Security Analysis Summary: Benjamin Graham

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Security Analysis Summary

Security Analysis Summary provides a free book summary, key takeaways, review, top quotes, author biography and other vital points of Benjamin Graham’s famous investment book.

This book Security Analysis has been continually in print since its first version. Hence, it has never-ending relevance. Benjamin Graham and David Dodd wrote this book in 1934. Ever since then, their investment principles have helped many investors. Countless investors have made fortunes from these principles. As per Warren Buffett, this book Security Analysis is his Bible. A lot has changed on the Wall Street since then. But, the principle of investing in undervalued firms hasn’t. This book takes you to the time when lawmakers were still learning from the Great Depression. The norms of financial disclosure had changed because of the new Securities Act. Most public firms were mines, utilities, or railroads. This is a contrast with the blue-chip companies of today. We suggest this book Security Analysis for learners of financial history. Also, for serious investors, this is a great read.

“An investment in the soundest type of enterprise may be made on unsound and unfavorable terms.”

This Summary Will Help You Learn

  • What is security analysis;
  • How is it different from the market analysis;
  • What is the difference between fixed-value securities, common stocks and senior securities having variable value;
  • How security analysis guidelines apply to these three security types.

Take-Aways

  • Check a firm’s soundness before investing in it.
  • Real investments keep your principal safe. Besides, they offer a decent return. Any investment which doesn’t is only a speculation.
  • Buy securities that sell below intrinsic value. You’ll profit from them.
  • Three main security groups include common stocks, speculative bonds and preferred stocks, and investment bonds and preferred stocks.
  • Bond’s safety depends on two things. First is the financial strength of the issuer. Second is their ability to pay.
  • Preferred stocks must pass all safety tests needed of bonds.
  • You may profit from buying some preferred stocks and bonds that aren’t investments. It’s possible if they’re selling at less than the internal value.
  • Privileged issues are safe as preferred stocks. But, they even have the common stock like upside potential.
  • You can balance the changes in prices of common stock. The key is portfolio diversification.
  • Analyse common stocks by earnings, dividends and asset value.

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Security Analysis Summary

What Is Security Analysis?

Security analysis helps in finding which securities are good investments. Real investments will keep the principal safe. They’ll also give good returns. Hence, anything which doesn’t do this is speculation.

There are three functions of security analysis:

  1. “Descriptive function” – This compares different securities. Plus, it smartly outlines facts.
  2.  “Selective function” – It helps judge if an investor must sell, buy or hold a security.
  3.  “Critical function” – This observes management, company policies, and structure on a regular basis.

Market analysis is different than securities analysis. It tries to predict the prices of individual securities. Or the performance of the market in general. It doesn’t consider the core facts of different firms. Technical analysis is a form of market analysis. Under this, future values are predicted by seeing old market values. Another type checks indices of economic activity external to the market. These activities influence the security prices to some level. None of these market analyses have proven effective. In fact, both mainly promote speculation.

Internal value is a crucial concept in security analysis. But, it’s also a vague concept. It’s a value justified by facts. These include earnings, assets, dividends, etc. Such facts are then manipulated artificially. Investors can’t measure the exact intrinsic value of a security. This is because there’re many variables involved. But, careful analysis can help find if the price quoted by the market is proper. Securities should pass safety tests to be profitable investments. Also, they must sell below their internal value.

Types of Securities

Securities are of two kinds: bonds and stocks. But, such classification isn’t enough. This’s because it focuses more on the type of security than its purpose and safety. Hence, securities can be more accurately grouped into three classes. These are:

  1. Common Stocks;
  2. Fixed-value securities which include preferred stocks and high-grade bonds;
  3. Variable-value senior securities, which include preferred stocks and speculative bonds. 

Criteria for Investing in Fixed-Value Securities

Bonds don’t become naturally safe due to their form. Instead, they get their reliability from the ability of an issuer to pay. This, in turn, is decided by its financial power. Hence, anyone considering bonds must ask a few questions first. Is the company’s business value higher than its debts value? Can the firm fulfill its debts even in tough times, like the recession?

No firm or sector is recession-proof. But, two factors add to a firm’s strength in tough times. First is a dominant size in its industry. And, second is enough earnings to cover the bond interest with huge margins. Bonds which don’t meet these criteria aren’t investment worthy. Even if their return is very attractive. A high return can’t make up for failure to pay.

Preferred stocks mix the instability of common stocks with bonds’ limited return. But, even then they could be safe investments. For this, they also need to fulfill the same safety needs as bonds. First, their safety margin is big enough. And, second, the firm stability is higher than what’s needed for bonds. Such strict criteria restrict the amount of investment-worthy preferred stocks. Hence, only a select group qualify for investment.

