Security Analysis (book)

Last updated
Security Analysis
Security analysis.jpg
Author Benjamin Graham and David Dodd
CountryUnited States
LanguageEnglish
Subject Finance, Investing
PublisherWhittlesey House, McGraw-Hill Book Co.
Publication date
1934
Pages725
ISBN 0-07-144820-9 (2005 edition)
OCLC 2140220
332.63/2042/0973 22
LC Class HG4521 .G67 1934

Security Analysis is a book written by professors Benjamin Graham and David Dodd of Columbia Business School, which laid the intellectual foundation for what would later be called value investing. The first edition was published in 1934, shortly after the Wall Street crash and start of the Great Depression. Among other terms, Graham and Dodd coined the term margin of safety in Security Analysis.

Benjamin Graham American investor

Benjamin Graham was a British-born American investor, economist, and professor. He is widely known as the "father of value investing," and wrote two of the founding texts in neoclassical investing: Security Analysis (1934) with David Dodd, and The Intelligent Investor (1949). His investment philosophy stressed investor psychology, minimal debt, buy-and-hold investing, fundamental analysis, concentrated diversification, buying within the margin of safety, activist investing, and contrarian mindsets.

David Dodd American educator and economist

David LeFevre Dodd was an American educator, financial analyst, author, economist, professional investor, and in his student years, a protégé of, and as a postgraduate, close colleague of Benjamin Graham at Columbia Business School.

Columbia Business School business school

Columbia Business School (CBS) is the business school of Columbia University in the City of New York in Manhattan, New York City. Established in 1916, Columbia Business School is one of the oldest business schools in the world. It is one of six Ivy League business schools, and has been referred to as among the most selective of top business schools.

Contents

History

Security Analysis was published by McGraw-Hill, and written by David Dodd and Benjamin Graham in the early 1930s, when both authors taught at Columbia University's business school. Writes The New York Times, "it was intended as a common-sense guide for investors but turned out to be a thick textbook that went through five editions and sold more than 250,000 copies [by 1988]." [1] Economist Irving Kahn was one of Graham's teaching assistants at Columbia University in the 1930s, and made research contributions to Graham's texts for Security Analysis. [2]

Columbia University Private Ivy League research university in New York City

Columbia University is a private Ivy League research university in Upper Manhattan, New York City. Established in 1754, Columbia is the oldest institution of higher education in New York and the fifth-oldest institution of higher learning in the United States. It is one of nine colonial colleges founded prior to the Declaration of Independence, seven of which belong to the Ivy League. It has been ranked by numerous major education publications as among the top ten universities in the world.

Irving Kahn American value investor and money manager

Irving Kahn was an American investor and philanthropist. He was the oldest living active investor. He was an early disciple of Benjamin Graham who popularized the value investing methodology. Kahn began his career in 1928 and continued to work until his death. He was chairman of Kahn Brothers Group, Inc., the privately owned investment advisory and broker-dealer firm that he founded with his sons, Thomas and Alan, in 1978.

Content

First edition

The work was first published in 1934, following unprecedented losses on Wall Street. In summing up lessons learned, Graham and Dodd scolded Wall Street for its focus on a company's reported earnings per share, and were particularly harsh on the favored "earnings trends." They encouraged investors to take an entirely different approach by gauging the rough value of the operating business that lay behind the security. Graham and Dodd enumerated multiple actual examples of the market's tendency to irrationally under-value certain out-of-favor securities. They saw this tendency as an opportunity for the savvy.[ citation needed ]

Wall Street street in Manhattan

Wall Street is an eight-block-long street running roughly northwest to southeast from Broadway to South Street, at the East River, in the Financial District of Lower Manhattan in New York City. Over time, the term has become a metonym for the financial markets of the United States as a whole, the American financial services industry, or New York–based financial interests.

In Security Analysis, Graham proposed a clear definition of investment that was distinguished from what he deemed speculation. It read, "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative." [3]

A number of financial terms were coined in the book. For example, Graham and Dodd coined the term margin of safety in Security Analysis.[ citation needed ] It is not known when the Period of financial distress phrase was first used or by whom. However, it or phrases closely equivalent were almost certainly first used in connection with the theory of value investing as developed initially by Graham in Security Analysis in 1934.[ citation needed ]

Margin of safety is the difference between the intrinsic value of a stock and its market price.

A period of financial distress occurs when the price of a company or an asset or an index of a set of assets in a market is declining with the danger of a sudden crash of value occurring, either because the company is experiencing increasing problems of cash flow or a deteriorating credit balance or because the price had become too high as a result of a speculative bubble that has now peaked.

Value investing is an investment paradigm that involves buying securities that appear underpriced by some form of fundamental analysis. The various forms of value investing derive from the investment philosophy first taught by Benjamin Graham and David Dodd at Columbia Business School in 1928, and subsequently developed in their 1934 text Security Analysis.

