Friday, June 24, 2011

Security Analysis - Book Review

Security Analysis by Graham and Dodd is widely considered to be the best book on investment ever written and this is the second time I read this book (1934 Classic Edition). I got the feeling that more you read, more you like each and every sentence in the book. I don't know if I read it superficially in the first time, but I spent considerable amount of time this time around and I highly recommend that everyone who has aspirations to invest in stock market should read this before playing with your hard earned money.



The book offers timeless advice on investment principles, valuation methods, income statement analysis and balance sheet analysis. If you don't have an accounting or economics background / interest, this book could be bit of a hard read but for people who have basic understanding of economics / accounting / capital markets and instruments would find it relatively easy. The book extensively deals with the bond and senior security investments in the second and third chapter of the book and if you are someone racing against the time, then you can skip it. But all other chapters are very important ones and Graham discusses the mental and psychological aspect of stock investments at considerable length and to me that's where the success of this book lies. He has also allocated one chapter each for income statement analysis and balance sheet analysis where he explains each and every concept lucidly with real examples and tables. He has also touched upon corporate governance issues and various loopholes in accounting practices which we can easily correlate with present. Overall it teaches the reader to have very good understanding about the following;

1. Mental and Psychological aspect of stock investments
2. Established standards of Common stock investment
3. Corporate Governance and Loopholes
4. Income Statement and Balance sheet analysis
5. Asset valuation
6. Capital Markets

I have liked each and every sentence of the book but I want to give here some of the excerpts that I liked the most and hope that you will find it very useful as well.

Page 3 : "By mathematical law more speculators must lose than can profit".

Page 21 : "Security analysis must proceed on the assumption that the past record afford at least a rough guide to the future. The more questionable this assumption, the less valuable is the analysis."

Page 35: "Corrective forces are usually set in motion which tend to restore profits where they have disappeared, or to reduce them where they are excessive in relation to capital."

Page 54 : "An investment operation is one which, upon thorough analysis promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative."
My Example : Buying State Bank of India at current price (Rs. 2200 a piece) can be considered as an investment. Buying Jubilant Food works at Current price (Rs.800 a piece) can be termed as Speculative.

Page 303: "The function of analysis was to primarily search for elements of weakness in the picture. If the earnings were not properly stated; if the balance sheet revealed a poor current position, or the funded debt was growing rapidly; if the physical plant was not properly maintained; if dangerous new competition was threatening ; or if the company was losing ground in the industry; if the management was deteriorating or was likely to change for the worse; if there was reason to fear for the future of the industry as a whole – any of these defects, or some other one, might be sufficient, to condemn the issue from the standpoint of cautious investor."

Page 305 : "
Buying common stocks viewed as taking a share in a business."

Page 310 : "The notion that the desirability of common stock was entirely independent of its price seems incredibly absurd. Yet the new era theory led directly to this thesis. If a public utility stock was selling at 35 times its maximum recorded earnings, instead of 10 times its average earnings, the conclusion to be drawn was not that the stock was now too high, but merely the standard of value had been raised. Instead of judging the market price by established standards of value, the new era based its standards of value upon market price. Hence all upper limits disappeared, not only upon the price the stock could sell, but even upon the price at which it would deserve to sell."

Note : He refers 1931 as New Era.


Page 317 : Canon of common stock investment.

1. Purchase price must have rational basis

2. Past record of primary importance

3. Approximations to insurance principle and practice

4. Purchase of a single stock not an investment

5. Group purchase may constitute an investment operation

6. Price an integral part of every investment decision (In theory, you only need to follow the old and trite policy of buying when prices are low and selling out when prices are high. No advice could be easier to give or more difficult to follow. High prices and low prices are not marked with distinguished signals like red and green traffic lights. Not only “high” and “low” always relative terms, but in wall street their meaning is mainly retrospective)

7. Analytical techniques essential to intelligent common stock investment

Page 317. "Policy of withholding dividend questionable"

Note: Seems he thought not paying dividend every year out of profits was not a good corporate governance. Current corporate governance practices in India would make Graham roll over in his graveyard.


Page 432 : "Classical formula for “Beating the stock Market” – Obviously it requires strength of character in order to think and to act in opposite fashion from the crowd; and also patience to wait for opportunities which may be spaced years apart."


Page 453 : "People who habitually purchase common stocks at more than about sixteen times their average earnings are likely to lose considerable money in the long run."


Page 499 : "When a common stock sells persistently below its liquidating value, then either the price is too low or the company should be liquidated."

My Example : Temptation Foods or Country Club India. These companies are not offering any value to the shareholders. According to Graham, shareholders will be better off selling the business rather than running it.


Page 504: "Common stock which : a) are selling below liquid asset values; b) are apparently in no danger of dissipating these assets; and c) have formerly shown a large earning power on the market price, may be said truthfully to constitute a class of “Investment Bargains”.


Conclusion: If you read the book and follow the principles exactly as given, you will see the following happening automatically.

1. You will not buy stocks when you are not supposed to buy (100% sure) or you will not buy a stock which a sensible investor is not supposed to buy.

2. You will buy more often than not at a sensible or right price.

3. You will know the right time to exit.

What else you are looking for?

Kumaran Seenivasan

www.stockanalysisonline.com




3 comments:

Mahesh June 26, 2011 at 12:48 AM  

For novice investor..its better to read "the five rules of successful stock investing" very easy and elegant read before diving in to SA.

Thanks for post kumaran sir.

Thondaiman June 26, 2011 at 10:32 PM  

Hi Kumaran
Thanks for yet another good post. The excerpts are so powerful and applicable to all seasons of the market. I very much liked the examples you used to elaborate Graham’s points. As he also says analytical technical are essential to intelligent common stock investment. This should be a continuous process and very essential to investors.

While most of us know we need lot of patience to wait for good opportunities, however it is quite difficult to implement in practice. Market keeps us testing hopefully will prevail over it with our experience and guidance. Thanks.

Nannu,  June 26, 2011 at 11:11 PM  

Kumaran,

Nice post. My personal feeling is Security Anaysis is a very good read, but very tough to follow in reality. My personal favorite is "One up the Wall Street" by Peter Lynch.

Regards,
Nannu

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