Income Bonds

Income bonds are otherwise named adjustment bonds. They also need to meet the same strict criteria as above. Guaranteed issues have a place between preferred stocks and bond debt. Potential investors should check the terms of such guarantee. They must also verify the financial power of the guarantor. Even with fixed-value investments, it’s essential to analyze the holdings regularly. It’s because there isn’t anything like a permanent investment.

Many preferred stocks and bonds don’t meet the criteria to become investment-grade. But, still, some issues in this class may be worth buying. It’s because they sell at a rate less than intrinsic value. But, avoid issues selling at discounted rates for other reasons. For example, if the firm is not financially sound.

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Criteria for Purchasing Speculative Senior Securities

Few senior securities have some privileges. This makes them good buys on speculative grounds. These include:

  • “Convertible issues” – In some cases, it’s possible to swap convertible issues for common stock.
  •  “Participating issues” – Investors may get some increased dividend which common shareholders earn.
  •  “Subscription-warrant issues” – These cover option warrants to buy common shares.

Such issues have features of both senior security and common share. There’s the safety of the former and likely price increase of the latter. But, the attractive type doesn’t mean that every security of this kind is safe. Only some issues fulfill the safety criteria to be investment-worthy. The rest is same as common-stock investments. It’s because they have the same speculative traits of that class. When analyzing privileged issues consider three things. First, the level of profit-sharing benefits for every dollar invested. Second, the length of the privileges. And, third the closeness of the event which will lead to profit-sharing benefits.

Criteria for Investing in Common Stocks

Common stocks are more speculative than senior issues. Still, they’re crucial to the American financial system. Both, expert and new investors follow their prices. Hence, security analysts are aware of how to address them. Common stocks were a primary reason for the crash of 1929. It was a false belief that common stocks make a great buy at any price. As long as the firm’s earning cycle was positive. The criteria to make these stocks safer needs more analysis. This’s because the probability of price increase will always attract investors.

The shifts in common stock prices make any firm a doubtful investment. But, diversifying the portfolio may counter this risk to some degree. Investors must put their common stocks to careful analysis. Check the below three key factors: 

  • Dividends

Check a firm’s dividend rate and its record of paying dividends. The dividend rate is crucial. It’s because even a dollar of extra earning is more for an investor. The firm may choose to reinvest the surplus. But, instead, it decides to pay a dividend. And this is important for investors. Typically, firms which pay high dividends have a higher share price. But, management may hold dividends on common-stock any time. Hence, its crucial to check the firm’s dividend record. This’ll serve as a hint, though not a surety, of future income.

In contrast, extraordinary stock dividends are false. It’s because they don’t give investors anything more than they already own. An improvement on this is for firms to pay regular stock dividends.

  • Earnings

To verify earnings, study the income statement of a firm. Earnings are crucial. But security analysts give them unnecessary weight to measure investment reliability. Management may alter a firm’s earnings in many ways. Hence, always check the income statement carefully. For example, businesses can add non-recurring profits to show a positive earnings trend. The accountants may also produce earnings by increasing/decreasing the reserves. Firms may even show depreciation costs in misleading ways. 

Investors should focus on more than present earnings. They must check both the current trend and long-run earnings average. It can be 7-10 years preferably. The job of an analyst is not to predict the future of a trend. Or for that matter predicting likely price changes. Instead, it’s taking decisions by facts. 

  • Asset Value

To measure asset value, check the balance sheet. A company’s:

Book value per share = Total value of tangible asset/number of outstanding shares

Wall Street has ignored the significance of asset value. There are different ratios for the market price to book value. But you should check the core value of a firm’s assets before investing.

The current asset value is in fact, a more crucial figure. It doesn’t include fixed and intangible assets. Hence, it’s a rough estimate of the firm’s value if it goes into liquidation. There’s a general rule for this. If a company’s market price is less than its liquidation value, there may be two cases. First, it’s either undervalued. Or second, it must be liquidated. Investors need to differentiate the undervalued issues from poor performing ones. Only then can they realize significant upside.

Besides this, check if the firm has a good cash position. That its current assets don’t fall below its current liabilities. Also, see if the firm has a vast debt maturing soon. This may lead to problems with refinancing.

“Safety does not reside in titles, or forms, or legal rights, but in the values behind the security issue.”

The Relationship Between Owners and Managers

Management and shareholders’ interest hardly coincide. Most shareholders submit to the expertise of management. They don’t even demand their rights as the business owners. Firms whose common shares are selling below liquidation value should liquidate. This is in the best interests of the shareholders. But, this would place management out of a job. Hence, shareholders can’t rely on management to take the correct decision. Investors should learn about management practices. Then they should consider this while making investments.

