Sunday, September 17, 2006

Interesting opinions, thoughts and Ideas of Graham and Dodd

I have an invitation to present the ideas and methods of Benjamin Graham to associates of two broking companies in Mumbai. To do this in a better manner, I started study of the 2nd edition of Security Analysis by Graham and Dodd. I thought it would be a good idea to post the ideas that I feel are important in this round of my study in this blog. I request the readers/viewers to present their reactions to these ideas.

From Security Analysis, Graham and Dodd, Second Edition, McGraw-Hill Book Company

Page 13

The numerous issues selling below net current asset value, even in normal markets, are a powerful indication that Wall Street’s favoritism has been overdone.

Page 15

Traditionally the investor has been the man with patience and the courage of his convictions who would buy when the harried or disheartened speculator was selling. If the investor is now to hold back until the market itself encourages him, how will be distinguish himself from the speculator, and wherein will he deserve any better than the ordinary speculator’s fate?

Page 16

Our search for definite investment standards for the common-stock buyer has been more productive of warnings than of concrete suggestions. We have been led to the old principle that the investor should wait for periods of depressed business and market levels to buy representative common stocks, since he is unlikely to be able to acquire them at other times except at prices that he future may cause him to regret. On the other hand, the thousands of so-called secondary companies should offer at least a moderate number of true investment opportunities under all conditions, except perhaps in the heyday of a bull market. This wide but quite unpopular field may present the more logical challenge to the interest of the bona fide investor and to the talents of the securities analyst.

Page 20

We must recognize, however that intrinsic value is an elusive concept. In general terms it is understood to be that value which is justified by the facts, e.g., the assets, earnings dividends, definite prospects, as distinct, let us say, from market quotations established by artificial manipulation or distorted by psychological excesses.

Page 21

Sometime ago intrinsic value (in the case of common stocks) was thought to be about the same thing as “book value,” i.e., it was equal to the net assets of the business, fairly priced. This view of intrinsic value was quite definite, but it proved almost worthless as a practical matter because neither the average earnings nor the average market price evinced any tendency to be governed by the book value.

Hence this idea was superseded by a newer view, viz., that the intrinsic value of a business was determined by its earning power.

This means that the concept of “earning power,” expressed as a definite figure, and the derived concept of intrinsic value, as something equally definite and ascertainable, cannot be safely accepted as a general premise of security analysis.

Page 22

Let us try to formulate a statement of the role of intrinsic value in the work of the analyst
which will reconcile the rather conflicting implications of our examples. The essential point is that security analysis does not seek to determine exactly what is the intrinsic value of a given security. It needs only to establish either that the value is adequate-e.g., to protect a bond or to justify a stock purchase-or else that the value is considerably higher or considerably lower than the market price. For such purposes an indefinite and approximate measure of the intrinsic value may be sufficient. To use a homely simile, it is quite possible to decide by inspection that a woman is old enough to vote without knowing her age or that a man is heavier than he should be without knowing his exact weight.

Page 29
In anticipation of amore detailed inquiry in a later chapter, we have assumed throughout this chapter that investment implies expected safety and speculation connotes acknowledged risk.

Page 37

The analyst must pay respectful attention to the judgment of the market place and to the enterprises which it strongly favors, but he must retain an independent and critical viewpoint. Nor he should he hesitate to condemn the popular and espouse the unpopular when reasons sufficiently weighty and convincing are at hand.

Page 43

It follows that the qualitative factor in which the analyst should properly be most interested is that of inherent stability.

But in our opinion stability is really a qualitative trait, because it derives in the first instance from the character of the business and not from its statistical record.

Page 44

To sum up this discussion of qualitative and quantitative factors, we may express the dictum that the analyst’s conclusions must always rest upon the figures and upon established tests and standards. These figures alone are not sufficient; they may be completely vitiated by qualitative considerations of an opposite import. A security may make a satisfactory statistical showing, but doubt as to he future or distrust of the management may properly impel its rejection. Again, the analyst is likely to attach prime importance to the qualitative element of stability, because its presence means that conclusions based on past results are not so likely to be upset by unexpected developments. It is also true that he will be far more confident in his selection of an issue if he can buttress an adequate quantitative exhibit with unusually favorable qualitative factors.

But whenever the commitment depends to a substantial degree upon these qualitative factors-whenever, that is, the price is considerably higher than the figures alone would justify-then the analytical basis of approval is lacking. In the mathematical phrase, a satisfactory statistical exhibit is a necessary though by no means a sufficient condition for a favorable decision by the analyst.
Narayana Rao
Sunday, 17 Sep 2006, 3.45 p.m.

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