In Arnold Bernhard’s own words
Value Line’s new generation of investment research tools is the logical next step in our heritage of innovation in securities research and analysis. Founded in the depths of the Depression by Arnold Bernhard, Value Line remains wholly dedicated to providing independent, unbiased research and opinion that ambitious investors can rely on to act decisively.
Mr. Bernhard was known as the “Dean of Wall Street” during his life for his revolutionary approach to securities analysis. In the following speech, given on June 2, 1981, Mr. Bernhard tells how Value Line began, and expresses the essence of his
"I cannot think of anything particular that I have learned over the last half century in my service business that would not be anything but old hat to you. The only thing I might be able to contribute is an account of the series of catastrophes that somehow turned out to be the luckiest events of my business life... all you need is an idea and faith in yourself. Of course, a lot of hard work helps.
My field, as you probably know, is the investment advisory service business. After college and a couple of years as a reporter, I came to Wall Street. My job was as a trainee in the Railroad Department of Moody’s Investors Service. In those days, the late 20s, the business of America, it was proudly proclaimed, was business. The financiers of Wall Street were the lords of creation. It was a prestigious job just to be on Wall Street in almost any capacity. We were about to enter a new era of prosperity in our country — a new era in which poverty would be abolished throughout the land once and for all. Stock prices were bid up and up in anticipation of the great new era that was about to blossom out.
My mother, a widow of very modest means, was caught up in the spirit of the times. The insurance money left her by my father was first invested in Liberty Bonds, then later for larger income in foreign bonds and after that in common stock and lastly in stock on margin. Success bred success and confidence led to overconfidence. But who could go wrong on this Titanic of a country that was riding the wave of the future?
Then came the crash of 1929. It was a shock. But 1929 was just the tip of the iceberg. The stock market lost about 40% of its value in the last quarter of 1929 alone. But it recovered about half of that loss in the early months of 1930. Then came the real deluge in 1931 and 1932. When the market finally struck bottom in 1932 the Dow Jones Industrial Average had lost 90% of its 1929 peak value. Yes, stocks, as measured by the Dow, sold for only 10% of what the market said they were worth only a few years earlier...
I have always been, and still am, more than ordinarily gullible. So it is not surprising that the Great Crash came as a traumatic experience to me. Being young, I was able to live through the trauma and forgive myself for my gullible belief in a new era. But there was Moody’s Investors Service, the soundest, most highly respected organ of opinion in the world of finance. They, too, had been unaware of the impending enormous deflation of stock values that was to come. My mother’s estate was virtually wiped out. But here is the lucky part for me: that experience forced me to conclude that a standard of value had to be discovered, a standard that would signal when stocks were overvalued, and when they were undervalued, a standard that would not give way to emotionalism. There was no such thing in existence at the time. There were Moody’s Bond Ratings, but not stock ratings. Indeed, even today, theory holds that the market is efficient: that the price in the market place is value and that value is price. That is all you know or need to know. Ergo, there can be no such thing as undervaluation or overvaluation in a free market. There can be no independent standard of value, for the market price itself is the only rational value.
I refused to accept this proposition and in my arrogance or naïveté, determined to find and disclose a standard of normal value which would so enlighten the investing public that the extremes of 1929 and 1932 could never again be repeated. That was how the idea of the Value Line Ratings of Normal Value originated.
In 1930, Moody’s started a Personal Investment Counseling Division. I was assigned to be the first Account Executive under the Vice President of the division, probably because during the 1929 panic a couple of Moody’s subscribers seemed to want me to help them through the upheaval of the time. One of those clients was a thoroughly delightful, but totally unpredictable gentleman from Georgia. With the help of Gerald Loeb of E.F. Hutton, our Georgia client survived his technical difficulties, and I became his Account Executive at Moody’s. I also was assigned the account of Mr. Herbert S. Crowther, an officer of the Woolworth Co. Shortly thereafter a couple of dozen other accounts came along.
After surviving the 1929 crash, my clients, along with Moody’s other investment counsel accounts, remained fully invested in stocks, to the extent that stock investing was part of their investment strategy. They did well until the 1930 recovery peaked out, to be followed by the great deluge of 1930, 31, and 32. To my consternation, my unpredictable Georgia client brought suit against Moody’s for my managing his account. Truth to tell, Gerald Loeb and I had done some speculative trading for him, but that part had turned out all right. The 1930 deluge was what caused him to blow up. I don’t think I was to blame for not being bearish in 1930. Moody’s advice was to stay in good common stocks. Prosperity was just around the corner and so forth. But that lawsuit was a disgrace, and in addition I must have been something of a nuisance — what with my notions of normal value — and I was a chartist too — feeling the charts could often signal when a stock should be looked into more fully. The combination was too much. I was fired.
You can have no idea what it meant to be out of a job in 1931. Nothing like today, when if you can read and write you can get some kind of work — and you can get Social Security too. My situation then was dire. I really didn’t know which way to turn. I even contemplated some desperate remedies, but after some days of agony, my unpredictable friend from Georgia telephoned to say he wanted me to go on being his investment counselor even if I were no longer with Moody’s. Mr. Crowther called to give the same good news.
So the great crash made me go to work on my Value Line Rating Theory, and getting fired from Moody’s set me up in business for myself. Had it not been for these apparent catastrophes, I think I would still be a securities analyst at Moody’s.
As the number of accounts that I counseled increased, mostly by way of reference, it became more and more important for me to get my Ratings of Normal Value lined up. I had to have — and so did everyone else, I thought — standards by which to judge whether stocks were too high or too low.
