Security Analysis: The Classic 1940 Edition

In other words, the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. Rather should we say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion.

... Bond selection is primarily a negative art. It is a process of exclusion and rejection, rather than of search and acceptance.

One example of a high-tech company that submits to a Graham type of analysis is Amazon.com. Though it does business exclusively on the Web, Amazon is essentially a retailer, and it may be evaluated in the same way as Wal-Mart, Sears, and so forth. The question, as always, is, does the business provide an adequate margin of safety at a given market price. For much of Amazon’s short life, the stock was wildly overpriced. But when the dot-com bubble burst, its securities collapsed. Buffett himself bought Amazon’s deeply discounted bonds after the crash, when there was much fearful talk that Amazon was headed for bankruptcy. The bonds subsequently rose to par, and Buffett made a killing.

Abnormally good or abnormally bad conditions do not last forever.

While a trend shown in the past is a fact, a “future trend” is only an assumption.

Astute observers of corporate balance sheets are often the first to see business deterioration

The Interborough issues are an example of a rather special group of situations in which analysis may reach more definite conclusions respecting intrinsic value than in the ordinary case. These situations may involve a liquidation or give rise to technical operations known as “arbitrage” or “hedging.

... The soundness of the best investments must rest not upon legal rights or remedies but upon ample financial capacity of the enterprise.

In all of these instances he appears to be concerned with the intrinsic value of the security and more particularly with the discovery of discrepancies between the intrinsic value and the market price.

The essence of proper bond selection consists, ... in obtaining specific and convincing factors of safety in compensation for the surrender of participation in profits.

As a rule of thumb, investors should spend the bulk of their time on the disclosures of the security under study, and they should spend significant time on the reports of competitors.

I quickly convinced myself that the true key to material happiness lay in a modest standard of living which could be achieved with little difficulty under almost all economic conditions”—the margin-of-safety idea applied to personal finance.21

Texaco's unusual situation can be summarized in one sentence, often repeated by Graham and Dodd disciple Warren Buffett: A great investment opportunity occurs when a marvelous business encounters a onetime huge, but solvable, problem.

We must recognize, however, that intrinsic value is an elusive concept.

... the value of the pledged property is vitally dependent on the earning power of the enterprise.

... investors are constitutionally averse to buying into a troubled situation.

We are convinced that the public generally will derive far better results from fixed-value investments, if selected with exceeding care, than from speculative operations, even though these may be aided by considerable education in financial matters.

... generally speaking there can be no high-grade obligations of a weak enterprise.

And I suspect that Graham and Dodd have been ignored by those who suffer from the misconception that trying to make serious money requires that one take serious risks.

Principle for the securities analyst: Nearly every issue might conceivably be cheap in one price range and dear in another.

Objective tests of managerial ability are few and far from scientific. In most cases the investor must rely upon a reputation which may or may not be deserved.

Security analysis does not assume that a past average will be repeated, but only that it supplies a rough index to what may be expected of the future. A trend, however, cannot be used as a rough index; it represents a definite prediction of either better or poorer results, and it must be either right or wrong.

The trend is, in fact, a statement of future prospects in the form of an exact prediction.

When values are determined chiefly by the outlook, the resultant judgments are not subject to any mathematical controls and are almost inevitably carried to extremes.

Analysis is concerned primarily with values which are supported by the facts and not with those which depend largely upon expectations.

The analyst’s conclusions must always rest upon the figures and upon established tests and standards.

It is our view that stock-market timing cannot be done, with general success, unless the time to buy is related to an attractive price level, as measured by analytical standards. Similarly,

The recurrent excesses of its advances and declines are due at bottom to the fact that, when values are determined chiefly by the outlook, the resultant judgments are not subject to any mathematical controls and are almost inevitably carried to extremes.

The market made up new standards as it went along, by accepting the current price - however high - as the sole measure of value. Any idea of safety based on this uncritical approach was clearly illusory and replete with danger.

Investment must always consider the price as well as the quality of the security.