David Dodd, a finance professor at Columbia University, wrote Security
Analysis, which became the bible of the value-oriented approach to ana-
lyzing stocks and bonds. Through its many editions, the book has had a
lasting impact on students and market professionals alike.
Graham and Dodd clearly blamed Smith’s book for feeding the bull
market mania of the 1920s by proposing plausible-sounding but falla-
cious theories to justify the purchase of stocks. They wrote:
The self-deception of the mass speculator must, however, have its element
of justification.... In the new-era bull market, the “rational” basis was the
record of long-term improvement shown by diversified common-stock
holdings. [There is] a small and rather sketchy volume from which the
new-era theory may be said to have sprung. The book is entitled Common
Stocks as Long-Term Investmentsby Edgar Lawrence Smith, published in1924.^19
THE POSTCRASH VIEW OF STOCK RETURNS
As the news spread about all the people who lost their life savings in the
market, the notion that stocks could still beat other financial assets
sounded ludicrous.
In the late 1930s, Alfred Cowles III, founder of the Cowles Com-
mission for Economic Research, constructed capitalization-weighted
stock indexes back to 1871 of all stocks traded on the New York Stock Ex-
change. Cowles examined stock returns including reinvested dividends
and concluded:
During that period [1871–1926] there is considerable evidence to support
the conclusion that stocks in general sold at about three-quarters of their
true value as measured by the return to the investor.^20
Yet Cowles placed the blame for the crash of 1929 squarely on the
shoulder of the government, claiming that increased taxation and gov-
ernment controls drove stock prices downward.
As stocks slowly recovered from the Depression, their returns
seemed to warrant a new look. In 1953, two professors from the Univer-
sity of Michigan, Wilford J. Eiteman and Frank P. Smith, published a
study of the investment returns on all industrial companies with tradingCHAPTER 6 The Investment View of Stocks 83
(^19) Benjamin Graham and David Dodd, Security Analysis, 2d ed., New York: McGraw-Hill, 1940, p.
357.
(^20) Alfred Cowles III and associates, Common Stock Indexes 1871–1937, Bloomington, Ind.: Pricipia
Press, 1938, p. 50.