股票市场研究——在美国参议院银行与货币委员会作证（富布赖特听证会），1955年3月11日

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STOCK MARKET STUDY

HEARINGS

BEFORD THE

COMMITTEE ON BANKING AND CURRENCY

UNITED STATES SENATE

EIGHTY-FOURTH CONGRESS

N FIRST SESSION

ON

FACTORS AFFECTING THE BUYING AND SELLING OF

EQUITY SECURITIES

22, AND 23, 1955

Printed for the use of the Committee on Banking and Currency

UNITED STATES

GOVERNMENT PRINTING OFFICE

60659 WASHINGTON: 1955

no

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""!:

COMMITTEE ON BANKING AND CURRENCI

J. W. FULBRIGHT, Arkansas, Chairman

A. WILLIS ROBERTSON, Virginta

JOHN J. SPAREMAN, Alabama

J. ALLEN FREAR, JB, Delaware

PAUL H. DOUGLAS, Illinois

HERBERT H. LDHMAN, New York

A. S. MIKE MONRONEY, Oklahoma

WAYNE MORSE, Oregon

HOMER B. CAPERART, Indiana:

JOHN W. BRICKER, Ohio

IRVING M. IVES, New York

WALLACE F. BENNETT, Utah

PRESCOTT S. BUSE, Connecticut

J. GLENN BEALL, Maryland

FREDERICK G. PAYNE, Maine

ROBERT A. WALLACE, Staft Director

J. I. IINGLING, Chief Clert

II

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.518 • STÖCK MARKET STUDY

General WooD. I think it is very good. You put your finger, as I expected you would, on the one potential weakness, which is that It somebody gets control of these big funds for selfish purposes, it would be bad.

The CHAIrMAN. That is right.

General Wood. All I can say is I think I have indoctrinated my 40 betes and directors a dafice prey hall, me t cathod ansver for will be done in the next 10 years. After that time I cannot answer for

Senator BrIcKEr. May I express a word of appreciation to General Wood for coming here and the information he has brought to us. It is an example of one of the great American industries. The CHAIrMAN. Thank you very much , General. The next witness 1S Mr. Benjamin Graham, chairman and president of Graham-New-man Corp., of New York. Mr. Graham, we are very happy to have you this morning and are looking forward to your testimony.

Would you care to read your statement or would you rather summarize it?

• STATEMENT OF BENJAMIN GRAHAM, CHAIRMAN OF THE BOARD,

GRAHAM-NEWMAN CORP., NEW YORK

Mr. GRAHAM: I would prefer to summarize it if I may. The CHAIrMAN. Fine. Mr. GRAHAM. But in the first place may I make a correction? The CHAIRMAN. Yes. Mr. GrAHAM. The correction is to the effect that I am not president of Graham-Newman Corp., but chairman of the board. I would like to ada, it 1 may, 1 am also chairman of the Government Employees Insurance Co. of this city, which is a smaller but rather vigorous competitor of General Wood's Allstate Insurance Co., and ie have paid Sears, Roebuck the compliment of patterning our profit sharing plan very closely on theirs. I have tried in the statement to deal with three factors: First, the question ot tae present level of stock prices from the standpoint of the relationship between price and value. Secondly, causes of the rise in the market since September 1959; and, thirdly, feasible methods of controlling excessive speculation in the future. With respect to the present level of stock prices, my studies lead to the impression that leading industrial stocks are not basically over-valued, but they are definitely not cheap; and they are in danger of going over into an unduly high level. I would like to add on this point while I deal in my statement with leading industrial stocks I am going to be criticized for not taking nto account the tact that the stock market is made up of many hun- ¡reds of issues which have different price patterns. The fact remains in the last year or so the market pattern has been more unitorm, 1 think, than it has been in most markets, and the level of advance in the market price has been fairly evenly distributed over all types ot stocks-both the leaders and secondary issues. With respect to the causes of the rise in the market since September 1953, my statement indicates 1 would emphasize very much the change in investment and speculative sentiment, more than any change in basic economic factors. "I wanted to point out that that carries an

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STOCK MARKET STUDY 519

element of danger because a change of sentiment for the better may be followed by a change in sentiment for the worse.

finally, in regard to the feasible methods of controlling excessive speculation in the future, 1 am in sympathy with the action of the peal see in ne in main pea with the ion of the activity increases. 1 teel in general speculation on margin is expensive to the public; and is sound only when it is practiced by people who have a great deal of experience and a great deal of ability. I also have an idea with respect to temporary modifications of the capital-gains tax if it appears desirable to increase the supply of stocks for a temporary period of time. I would rather answer questions from this point on instead of going into more detail about my statement. The CHaIrMaN. Ihank you very much, Mr. Graham. In connec lion with your own company, does it invest in a representative sample of the best stocks in the market, or does it use some other guide for investment? Mr. GRAHAM. No. We have not been purchasing the market leaders. Our business has been something of a specialty business. We have emphasized the purchase of securities selling under intrinsic value, and have gone to what is generally known as a special situation. the CHAIRMAN. Would you describe that for us—for our informa-

You understand you are talking to a committee at least the members who you notice are present now—who know very little about this. Would you tell us what specialty situations are and how you approach it! How do you determine whether a special situation is undervalued or not? Mr. GraHam. There is a slight distinction between an overvalued security as such, and a special situation. I shall try to make that distinction clear. In the first place, with respect to a special situation as it is known in Wall Street. That is a security which upon study is believed to have a probability of increasing in value for reasons not related to the movement or stoca prices in general, but related to some development in the company's affairs. That would be particularly a matter such as recapitalization and reorganization. merger and so forth.

example, the typical example of the special situation is a company in trusteeship undergoing reorganization. Because of the fact that it is in trusteeship, the securities tend to sell at less than their intrinsic value. When the reorganization is completed, the proper value is established and there will normally be a profit in the purchase of such securities. , There are other examples of that kind. The public utility breakups were a very interesting generic group of securities, because we had . an underlying situation in which these holding companies, being in ill favor in general with the investing public, tended to sell at less than the value of their constituent com-panies, and when they were broken up the value of the constituent companies in the market greatly exceeded the value of the holding company shares. With respect to undervalued securities in general, not special situations he pect to bender upon a ries in eat ot specia, sia. shows by a study of the company's balance sheet and income account that it is selling for considerably less than its intrinsic value, which

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520 STOCK MARKET STUDY

in general can be defined as considerably less than the value of the company to a private owner. The CHAIrMaN. How do you evaluate management! Mr. GRAHAM. Management is one of the most important factors in the evaluation of a leading company and it has a great effect upon the market price of secondary companies. It does not necessarily control the value of the secondary companies for the long pull because it the management is comparatively poor there are forces at work which tend to improve the management and thereby improve the value of the company. The CHAIRMAN. When you go into special situations and buy large blocks, do you usually try to get control of the company? •Mr. GRAHAM. No; that is very exceptional. I would say out of about 400 companies that we may have invested in in the last fen years, there would not be more than 3 or 4 in which we would have nad any interest in acquiring control. The CHAIrMAN. You would have if you thought the management was bad, would you not? I mean that would be one of the principal elements in that case? Mr. GRAHAM. That could be a reason for our seeking control, hoping to improve the management situation. The CHAIRMAN. How do you go about acquiring large blocks with-ut disturbing the market too much! Do you do it in your own name or what is the procedure? Mr. GRAHAM. Well, there are two procedures. One is to acquire shares in the open market over a period of time. The other is by making a bid for a specified or unspecified number of shares, which is made public and which all stockhoiders have an opportunity to accept. The CHAIRMAN. What I mean is, 1 assume that you specialize in special situations. You analyze it and after considerable work, I take it, you decide that it is undervalued and it is a good special situation. You start buying in the market, and you reveal your interest and everyone knows what you are doing. I wondered how jou proceed: Mr. GRAHAM. That could happen, but very often it does not. May I give you an example of that, Senator. In a book I wrote, The Intelligent Investor, - gave an example of an undervalued security, the Northern Pacinc Railroad stock, which at the time of my first analysis sold at 20 and later went down to 14. We decided to buy a tair amount of stock. I should say that after reading the book once or twice I convinced myself the shares should be bought. We went ahead and acquired about 50,000 shares of that stock in the market with comparatively little effect upon the price. The CHAIRMAN. Were there a lot of shares of that? Mr. GRAHAM. There were about 2½ million shares altogether. The CHAIrMAN. That is a pretty big company? Mr. GRAHAM. Yes, indeed, but that was à large investment for us. But there are other instances in which where companies are smaller it might be desirable to modegbir or arer, as he open market, and it might be desirable to make a bid or offer, as it is generally called, to acquire shares in some public way. The CHAIRMAN. You make no ettort to conceal your interest in a speciai situation or to deal through trust companies or other accounts! Mr. GRAHAM. Well, in most of our purchases, the vast majority of

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STOCK MARKET STUDY 521

them, we purchase shares the same way as anyone else would through brokerage houses, who act for uș, and there is no concealment.

The CHAIRMAN. Io your knowledge are there many instances of concealment of the purchaser in acquisition of stock ?

Mr. GRAnAy. Well, you might say that virtually all of the com-panies that are acquired in the open market—1 mean where control is acquired in the open market, in virtually all these cases there is some degree of concealment. That is to say, nobody publishes the ract that he and his group are acquiring control in the open market. time ule nbris sets be und, but tisa beeals noni. ere han-times the news gets around , but it is generally unofficial. There have been a te winstances, comparatively few, in which efforts are made to acquire control of a company generally through a reputable bank or trust company where the name of the purchaser is not revealed; in other cases it is revealed. The CHAIRMAN. We have had suggestions that this is done, and I was wondering what the process is and whether or not you do it ol nave done it. I wonder it you could describe for us the way you can acquire control without revealing your identity, not applicable to yourself necessarily. How would anyone do it? Mr. GRAHAM. Well, outside of the method of acquiring control in the open market, which as 1 said betore is the more customary way. the other method would be to ask a bank or trust company to communicate to the stockholders an offer to buy the shares, generally at a price above the market, and state that the acquisition is bing made for clients of the trust cempany, without giving their names. Ithe CHAIRMAN. There is no requlement it a trust company purchases stock on the exchange to reveal the benenclal owner; is that right! They do not have to say, "We are buying this for Mr. Jones or Mr. Smith"? Mr. GRAHAM. No, obviously not, sir. The CHAIRMAN. So that that would be the usual way, simply to use an established firm which is in and out of the market, for your agent to purchase for you? Mr. GRAnAM. Yes. That would not be a trust company. Normally that would be a brokerage firm. The CHAIRMAN. Does a broker have to reveal who his principal is? Mr. GRAHAM. No. On the contrary, it is one of the basic principles oI Wall Street that the relationship between the broker and the client is confidential that the name solid not ben the eder and he chant. is confidential and the name should not be revealed except to authorı. ties who have a legitimate reason to ast for the information. The CHAIRMAN. Well, that is an important exception. What about a trust company? If the Chase National Bank purchases shares and they are asked by the president of the exchange whom they are buy-ing tor, do they tell him? Is it same as the broker! into do ther. the president ofte the broke Stock Exchange has Mr. GraHaM. The president of the New York Stock Exchange has no authority over anyone except members of the New York Stock Exchange. The CHArMaN. Well, then, there is a difference. As to the brokers, he has access to the beneficial owner, but he does not have as to the trust company. Is that right? Mr. GRAHAN. That would be true with respect to the president of the stock exchange, yes. The CHARMAN. Who would have control, the SEC?

