“The soundness of the best investments must rest not upon legal rights or remedies but upon ample financial capacity of the enterprise.” -Benjamin Graham
Benjamin Graham was an American investor and economist born in 1894. He was an incredible mentor for the investors and is also regarded as the father of value investing. ‘Security Analysis’ by Benjamin Graham, published in 1934 and co-written by David Dodd was a guide to the investors. The book gives a brief description about security analysis and how it differs from market analysis? Graham says that a sound investor is one who follows security analysis in order to have a safe investment.
What is Security Analysis?
Graham says that security analysis is the process of deciding securities which are safe and sound investments. It is done to keep the principal safe and that the investors get a profitable and a worthy return. Security analysis has three functions:
- “Descriptive function” – It presents the relevant facts in an intelligible fashion and compares various securities.
- “Selective function” – It tells whether an investor should buy, sell, hold or exchange a security.
- “Critical function”
- It performs the function of examining corporate policies of the company, efficiency of management on an ongoing basis.
According to the author, intrinsic value is an important concept in security analysis. The description of the concept is from facts and assumptions, definite prospects. An investor cannot calculate the exact intrinsic value. Since it has many variables, but he can examine carefully whether the price the market quotes is appropriate.
Furthermore, securities fall into three categories and each of them has some criteria for investing in them. Graham has explained them in detail so that investors can be well equipped with the knowledge of investing in securities. The three categories are fixed-value securities, variable-value senior securities and common stocks. Fixed value securities include bonds and preferred stocks. Benjamin says that bonds are only safe if the issuer ability to pay is strong. The company should have such strong fundamentals so that it can pay to its holders.
Further it can also pay even if the company is under recession. Talking about the preferred stocks, they are safe sound investments if their margin of safety is large enough. The stability of the company should exceed the requirement is for a bond investment. Graham says that investors should realize there’s nothing called as permanent investment. Evaluation of fixed income security is important.
Benjamin talks about the next type of security which is variable-value senior securities.
Some of these carry certain worthy privileges.
- Investors can exchange convertible issues for common stock.
- Investors can receive part of any increased dividend that common stockholders earn.
- Subscription-warrant issues include option warrants to purchase common stock.
Are common stocks the safest security?
Common stocks are more speculative than variable-value senior securities. After the crash of 1929, graham believes that common stocks cannot be good buy at any price. It will not be a good buy even if the company’s earnings trend is positive. Investors should analyze their common stock portfolio efficiently. Benjamin asks the investors to examine some crucial factors like dividends, earnings and asset value. In addition, he says that examining balance sheet is very essential. The investors come to know that the company has an adequate cash position, and their working capital is decent enough. Balance sheet also tells the investors about the maturity of debts.
The author explains about ‘The Relationship between Owners and Managers’. According to him as an investor, you should know about the management practices. And this knowledge should be taken into consideration while making investment decisions. The author describes his experience after the great depression and what effect did it have. Anyone who read this book gets that this old book provides plenty of knowledge for a security analyst.
Graham said that one should purchase stock under net current asset value. And that has become famous in the current bear market. Graham has included introduction in each of the seven sections of the book. No wonder that all of them are worth a read. Also Benjamin explains with the tools that will help you make decisions regarding investments. By reading this book, you will understand the difference between speculation and investment. All the commentary and forwards provided serve great purpose to the investors. The book is simply the best and most complete resource on value investing.
The book throws light on what real investment market looks like. In addition to this it also one should analyze decision making before investing. Hence the name of the book is-‘Security Analysis’.