Security Analysis Summary


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Originally published at: https://blog.12min.com/security-analysis-summary/

Do you want to learn a thing or two about securities from the father of security analysis himself?

Then read on to get a glimpse of what you can expect from “Security Analysis.”

Who Should Read “Security Analysis”? And Why?

“Security Analysis” has been in print continuously ever since it was first published in 1934. This alone witnesses this book’s relevance.

Numerous investors have made fortunes basing their investing practices on Benjamin Graham and David Dodd’s principles of value investing.

Even the legendary Warren Buffett calls this book his Bible.

We recommend “Security Analysis” to all investors who want to work on their investing-craft as well as to students of financial history.

About Benjamin Graham and David Dodd

Benjamin Graham passed away in 1976, but until today his theories remain relevant. He was the founder of the value school of investing, a co-author of several books on finance and investing and is considered the father of modern security analysis.

David Dodd was an assistant professor of finance at Columbia University in New York City.

"Security Analysis Summary"

Security analysis is a process of deciding which securities would be good investments.

What is a sound investment anyway?

It is an investment which keeps the principal safe, and on top of that delivers a return.

Any kind of investment that does not meet these two conditions is not an investment, but speculation.

Market analysis, unlike security analysis, tries to forecast the action of the market, or the prices on individual securities, without looking at facts about different companies.

There are a few types of market analysis.

One of them, called technical analysis, uses past market values to forecast future prices.

The other one uses indices of external economic activity, that has influence over the prices of the securities.

However, experience has shown that none of these market analysis is valid. In fact, the only thing they do is promoting speculation over fact-based investments.

A term you should know about when it comes to security analysis is intrinsic value.

It is “an elusive concept. In general terms, it is understood to be that value which is justified by the facts…the assets, earnings, dividends, definite prospects, as distinct…from market quotations established by artificial manipulation or distorted by psychological excess.”

Investors are not able to calculate an intrinsic value for particular security since there are too many variables involved.

However, a careful study can end up in a conclusion if the price the market puts is proper.

Traditional economics divides securities into two categories: stocks and bonds.

However, this division is inappropriate since it accentuates the form of the security, instead of focusing on its purpose and safety.

A better classification can be done by grouping securities in three groups: fixed value securities, including preferred stocks and high-grade bonds; variable-value senior securities, consisting of preferred shares and speculative bonds; and common stocks.

Now, you should not mix the soundness of the bonds with their form. The security of the bonds comes from the issuer’s financial strength.

Granted, no industry, and hence no company is depression-proof. However, there are two factors that make a company resilient in hard times:

  • A dominant size within its industry
  • Sufficient earnings to cover its bond interest by a large margin
Companies that do not meet these conditions are not a right place to invest in, even though the bond may seem very attractive.

Preferred stocks are a mix between the instability of common shares and the limited return of bonds.

These may sound like unwanted characteristics, but preferred stocks can be safe investments as well. They only have to meet the safety requirements of bonds that we mentioned before.

You will notice that following these requirements and searching for investments that have these characteristics will limit your choice of investments.

This, you need to consider, as a positive sign.

Income bonds are also called adjustment bonds and should fulfill the same criteria as preferred stocks.

Guaranteed issues are placed somewhere between preferred stocks and bonds. Investors should do the same as they would do with bonds: examine the guarantor’s financial soundness.

Remember that there is no such thing as a permanent investment.

Of course, there are always exceptions to the rule, so although you should stay away from many of the preferred stocks and bonds that do not meet the criteria, you can consider purchasing some of them, since you will buy them at a discount to their artistic value.

However, make sure that the company is not selling at a discount because it is not financially stable.

Now, common stocks are much more speculative than other securities.

So, when investors decide to purchase common stocks, they can decrease their risk by portfolio diversification.

When investing in common stocks analyze the following vital factors:

  • Dividend rate
  • Earnings
  • Asset Value

Key Lessons from “Security Analysis”

1. The Three Functions of Security Analysis 2. Questions an Investor Should Ask Himself When Purchasing a Bond 3. Criteria for Purchasing Speculative Senior Securities

The Three Functions of Security Analysis

  • “Descriptive function.”
  • “Selective function.”
  • “Critical function.”

Questions an Investor Should Ask Himself When Purchasing a Bond

  • Is the value of the company’s business more than the value of its debts?
  • Can the company meet its financial obligations even in the worst-case scenario, such as a recession or depression?

Criteria for Purchasing Speculative Senior Securities

Some senior securities come with privileges that make them tempting:
  • “Convertible issues.”
  • “Participating issues.”
  • “Subscription-warrant issues.”
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“Security Analysis” Quotes

[bctt tweet="The fact that no good bonds are available is hardly an excuse for either issuing or accepting poor ones." username="get12min"]

[bctt tweet=“Needless to say, an investor is never forced to buy a security of inferior grade.” username=“get12min”]

[bctt tweet=“An institution with securities of its own to sell cannot be looked to for entirely impartial guidance.” username=“get12min”]

[bctt tweet=“Safety does not reside in titles, or forms, or legal rights, but in the values behind the security issue.” username=“get12min”]

[bctt tweet=“There is very little altruism in finance.” username=“get12min”]

Our Critical Review

Many things have changed since the 30s when “Security Analysis” was first published, however, the concept of investing in companies that are undervalued has stayed the same.

This book explains investment basics and gives a glimpse of the times when policymakers were still learning the lessons that the Great Depression had to offer them.