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522 STOCK MARKET STUDY

Mr. GRAHAM. As a reservation, I am not certain the constitution of the stock exchange gives the president the power to ask the brokers for the names of their clients or their dealings, but I assume that in the investigations that the stock exchange makes into its own dealings, including such things as manipulation and so forth, such information is asked for and given. The CHAirMAN. I understood that with regard to the members for disciplinary purposes they have the right to inquire, but I would not be too certain about that.

VIT. GRAHAM, I believe that is șo, but 1 am not sure. The CAN . Ween there is a battle for costral of a company,

The CHaIrman. When there is a battle for control of a company, the stockholders who intend to remain with the company would want to know whether they should participate in the battle or should sell out, and the Identity of the purchaser would be important to them in such circumstances, would It not! Mr. GraHaM. Well, if you are speaking of a battle for control in terms of a proxy battle, of course, the identity of the people who are endeavoring to obtain a majority of the votes by proxy solicitation is absolutely vital, and the proxy rules require that complete disclosure be made of the identity ot such persons. With respect to purchases of shares, however, that is an entirely different matter, and the theory of the stock market is that people are allowed to purchase shares anonymously. It will be a little embarrassing for many peoplé li each time they bought or sold shares their identity would have to be revealed. The CHAIRMAN. Of course, it is not done customarily, but it is subject to being revealed in an investigation at any time, is it not? Mr. GraHaM. As far as I know, the revelations of purchasers oi hares have been limited pretty much to criminal activities. I do not recall cases in which the names of buyers have been revealed, even though they may be known to the authorities, merely because these. people happen to have bought stock. The CHAIrMAN. Do you recall the Lawrence Portland Cement Co.? Did you make an attempt to gain control of that company? Mr. GRAHAM. LeS; In assoclation with other people, who at that time, 1 believe, were either the largest or second-largest holders, we made a bid for a specified number of shares. The CHaIrMan. How did that work out? Mr. GRAHAM. It did not succeed. The price advanced above our id price The CARMA Do You think that was ta is quace of their having known that you were interested and having great respect for Jour Judgment, and it went up betore you could get control! Mr. GRATIAN. No. Un the contrary, what happened was that the company itself went into the market and forced the price up above our bid price. The CHAIrMaN. Well, I do not know how it could have been otherwise. You could not have purchased that amount in open market, could you! Mr. GRAHAM. No, but we made a blanket offer to the stockholders to turn in their stock to us at agiven price, which was above the market at the time the offer was made. The CHAIRMaN. What was your offer? Mr. GRAHAM. I think it was $26 a share.

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STOCK MARKET STUDY 523

The CHaIrMAN. When was that? Mr. GRAHAM. Four years ago, perhaps The CHaIrman. What is it selling for now! Mr. GraHaM. I do not know. The CHaIrMAN. Has it been split? Mr. GRAHAM. It has advanced, and the name has been changed. The CHAIRMAN. What is the name of it now? Mr. GRAHAm. Dragon Portland Cement. The CHAIRMAN, I am told that, allowing for the split, it is now selling for $lsu a share. I'hat vindicates your judgment, does it not Mr. GRAHAM. I wish we had been able to buy it; yes. The CHAIrman. Was it true that in that case you got no stock at all? MI. GRAHAM. NO; because our ofter was a contingent offer. We made an offer to the stockholders to buy their shares at a price above the then market, provided a sullicient number of shares would be de-posited. What happened then was, as I said before, that the oticer of the company, not wishing this bid to succeed, went into the market ale did not turn any number share to pence and peo

i, and we dropped the whole thing. The CHAIrMan. I am not sure—do you wish to discuss these individual cases or not? Mr. GRaHAM. Well, I have no strong feeling on the matter. I do not know to what extent it would be useful to the committee. If it is useful to the committee, I have no objection. The CHAIrMaN. I do not wish to embarrass you about it. I had made nad that it of peate all re ht. Tave discused go set at ine lave had a number or people nere who have discussed general prin ciples. None of them, I believe, were what we call active traders. I suppose that is what you are, is it not! Mr. GRATIAM. Well, we do not consider ourselves as traders in the ordinary sense. Technically you might call us that. The CHAIRMAN. What I was trying to do was to illustrate procedures that are followed by people actually in the market. If you edures that are quoted d bop to dial in the made no want clo not care to be questioned about individual cases, I would not want to press the matter. Mr. GRAHAM. I have no sensitiveness on the subject at all. We are very proud of our achievements in our company. The CHAIRMAN: I thought maybe you were a little reluctant in the case of the Dragon Cement to discuss the details. Mr. GRAHAM. I am not a reluctant dragon, Senator, except I do not remember the details too well. I was not active personally in the matter. The CHAIrmaN. Can you think otihand of other similar examples of the intent to gain control! Mr. GRAHAM. You mean examples similar to the one made in Lawrence? The CHAIRMAN. Yes. Mr. GRAHAM. Well, there was one recently. The CHAIrMAN. What is that? Mr. GRAHAM. I am trying to remember the name. I remember that a trust company in Boston The CHAIRMAN. The Atlantic Gulf and West Indies Steamship Co.?

6065055—34

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524 STOCK MARKET STUDY

Mr. GRAHAM. No, that was a different situation. You are referring now-to our own experience. The Atlantic Gulf and West Indies was quite a different situation. At that time we made an arrangement with the chief stockholder of that company to purchase, - think, the greater part of his holdings, and made a corresponding bid to every. body else to buy their shares at the same price, which was considerably above the market at the time we began our negotiations.

The CHAIRMAN: Was that a negotiated sale you were trying to effect off the exchange, or was it a listed stock?

Mr. GRAHAM. Yes, it was a listed stock. The negotiation was done with the large stockholder, and the rest was an offer extended to all the stockholders on the same terms. The CHAIRMAN. Was that negotiation directly with the stockholder?

Mr. GRAHAM. That is correct.

The CHAIRMAN. Did it succeed?

Whe CHAIN. Y it did not use an intermediary in that case? Mr. GRAHAM. No, that offer went over our name, I believe. The difference was this: At that time we had already arranged to buy a Large amount of this stock, and we felt that, for one thing, that should be a matter of record and was made a matter oi record. The CHAIRMAN. So that is an illustration of the successful way to purchase control of a company? Mr. GRAHAM. Yes. It is much more desirable to buy it by negotiation to begin with. The CHAIrman. Do you think there is any serious problem from the public's point of view with regard to the anonymous purchase of the pable poin of we with gear to the a man hase of Mr. GRAHAM. Senator, I have observed this thing for the last 40 years. I cannot think of a single instance in which the public has been hurt by otiers to buy control whether the names were revealed or not revealed. In every such instance the public has been helped because they have been able to get a higher price for their shares than they would have been able to get it no such bid had been made. Lhe CHAIRMAN. You see nothing wrong with that procedure! am not arguing with you. I am only asking you. 'Mr. GRAHaM. I have had occasion to think about that matter for a long time, Senator, and it seems to me that the true arguments are all, from the public's standpoint, in favor of not preventing bids being made to the public at higher than the prices previously ruling. The CHARMAN. Is your company an open-end or closed-end company? Mr. GRAHAM. We are technically an open-end company, and practically a closed-end company. Let me explain that. The CHAIrMAN. I will be very happy for you to. •Mr. GRaHaM. We are registered under the Investment Company Act of 1940 as an open-end company, which means that we are contractually obligated to'repurchase shares at any time at the net asset value when presented to us. However, no such shares have been pre-sented to us for a great many years. Our shares have sold consistently at well over their net asset value. Furthermore, we have not sold any shares of stock to the public at any time and have not increased our capitalization for many years, so that we operate actually as a closed-end company, namely, with a fixed capitalization.

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STOCK MARKET STUDY 525

The CHAIRMAN. What is the capital? Are these trade secrets or not?

Mr. GRAHaM. Not at all They would not be a secret in any case, Senator, but as it happens our figures are made public. They are filed with the Securities and Exchange Commission. We have 5,000 shares of stock with a present asset value on the order of $1,100 a share and with a market price rather considerably above that.

Ine CHAIRMAN. A market price above that?

A . But the hares sal vary se

The CHAIRMAN. But the shares sell very seldom, I understand? Mr. GRAHAM. That is true. There are very in frequent sales. Nonetheless, there are quite a number of them in the course of a year or two. The CHATMAN. When was your company started? Mr. GRAHAM. The company was incorporated in 1936, but it was a continuation of a business which was set up in 1926. The CHAIRMAN. To what do you attribute your great success in this business? Mr. GRAHAM. Well, Senator, that is assuming that we have made a great success. The CHAIRMAN. Would you not consider it a success? Mr. GRAHAM. I will admit that we think it is, but I did not want to be in the position of passing over your question as taking for granted that we have made a great success. The CHAIRMAN. I will take responsibility for saying you obviously have made a success. Mr. GRAHAM. I think our success is due to our having established sound principles of purchase and sale of securities, and having fol- Jowed them consistently through all kinds of markets. The CHAIrMAN. I take it that ordinary members of the public cannot buy your shares; is that right? Mr. GRAHAM. Well, they cannot buy them in unlimited amounts, but they can buy them over the counter in small amounts. The CHAIRMAN. Are they quoted over the counter? Mr. GRAHAM. They are quoted over the counter; yes, sir. : The CHAIRMAN. At what, $1,100? Mr. GRAHAM. I would say probably around $1,250 or $1,800 a share now. The CHAIrMAN. Above the asset value? Mr. GrAHAM. That is correct, sir. The CHAIRMAN. Is it customary for open-end companies to be selling above their asset value? Mr. GRAHAM. Well, it is unusual for any investment company to sell above its asset value, but there are a number of instances. The best-now instance is the Ishman Corp., which for a good part he

the fimy els a borpose be forale Tend Company to sel at more than the selling premium over its asset value as long as it offers shares of stock to the public. That is obvious. In some instances a company like State Street Investment has followed a policy like ours and has not offered shares generally to the public, and the shares have sold at a premium. The CHAIRMAN. Do you personally control your company? Mr. GRAHAM. No; I am à comparatively small stockholder.

