbelieve the media, another implication stemming from the point. A lot of silly things, and it's no news to you, appear on the news from day to day. The fact that if a market index falls on a given day, quite often journalists will talk about a sell-off, which is silly because for every security that's sold, there has to be a corresponding buyer. For every person selling, there has to be a buyer. Why not call it a buy-off? It's then simply silly to talk about a rush to get out of the market, a rush to get into the market. Why? Because the queue is going in either direction, the one balances the other, ignoring IPOs and the like on a given day.

19:12The number of securities at the end of the day is identical to that at the beginning of the day. It's simply silly to talk about a rush in one direction or the other. Let me skip to my conclusion then, running short on time. From an applied point of view, from the point of view of someone who runs an investment company and who interacts with investing institutions, the relevance of Austrian economics. Point one, it helps to inoculate against absurdity. And I've put in a quote there, the next time somebody tells you with a straight face that all investors have the same information, expectations, time horizon, That markets are very liquid, making transaction costs so small that they can be ignored, and that value and price are synonyms, the next time they tell you that, it seems to me the sane response is simply to laugh.

20:00Austrian economics, if you like, and I can stretch the analogy, are prophylactic against a lot of silly things that one hears and reads on a daily basis. Second point, helps to avoid over-optimism and unwarranted pessimism. and pessimism. Jim Grant has a really good quote at the beginning. I put it in the paper. He equates Austrian economics, if you like, to the ability to avoid getting up in the middle of the light and stumbling over the lampshades or the lampstand and so on. The future is always unlit, but it helps to have a theoretical edifice that enables you sometimes to avoid the more severe injuries of stumbling over lamps and lampshades and furniture in the middle of the night. I think that really encapsulates the point far better than I The final point, and I'll stop with perhaps a minute or so left, is that for businessmen and investors, or business people and investors, Graham said the two are in effect identical, that to be a good investor you have to be a good business person and vice versa.

20:59Austrian School economics, it's neither necessary nor sufficient, that's to say to be a good Austrian School economist, that has no necessary implications for your style of investing, to be a Grahamite investor doesn't necessarily predispose you towards the Austrian School. in School. The point of my paper though is to show that seems to me there's a fair bit of overlap and intriguingly big overlap such that these things are neither necessary sufficient but goodness me by my experience and it certainly helps. So I'll stop there and thank you very much for your attention.