A 800 page timeless masterpiece that is the Vol II of another 800 page classic ‘The Intelligent Investor’ by Benjamin Graham & David Dodd (Warren Buffett’s Gurus). To be honest, reading them both cover to cover can be quite a task in itself. But the fundamentals laid out in this have stayed true through the test of time. I may not have done complete justice to this book but have tried to cover major concepts of investing. Below is my interpretation of the book –

PS : I have to breach the 25 point rule for this one!

Security Analysis

DEFINITION: An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative

  • Market is not a ‘Weighing Machine’ but a ‘Voting Machine
S1 - Security Analysis S2 - Security Analysis
  • The ‘Speculator’ admittedly risks his money upon his guess or judgment as to the general market or the action of a particular stock or possibly on some future development in the company’s affairs
  • 4 problems that an investor must look to attend –
    1. General future of corporation profits
    2. Differential in Quality between one type of company and other
    3. Influence of interest rates on dividend on earnings
    4. Extent to which your sales or purchases must be governed by factor of timing as distinct from the price
  • 3. Three functions of analysis –
    1. Descriptive (all facts relevant are out across and compared with similar issues)
    2. Selective (specific judgement on an issue to buy, sell, retain)
    3. Critical (specific review on an issue) 
S3 - Security Analysis
  • To buy an Attractive enterprise at Unattractive terms vs an Unattractive enterprise at Attractive terms – the untrained investor must not venture into unattractive enterprises as historically lesser money has been lost by investing in sound businesses
  • Quantitative factors to be considered –
    1. Capitalisation
    2. Earnings and dividends
    3. Assets and liabilities
    4. Operating statistics
  • Qualitative factors to be considered –
    1. Nature of business
    2. Relative position in the industry
    3. Management character
    4. Operating characteristics
    5. Outlook for the industry
  • For bonds, 3 aspects pose a dilemma –
    1. security of principal and interest
    2. future of bond yield and prices
    3. future value of dollar
  • Bond selection is based on ‘Minimizing Loss’ whereas stock selection is based on ‘Maximizing Profit’
  • Guarantees and Rentals must be included in the calculation of fixed cost and evaluating coverage ratios
  • There are no permanent holdings. Have periodic reviews
  • Bull markets are ‘Born in Pessimism’, ‘Grow in Scepticism’, ‘Mature on Optimism’ and ‘Die on Euphoria’
  • This is the nature of financial services: you see a steady decline, and then you fall off a cliff – Never hold on to any stock (whose fundamentals are not in place) in hope – you know what I mean 😉
  • The convertible stock is not bought for conversion but must be either held or sold. They are bought for long term with the hope of realising gains fairly soon
  • It is desired to buy the ‘Right Company’ than at the ‘Right Terms
  • Invest in Common Stocks because of
    1. Suitable and established dividend return (now just a slight bearing)
    2. Stable and adequate earning record (only to estimate future earnings)
    3. Backing of tangible assets (now entirely devoid of importance)
  • Check for ‘Earnings Average’ vs ‘Earning Trend’ in common stock investment. The shift is due to instability in businesses
  • The income statement and cash flow must converge. 3 factors for common stock –
    1. Dividend record
    2. Earning power
    3. Asset value
  • Value of a business = EPS * quality factor is the P&L way. But we must also consider balance sheets as solely this is misleading. Important to take into account the non-recurrent profits and losses, operations of subsidiaries, reserves etc
  • Watch out for
    1. idle property depreciation
    2. deferred payment
    3. loss/profit from sale of asset
    4. cost stricken off against surplus
    5. valuations of goodwill and trademark should not be changed frequently
  • Analysis of the future must be penetrating rather than prophetic
  • People who habitually purchase common stock at more than 20 times the average earning are more likely to lose considerable money in the long run
  • Earnings power unsupported by asset values—measured as reproduction values—will, absent special circumstances, always be at risk from erosion due to competition
  • Learning from balance sheet
    1. It shows how much capital is invested in the business
    2. It reveals the ease or stringency of the company’s financial condition, i.e. the working-capital position
    3. It contains the details of the capitalization structure
    4. It provides an important check upon the validity of the reported earnings
    5. It supplies the basis for analyzing the sources of income
  • Book value = (all tangible assets – all liabilities)/total shares
  • The Current Asset value of a stock consists of the current assets alone, minus all liabilities and claims ahead of the issue. It excludes not only the intangible assets but the fixed and miscellaneous assets as well
  • The Cash Asset value of a stock consists of the cash assets alone, minus all liabilities and claims ahead of the issue. Cash assets, other than cash itself, are defined as those directly equivalent to and held in place of cash. They include certificates of deposit, call loans, marketable securities at market value and cash-surrender value of insurance policies
  • Basic rules on working capital – Ratio of 2 (current assets to current liabilities) was standard for industry
  • Raising large debt frequently a sign of weakness – industry may be stressed if it is not for trade. Eg Telecom in current state
  • This important part of security analysis may be considered under three aspects, viz.:
    1. As a check-up on the reported earnings per share
    2. To determine the effect of losses (or profits) on the financial position of the company
    3. To trace the relationship between the company’s resources and its earning power over a long period
  • On Selling – sell targets must be revised regularly to reflect all current available information. Tax consequences must be considered

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