How Investing Has Changed Over the Past Century

Benjamin Graham is widely considered to be the “father” of value investing, the process of finding individual stocks whose businesses offer the prospect of future price gains while offering reasonable protection against future losses.  Graham co-founded Graham-Newman Corp. nearly a century ago.  Stock markets have changed drastically since then.

Early in Graham’s investing career, his approach was to buy stock in companies that were out-of-favour and severely undervalued.  He described these methods in his 1934 book Security Analysis.

But Graham’s investment methods were never static.  As Jason Zweig explained in Episode 75 of the Bogleheads on Investing Podcast:

“People criticize Graham all the time for being old-fashioned, for having these formulaic techniques for valuing stocks, … and then people say these things are all out-moded.  Nobody invests like that any more.  Nobody should.  And that completely misses the mark for two reasons.  First, during his lifetime, Graham revised the book [The Intelligent Investor] several times, and every time he revised it he changed all those formulas.  He updated them to reflect the new market realities at the time the new edition of the book was coming out.  … If he were still around today, he would update all those formulas all over again, and they would look nothing like what’s in the books.  … The second objection is much more basic, which is: that’s not Graham’s message.  … Graham’s message is that if you try to play the same game as Wall Street itself, you will lose.”

Graham recognized that markets change over time.  To keep beating the market averages, as he did for many years, his investment methods had to change over time.

However, in Graham’s last version of The Intelligent Investor in 1973, he wrote

“We have some doubt whether a really substantial extra recompense is promised to the active investor under today’s conditions. But next year or the years after may well be different. We shall accordingly continue to devote attention to the possibilities for enterprising investment, as they existed in former periods and may return.”

Graham expressed optimism that conditions might change so that some version of his investment approach might beat the markets.  However, that hasn’t been the trend.  Markets have become ever more competitive with each passing decade.

Another quote from Graham in the same 1973 book:

“Since anyone—by just buying and holding a representative list [a market index]—can equal the performance of the market averages, it would seem a comparatively simple matter to ‘beat the averages’; but as a matter of fact the proportion of smart people who try this and fail is surprisingly large.  Even the majority of investment funds with all their experienced personnel have not performed so well over the years as the general market.”

By 1976, Graham become more pessimistic about beating markets:

“I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook ‘Graham and Dodd’ was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost.”

Graham remains a hero to many value investors, despite the fact that 48 years ago he doubted whether analyzing businesses to find good value worked any more.  Graham’s methods worked from 50 to 100 years ago because of the ample dumb money flowing in stock markets.  For superior investors making excess returns to exist, there must be many inferior investors performing worse than market averages.

The proportion of money in stock markets controlled by individual investors has declined steadily over the decades.  Investors who knew little used to buy their own stocks.  Now, many such investors use mutual funds and exchange-traded funds to have their investments controlled by experts.  Dumb money has shrunk as a percentage, and the competition among investment professionals to exploit dumb money has become so sophisticated that few understand it.

Markets have reached the point where many smart investment professionals seem like dumb money when compared to their competition.  In this environment, individual investors have little chance as stock pickers.  In the third edition of The Intelligent Investor, Jason Zweig wrote

“Millions of investors spend their entire lives fooling themselves: taking risks they don’t understand, chasing the phantoms of past performance, selling their winning assets too soon, holding their losers too long, paying outlandish fees in pursuit of the unobtainable, bragging about beating the market without even measuring their returns.”

Markets have changed dramatically over the past century.  Simple methods of beating markets stopped working decades ago.  There may be some brilliant investors, such as Warren Buffett, who can still beat markets, but most investors actively investing their own money are just fooling themselves.  We could make the case that if Graham were around today, he might be a passive index investor.