Graham Final Plays and His Lasting Legacy on Wall Street

Every company tells a story with its financial statements. Problem is, some companies are better at fiction than others. Earnings per share sounds simple – net income divided by shares. But dig in and you find four different versions of the same number, special charges from nowhere, and tax situations that make no sense. This is where an engineer’s skepticism becomes your greatest asset.

Four final case studies, each a different flavor of corporate deception or destruction. Then a look at the man who taught us to see through all of it.

Aluminum Company of America – Four Versions of the Truth

ALCOA reported earnings for 1970. The headline number: 5.20 dollars per share. Looks fine. Fourth quarter showed 1.58 versus 1.56 the prior year – slight improvement. At a stock price of 62, that is less than 10 times earnings. Cheap, right?

Not so fast. Read the footnotes. The footnotes took up twice as much space as the actual figures. And hidden in that fine print were not one, not two, but four different earnings figures for the same year:

• Primary earnings: 5.20 per share
• Net income after special charges: 4.32
• Fully diluted, before special charges: 5.01
• Fully diluted, after special charges: 4.19

For the fourth quarter alone, the picture was even worse. Primary earnings showed 1.58. But net income after special charges was just 70 cents. Annualize that and you get 2.80 per share – making the stock trade at 22 times earnings instead of 10. A completely different investment case from the same set of facts.

The dilution from 5.20 to 5.01 was straightforward – ALCOA had convertible bonds, and you must assume conversion happens. The real trick was the “special charges”: 18.8 million dollars dumped into the fourth quarter for estimated costs of closing divisions, shutting plants, and completing a construction contract. All future costs. All estimates. None had actually happened yet.

By booking future losses now, the company escaped showing them in whatever year they occurred. The losses did not belong to 1970 because they had not happened. They would not appear in future years because they had been “provided for.” A neat trick that left the runway clean for impressive earnings in 1971 and beyond.

The timing was suspicious too. The 1970 crash had happened. Everyone expected bad results. Companies across Wall Street dumped every charge into that year – already mentally written off – to make future years look strong. Like a sundial that only marks the sunny hours.

Real earnings? Probably 5.01 after dilution, minus whatever portion of special charges belonged to 1970. But management never told us what that portion was.

Penn Central Railroad – Bankruptcy Hiding in Plain Sight

Penn Central was the largest railroad in America by assets and revenue. Its bankruptcy in 1970 shocked everyone. Stock went from a high of 86.50 in 1968 to 5.50 in 1970. Bondholders got crushed. The financial world acted surprised.

They should not have been. The warning signs were screaming.

First, interest coverage. Penn Central earned its interest charges only 1.91 times in 1967 and 1.98 times in 1968. Conservative analysis requires at least 5 times coverage before taxes and 2.9 times after taxes for railroad bonds. Penn Central was nowhere close. But it gets worse – the company had not paid any meaningful income taxes for eleven years. So its before-tax coverage was less than 2 times against a requirement of 5. Totally inadequate.

Second, that tax situation itself was a red flag the size of a billboard. A company reporting profits year after year but paying no income taxes? Something does not add up. Either the reported earnings were fictional, or there were massive losses hiding somewhere that generated enough tax credits to wipe out the tax bill. Neither explanation inspires confidence.

Third, the merged company had reported 6.80 per share in 1966, driving the stock to its all-time high. Later, a special charge of 275 million – 12 dollars per share – appeared for merger “costs and losses.” Announce 6.80 in profits on one page, 12 dollars in losses on another. Wall Street did not blink.

Fourth, operations were terrible. Transportation ratio of 47.5 percent versus 35.2 percent for Norfolk Western. Penn Central burned far more cash to move the same cargo.

The killer detail: bondholders could have swapped Penn Central bonds for Pennsylvania Electric Company bonds at the same price and yield. The utility covered interest 4.20 times. By end of 1970, the railroad bonds traded at 18.50 cents on the dollar. The utility bonds closed at 66.50. Same swap price, radically different outcomes.

No competent analyst should have held Penn Central securities past 1968. The data was all public. The math was simple. The conclusion was obvious. But people saw what they wanted to see.

Ling-Temco-Vought – When Debt Becomes the Business

If Penn Central was a slow-motion collapse, Ling-Temco-Vought was a spectacular explosion. A story of expansion so reckless it reads like a cautionary fairy tale.

The numbers tell it all. In 1958, LTV had 6.9 million in sales. By 1960, 143 million – twentyfold in two years. By 1967, 1.8 billion. Another twentyfold. A young empire builder acquiring everything in sight.

But look at the financing. Debt went from 2 million to 44 million to 1.65 billion to 1.87 billion. At the peak, total debt was 1.87 billion against negative shareholder equity. The company owed more than it owned.

