A Brief Book Review of Common Stocks as Long Term Investments by Edgar Lawrence Smith
Toward the end of Chapter 27 of their 1940 edition of Security Analysis, Benjamin Graham and David Dodd discuss Edgar Lawrence Smith's 1924 book Common Stocks as Long Term Investments, which they deride as a "small and rather sketchy volume." Writing after the Great Depression, you can't blame them. With hindsight, we know that Smith's book was used by many at the time of its publication to justify what became the Coolidge-era stock market bubble of the late 1920s. From one man's sound premise came a nonsense conclusion on a massive scale: While it is true that stocks are advantaged over bonds in the long-run because of (a) the positive effects of retained earnings on the growth of businesses and (b) the negative effect of inflation on debt holdings, these two ideas unfortunately were used to justify paying any price at all for a stock if it had an attractive trend in earnings. As Graham and Dodd note:
"This example illustrates one of the paradoxes of financial history, viz., that at the very period when the increasing instability of individual companies had made the purchase of common stocks far more precarious than before, the gospel of common stocks as safe and satisfactory investments was preached to and avidly accepted by the American public."
That all aside, this small book is still worth reading, especially as a historical document on evolving theories related to portfolio construction and investment management; but only if, as soon as you finish this book, you remember that reality is more complex than theory and price still matters.