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526 STOCK MARKET. STUDY

The CHAIrMAN. You are? Mr. GRAHAM. Yes, sir. The CHAIrMAN. Does your family control it? Mr. GRAHaM. No. We have a comparatively small number of shares. The CHAIrMiN. Does any one family or person control it, or is it distributed rather evenly? Mr. GRAHAM. The shares are distributed fairly evenly. I would say there is a family with whom we have no relationship that represents the largest stockholding at the present time. The CHAIRMAN, If someone wishes to sell their shares, they still can demand what from you! Mr. GraHaM. They can demand the net asset value. The CHAIRMAN. Which, of course, they do not do, because they can • get more? Mr. GraHaM. That is correct. We have not taken in any shares for many years. The CHaIrmaN. What inspired you to form an investment company? You did start this investment company; did you not? Mr. GraHam. Yes. May I say that I entered the brokerage business in 1914 and became a junior member of a stock-exchange firm, and in 1923 I believed that sound investing principles would be successful, and I started a private fund in 1923, which was changed around in 1926. •The CHaIrMAN. What is a private fund? Mr. GRAHAM. A private fund would be one in which no offering was made to the general public through advertisements, circulars, or any other way, but merely to triends who were permitted or asked to contribute. The CHAIrMAN. How large was that company? Mr. GRAHAM. It was about a half million dollars at the beginning.. The CHAIRMAN. Just Jou and your friends? Mr. GRAHAM. That is correct, sir. My own participation was very small. I had very little money. The CHAIRMAN. You started buying stock; is that right? Mr. GRAHAM. Stocks and bonds; yes. The CHAIRMAN: I would be interested, if you do not mind telling • us, to have the history of this development. Mr. GRAHAM. Well, Senator, if you feel there is any value in this. The CHAIRMAN. There is, because we like to get some feel of how these trust companies develop. However, I do not wish to embarrass you. If you think it puts you at a disadvantage with competitors or anyone else, you do not have to. Mr. GRAHAM. No, Senator. 1 have been accused of telling all my secrets. I have written a number of books, and I reveal them all in these books. The CHAIRMAN. I was particularly interested to know what hap-pened to you in 1932. Mr. GRAHAM. We had rough going. The CHaIrmaN. You first started at the beginning with a half million dollars. What happened then up until 1929? Mr. GraHaM. We were quite successful, and the fund grew to $2 million at the beginning of 1929. The CHAIrMAN. In stocks, I take it?

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STOCK MARKET STUDY 527

Mr. GraHaM. In stocks and bonds.

The CHAIrMAN. What did you do in 1929?

Mr. GRaHAM. In 1929 we lost money.

The CHAIrMan. Well, a lot? Did you go down with the market or see it coming or what?

Mr. GRAHAM. We did pretty well in 1929 alone, but the real dith-culty we experienced in 1930 and 1931 when the market went much further downward than we had anticipated. We had pretty well anticipated the 1929 decline. And so our resources were shrunk pretty much. I do not think they shrank as much as General Woods' pension fund dia, which he mentioned betore, but they went down fairly low, and it was not until 1936 that a person who had been with us In 1920 and had held on would find himselt even, but by 1936 he was even in our business.

The CHAIrMAN. You said you changed. When did it become a registered investment company!

Mr. GRAHAM. It became a registered investment company in 1941 atter the passage of the investment Company Act

The CHaIrman. What happened in 1936! Did not some change occur?

had originally We ted as a fated, coo at, and pere ind radial men-had originally operated as a joint account, and the individual members reported on a partnership basis. The CHAIRMAN. Each participant in the fund?

Mr. GRAHAM. That is correct, reported his share of the results. But before 1936 the Treasury claimed that we were an association taxable as a corporation, and we had considerable problems as to where we stood, whether we were or were not a corporation. So our counsel said, "You had better incorporate and settle this matter once and for all, because the Treasury will get you either way." The CHAIRMAN. This was the original group of friends; is that right? Mr. GRAHAM. That is correct. The CHAIrMaN. That is all that were in it in 1936? Mr. GRAHAM. There were accretions on a private basis. I had more SARAN friends in 1936 than I had in 1923. The CHAIrMAN. When did Jou make them, during the depression? Mr. GRAFAM. Not so many as afterward. The CHAIRMAN. Go ahead. You incorporated in 1936 and in 1941 you registered. When did you sell any stock to the public, or did you ever sell any? You have 5,000 shares, you say? Mr. GRAHAM. Yes. May I say that we originally had more shares, that is, we sold stock up to 50,000 shares with a nominal par value and stated value of $100 a share. The CHAIrMAN. When did you do that? Mr. GRaHAM. Well, we did that in series by offering rights primarily to our older stockholders, and that built our capital up to $5 million, consisting of 50,000 shares worth about $100 a share. But we discovered—this may interest you, Senator-that we were beginning to get a great many one-share stockholders, people we had never heard of who came in and invested a hundred-odd dollars and then got our reports and found out what we were doing and imitated it So ood so with hd find on what me are da never micap in which we issued 1 share for 10, increased the unit value in the market

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528 STOCK MARKET STUDY

to about $1,200 or $1,300 a share, and from that time on we did not. get quite so many 1-share stockholders. The CHaIrmaN. What do you charge for managing the investment company? You are the manager of the company; is that right! Mr. GrAHaM. I am 1 of 3 managers. The other two managers are Mr. Jerome A. Newman, who has been a partner of mine since 1921,

The CHAIrMAN, Is it public knowledge what you charge? salaries on the order of 805,000 515,00, and we have a

, and me also have a profit-sharing plan under which after a $40-a-share dividend is earned and paid in any year the management as a whole receives 20 percent of the additional amount earned and paid. The CHAIrMaN. Are your earnings largely capital gains! Mr. GRaHaM. Yes; very largely capital gain. As a matter of fact, you might say they are almost exclusively so. The CHAIRMAN. I hope it is clear that if you do not wish to say, if it is a matter that you do not wish to discuss, particularly your own compensation, I am not trying to fish. That is just illustrative of what I assume is a typically successful man, and if you do not care to answer, I hope you will feel free to say so. to the the go, are a set to hate a lie one ne. In the first place, I have no hesitation whatever in telling you things that the investors in my fund know, obviously; but, secondly, I think it is a misconception to consider that we are typical managers of a

• The CHAIrMaN. I want to clear up the misconception. That is exactly why you are here. Why is it not typical? I would like you to describe what is a typical situation. Mr. GRAHAM. The ditterence is first, that our compensation arrangement is much more liberal than that received by other investment funds. This 20 percent which we receive on excess earnings is a very large percentage. The CHAIRMAN. But that depends on what you pay. You said $40 a share, which struck me as a rather liberal dividend. Mr. GRAHAM. That is just the base dividend. We paid $340 a share last year. The CHAIRMAN, That is still better than General Motors paid. Mr. GRAHAM. Yes. I just want to make two things clear, sir. is that our compensation arrangement is much more liberal in its terms than the standard arrangement. Secondly, we believe, and I think our stockholders believe, that we earn our compensation because our results to them after deducting compensation have been good The CHaIrMaN. I assumed that or vou mould not be there. I mas trying to get a picture of this business. You are helping us a great deal, 1 may say. Can you put it in a little difterent terms so that we can compare your situation with the managers of some of the well-known firms? I would appreciate it if you would put that in the record so that we will have it. Mr. GRAHAM. Oh, yes. The difference is tremendous between our own situation and that of a typical investment fund. Let us take the largest one, Massachusetts Investors Trust. The CHAIRMAN. Yes.

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STOCK MARKET STUDY 529.

Mr. GRAHAM. Their capital may be a hundred times ours. Their

Their expense penses are much less than a hundred times ours. urden is very little, percentagewise, as compared with ours. The

ustees receive compensation on the order of maybe one-fourth of

percent on capital.

hę CHAIrMaN. Wait a minute. Of earnings or capital?

• GRAHAM. This would be capital.

@ CHAIRMAN. Per year! One-quarter of 1 percent?

A GRAHAM. NO, 1 think 1 have overstated it. It might have been

tow it well enough, but I do know in general that their rate of com-

sation is very conservative in relation to the funds that they

The CHAIrMAN. What percentage of the capital invested in your fund is represented by the compensation to management? Can you "! e Press It in terms that would be comparable? Would it be 1 percent? UNT GRAHAM. Well, let us put it this way: Over a-period of years we have tended to earn about 20 percent on capital per year before compensation and about 3 percent of that has been paid to management as compensation, leaving 17 percent to the stockholders. he CHaIrMaN. Three percent of the earnings! """ TOMI GRAHAM. No; 3 percent on capital out of the 20 percent earned "„"" on capital. The CHAIRMAN. I do not follow you there. You earn 20 percent on Fae invested capital per year; is that right? :

GRAHAM. That is roughly true on an average. The CrAmM. That at pought fred hat 20 ded you get as manage- The CHAIRMAN. What percentage of that 20 did you get as management? Mr. GRAHAM. We got about 15 percent, the reason being that there 1s at percent deduction first. He CHAIRMAN. Fifteen percent of the 20 percent earned? ME GRAHAM. That is right. The CHAIrMAN. I see. Mi GRAHAM. Not 15 percent out of 20, leaving 5; but 15 percent of 20- The CHaIrMan. Leaving 85 percent for the stockholders of the 20? Mr. GRaHAM. That is right. The CHAIRMAN. I understand that. Maybe this is a silly question and jou never do it, but is it ever translated into a percentage of the capital invested per year? Mr. GRAHAM. Well, these figures 1 am giving you start with the percentage of capital invested. The CHAIrMAN. No, that is earnings. Mr. GRaHaM. Well, we earn 20 percent on capital. May I sum-marizo des are en t pates on pical suit capital, are gotten an amount equivalent to 3 percent on their capital. The CHAIrMAN. I see, whereas the normal or average investment company, 1 take it, Is less than 1 percent; is that right! Mr. GRAHAM. Yes, that is certainly true. The CHAIrmaN. You get three times as much as the average, or better?