Later editions

In The Intelligent Investor, Benjamin Graham describes a Benjamin Graham formula he used to value stocks. The formula as described by Graham in the 1962 edition of Security Analysis, is as follows:

The Benjamin Graham formula is a formula proposed by investor and professor of Columbia University, Benjamin Graham, often referred to as the "father of value investing". Published in his book, The Intelligent Investor, Graham devised the formula for lay investors to help them model growth formulas in vogue at the time of the formula's publication.

V = Intrinsic Value
EARNINGS = Trailing Twelve Months Earnings
8.5 = P/E base for a no-growth company
g = reasonably expected 7 to 10 year growth rate

Where the expected annual growth rate "should be that expected over the next seven to ten years." Graham’s formula took no account of prevailing interest rates.

Market application

The book represents the genesis of financial analysis and corporate finance. However, by the 1970s, Graham stopped advocating a careful use of the techniques described in his text for security analysts in selecting individual stock investments, citing that "in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent I'm on the side of the "efficient market" school of thought now generally accepted by the professors." [4] Graham stated that the average manager of institutional funds could not obtain better results than stock market indexes, since "that would mean that the stock market experts as a whole could beat themselves — a logical contradiction." [4] Regarding portfolio formation, Graham suggested that investors use "a highly simplified" approach that applies one or two criteria to security prices "to assure that full value is present," relying on the portfolio as a whole rather than on individual securities. [4]

Reception and impact

"The Superinvestors of Graham-and-Doddsville" is a 1984 article by Warren Buffett promoting value investing, which was based on a speech given on May 17, 1984, at the Columbia University School of Business in honor of the 50th anniversary of the publication of Security Analysis. Using case studies, the speech and article challenged the idea that equity markets are efficient. Buffett brought up 9 investors whom he considered direct protegés of Graham and Dodd, and using their finances, then argued that "these Graham-and-Doddsville investors have successfully exploited gaps between price and value," despite the inefficiency and "nonsensical" nature of the pricing of the overall market. [5] Buffett concluded in the 1984 article that "some of the more commercially minded among you may wonder why I am writing this article. Adding many converts to the value approach will perforce narrow the spreads between price and value. I can only tell you that the secret has been out for 50 years, ever since Ben Graham and Dave Dodd wrote Security Analysis, yet I have seen no trend toward value investing in the 35 years I've practiced it. There seems to be some perverse human characteristic that likes to make easy things difficult. The academic world, if anything, has actually backed away from the teaching of value investing over the last 30 years. It's likely to continue that way. Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper." [5]

The CFA Institute in 2012 wrote that "The roots of value investing can be traced back to the 1934 publication of Benjamin Graham and David Dodd’s classic, Security Analysis. Graham later disseminated his views to the general public in the highly regarded book The Intelligent Investor. The influence of Graham’s methodology is indisputable." [6] In 2015, The Wall Street Journal wrote that Security Analysis "is widely viewed as the urtext of modern value investing. The long-held idea is that some stocks trade significantly below an identified “intrinsic value” and can be bought at a discount, with a built-in margin of safety against a complete washout." [7] In 2016, Fortune called the book "still the best investment guide" and noted its "extraordinary endurance." The article states that "Graham, the primary author, then an obscure professor and money manager, chose the Great Depression as the time to assert his faith in patient security analysis and long-term investing. Given that the market was in the throes of an epochal collapse, very few folks were interested in investing. But Graham had the courage to see through the moment." Fortune also argues that one reason the book remained popular is that "it proffered an irreplaceable approach to investment. Stocks were to be valued as a shares of a business, bought and sold on that basis. No one contemplating the purchase of a family farm pondered the market trend or the latest jobs report; so should it be with common stocks." [8]

Domestic editions

Black bound cover (1st printing) was printed by The Maple Press Co., York, PA, for a small distribution in the United States
Maroon bound cover (2nd printing) was published that same year for sale abroad, The Maple Press Co., York, PA
Reprint 3rd ed. (May 1976) McGraw-Hill - ISBN   0-07-023957-6
Reprint 1st ed. (October 1, 1996) McGraw-Hill - ISBN   0-07-024496-0
Reprint 1st ed. (February 1, 1997) McGraw-Hill - ISBN   0-07-024497-9
Reprint 2nd ed. (October 10, 2002) McGraw-Hill - ISBN   0-07-141228-X
Reprint 3rd ed. (December 10, 2004) McGraw-Hill - ISBN   0-07-144820-9
Limited Leatherbound Edition (September 19, 2008) McGraw-Hill - ISBN   0-07-162357-4

See also

Related Research Articles

Fundamental analysis analysis of a businesss financial statements

Fundamental analysis, in accounting and finance, is the analysis of a business's financial statements ; health; and competitors and markets. It also considers the overall state of the economy and factors including interest rates, production, earnings, employment, GDP, housing, manufacturing and management. There are two basic approaches that can be used: bottom up analysis and top down analysis. These terms are used to distinguish such analysis from other types of investment analysis, such as quantitative and technical.

To invest is to allocate money in the expectation of some benefit in the future.

