Essential Takeaways From Chapter 18 of The Intelligent Investor: A Comparison of Eight Pairs of Companies

In this chapter, Graham compares eight pairs of companies. Graham uses practical examples of companies and sets them side by side to show the strengths and weaknesses of each firm, and to provide instructional advice as he did in his teaching days. Instead of reviewing each of the eight pairs of companies, this article will highlight the major points of each pair and provide broad advice from Graham's work.

The first pair of companies compared are the Real Estate Investment Trust and Realty Equities Group of New York, which have similar names but are different in the market. The Trust is long-established and appropriately leveraged, while the conglomerate is highly leveraged by almost 10x the amount of the Trust. While Wall Street was in love with the fluffy valuations the market was set for the conglomerate, the Trust was the one delivering value.

Mr. Market eventually realized that the conglomerate was overvalued based on its earnings and assets, leading the conglomerate to trade at $2 a share compared to its 1960 price of 32.5, while the Trust held close to its 1960 price and paid a dividend over 1.20 the whole time.

The second pair reviewed are Air Products and Chemicals (Products) and Air Reduction Co. (Reduction), which are similar in industry and offerings but differ in age. Products sold at 25% more than the aggregate of Air Reduction’s stock, and while Reduction was the cheaper buy, it was not the quality compared to the overpriced Products. Air Products did better than Reduction during the 1970s market and declined only 16% compared to Reduction at 24%. Buying Reduction would have put you 12% over Products.

The third pair of companies compared are American Home Products Co. and American Hospital Supply Co., which are only similar in name. Both companies had a great financial position and 100% earnings stability, but Hospital’s rate of earnings on its capital was only at 9.7%, while Home’s growth rate was much better. Graham concludes that both companies were overpriced for any investor looking to keep “conservative standards” and were selling at multipliers of over 5x their book value with Home being at 12.5x! These multipliers mixed with Graham’s review foreshadow his conclusion that the price contains too much hope and that they are not good buys.

In the fourth comparison, Graham presents a comparison between H&R Block and Blue-Bell Inc., two companies operating in different industries. Despite H&R Block's remarkable success, Graham notes that the market only gave Blue Bell a price-to-earnings ratio of 11, compared to 17 for the S&P composite. While H&R Block had a multiplier of over 100x, Blue-Bell was selling for less than one-third the total value of H&R Block, despite earning 2.5 times as much for its stock, having 5.5 times as much in tangible investment, and offering a dividend yield that was ten times higher. Graham observes that both companies would appear attractive to an analyst, with H&R Block being viewed favorably from a momentum perspective and Blue-Bell from the perspective of someone buying into the business itself. However, Graham favors Blue-Bell, as it weathered the market's turbulence better and ended up in a superior position.

In the fifth comparison, Graham compares International Harvester, a well-known company, with International Flavors and Fragrances, which was relatively unfamiliar. Despite having over 17 times the stock capital and over 27 times the annual sales of Flavors, Harvester was selling at a discount compared to Flavors, which was lavishly valued due to its remarkable profitability and growth. Graham notes that Harvester's earnings were mediocre and thus not attractive, even though the company was selling at a discount. This serves as an important lesson that an issue on discount may not be attractive based on standards of value.

In the sixth comparison, Graham juxtaposes McGraw Edison, a utilities and housewares company, with McGraw-Hill, a company that specializes in books and information services. Graham cautions against over-optimism and points out that at the time of the comparison, Hill was selling for more than Edison despite having comparable offerings. This was due to the sentiment of buying into publishing companies, which led to artificially inflated prices, even though profits were declining. While Hill recovered eventually, its decline served as a reminder that buying in at high prices based on optimism is likely to lead to failures down the road. In contrast, Edison, while not as glorified, was a steady company that paced itself well and closed near its high just after fully recovering in 1971.

The seventh comparison involves Presto and General, where General's use of warrants and convertibles on their books can have a significant impact on their market capitalization. Graham emphasizes the need to factor in these elements when analyzing a company's value. On the other hand, Presto's FFO is bolstered by their "War Work," which is a cause for concern if these contracts were to disappear. Therefore, it is important to evaluate the soundness of Presto without considering the FFO from ordinance deals.

The eighth comparison involves Whiting Corp and Willcox and Gibbs, which highlights Mr. Market's irrational behavior. Despite Willcox heading towards a large loss and not paying dividends for thirteen years, Mr. Market overvalues the company, which on paper, is far inferior to Whiting. Graham suggests that owning Whiting might be suitable for the enterprising investor as part of a grouping of sound and attractive secondary-issue investments. Graham concludes the chapter by emphasizing the need for analysts to focus on exceptional or minority cases where they can confidently judge that the price is below value.

Conclusion

Chapter 18 of "The Intelligent Investor" provides a valuable lesson on the importance of comparing companies in pairs, especially in terms of their financial strength and performance. By analyzing eight pairs of companies, Graham highlights the various factors that can influence a company's value, such as its book value, market capitalization, earnings, and dividend record. Additionally, he emphasizes the need for investors to maintain a margin of safety when making investment decisions, especially when dealing with companies that have volatile earnings or unusual market valuations.

Overall, this chapter serves as a reminder that careful analysis and comparison of companies can provide investors with valuable insights and help them make informed decisions about their investments.