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530 STOCK MARKET STUDY

Mr. GRAHAI. That is true. The CHAIRMAN. Well, I take it you are worth it. You manage it more effectively than they do. Is that not correct? Mr. GRAHAM. Well, naturally me have to believe that, and our stockholders believe that. 2 The Certake it fun do proach this for basis in guite

The go into themand the nd dis by the un of homing, do they Mr. GRAHAM. Well, that is correct in a general way, but not completely. Some of the bigger funds, particularly like the Lehman Corp, which it large fund in anys had a recher keen interest in special situations, and a certain amount of their capital-by no means the major amount—has gone into special situations. The CHAIRMAN. When you say "large," how large is Lehman? Mr. GRAHAM. Lehman would be over $100 million. The CHAIrmAN. Of invested capital? Mr. GRAHAM. At present market values. The CHAIRMAN. As compared to yours! Mr. GRAHAM. Ours is on the order of 6½ million. The CHAIRMaN. On market value. That is not the original investment. That is the capital as now valued on the market; is that correct? Mr. GraHAM. That is right. We have paid back to our stockholders virtually all the earnings that have been made, so that in a sense our present value is very similar to the amount of money paid in. The CHAIRMAN. You do not seek to increase the invested capital, I take it. Any particular reason for that? Mr. GRAHAM. The basic reason, Senator, has been that tre have not believed that we could get the same satisfactory results on very Jarge capital as we can get on a moderate amount of capital. The CHAIrMAN. Why is that? Mr. GraHanI. Because if you deal with special situations and under-valued securities, the markets in those for the most part are not very large. It is not possible to acquire an unlimited amount without affecting the market price. and if me had 10 times as much capital it would be very difficult for us to invest it the same way as our present capital. The CHAIRMAN. I know some who have undervalued stocks down in Arkansas in my hometown who might talk to you about it. Mr. GRAHAM. We are always open to suggestions, Senator. The CHAIrMaN. There is no market for them. I believe you said in your statement that as far as rhether the market is too high or too low right now, you could not say it is too high or too low. I take it that you think It is a period that requires caution, and you do not believe in jumping in and purchasing stocks? Mr. GraHAn. Well, let us put it this way, Senator: Quantitatively the market seems to be about right, but qualitatively I consider it to be on the high side and getting into a dangerous situation. The (HAIRMAN. Well. that is, 1 think, a very understandable state-

That ought to be plain to anyone. It is about on dead center! means it is not likely to go up or down? Mr. GRAHAM. On the contrary. Senator, it may be about right, but that is likely to be accidental. A Jear from non—pardon me, sir.

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STOCK MARKET STUDY 531

The CHAIRMAN. I take it you meant the relationship between prices and earnings and income is at a figure that is not clearly undervalued or overvalued; is that right? Mr. GraHaM. I would say that is true for the most representative stocks as a whole. The CHAIRMAN, There will always be exceptions both ways? Mr. GRAHAM. Yes, indeed. The CHAIrMAN. I am not trying to tell you, you understand. I am rephrasing it only for the purpose of trying to understand what you said: I haven't any idea about whether it is high or low. 1 am trying to put in language so I could understand what I thought you said. ja you notice the testimony ot Mr. Galbraith the other day regarding the tendency of the market and speculators losing their rela-tonship to reality, that the market generates enthusiasm all its own for capital gains? Did you notice that testimony! Mi. GRAHAM. Yes, indeed, sir. Une CHAIrMAN. Would you agree with it? Mr. GRAHAM. Yes; I would agree with it in general terms. The CHaIrMaN. That is interesting, because he is purely an academic figure and you are a practical one, and yet this is one point upon which you agree. Mr. GRAHAM. I should say, Senator, that I am something of an academic man myself. The CHAIrMAN. I did not know that. Mr GRAHAM. I have the title of adjunct professor of finance at Columbia University, and I give a course in the evaluation of common

The CHAIrMAN. I saw you on television in an Ed Murrow show, but I did not understand that you were a professor. I thought they bad brought you in as a practical operator to tell them how it was done. I misunderstood. Mr. GRAHaM. They made me a professor because I am a practical operator. The CHAIRMAN. That is very unusual, is it not? Mr. GRAHAM. Yes. The Columbia School of Business has about 4 or 5 such practicing professors. The CHAIRMAN. I see. I think that it is interesting that you agree that it is a dangerous element when the market becomes too overenthusiastic and loses, as Professor Galbraith says, contact with rear-ity. You think there is a tendency to that at the present time! Mr. GRAHAM. Yes, there are some tendencies, undoubtedly. The CHAIRMAN. Then you would say, as he put it, I believe, that :. there is too much speculative activity in the marketi Mr. GRAHAM. Well, "too much" is a difficult phrase to define. I think it the market continued pretty much as it has been doing now in regard to the total amount of speculative activity, I would not be too concerned about the outcome. I am afraid of the cumulative effect of more and more speculative activity. ! The CHAIrMaN. I am not sure that is different from the way he

id. put it. I think he was careful to say he did not think the level of prices was too high, but that during the past year there had been too rapid a rise. That there had not been any developments in the business world, productivity or all the other things that would justify that rapid rise." It was the rapidity of the rise and the tendency to

[p.17]

532 STOCK MARKET STUDY

generate a sentiment, as he put it, of overenthusiasm that disturbed fenerate sentiment ed, as pot it, of an enthus in the it ed

• as you know, an increase in the margin requirements. Would you recommend an increase in margin requirements?

Mr. GRAHA. I would like to duck the responsibility to this extent: I said in my statement that I feel the Federal Reserve should have no hesitation about increasing margin requirements further if it be-came increasingly concerned over the estent of speculation. I do not think it is necessary for me to make the decision for my friend Bill Martin, but I think the Federal Reserre has as good jüdgment as anyone in that connection. The CHAIRMAN. That is a proper answer. I see nothing wrong with that. It is not your responsibilty. Some, though, have taken the position that it would be discriminatory and a bad thing to increase the margın requirements to 100 percent.

Do you think if the capital gains tar were eliminated and there was no tax upon capital gains that that would increase the attractiveness of speculation or decrease it? Mr. GraHaM. On the whole it would increase the attractiveness of speculation. The CHArAN. If it did, that would tend to increase the level of prices; would it not! Mr. GRAHAM. 1natis my best judgment. It is true that there would be some unfreezing of shares now held by long-time owners, but my own feeling is that rery likely the net result would be an increase in speculative enthusiasm. The CHAIRMAN. Is it fair to ask you now whether your own company —and you do not have to answer it you do not want to—is buying or selling stocks? You can he perfectly free to say you do not care to answer. Mr. GRAHAN. We have been selling on balance from our general portfolio of undervalued securities and endearoring to put our money into special situations which are not at the risk of the market. The CHARyAy. Has it happened that in the past year or tro you have made any particular study of any industri which is primarily dependent upon defense contracts for its business? Mr. GRAHAM. No: we have bad no occasion to study them in any detail. We just have a general knowledge of the picture The CHAIRNAN. Would you care to elaborate at all about your knowledge of the defense industry picture? Mr. GRAHAM. Well, it is comon knowledge, of course, that the aircraft-manufacturing companies are largely dependent on the defense program. The ('HAran. Would the fact that a company which is wholly dependent upon a defense contract had profits which increased in the last 6 months of 400 or s00 percent over the preceding year or similar period mean anything to you at all with regard to the Government's contracts with that company? NIr. GRATA. Senator, I did not state in my statement that I mas chairman of the research committee of the War C'ontracts Price 1d-justment Board during the war. That is the renegotiation board, and me had to consider principles of renegotiation, including the profits of aircraft-manufacturing concerns. The mere increase in

[p.18]

STOCK MARKET STUDY 533

protts as such is not an indication that the contracts are improvident, but there is a prima facie suggestion that they be examined into. she CHAIRMAN. Do you not think that 400 or 500 percent is a rather unusual increase in profits in the course of 12 months? +Mr: GRAHAM. I do not recall any particular instances in which that ratio existed, but if it should exist I am sure the renegotiation people will study that with care. The CHAIrMAN. Do Jou think the Renegotiation Act ought to be reenacted! It expired, you know, at the end of December. Mr. GraHaM. I am convinced that it should be, or something similar. The CHAIrMAN. The administration has not requested it, has it? MADGRAHAM, 1 am not part of the administration, Senator. the CHAIRMAN. I understand they did last weekend; yes. It was aiso in the state of the Union message. I had forgotten that. If nothing else happens in these hearings, maybe that is worthwhile. But you are in favor of the reenactment of that? Mr GRAHAM. Yes, indeed. The CHAIrMAN. Would you mind commenting upon the situation which i notice recurs in many instances—there was a notable one this morning in the case of Du Pont, one of our big companies, and the same thing is true with General Motors—where so many of them have shown during 1954 a substantial increase in profits on a decreased volume. In some instances, of course, as we saw in the tigures of Genera. Motors, it was the difference in excess-profits tax, but I believe in many cases that plays a relatively minor pait. What do you think is going on in our big industries that accounts for that! Mr GRAHaM. Well, of course, the hrst point is what you have men-tioned-that the good showing for 1954 earnings in the large com-panies (approximately equal to the 1953 earnings in the aggregate) 1s due to, a considerable degree to the repeal of the excess-profits tax. To some extent it is also due to the fact that corporations, both large and small, have been getting somewhat better control over their costs in recent years. Ihat I would say is more true actually in the case of the small companies than it is in the big ones, because the small com-panies suffered most from the costs getting out of hand. The CHAIRMAN. Would such a circumstance indicate a lack of competition? Mr. GRAHAMI. I do not think so, because for one thing the margin ot profit in and of itself is no larger now than it was in previous years. In the case of General Motors, year, I think, after taxes wors about 82 peent Pima regin tat year, 1 think, after taxes was about 8.2 percent. I imagine that in 1936 it was probably around 14 to 15 percent aiter smailer taxes, but before taxes I would say the profit margin is approximately the same, maybe somewhat less now than it was in 1936. The CHAIRMAN. You do not see anything to criticize about General Motors carrying all of the reductions in taxes in profit rather than decreasing the prices? Mr. GRAHAM. My own views on that may seem peculiar to you, Senator, but I think that General Motors does not care to reduce its prices substantially because the effect on the competitive situation would be disastrous, and they would The CHAIRMAN. Why?

