Martin J. Whitman - Modern Security Analysis: Understanding Wall Street Fundamentals

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Copyright 2013 by Martin J. Whitman and Fernando Diz. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Whitman, Martin J.
Modern security analysis : understanding Wall Street fundamentals / Martin J. Whitman, Fernando Diz.
pages cm. (Wiley finance series)
Includes index.
ISBN 978-1-118-39004-7 (cloth); 978-1-118-60265-2 (ebk); 978-1-118-60301-7 (ebk); 978-1-118-60338-3 (ebk)
1. Investment analysis. I. Diz, Fernando, 1956. II. Title.
HG4529.W487 2013
332.632042dc23

2013000737

To the Deans, Faculty, Staff, Students and Alumni of

The Whitman School of Management

at

Syracuse University

Acknowledgments

There are so many people who contributed to our knowledge, and to the specifics of this book, that it is impossible to acknowledge and thank all of them. We have singled out a few names but in doing so have no intent of shortchanging those contributors who we fail to mention.

At Syracuse University we are especially grateful for the help and advice given to us by Deans Mel Stith and Tom Foley; Professors Bill Walsh and Randy Elder; students in the Orange Value Fund programall at the Whitman School of Management; University Trustees and alumni Dick Haydon, Steve Ballentine, Bernard Kossar, Mike Dritz, John Couri, Steve Barnes, Ken Goodman, and Jay Genzer.

At Third Avenue Management, we benefited much from advice rendered by David Barse, Tom Gandolfo, Vinny Dugan, and Hal Drachman. Bridget Wysong also was helpful. This book never would have seen the light of day without the herculean efforts of Beth Connor, executive assistant to Martin Whitman and Betty Ross, administrator of the Ballentine Investment Institute and the Orange Value Fund program coordinator at the Whitman School of Management.

One faculty member at Syracuse University Law School, Gregory Germain , and two at the Yale University School of Management, Stan Gartska and Martin Shubik, have to be singled out for their contributions. Others worthy of mention are Ronnie Chan, Bruce Flatt, Bruce Greenwald, and Arnie Jacobs.

It ought to be noted that both of us learned a lot from people we came to believe were bad guys and with whom we would never again invest. We wont name names but rather just acknowledge that one tends to learn more from ones mistakes than from ones successes.

Also, our students at Syracuse, Yale, and Columbia contributed much to our knowledge. Quite possibly we learned more from them than they learned from us.

Finally, thanks to our families, especially Lois Whitman and Josefa Alvarez.

The errors and shortcomings of this book belong to us alone, not at all to the various contributors.

Martin J. Whitman
Fernando Diz

Introduction

OUR FOCUS

This book is different from other books published about securities investing, securities trading, and academic finance as embedded in modern capital theory (MCT). It seems to us that all other books on investing and academic finance ranging from Principles of Corporate Finance (McGraw-Hill, 2002) by Brealey and Myers to Security Analysis: Principles and Technique (America Media International, reprinted 2003) by Graham, Dodd, and Cottle (G&D), and to tracts on trading techniquesfocus on forecasting and explaining short-run market prices, especially prices at which securities are traded in markets populated by outside passive minority investors (OPMIs). This book, in sharp contrast, focuses strictly on explaining and understanding commercial enterprises and the securities they issue. For us, short-run market prices in OPMI markets are so-called random walks except for the special cases of sudden-death securities such as options, warrants, certain convertibles, and risk arbitrage situations where there will be relatively determinate workouts in relatively determinate periods of time.

It seems to us that our approach became more relevant as a consequence of the 20082009 meltdown, whereas MCT and G&D approaches became less relevant.

In this book the emphasis is on creditworthiness rather than earnings and cash flows, the appraisals of managements not only as operators but also as investors and financiers, and understanding the motivations and practices of activists.

CREDITWORTHINESS

Throughout the book we emphasize the importance of creditworthiness. Three elements go into the determination of creditworthiness for functional purposes: