Benjamin Graham - Security Analysis

This chapter is from Security Analysis, which has withstood the test of time as well or better than any investment book ever published. Now the Sixth Edition updates the masters ideas and adapts them for the 21st centurys markets. This second edition, which was published in 1940 and still considered the definitive edition, has been updated by a dream team of some of todays leading value investors. Featuring a foreword by Warren E. Buffett (in which he reveals that he has read the 1940 masterwork at least four times), this new edition of Security Analysis will reacquaint you with the foundations of value investingmore relevant than ever in the tumultuous 21st century markets.

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In value-investing circles, you meet many people who claim to have been inspired by what Benjamin Graham and David Dodd wrote in Security Analysis. Most are, at the very least, stretching the truth. A fair number of aspiring and practicing value investors may indeed have devoured The Intelligent Investor. But I would wager that few have actually dug deeply into Security Analysis and fewer still have read the classic cover to cover. I have to confess that although I had delved into various parts of Security Analysis, I had never read it from first page to last. So when I was asked to write an introduction to covers a lot of ground: the valuation of warrants; the potential decrease in the value of a companys common stock when it issues options to management; the shortcomings of relative value analysis; and the greed of investment bankers. In the 75 years since the original edition was published, both the world at large and the financial markets have undergone cataclysmic change. Yet, as Graham and Dodd understood, how markets work, how companies are run, and how peopleboth investors and corporate managerstend to act in certain situations never change.

The world likes to categorize things, including investing styles, in neat little boxes. So it is that the financial media frequently label market participants as value, growth, or momentum investors. Thats all fine, but I can tell you that Ive observed a great many investors over the years, and Ive never seen a consistently successful one whose strategy was not based on a value approachpaying less for something than it is worth, either today or in the future. True, some people like to buy things that will grow and others are drawn to assets that beckon from the bargain counter, while still others like to engage in arbitrage activities, buying one thing and selling another to profit on the price differential, or spread. But every successful investor Ive ever known makes a calculation that compares an assets purchase price to its present or future value.

Whatever their approach, countless investors have used the principles laid out in Security Analysis to uncover bargains. Scads of people have become wealthy doing so, including many of the contributors to this revised edition, not to mention all the people who were smart enough to buy Berkshire Hathaway years ago. Their success is a testament to value investings glorious past. But what about its future? Is the road ahead bright and prosperous? Or is it bleak and beggarly? Are there more people practicing Ben Grahams underlying principles than there are bargains for them to find? Is there just too much money chasing a finite supply of bargains? Or might a serious security analyst still be able to prosper over time?

I am optimistic about the future of value investing. To be sure, there are many bright and savvy people in the financial markets employing Graham and Dodds techniques, but the markets themselves have grown exponentially. The chunk of capital being invested by the value-investing crowd is a small percentage of the overall capitalization of global financial markets. Having observed the markets for more than two decades, my sense is that, rather than a glut of Graham and Dodd acolytes picking through scarce opportunities to find a place for their cash, money is ever more prone to sloshing around in giant waves, flowing from one fad to the next. If anything, it seems that the people controlling these mega-sums have become less intelligent and less sophisticated over time. The last decade alone has brought incredible extremes in valuation, starting in 1999 and 2000 with the high-altitude Internet bubble that was followed in short order by the utter collapse of the tech market. In the summer of 2002, we witnessed a tremendous corporate debt meltdown. But soon, these excessively low valuations were pushed off the front pages by the most generous and lax lending standards of all time. Now, as I write this introduction, the mortgage market is imploding, creating perhaps yet another new set of opportunities. That weve seen the last of these extreme swings seems doubtful.