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534 STOCK MARKET STUDY

Mr. GRAHAM. Well, the point Is this: General Motors has to make a very good profit in order that other automobile companies can exist at all. If it made a small profit, some of the other automobile companies mould go out of business completely The CHAIrMaN. Why do you want to subsidize these other automobile companies at the expense of the poor farmer, who is struggling along on a starvation diet now? Mr. GRAHAM. Senator, 1 did not suggest that.

The CHAIrMAN. I'he prices for these Chevrolets are enormous. It they could cut them $800, it would help a lot. Mr. GRAHAM. I would like to make my point of view clear again. I am not expressing my own opinion as to what should or should not be done. I am only telling you what I think is General Motors' policy, and that General Motors itselt cannot dare in the present state of the economy and the political sentiment to reduce its prices to a point where other companies were forced out of business and General Motors had almost a monopoly of the business. Ine CHAIRMAN. Well, in another way you are saying there is no competition in the automobile business; are you not! Mr. GRAHAM. No, sir, that is not true either, because in the first place the competition between General Motors and Ford is very keen, and the competition between General Motors and Chrysler used to be very keen and is now again becoming keen. The CHAIrMAN. To show you how innocent I am, I do not understand it at al. I always thought price happened to be the principa. element in competition, that you could not have competition if you dic not care what the price was, and that all the rest was shadowboxing and just make-beliere. If you were really competitive and your desired to have the market, I had thought one of the first things to do was sell cheaper. That used to be the orthodox doctrine. that the competition is just in advertising, to keep the price up, makes no sense to an old-fashioned man. no tens to an old ashie spit up the sounds exad all like our artel, and then tre advertise and make people believe me are compețing"- and there is no real competition. If General Motors really is com-peting and is desirous of obtaining the market, she would get it, would she not, by cutting the prices?

senator, my view of this thing mat be wrong. but it differs quite a bit from yours. I think the competition that existed between General Motors and Chrysler, for example, was rery intense, and its effect on Chrysler was almost disastrous. Chrysler® lost virtually all its earning power last rear, and although its business remainer high in terms of dollars, it lost out on sales of cars to a point where the earnings almost disappeared and tremendous effort was necessary by Chrysier to improre its cars and to improve its sellins neese Now, rye to fim as case into tess a salual practice. example of the actual working of competition. The C'HArRay. I am afraid I gare a false impression. I am not not at least trying to express an opinion for ni against it. I am trying to derelop whether or not there is competition in the automobile

I am unable to see that there is, in view of your statement that all General Motors needs to do to put them all out of business is lower the prices to where it could still get along and it would not go broke but it could break its competitors. In orthodox competitire

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STOCK MARKET STUDY 535

ness that is what happens, is it not? In the old days that is what

pened, was it not?

It GRaHAM. Well

he CHAIRMAN. I do not say I disagree with you that that would

bad thing socially, and politically, That is a

tent thing trom saying that it is really competitive. Do you

y feel that it is competition or do you feel that it would be inad-

He to permit competitive forces to have their tull sway!

Reve meis a great deal of sumpetition in tre automobie in dust

deve there is a great deal of competition in the automobile indus-

oday, but it is not competition carried to its final conclusion,

i would mean the destruction of the weaker companies.

le CHAIRMAN. It is sort of superficial competition? i GRAHAM. It is a limited-objective competition. he CHAIRMAN. Some of the bureaucrats, or somebody, developeo Alterm called "administered prices." Is that not what it is? They out ot get together and decide if you go below a certain amount you destroy Chrysler, and it is not wise to destroy Chrysler! Mr. GRAHAM. As long as you are speaking of economic principle, bumust remember there is such a thing as the optimum or maximia-non of profits, and it is quite possible that General Motors by cutting its prices could do more business but at the same time earn less money. There is no reason in the world why General Motors as an ordinary business should not charge such prices as will give it maximum profits. The CHAIrMAN. If it ran them all out with a monopoly, they could arge what they like? Mr: GRAHAM. No, sir. The United States would interfere. The CHAIRMAN. That is what I am talking about. You are getting into a different field and leaving old-tashioned competition when you talk about interterence by the Government and what the social and political effects may be. I am not sayıng'it is a good or bad thing T have heard it said before and I was interested that you confirmed that General Motors could make a reasonable profit—I think that is the language and still destroy all its competition because of the way it is set up and its eficiency, it you like that term, or at least its distribution and volume. I would gather you would agree with that! Mr. GRAHaM. I do not know the situation intimately, but I feel that

The CHAIrMan. I think it is important simply because as your economy changes these ditterent aspects arise which do involve thing beyond the immediate profits of a company. I think it would be a great catastrophe if all the other companies were put out of busi ness. I would agree with you on that, but at the same time i do not ¡ke to tid myselt that they are out there lighting for the business because they are not. General Motors could get it It it thought 11 wise to do it and still not really injure itselt Of course, its own personal advantage or disadvantage regardless of the Nation would be another matter or disadvantage regardless of the Nation ould ce another matter. Mr. Graham, if you do not mind, our staff director would like to ask you a few questions. Mr. WALLACE. Mr. Graham, in buying a company do you confer with management and obtain information about the company which is not generally available?

[p.21]

536 STOCK MARKET STUDY

Mr. GRAHAN. Well, where the purchase was made by agreement with large stockholders who are part of the management, we would ordinarily get, say, a copy of the audit report and material of that kind which is not published, largely, I think, because it is just a matter of inconvenience to publisli it.

But I should add, in order to avoid a misconception, that 1 can think of no instance in which we have gotten any information of importance which had any effect on our judgment, which information was not given to the stockholders in connection with the offer to buy.

Mr. WALLACE. To the degree that reports are published quarterly, you might get a report on earnings in between these reports, for example, which was not published!

Mr. GRaHAM. Well, that is conceivable, a monthly report, but It would be very unusual if it had any effect. I might give you an example of that. When me made our offer to purchase the Atlantic. Gult and West Indies stock-and, incidentally, I might say the offer was made through the Manufacturers Trust Co.—we published, and, I think, at the suggestion of the Securities and Exchange Commission, with whom we had discussed the matter before, a semiannual balance sheet which had been supplied to us by management and had not been made public. It did not give any particular information of value, but it was published as a matter of general policy.

Mr. WALLACE. In general, When you buy a block of stock, do the people from whom you buy the stock have the same information that you have? Mr. GRaHAM. As far as any important pieces of information are concerned, I would say "Yes." Mr. WALLACe. But if you were to buy stock on the open market on the basis of information that you had gotten in conferring with management, would this be considered trading on the basis of inside intormation! Mr. GRAHAM. NO, Sil'; because, as 1 understand the interpretation ct the rules, trading on inside information applies only to those who have a fiduciary relationship toward the stockholders, namely, officers, directors, and major stockholders. Mr. WALLACe. Is it not illegal for an officer of a corporation to divulge to you any inside information which is not available to the it acarporaton to public? Mr. GRAHAM. I mould like to clear that point up a little, because I am on both sides of that fence. I am an officer and director of a number of corporațions, and I think it is worthwhile for the Senators to get a realistic view of the way corporate affairs actually operate. A good deal of information from day to day and month to month naturally comes to the attention of directors and officers. It is not at all feasible to publish every day a report on the progress of the company in the newspapers or send out letters to the stockholders. On the other hand, as a practical matter, there is no oath of secrecy imposed upon the officers or directors so that they cannot say anything about information that may come to their attention from week to

The basic point inrolved is that where there is a matter of major importance it is generally felt that prompt disclosure should be made to all the stockholders so that nobody would get a substantial adrantage in knowing that. But there are all degrees of importance, and it is very difficult to determine exactly what kind of infor-

[p.22]

STOCK MARKET STUDY 537

mation should or must be published and what kind should just go the usual grapevine route. Mr. WALLACE. Of course, the SEC act itselt makes it illegal for an ófficer of a corporation to trade on the basis of inside information him-

At least, if he does trade on the basis of inside information the corporation or stockholders may sue to get his profits back?

Mr. GRAHAM. Yes. That is defined in the law in relation to 6- months' trades, and I imagine that there is a general idea of the law that it applies to any other kind of trade.

Mr. WALLAce. Am i to understand that an officer of a corporation can reveal inside information which would enable a person to trade in stocks on the basis of such information which is not available to the public?

Mr. GRAHAM. I believe you are right about that, Mr. Wallace, and it is an interesting area for consideration. It has given me a great deal of thought.

Mr. WaLLace. I was going to ask you what your opinion was oi the adequacy of the present law. As 1 understand it, in talking witt Mr. Wood when he was here, of the National Association of Securities Dealers, he said that it was not illegal for a director of a corporation whose stock is not listed to do all the trading he wants on the basis of inside information. The question I am raising with you in the case of listed stock is trading on the basis of inside information, not by the director himselt but by the director divulging information to someone else. For example, if there is consideration of a merger that Is not generally known about, but the officer knows about it and he can tell whether the merger may come of, or on earnings reports he may be in a position to know the dividend will be higher than it was originally th have ior de to dividend ore to split, ted come is ding on to months' basis himself, but I would like to ask your opinion if you think the law should be tightened up with respect to his divulging intor-mation so that others may trade on the basis of inside information which is not available to the public generally. Mr. GrAHAM. Well, if a feasible method of tightening the law could be devised which would get that objective without countervailing disadvantages of many sorts, I would be for it. But my experience in these things mates me hesitate to endorse the idea because of gradations of knowledge between the mere beginning of a possibility of something and its finalization. That would be particularly true with respect to a merger. When a merger is only a gleam in a person's eye, it is undesirable, of course, to make any public statement of it. the other hand, it is very ditticult for people to be so discreet that not a word can leak out from anybody when somebody has sat down with Somebody else, and from that earliest idea to the later point the gradations are so numerous that it seems very difficult to me to control the passing out of intormation by officers to other people. Mr. WALLaCe. There are how many stockholders of publicly held corporations-between 6½ and 7½ million? MI. GRAHAM. That seemed to be the figure published by the stock exchange in its study. Mr. WALLace. Is it your opinion that these 6½ or 7½ million stockholders realize and understand that it is possible to trade on the basis of inside information which they do not have?

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538 STOCK MARKET STUDY

Mr. GRAHAM. Some do and some do not. I think that the arerage experienced person mould assume that some people are bound to know more about the company than he would, and possibly trade on the additional knowledge. Mr. WALLACE. NoW, Nr. Graham, just for the record. You are an expert in this heid. Could you explain some terms to us? Could you tell us what is meant by the term "profit-taking"? Mr. GRAHAM. Well, profit-taking is very simple. It means that people who have a paper profit in their shares realize on their paper profit by selling, and the general interence is that there is some pressure on prices as a result of that which puts the market down when that happens. There is some profit-taking going on all the time. Mr. WALLACE. Profit-taking would have in general an etiect of depressing the market slightly for a temporary period Mr. GraHaM. Well, proft-taking as it is used in markets means there is enough profit-taking to depress prices, because there is profit-theing en the me in the marke depressie it is gain there is profit-taking all the time in the market even while it is going up. Mr. WArrace. Is that similar to a sell-off? Mr. GRATAN. Well, a sell-off is simply a decline, presumably temporary, in the market, for any number of reasons. Profit-taking may be the reason advanced, or a tar scare, or something that happens in this committee room or anything else. Mr. WaLLace. Or a technical adjustment is another term? Mr. GRANTATI The teclinical adjustment is very likely related to pront-taking. The Curatorax. You do not think anything we have been doing here has accounted for any fuctuations in the stock market, do you? Mr. GRAHAM. Yes, sir. The CrAIRYLIN. You do? Mr. GRAHAM. I do, yes. I think that the market, being at a rather sensitive level, is subject to a rast number of influences which might put the market down or up, and among those influences are these hearings. Mr. WALLacE. Mr. Graham, one of the reasons I was discussing Inst guit not fat the make eva ple pesty high ere da Friday last, did it not! The total market was pretty strong last Friday! Mr. GRAFIR. les. Mr. WaLLace. Over the weekend the President announced he ras going to extend the Renegotiation Act, did he not? Mr. GRAITASI. Tes. Mr. WALLace. The foreign picture was in the news considerably, was it not? NIr. GRAHAI. Well, I sam rather minor reference to it in the news. Mr. WaLrace. Then rou hare this tendency for profit-taking, sell-offs, technieal adjustments, following on a relatively high market, do you not? Mr. GRATAN. Yes. Mr. WALLacE. So that mould you not sat that all these factors entered into what happened to the market on Monday and Tuesday-all these factors had some bearing and rou cannot really decide which one had the most bearing. But there are many, many factors influenc-ing the market, including the feeling of the stockholder and whether his ulcers are acting up?

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STOCK MARKET STUDY 539

GRAHAM. I agree with that, and I tried to convey that im-

on in my previous answer.

WALLACE. This study then, has some effect on the market only

of a great, great many Iactors!

GRAHAMi might leave out one of the "greats" but it is one

umber of factors.

WALLACE. Thank you.

è CHAIrMan. I am impressed that they are taking notice that we

enterested in and concerned with what goes on in the market. I do

see any reason why the study should necessarily put the market

when I say eyebody we received quite a hate number ot

cams the other day—I guess 15 or 20complaining bitterly that

ere putting the market down, rocking the boat, and all that. You

d'not agree to that, would you!

Ir. GRAnAM. No. I think I can say something that would be reas-

Ning to you, Senator, and put it this way: If the study actually does

the market down, then the market was due to go down and should

own.

THe CHAIrMAN. That is'a very fair observation, it seems to me. It mighty weak market that this hearing could put down, is it not?

WE GRAHAMI would agree on that.

the CHAIRMAN. Now one or two things that have occurred to me. Did you notice Mr. Eceles' proposal yesterday on capital-gains tax! Was it brought to your attention? ME. GRAHAM. Iread it in thismorning's paper. The CHAIRMAN. Does it appeal to you at all! VE GRAHAM. Yes: I had a proposal of my own. •I guess all' of us have proposals on this thing. I think Mr. Baruch will make one when Mean, a sound ol, to pretentite more than the law now literan Lthink, a sound one, to differentiate more than the law now differen-tates between various holding periods. The CHAIrMaN. Your proposa,, 1 thought, was simply a temporary device and then, I assumed, a return to what we have? Mr. GRaHam. Yes; that would be true. The CHAIRMAN. Which is certainly worthy of consideration. The effect is that if you hold it really a long time, beyond, say, 5 years he was not dogmatic about the precise ending of it—that there would be no capital gains. Does that appeal to you? Mr. GRaHaM. On the whole it does, Senator. You may recall that a number of years ago we had a capital-gains tax of that type, and that the amount of the tax went down to about 10 percent, I think, on holdings between 5 and 10 years, and zero I think after 10 years. So these gradations are largely a matter of judgment, but I think the principl Is Sound. The theoretical objection to the capitai-gains taxes is thai it is taxing something which does not appear anywhere in the national income or the gross national product, and so on. This theoretical objection could be met in part by this gradation. The CHAIRMAN. This is a rather technical question, but perhaps you an nelp us., While i realize it is ditticult to generalize, would yo ive us vour best estimate as to how much the market value of a dolla of retained earnings in comparison to a dollar of dividends paid-now much market value in dollars?

60650-55— -35

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540 STOCK MARKET STUDY

Mr. GraHan. That takes a few sentences to answer. In the first. place, I have made studies on that subject and have written on ther subject, and in the past it was possible to show that a dollar of paid-out earnings had four times the value of a dollar of retained earnings in; their effect on the market for the average stock, the exception being stocks that were bought mainly for their long-term prospects and were treated in the market in a separate category. I have a feeling, liow-ever, that te are now going through a transition period on the question of the weighting of dividends as against retained earnings. I think the transition is going on fairly rapidly. I cannot tell you just where we stand at this minute, but I will predict that in a tew years trom now the weight of retained earnings will be better, considerably better, than it had been as against distributed earnings. The CHAIRMaN. Is that not very largely influenced by the tax structure—the difference between capital gains and normal and surtax rates? Mr. GRAHAM. Well, no, sil'; It has not been influenced in the past. Un the contrary, the behavior of investors and speculators has been very illogical. In theory they should have preterred retainea earnings by successful companies, because those earnings were subject to only one tax to begin with and ultimately only to a capital-gains tas in addition, whereas the distributed earnings were subject to two large taxes immediately. However, the ingrained desire of investors for dividends was so great that it has not yet adjusted itself to the facts of life in the tax structure. It is only beginning now to do so. The CLAIRMAN, I see. What you mean is they will slowly catch

Mr. GRAHAM. They have been extremely slow, and I think extremely unintelligent. The CHAIrMAN. That is a very understandable statement. Incidentally, do you think that stock options are largely motivated by the desire to compensate directors by capital gains rather than salaries? Mr. GRAHAM. Well, sir, it is the desire to compensate officers by capital gains. There is no doubt about that at all. That is the admitted purpose of stock options. The CHAIRMAN. No, it is not admitted by some of the people that we have had on the stand.. 'They say, "Oh, it is just to inspire loyalty. It has nothing to do with the retaining of earnings." You do not subscribe to that? Mr. GRAFIAN. I do not, sir. The CHAIRAN. I agree with your views quite often. Mr. GRATIAN. Senator, I have no intention of shaping my views with the expectation of your agreement. The CHAIRMAN. I did not accuse you of that. I mas only impressed with your wisdom. MIr. GRAHAM. Thank you, Senator. The CITATROLiN. I used to be a professor. Maybe that is my weakness. You noticed this morning that Sears, Roebuck has found a tray to compensate the ordinary employees by capital gains, which I never realized before. Is that not the effect of that pension plan? Mr. GRinA. It is provided you have got a Sears, Roebuck type of company. It you had the ordinary company—let me add this,

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STOCK MARKET STUDY 541

• If you took the ordinary company

dom on the New York Stock Exchange and tried to put in a

Koebuck type of plan, not only would it be true that in the

un the returns would be comparatively small as against Sears, :

nick, but I think it would be impossible to maintain such a plan

so of the variations in results and in stock prices from year to

the people just woula not have the guts to keep up a plan of

ind in the ordinary company.

CHAIRMAN. Well, a company like General Motors could do it,

Lit not?

GRAHAM. I think so

CHAIRMAN. Do you know whether other funds have this system

ing into a pension fund as much as 10 percent of their income

taxes as a compensation really to their employees, without pay-

e normal tax rate?

GRAnAM. Well, the only difference is the 10-percent figure that

re mentioning. len percent is a fairly high figure, but it is by

vans unexampled. I wish I could think of the other companies

ere have been instances _ know of of more than 10 percent oi

nings going to a combination of executive and run-of-the-min‹ employee compensation. The CHAIRMAN. I do not believe the compensation to the executives was included in this morning's testimony. ME GRAHAM. The executives are part of this, but they are limited to this $500-a-year figure or whatever the maximum is. i The CHAIRMAN. I meant in addition to that they have bonuses and stock options, which is in addition to the participation in the pension fund. Mr. GRAHAM. That is correct, sir. •The CHAIrMAN. Which may result in an overall figure beyond 10 percent. Mr. GRAHAM. Yes. Whe CHAIrMaN. What do you think of that? Mr. GraHAM. There are two parts to it. In the first place, I think it is a remarkably good device for establishing the proper relationship between the business and its employees and a tair treatment of profits. Asil said at the beginning, we have a similar approach in our Government employees insurance company, and it has worked out very well for us and our employees. The tax status, of course, is another matter. It is a very favorable tax status in these plans that the Congress adopted, and I am sure knowing full well what the consequences would be with the intention of encouraging this kind of development in corporate business and in the position of corporate employees. I think personally even at the cost of some loss of revenue to the Treasury it would be very desirable to encourage this development of medium-size capitalist or, in any event, happy and prosperous employees at the end of their working career. The CHAIRMAN. I agree with you as far as you go. It is a fine thing if you look only at that. What do you say about these people to pay the strain of adjustina their incomto capitem fain on haye o pay the straight tax! What is your answer to them! Do you say. Do you say, "Well, it is too bad," or how do you justify one set of employees receiving compensation and paying only capital-gains rates and

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542 STOCK MARKET STUDY

another set doing almost the same thing paying the other rate! I you were in my place and they blamed you for all governmenta. policies, what would you say to them!

