Jeremy Grantham: The Man Who Loves Dogs

1978 Barrons Interview

Jeremy Grantham founded GMO LLC in 1977 and remains a member of GMO's Asset
Allocation team, serving as the firm's chief investment strategist. Today, GMO manages
$117 billion in client assets.
During December 1978, a year after GMO LLC was founded, Jeremy Grantham sat down
for an interview with Forbes magazine to discuss his contrarian style. The article was
titled "The man who loves dogs" and at the time, GMO was known as Grantham, Mayo,
Van Otterloo & Co., with assets under management of only $65 million. Here are the
highlights of the interview from the archives.

Jeremy Grantham: The man who loves dogs

"There is a single principle to which all Wall Street would agree it is: Cut your losses
and let your profits run...Nonsense, insists Jeremy Grantham, 40, who thinks the best
policy is: Cut your profits and let your losses run." -- Forbes 1978
Jeremy Grantham advocates buying more of your losers, averaging down and selling
winners early as to book gains. From any normal fund manager running just $65
million, this may have seemed like a silly statement. However, before founding GMO,
Grantham had come from a nine-year-old investment firm based out of Boston with
$1.8 billion under management. Grantham left because he thought the fund was
becoming too big. He said, "if you want to concentrate your money in your best
handful of ideas and move quickly, you have to be small."
"Like most younger money managers, Grantham believes that the market is 'pretty
damned efficient' -- that is, the market prices stocks at what they are worth at any

given moment, which is the sum total of all the judgments based on all the information
known to investors and speculators about that stock." -- Forbes 1978
As a result, Grantham didn't believe that there were any bargains to be found in the
market. A $50 stock is worth $50. That said, some people can find bargains, but they do
this by making intelligent, informed decisions about the future.
He says one of the safest predictions to make is as follows: A group of highly profitable
companies will become less profitable as time passes. The high profits will attract
competition. Conversely, a group of low-profit companies will tend to become more
profitable. Further, competition will drift away, and no new capacity will be built. This is
a theory, of course, but Jeremy Grantham believed that this theory was a rough, but an
accurate guide of predicting market movements.
An example given is Avon Products, Inc. (NYSE:AVP). When the company was rising
high during the early 70s, few investors bothered to buy into the second-tier stocks
trading at low multiples, as they were trading far below the rest of the market's
valuation. From 1972 to 1974 the perfect trade would have been to sell Avon and buy
the second-tier stocks. Several years later the market rewarded the risk takers, and those
who held Avon lost money while investors who had gone for the low P/E, second-tier
stocks, reaped big gains.
"A Grantham dictum: 'If a stock is comfortable to buy, don't buy it.' Right now Avon is
once again comfortable to own, but Chase Manhattan isn't. Grantham's accounts are
heavily in Chase Manhatten and out of Avon." -- Forbes 1978
To define what is comfortable and uncomfortable, Grantham and his team used a
number of screens to measure relative value -- looking for groups of stocks that trade at
discounts to the rest of the market. Grantham's most valuable screen was the "present
value" screen, which meant, according to Forbes:

"...taking a ten-year estimate of a company's future earnings, discounting them to the

present and then making a ratio between that number and the stock's price. The
average ratio of some 1,500 stocks is labeled "fair value." Using Grantham's model, for
example, the top 10% of the companies at year-end 1974 have appreciated more than
200%. The bottom 10%, only 30%."
Aren't ten-year estimates a little ludicrous asks Forbes?
"...you're less likely to be as far off as you will be for next year. The longer the period,
the more obviously silly overoptimistic assumptions appear [replies Grantham]. The
estimates are crude, but they provide a useful start."

Jeremy Grantham: Looking for bargains

The purpose of Grantham's screens is to find bargains. After the screens comes the hard
work. Computer models can only identify the opportunity, Jeremy Grantham then starts
to dig through the numbers himself.
The single most important question Grantham asks is "why is the stock cheap?". He and
his team want to find out why the market is avoiding the company. Why is the stock
uncomfortable for investors?
"Grantham cites a computer test involving two hypothetical investment programs
between 1926 and 1976...One portfolio is left unattended. In the other, all positions are
reequalized at the end of each year -- the better performances are cut back, the weaker
ones enlarged. The $10,000 in the unattended portfolio appreciated to $500,000 by
the end of 1976. The reequalized portion, to $1 million. The dog-buyers outperformed
the market two-for-one. Scary but true."
Grantham believes that this dog buying strategy works because the flow of capital
among industries is relatively efficient. High return industries attract capital while

investors avoid low return industries. The results, as Forbes puts it, is that the wretched
inherit the earth.
But there are times when the dog-buyers suffer and contrarians have to swim against
the tide, stomaching losses. Dull large-caps and medium-sized companies (medium by
70s standards of $5 million to $40 million) are Grantham's favorites.
"Eighty percent of the time they are better value because 80% of the time they are less
comfortable to own."
The article then draws to a close by discussing Grantham's view on the market for the
next few years. Not where the market is heading but how investor attitudes will change.
He predicted that active management will die out as investors find value in index funds
at a lower cost. Moreover, Jeremey Grantham stated that he would not let his fund's
AUM exceed $200 million.
The Forbes article ends:
"Meanwhile, there it is folks: Cut your profits and let your losers run. If you've got the
guts for it and can avoid being swayed by market letters and cocktail party chatter,
Grantham says, you can beat the market that way. If you have the guts for it."