But, remember that “analysis means careful study of facts”. It involves concluding those facts with sound logic. It’s a scientific method. But, you may face some barriers when analyzing securities. This is because investment is not purely science. Still, the analysis isn’t just helpful, but essential.

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Security Analysis Review

The book “Security Analysis” is continuously getting more attention of readers and still the process of printing is continue due to higher demand of book in the customers. We like the ways that the author mentioned the norms because in business the significant factors are principles of the investment and financial disclosure. We understood interest convergence as Benjamin Graham explained it smoothly. Most of the fundamental analyses of investment we have learned after reading the book. The analytics are income statement, cash flow statement, interpretation of financial statements and margin safety in the book. The book disclosed some cases about the severity that great crash had offered to the investor. In the book, we found some of these chronicled. We were not able to disbelief on some of the opportunities of a day.

The prices of common stocks changes and safety of a bond depend on the two main things including the ability of the investor to pay and the second one was a financial strength. The internal value showed privilege issues for the preferred stocks. We found that my concept about the changes in balance was different up to some extent with the author and he named it portfolio diversification. We have learned about asset values, dividends, and earning in the book and learned the method of common stock earnings. In the security analysis, there are three main functions including selective functions, critical functions, and descriptive functions. The indices of the economic activities were different at some levels for the security prices and sales levels as a crucial concept was mentioned for internal values for the security analysis. The most appealing quote of the book for me was “safety does not reside in titles, or forms, or legal rights, but in the values behind the security issue.”         

Security Analysis Quotes

“An investment in the soundest type of enterprise may be made on unsound and unfavorable terms.”

“Safety does not reside in titles, or forms, or legal rights, but in the values behind the security issue.”

“The fact that no good bonds are available is hardly an excuse for either issuing or accepting poor ones.”

“Needless to say, an investor is never forced to buy a security of inferior grade.”

“The investor cannot safely judge the merits or demerits of a security by his personal reaction to the kind of business in which it is engaged.”

“An institution with securities of its own to sell cannot be looked to for entirely impartial guidance.”

“Whatever benefits a business benefits its owners, provided the benefit is not conferred upon the corporation at the expense of the stock­hold­ers.”

“Undervalued investment issues may be discovered in any period by means of assiduous search.”

“Very frequently, the market’s appraisals are based on mob psychology, on faulty reasoning and on the most superficial examination of inadequate information.”

“You cannot make a quan­ti­ta­tive deduction to allow for an un­scrupu­lous management; the only way to deal with such situations is to avoid them.”

“Modern financing methods are not that far different from a magician’s bag of tricks; they can be executed in full view of the public without it being very much the wiser.”

“The typical American stockholder is the most docile and apathetic animal in captivity. He never thinks of asserting his individual rights as owner of the business.”

“There is very little altruism in finance.”

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About the Authors

Benjamin Graham is seen as the father of modern security analysis. He was also the founder of the value school of investing. Benjamin mainly influenced Warren Buffett and many others. He co-authored The Intelligent Investor and The Interpretation of Financial Statements. David Dodd was Graham’s protégé, and investors and economist. He was also an assistant professor of finance at Columbia University.

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Best Selling Books

SaleBestseller No. 1
Security Analysis: Sixth Edition, Foreword by Warren Buffett (Security Analysis Prior Editions)
365 Reviews
Security Analysis: Sixth Edition, Foreword by Warren Buffett (Security Analysis Prior Editions)
  • McGraw-Hill
  • Benjamin Graham, David Dodd
  • Publisher: McGraw-Hill Education
  • Edition no. 6 (09/25/2008)
  • Hardcover: 700 pages
SaleBestseller No. 2
Security Analysis: Principles and Techniques
365 Reviews
Security Analysis: Principles and Techniques
  • McGraw-Hill
  • Benjamin Graham, David Dodd
  • Publisher: McGraw-Hill Education
  • Edition no. 2 (10/10/2002)
  • Hardcover: 851 pages

Last update on 2018-09-24 / Affiliate links / Images from Amazon Product Advertising API

2 COMMENTS

  1. I agree with you, Earning, dividend, and asset values are the best predictors and indicators for the analysis of the common stock. I read the book of Benjamin Graham before reading this article. Here I would like to share my views. The best way to make Investment in securities is to purchase securities with different trends. The portfolio should be diversified and one must view the previous trends and dividend policies before making the investment.

  2. You are right, security functions are three descriptive, selective function, critical functions. These cover the revenue assets etc. here I want to ask you a question what is the best security for a person who is going to invest for the first time are bonds investment safe for the beginner

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