Mr. GRAHAM. I would say that what we are talking about is a marginal part of the total compensation of employees. The Sears Koebuck case, of course, is not so marginal, because you have had this extraordinary success of the corporation itself. But if you take a typical corporation, which sets aside 10 percent of its earnings for this purpose, the amount of additional gains and income to the employees would represent not an inconsiderable part of their earn. ings, but at least a minor part of their earnings, and the tax advantage I should think should be accepted philosophically because of the desirable consequences that fiow from it. they re dred er Sud agend erated tre percent 50-posing. they reduced everybody's wages and transferred that to a 50-percent payment into the fund. If you accept the principle, why could you not pay them all on a capital-gains basis? Mr. GRaHaM. No; the principle cannot be accepted to an unlimited appication, and the present act, it 1 understand it correctly, imposes a limitation on that. The amounts which can be put to the benefit of employees in pension funds and profit-sharing funds I believe are limited to 15 percent of the compensation in each year. The CHAIrMaN. I wonder it you would give us your views in a broad sense about the economic future of the next tew years. Do you see any culmination of a business cycle, or do you subscribe to this view that I read the other day of one of your colleagues in the investment field in New York that a final blowout is necessary? Mr. GRaHaM. Is not necessary? The CHAIRMAN. I read into the record an opinion that it always must come, that we have to have this final orgy of buying. I wonder It you would give us an idea of your views ior the next tew years. How has your mind been working! Mr. GRAHAM. I will do it with the proviso that these views should not be taken too seriously. The CHAIrMAN. I do not believe you are infallible. Mr. GRAHAm. As a matter of fact, I have never specialized in economic forecasting or market forecasting either. My own business has been largely based on the principle that it you can make your results independent of any views as to the future you are that much better off. Nevertheless, as an economist of a sort I have studied this question, and I will be glad to give you my view on the matter. I think that in all probability we would have some economic recession of an appreciable amount, not necessarily a very serious amount, in the natural course of events, which means such things as the inventory situation, the consumer credit situation, the housing situation, capital goods situation, all of which tend on the whole to operate in cycles, and which on the whole could not be continued, in my opinion, ndetinitely at the rate at which we see them developing right now And of course I am now expressing merely the view of an experienceo conservative economist who expects history to repeat itself or the pattern of history to repeat itself. You have an unknown factor, which is Government intervention The Government, it seems to me, is committed now through both par-ties to intervene perhaps nationally to prevent any serious decline in

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STOCK MARKET STUDY 543

ho business activity which is accompanied by substantial unemploy-eat I might say that you could have substantial unemployment Than increase in the gross national product and with apparent rosperity, merely because of the development of productivity. And eare approaching an interesting period, in which, I believe, the in-nions ot the Government vis-a-vis employment will be tested out ast year we expected that it would be tested out, but it was not. We ere all very pleasantly surprisea. I think in the next years such: will take place, and t think you will see, in all probability, th st will take place Government taking action of an important kind to prevent large-scale inemployment. The CHAIRMAN. You think the Government should add an element of stability to the normally fluctuating economy Mr. GRanaM. The Government will try. The CHaIrMaN. It will depend upon the wisdom of the Government's policy! Mr. GRAHAM, Les; 1 guess it you Judge wisdom in terms of resuits. The CHAIrMAn. How do you judge wisdom? Mr. GRAHAM. I have an a priori test of wisdom in most cases, but *taink in economics it is very difficult to tell what is wise until you have been through it. The CHAIrMaN. I suppose I should not ask you to look back and see what happened in the twenties to see who was wise in administration of government; should I! Mr. GRAHAM. I think not. The CHAIrMAN. What is your commodity reserve plan! I understand you have one. Mr. GRAHAM. I can put it in a very few words. It is related to your question as to the future of our economic system. In the last 20 years I have been identified with a concept of stabilizing the economy by stabilizing the price level of raw materials taken as a whole and not in individual commodities. The objective has been to permit individual commodities to fluctuate but to establish a narrow range of fluctuation and virtual stability for the value of a market basket of the important commodities. I have added to it the very important factor, quite radical, that those commodities would represent a sound backing for our money, because they represent the things that we need and usa, and by so doing they would become commodity reserves and would be self-financing in the same way our gold reserves are self-fnancing. The consequence would be that by stabilizing pretty well the general level of raw materials great pond at act importan into sailing to it. press econome add. The CHAIRMAN. I do not think I quite understood what the limitation of the commodities involved would be? Mr. GRAHAM. These are major storable commodities for the most part, those dealt in on commodity exchanges, but not absolutely. The CHAIrMAN. What agricultural commodities, if any, would it include? Mr. GRAHAM. They would include such products as wheat, corn, cotton, sugar, and rubber. The CHAIrMAN. Rubber and cotton would be storable indefinitely? Mr. GRAHaM. They would be storable indefinitely through rotation.

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544 STOCK MARKET STUDY

The CHAIRMAN. I forgot to mention one thing. With regard to Government policy and interference, do you regard tax policy as of major importance in this element of interference in the economic system!

Mr. GRAHaM. It could be. That is to say that one of the means

t could hat by which the Government could intervene to an important degree in the economy would be through a tax-reduction plan. Another method would be through an increase of its expenditures.

The CHAIRMAN. Did you hear Mr. Eccles yesterday? I am not using him as a model, but simply to save the time of describing the situation, because it does take time. Do jou remember his proposal yesterday on taxes? Mr. GRAHAM. I have forgotten it. The CHAIrMAN. Well, it does not matter. One other question and

decide it is worth 30, how is that process brought about—by advertising, or what happens? Mr. GRAHAM. That is one of the mysteries of our business, and it is a mystery to me as well as to everybody else. We know trom experience that eventually the market catches up with value. It realizes it in one way or another. The CHaIrmAN. But do you do anything to help that! Do you advertise, or what do you do? Mr. GRAHAM. Un the contrary, we try, as a matter of tact, to keep our operations as confidential as we can. The CHaIrMAN. Even after you buy? Mr. GRAHAM. Even after we have acquired our shares. The CHAIrMAN. Why? Mr. GRAHAm. Basically for the reason that we just are not interested in other people knowing about our business, and we have no interest in endeavoring to persuade people to buy stocks in which we have an ownership. We have never done it and we never will do it. The CHAIrMAN. That is rather unusual. • Since you make your capital gains, a lot of people have got to decide it is worth 30 capital gain a to haple a very to decide in re prence by finding that people decide that that stock that you mention is worth 30 without the necessity of our doing anything about it on the advertising side. We might conceivably at times interrene in a managerial policy. we might suggest some change in the procedure, but that of course is merely because we are substantial stockholders. The CHAIRMAN. I think that is about all. There are many other things we could ask you about, l am sure. Forever, you have other things to do, and the hour is late. I would like to express the appreciation oi the committee for your having taken your time to come down here and volunteer this information. I am sure it is not very pleasant for you to have to talk about these things, but 1 know no other way we can learn about them. I do appreciate the contribution you have made to our knowledge of the market. Mr. GRAHAM. If I have made a contribution, I do not mind the discomfort.

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STOCK MARKET STUDY 545

The CHAIRmAN. If you have any further suggestions that occur to you which you think we ought to know about we will welcome your writin them to sul prepared tatey ent is as folovs, .•

Mr. Graham's full prepared statement is as follows: • i

STATEMENT OF BENJAMIN GRAHAM, CHAIRMAN OF GRAHAM-NEWMAN CORP.

My name is Benjamin Graham. Say m-news Be Comp, a registered investmeat company or tave chaint and. I am also adjunet professor of finance at the Graduate School of Business, Columbia University.

This statement will address itself mainly to three points;

(a): Ihe present level of stock prices from the standpoint of the relationship between price and value. (b) Causes of the rise in the market since September 1953. • (G) ¡easible methods of controlling excessive speculation in the future. With regard to the present level of stock prices, common stocks look high and are nigh, but they are not as high as they look. The market level of industrial stock is far above the 1929 high as shown by the Standard & Poor's inder of. 420 industrials. The present figure is above 300 as compared with the 1929 high of 195. . The Dow-Jones industrials average at about 410 is now only moderately. above its 1929 high of 382, but the difference would be much larger except for the substitutions made in the average. However, the railroad and utility issues as a whole are well below their 1929 highs. The true measure of common stock values, of course, is not found by reference to price movements alone, but by price in relation to earnings, dividends, future prospécts and, to a small extent, asset values. • Present concepts of common stock valuation turn largely on estimating average future earnings and dividends and applying thereto a suitable capitalization rate or multiplier. Since these elements are all matters of prediction or judg- 'ment, there is room for a wide difference of informed opinion as to the proper value for a single stock or group of stocks at any time. Uninformed or speculative opinion will, of course, cover an even wider range as the market swings. from the depth of pessimism to the heights of optimism. • As a guide to identifying the present level of stock prices in the light of past experience, I have made 2 sets of comparisons-1 relating to the Dow-Jones industrial average; the other to General Electric, a component of that average and an outstanding blue chip issue. I have related the present prices and the high prices in 1929, 1937, and 1946 to earnings of thé preceding year, the preceding 5 years and the preceding 10 years. This information, together with certain other data, appears on the appended table. •The Dow-Jones industrials are now at a lower ratio to their average earnings in the past than they were at their highs in 1929, 1937, and 1946. The same ap-plies to General Electric as an individual stock. It is clear that the issues referred to~ which may be considered as reasonably representative of the larger indistrials as a whole —have a considerable way to go before reaching the ratios shown at their former tops. It should be pointed out also that high-grade interest rates are now definitely lower than in previous bull markets exeept for 1946. Lower basic interest rates presumably justify a higher value for each dollar of dividends or earnings. • Much has been made of these relationships as indicating that the market is stil on safe ground. However, such comparisons fail to take into account the extent of the subsequent declines from past bull market highs. Since the Dow- Jones average lost 90 percent of its price from 1929 to 1932, it is evident not only that 381 was much too high in 1929, but that the market had entered dangerous ground at a point far below that figure. I have found it useful to estimate the central value of the Dow-Jones industrial average by the simple method of capitalizing 10-year average earnings at twice the interest rate for high-grade bonds. This technique presupposes that the average past earnings of a group of stocks presents a fair basis for estimating future earnings, but with a conservative bias on the low side. It also assumes that by doubling the capitalization rate presented by high-grade bonds, we allow property for the differential in imputed risk between good bonds and good stocks. Altbough this method is open to serious theoretical objections, it has in fact given a reasonably accurate reflection of the central value of industrial common stock averages since 1881. It may be interesting to note that the central value

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546 STOCK MARKET STUDY

found by this method in 1929 was 120, which happens to be about the geometrie

mean between the high of 381 and the subsequent 1932 low of 41. Similarly, the

central value in 1960 was 1os, higher than il 1i5o, and this provea to be about

the mean between the 1937 high of 194 and the low of 99 in 1938.