Interest coverage collapsed: 5.5 times in 1958, 4.8 in 1960, 5.4 in 1967, then 1.02 in 1969 and 0.68 in 1970. They could not cover two-thirds of what they owed. Equity-to-debt ratio went from 5.4 times down to 0.13. Leveraged beyond any reasonable limit.

Stock went from 169.50 to 7.125. Bonds traded at 15 cents on the dollar. Two respected banking firms had offered 600,000 shares at 111 dollars just three years before it hit single digits. Combined losses in 1969-1970 exceeded all profits LTV had ever earned.

The real question is not why LTV collapsed – that was inevitable given the leverage. The question is why the commercial banks kept lending. They advanced nearly 400 million dollars in additional loans after the company already failed basic coverage tests. Bankers fueling irresponsible expansion with other people’s money. Sound familiar?

AAA Enterprises – Pure Speculation, Pure Destruction

If LTV was reckless growth, AAA Enterprises was something worse: a company with almost no real business that somehow went public and attracted millions.

The founder started selling mobile homes, incorporated in 1965 with 5.8 million in sales and 61,000 in profit. By 1968 he jumped on two fads: franchising and tax preparation. He formed “Mr. Tax of America” – franchises using mobile homes as tax offices.

In March 1969, a major Wall Street firm offered 500,000 shares at 13 dollars. Stock doubled to 28, valuing the company at 84 million. Book value: 4.2 million. Maximum earnings ever: 690,000 dollars. That is 115 times earnings for a mobile home and tax franchise company. The founder cashed out 300,000 shares, netting 3.6 million for stock with a book value of 180,000.

After the IPO, AAA expanded into retail carpet stores and mobile home manufacturing. First nine months of 1969 showed 22 cents per share – modest but positive. Then came the fourth quarter: a loss of 4.365 million dollars, or 1.49 per share. This single quarter wiped out all the capital the company had before the IPO, plus the entire 2.4 million raised from new investors, plus two-thirds of the prior nine months’ earnings. All gone.

What remained: 242,000 dollars of equity. Eight cents per share. For stock that investors had paid 13 dollars for seven months earlier.

The market’s response? The shares closed 1969 at 8.125 bid – a valuation of 25 million dollars for a company with almost nothing left. You cannot explain that with any rational framework. By January 1971, AAA filed for bankruptcy. The stock was still quoted at 50 cents – 1.5 million dollars of imaginary value for wallpaper.

The speculative public cannot count beyond three. They will buy anything at any price if there seems to be “action” in progress. Franchising, computers, electronics, AI, crypto – the specific mania changes but the human behavior stays identical. That observation was made decades ago and it has not aged a single day.

Graham’s Lasting Influence

What makes these case studies matter is the analytical framework behind them. One man essentially invented security analysis. Before him, buying stocks was closer to gambling than investing. He brought rigor, quantitative standards, and the idea that a stock is fractional ownership in a real business with measurable value.

Warren Buffett read his work at nineteen and called it the best material on investing ever written. A sound intellectual framework for decisions and the emotional discipline to stick with it – that framework came from one source.

But the influence extends far beyond one famous student. Generations of investors built careers on these principles: margin of safety, intrinsic value, the distinction between investment and speculation, Mr. Market as servant not master. These concepts are so fundamental now that people forget someone had to invent them.

Those who knew him personally describe someone warm, generous, without pretense. He hoped every day to do something foolish, something creative, and something generous. The third was where he excelled most – open-ended, no-scores-kept generosity of ideas, time, and spirit. He planted trees that other people would sit under.

He left behind not just a method for analyzing securities, but a philosophy for approaching markets with discipline, humility, and rationality. In a world that cannot count beyond three, that philosophy remains as necessary as ever.

Key Takeaways

Always read the footnotes. ALCOA had four different earnings figures for the same year. The headline number and the real number can be wildly different. Management has significant leeway in what it reports, and that leeway is not always used in your favor.

Bankruptcy announces itself in advance. Penn Central failed every basic coverage test years before it went bankrupt. No income taxes for eleven years, interest barely covered, terrible operating ratios. The data was public. The analysis was elementary. Nobody bothered to do it.

Debt-fueled growth is not real growth. LTV grew twentyfold twice but financed everything with borrowed money. When interest coverage drops below 2 times, you are not investing – you are speculating that the music will not stop. It always stops.

Hot IPOs are almost always bad investments. AAA Enterprises at 115 times earnings with no real business is an extreme example, but the pattern repeats in every market cycle. When the excitement is highest, the risk is greatest.

A sound analytical framework beats everything else. Decades of market history, crashes, frauds, and manias all point to the same conclusion: disciplined analysis of fundamentals, honest assessment of risk, and the patience to wait for a margin of safety. That is the entire legacy, and it works.