<i>The Intelligent Investor</i> 1949 book by Benjamin Graham

The Intelligent Investor by Benjamin Graham, first published in 1949, is a widely acclaimed book on value investing.

Growth investing is a style of investment strategy focused on capital appreciation. Those who follow this style, known as growth investors, invest in companies that exhibit signs of above-average growth, even if the share price appears expensive in terms of metrics such as price-to-earnings or price-to-book ratios. In typical usage, the term "growth investing" contrasts with the strategy known as value investing.

Lawrence A. Cunningham is an American scholar, an author of corporate governance and investing books, and the Henry St. George Tucker III Research Professor of Law at George Washington University. In 2018, he received the Kenneth D. West Lifetime Achievement Award from the National Association of Corporate Directors (NACD), in recognition of his board service, board advice, and research on corporate governance.

<i>A Random Walk Down Wall Street</i> book by Burton Malkiel

A Random Walk Down Wall Street, written by Burton Gordon Malkiel, a Princeton economist, is a book on the subject of stock markets which popularized the random walk hypothesis. Malkiel argues that asset prices typically exhibit signs of random walk and that one cannot consistently outperform market averages. The book is frequently cited by those in favor of the efficient-market hypothesis. As of 2019, there have been twelve editions and over 1.5 million copies sold. A practical popularization is The Random Walk Guide to Investing: Ten Rules for Financial Success.

Financial statement analysis

Financial statement analysis is the process of reviewing and analyzing a company's financial statements to make better economic decisions to earn income in future. These statements include the income statement, balance sheet, statement of cash flows, notes to accounts and a statement of changes in equity. Financial statement analysis is a method or process involving specific techniques for evaluating risks, performance, financial health, and future prospects of an organization.

"The Superinvestors of Graham-and-Doddsville" is an article by Warren Buffett promoting value investing, published in the Fall, 1984 issue of Hermes, Columbia Business School magazine. It was based on a speech given on May 17, 1984, at the Columbia University School of Business in honor of the 50th anniversary of the publication of Benjamin Graham and David Dodd's book Security Analysis. The speech and article challenged the idea that equity markets are efficient through a study of nine successful investment funds generating long-term returns above the market index. All these funds were managed by Benjamin Graham's alumni, pursuing different investment tactics but following the same "Graham-and-Doddsville" value investing strategy.

Charles H. Brandes is an American investor, businessman, and philanthropist. He is a disciple of the Benjamin Graham school of value investing. Brandes Investment Partners, which was started in 1974, currently has over $28.9 billion under management and is based in San Diego, California. In the Forbes 400 Richest Americans publication for 2007, Brandes ranked 165.

Walter Schloss American investor

Walter J. Schloss was an American investor, fund manager, and philanthropist. He was a well-regarded value investor, as well as a notable disciple of the Benjamin Graham school of investing. He died of leukemia at the age of 95.

Gerald Loeb was a founding partner of E.F. Hutton & Co., a renowned Wall Street trader and brokerage firm. He was the author of the books The Battle For Investment Survival and The Battle For Stock Market Profits. Loeb promoted a view of the market as too risky to hold stocks for the long term in contrast to well known value investors. He also created the Gerald Loeb Award, given annually for excellence in various categories of financial journalism.

The price-to-book ratio, or P/B ratio, is a financial ratio used to compare a company's current market price to its book value. It is also sometimes known as a Market-to-Book ratio. The calculation can be performed in two ways, but the result should be the same each way. In the first way, the company's market capitalization can be divided by the company's total book value from its balance sheet. The second way, using per-share values, is to divide the company's current share price by the book value per share.

Quantitative value investing, also known as systematic value investing, is a form of value investing that analyzes fundamental data such as financial statement line items, economic data, and unstructured data in a rigorous and systematic manner. Practitioners often employ quantitative applications such as statistical / empirical finance or mathematical finance, behavioral finance, natural language processing, and machine learning.

The net current asset value (NCAV), commonly referred to as the Cigar Butt Investment Strategy, is an investment technique outlined by Benjamin Graham in Security Analysis.

References

  1. Obituary, David Dodd, The New York Times, September 20, 1988
  2. "IRVING KAHN's Obituary on New York Times". New York Times. www.legacy.com. Retrieved 18 November 2016.
  3. Benjamin Graham, The Intelligent Investor , 4th ed., 2003, chapter 1, page 18.
  4. 1 2 3 Financial Analysts Journal . A Conversation With Benjamin Graham. 1976.
  5. 1 2 Buffett, Warren (2004). "The Superinvestors of Graham-and-Doddsville". Hermes: the Columbia Business School Magazine: 4–15.
  6. L. Moy, Ronald (January 19, 2012), Book Review: Ben Graham Was a Quant, CFA Institute blog
  7. Weinberg, Ari I. (September 8, 2015), Can an Index Fund Deliver the ‘Value’?, The Wall Street Journal
  8. Lowenstein, Roger (June 25, 2016), "Why Index Fund Investing Isn't Always the Answer", Fortune