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Inis mechanical method applied to the situation in the beginning of 195ă yields a central value for the Dow-Jones industrials of 396, or only slightly under their present value. Such a figure, if reliable, would have to be regarded as rather reassuring. It would indicate that the market in terms of value is no higher now than it was in earls 1926, or in early 1936, or late 1945. However, the validity of this central value figure may be open to question if we observe that the 10 years ending in 1954, used to obtain average earnings, did not include any period of real depression. In a sense, theretore, the soundness of this appraisal of central value is bound up with our ability to escape serious business depression in the future as we have in the recent past. It is probably fair to say that the market is not too high today if we have really managed to lick the business cycle. Although such a development would involve a revolutionary break with the past, I am not prepared to deny its possibility. There is some reason for concluding that in the future serious depressions will he prevented, if not br the natural vitality of American business, then by gorerimental interrontion and possible inflationary moves. The above analysis is by no means unfavorable to the present level of stock prices. However, in reaching my overall conclusion on the subject, I am inclined to hark back to the analysis I made of the stock market in October 1945 at a time when the Dow-Jones average stood at 185. This was published in The Commercial and Financial Chronicle, Oetober 18, 1945. I should like to quote intact the summars appearing at the end of that article and state that it expresses my view with respect to the stock market

"The three different approaches used in judging the present level of stock prices have yielded diverse indications. From the tirst, or historical, approach the market appears distinctly on the high side and vulnerable to a substantial setback. Contrariwise, our second category-that of appraisal based on figures and formula-about supports the present level, and suggests that the familiar bull-market enthusiasm might well carry prices eonsiderably higher. Our third approach, through guesses and projections as to future developments, supplies plenty of material but no detinite verdict. "What is the net significance of this analysis for the speculator and the prudent stock investor? Let us define the speculator as one who seeks to profit from market movements, without primary regard to intrinsic values; the prudent stock-investor as one who (a) buys only at prices amply supported by underlying value, and (6) who determinedly reduces his stock holdings when the market enters the speculative phase of a sustained adrance. "This speculative stage, we are convinred, is now at hand. Hence, the principles of the prudent investor will require him to lighten significantly his holdings of common stocks—the precise selling policy to depend, of course, on his ... individual position and methods. For the stock speculator we can say little that is helpful. We think he has a 50-50 chance or perhaps a little better-- of seeing the market attain substantially higher than preseut heights, subject to the probability of interrening reactions. But his chance of erentually holding on to the profts he makes heyond the current level, me should term no better than in former bull markets-and that is none too good." As to reasous for the market rise since September 1973, in general I agree with the answers by President Funston, of the New York Stock Exchange, question 1 ot the committee's questionnaire. Howerer, I shonld like to emphasize more than he dia the role of investment aud speculative sentiment in determining the wide rariations in stock market prices. In my view, the fundamental reason for the rise was the swing from doubt to confidence from emphasis on the risks in common stocks to the emphasis on the opportunities in common stocks. There has been no change of importance in the earnings of the Dow-Jones industrial average since 194). Actually, howerer, earnings of most secondary companies fell a great deal in 1953-51 fron the lerels of the previous 5 Jears. But prior to 1954, the publie was expecting a substantial setback and was braced for a large falling off in earnings when busiuess turned down after the middle

It was the mildness of the shrinkage-especially in gross national product and disposable incomes-that reversed the tide of sentiment and gave eurrency to the view that we no longer have to fear deep depressions. This change in sentiment produced a change in the publie's valuation of stocks, . especially in what it considered suitable multipliers of current earnings.

S202

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STOCK MARKET STUDY 547 effect, , the multipher advanced from about 8 for the Dow-Jones induştrials in 1948-50 to 10 in 1953, and to a current 14, which is slightly less than the 1936. 40 *My studies have led to the conclusion that sentiment alone, not supported by

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any visiblę change in value, will produce a swing on the order of 100 to 250

or 100 to 300 in price. It is interesting to note that while American Telephone &

Telegraph has paid a unitorm dividend of $9 since 1922, and while its earnings

have fluctuated comparatively little, its price advanced from 115 in 1922 to

370 in 1o29, declined to 70 in 1932, and since then it has fluctuated between lows

of'about 110 and highs of about 200.

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Among the secondary companies, the present situation is more complicated. Prices were very low as against earnings prior to 1953, but many of these com-panies had poor earnings results in 1953-54. The price behavior of this large group lagged behind the blue chip advance until July 1954. Recently the rise in secondary issues has more than kept pace with that of the leaders. Bargains anis fist. paris an ire a mere sectar de stere appears less overvalued today than it was in early 1946. Regarding feasible ways of controlling undue speculation in the future, I believe he committee should consider carefully and cautiously whether any plan o control is feasible. Speculation has not gone too far as yet, but there may be a grave danger that it will do so. Assuming that measures could be found that are useru and teasible, it would be wise to agree to such measures in advance of the necessity for their use rather than to begin discussing them while the fire is raging. It should be recognized that any form of intervention by Washington in the stock market is risky and controversial. You cannot be sure that what you are doing is the right thing and won't cause more harm than good. In this respect your problem corresponds to the publie's own quandary in deciding wnerner to buy or sell or sit tight in the present market. Yet, despite the hazards ot any intervention, a certain responsibility is there. It is actually being assumed—for example, by the Federal Reserve in varying margin requirements to correspond somewhat with the state of speculation. On balance, I am inclined to favor strict controls for margin trading and a taury rapia advance to the 100-percent-margin limit—that is, no borrowing at auras the federal Reserve beeemes increasingly concerned about the extent of speculation. My reason is that it is basically unsound for nonprofessionals to borrow money to speculate in stocks-or in anything else. It is unsound for them and for the economy as a whole. Responsibility should also be placed upon our commercial banks to avoid, in general, the direct lending of money to the public for the purpose of speculating in stocks. Much has been made of the capital gains tax as a deterrent to the selling of stocks. It is urged that this tax be abolished or cut in two, in order to inerease the supply of stocks by unfreezing holdings showing large profits. There is some merit in this contention, and I shall have a suggestion to make along these very lines. But I regret that the issue has usually been presented by Wall Street-of which I am proud to consider myself a partin an incomplete and rather one-sided fashion. Taxes on capital gains have been imposed since the modern income tax began it 1913. Thus the problem of their impact on speculative markets is by no means a new one. The evidence hardly suggests that the capital gains tax has by itself produced unduly high prices or unduly wide fluctuations. Impressive arguments may be made against capital gains taxes as inequitable in theory and unsound in practice. But there are also impressive arguments against per-mitting capital gains to go untaxed while imposing high rates on other forms of profit. Although I believe the present capital gains tax system is open to improvement, I would not consider it basically inequitable in relation to our tax burden as a whole. Finally, while a lightening of the tax might well increase the supply of common stocks by persuading holders to take large profits, it might at the same time stimulate further speculative buying, attracted by the new tax advantage. The net result of such a move cannot be foretold. The objections to reducing the capital gains tax would be overcome, in my opinion, if such a policy were adopted for a limited period of time only and for the specific purpose of dealing with a dangerous stock market situation. example, the tax might well be reduced from the present 25 pereent maximum to a 12½ percent maximum on securities owned at least 2 years, such reduction to be effective for a specified period only say 6 months. I believe such an

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548 STOCK MARKET STUDY

arrangement would have the desired effect of increasing the supply of common

stocks at a time when such increase is deemed necessary. From the standpoint

ot the Treasury, the result might well be that a larger revenue would be realized

in spite of the reduced tax rate, because of the inducement to sell locked-ug

Shares. Whatever its effect on the level of stock prices, bona fide investors

could not be harmed by such a concession, even if it ran for a limited period.

to the call sing are to han i bet ena rotor are me range.

in the capital gains tax. Perhaps the best method would be to give the Presi-

dent the power to make changes in the effective rate, within specified limits,

upon advice from the Board of Governors of the Federal Reserve System. We

have precedents for such powers in our tariff laws.

In conclusion, may I say that while Congress should not ordinarily meddle

with the stock market, there are times when it deserves attention from Congress.

We are probably in such a time at present.

CERTAIN PRICE-EARNINGS RATIOS FOR THE DOW-JONES INDUSTRIAL AVERAGE AND

FOR GENERAL ELECTRIC COMMON STOCK

TABLE A.—Dow-Vones industrial average

Ratio to earnings for the preceding.

Yield on Subsequent

Date Price AAA bonds

low price

1 year 5 years 10 years (Moody's) of average.

1955 (March). Percent

414 15X 15X 18X 2.95

1946 bigh.. 212 20 21

1937 high. 22 2.46 (1940) 163

194 19%½ 43 21/½ 3.42

1929 high._ 381 25 281½ (1932)

34 4. 69

1927 high. 202 14%½ 16 16 4.58

TABLE B—General Electric common stock

Ratle to ayrage earings for the

Price Subsequent

low price

1 year 5 Years 10 years

1955 (February). 1167 23

1946 high._ 28 38

52 26½ 30 31

1937 bigh._ 65 42 33(1948)

1929 high.. 84 51

2 101| 45 60 85 274 (1938)

1927 high 236| 23 29

34 8 (1932)

• Multiplied by 3 to reflect 1954 split

• Divided by 4 to reflect 1930 split

The CHAIRMAN. The committee will recess until Monday, when

Mr. Martin of the Federal Reserve will be with us.

(Whereupon, at 1: 15 p. m., the hearing was recessed, to be recon-

vened at 10 a. m., Monday, March 14, 1955.)

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