The Value Line Rating I designed was a correlation between the monthly prices of a stock over a period of 20 years on the one hand, and its concurrent annual earnings and book values on the other. United States Steel, for example, might be described as having been worth 1/3 of its book value and 6 times earnings. When the price deviated markedly from the standard thus derived, as in 1929, it was determined that the deviation was a measure of overvaluation. When it declined down below the line, a measure of undervaluation.
I worked these equations out for 120 individual stocks. Each was a separate equation. I charted the prices, earnings and drew in the corresponding Value Line Ratings. I bought a multilith press and printed 1,000 copies of my book of Value Line Ratings of Normal Value. If you design, write, print and bind your product, you really get to love it. I took an enormous pride in the book of ratings charts that was to reveal to the world the normal and rational prices at which a stock should sell. It was to be a discipline that would control the market. This is what the world needed and I was going to give it to them — for $200 a book — which really wasn’t too much even for those days, when you consider the cost of the irrational price fluctuations between 1925 and 1932.
It was hard for me to realize how little the world would be interested. I called on banks and institutions without success. Only curious, although usually polite stares greeted my presentations. I did make one sale to a reluctant and skeptical portfolio manager of the Phipps Estate, but that was all. And the selling effort was diverting time and energy from my investment counsel accounts. The inventory of 1,000 books took up an embarrassingly large percentage of my office space too.
One day a noted man came to see me. I don’t recall what caused him to drop in. His name was Major L.L.B Angas. He was, you might say, the Joe Granville of his day. Only he did not rely upon technical or chart analysis. His reliance was upon monetary conditions and he advertised himself as the scion of an old Scottish banking family. He showed some interest in my book and I avidly seized the opportunity to try to sell it to him. He didn’t buy, but he did say he might be inclined to study it and perhaps mention it favorably in his enormously influential bulletin. On hearing this, I urged him please to accept the book with my compliments, which he did. A couple of days later, he called to say that he found the stuff interesting and would comment favorably upon it in his forthcoming bulletin, which he did — sort of. He said in his bulletin that "This young fellow Bernhard has published a book of ratings which show when stocks are too high or too low. Everybody should own one. Write to Bernhard at 347 Madison Avenue, New York City — the price of the book is $55."
You can imagine my dismay on seeing my $200,000 inventory written down to $55,000 almost overnight. I was still more dismayed when I received a bill for $800 from the Major to cover the expense of printing the bulletin in which the endorsement appeared. Not only did my inventory shrink, but my quick assets were at one stroke diminished by about 50% by the occurrence of this new, unexpected expense. The building manager of 347 Madison, who had been a friend of mine at college, was consulted on my unfortunate situation and he agreed to let the rent accumulate for some months until I could recover.
But again came good luck. A little while after this happened, some 60 $55 checks appeared on my desk in response to the Major’s recommendation. That was how I learned that a service could be sold to the public by means other than direct, personal representation. It is obvious to you now, of course.
I won’t bore you with the story of how the Value Line Ratings System and Advisory Reports metamorphosed into something far more convenient to use and comprehensive than my original book of 120 stocks; how it switched from time series to cross sectional correlation. But I must admit that having the circulation up to about 65 subscribers I still had the problem of building it up to where it could be a paying proposition that would more than carry its overhead. I had no idea how this could be done.
One day, again by luck, a man from Barron’s magazine called on me. I think his name was McQueen. I’m ashamed to say I can’t really remember it as I should. For his advice turned out to be invaluable. He persuaded me to advertise in Barron’s for two weeks. Each ad would cost $35 for a total commitment of $70. I bought the deal. The advertisements were designed to bring in leads of $5 each — that is to say, the reader of the ad would send me $5, and I would send him a sample of the Value Line Ratings of Normal Value. The two ads pulled 9 leads for a total return of $45, which to my analytical mind was a poor way to spend $70. Then Mr. McQueen patiently explained to me that this was not the end-all of the campaign, but only the beginning. I was to write 7 or 8 follow-up letters telling the "Qualified Leads", that is to say the people who put up the $5, more about what I regarded as my earth-shaking revelation: that there was such a thing as a normal value for stocks. Well, I wrote 8 or 9 follow-up letters and sure enough 3 of the 9 leads subscribed at $55. So it really did pay off, after all.
I could go on telling you about a number of other setbacks that turned out to be blessings, but I’ll take your time for only one more, the icy refusal of the organized community of analysts and academicians to recognize the Value Line Ranking System as having validity. Whether because our methods challenge the efficient market dogma which holds that the market price is always the right price, or because we were perceived as competitors, I cannot say. For some years I was astounded to see the New York Society of Security Analysts, or perhaps it was the Financial Analysts Federation, publish in their magazine correlation analyses that followed essentially the same methods we had been using for some 15 years without even recognizing that there was such a publication and method as ours in being.
In the past 32 years, the time in which the present Value Line system has been in use, we have kept accurate records of every rank assigned in The Value Line Investment Survey on every stock we cover. The method has shown statistically significant success. That is to say, the 400 stocks we rank 1 and 2 for performance in the next 6 - 12 months have, as groups, outperformed in every single year the 1300 other stocks ranked 3,4, and 5 as groups. These results could not have been due to chance.
Entrepreneurs are bound to run into road blocks, even disasters, along the way. The message I would leave with you is, look upon those adversities when they strike — and they will — as opportunities. In my own experience, the worst catastrophes turned out to be the luckiest breaks. And I don’t think it would be any different for you if you have faith in your ideas and the will to persevere in their propagation."
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