I don’t think that the stock market will return 6.5% over bonds in the future. Stocks usually yield a little more, but that isn’t ordained. Every once in a while, stocks will get very cheap, but it isn’t ordained in scripture that this is so. Risk premiums are mostly nonsense. The world isn’t calculating risk premiums.
The best book prior to Graham was written by Edgar Lawrence Smith in 1924 called Common Stocks as Long Term Investments. It was a study that evaluated how bonds compared to stocks in various decades of the past. There weren’t a whole lot of publicly traded companies back then. He thought he knew what he was going to find. He thought that he’d find that bonds outperformed stocks during periods of deflation, and stocks outperformed during inflationary times. But what he found was that stocks outperformed the bonds in nearly all cases.
John M. Keynes then enumerated the reasons that this was so. He said that over time you have more capital working for you, and thus dividends would grow higher. This was novel information back then and investors then went crazy and started buying stocks for these higher returns. But then they started to get crazy, and no longer really applied the sound tactics that made the reasons given in the book true. Be careful that when you buy something for a sound reason, make sure that the reason stays sound.
If you buy GM, you need to write the price and the respective market valuation. Then write down why you are buying the business. If you can’t, then you have no business doing it.
Quote from Ben Graham: “You can get in more trouble with a sound premise than an unsound premise because you’ll just throw out the unsound premise”.
Source: Student Visit
Time: May 6, 2005