Bond real estate : Relation Value of Property to the Funded Debt

hello friends, today, article we see the bond real estate from Security analysis book chapter 10, Specific standard for bond Investment ( continued). In this chapter, we see Criteria 6: Relation of the Value of property to the funded debt. so let’s see the bond of real estate.

Previous Chapter 9

Bond real estate
Criteria 6:- Relation of the value of property to the funded debt (bond real estate)

As discussed soundness of bond investment depends on the oblique corporation to take the core of its depts, rather than the value of the property on which the bond has a lien.

so we say before that if a company fails, then their properties value also decreases.

so New York Statutes Recommend that the properties value is more than the 66.67% of bond issues.

let’s see an example to understand it

if Bond issued $100 million of any company, then properties value is about $167 million dollars.

so the author explains some special cases in that we have to consider the value of properties.

Some Special Cases:-bond real estate

1 ) Equipment Trust Obligations:

These issues issued by the railroad and also called as equipment trust certificate

In this case, we kept some mortgage for this valuation so railroad companies kept the locomotive like the engine of the railway and their parts as a mortage.

this type of investment company kept and then, they issue the debt.

so in this, we have to consider the Value Because, this instrument, that companies kept as a mortgage, and they are movable and they have their sellable price ( value) because any other companies railway use this type of assets.

If company fail, then does affect on that, because we can see this to other company and get the money.

2) Collateral-Trust Obligation:-bond real estate

In this, company issue, the debt and kept as mortgage as a security purpose, that company, buy that security

means, those are investment trusts, that trust company buy the security of other company and kept their security as mortgage and issue the debt for himself.

In this companies portfolio, we know the market value of the company and we can give them loans while considering their value.

3) Real- Estate bond:

In this case, the main criteria is that how much properties value.

The company gives loans, only 66.67% of the Properties value.

so property fair value matters

so let’s see how we get the property fair value from earning power.

For this, the author gives simple examples, how do we give the loan on properties?

Example, 

A home cost is about = $10,000

Rental Value is about = $1200

On the rent, you have to pay the Tax and whatever operation cost, you have to pay

so after this by paying tax and operation cost from $1200

your net income is about = $800

5% mortage, you get on that house, up to 60% of the value of properties, i.e. $6000

so 5% of $6000 = $300

so your coverage ratio is = $800 / $300  = 2.67 X

 

but any industrial plant they want to issue debt by they want from us

for this, we have to keep more coverage ratio, because, on that plant, this much rental value does not get us.

so after these special cases, the author gives the 7 things on Real Estate bond

Things to consider when dealing with these bonds:

1 ) Properties value increases, then rental value Increases:

If properties value decreases, then rental value also decreases

if this does not happen, then people directly buy the house instead of staying in rent, because properties value decrease but rental value increases

so Properties value increases, then rental value Increases.

2) Misleading character of Appraisals:

If sometimes, the real-Estate boom comes, then properties prices ( value) Increases.

so you have to consider those values of experienced buyers and lenders instead of the booming price of properties.

That experienced buyer wants to buy on the price, that price we have to consider instead that, we can think that if that much price is on booming time is have, then we can buy this property or not if the answer is no then don’t buy on that price.

or you can ask your friends, that price of booming time and they are comfortable to buy that price.

so let’s understand with examples

e.g. the building making cost is about $1 million and in boom time, their price increases after building full develop up to $1.5 million,

so 50% profit on making time of that building.

so let’s see a third thing or bond real-estate

3) Abnormal rental, used as a basis for Valuation:-bond real estate

let’s understand this thing, from previous examples, so property value increases 50% means, Original value is $ 1 million and in boom time is about $1.5 million

so your properties rental is abnormally high, so you have to correct them and adjust to the downside.

so in this problem is

If you get a high return i.e. 50% increase so people, try to make the building. and more and more building is developed then supply increases then all building prices suddenly goes down,

so abnormal rental, used as a basis for valuation.

4) Debt based on excessive construction cost:

in boom time, the company can issue more debt, in this boom time

because, properties construction cost is higher because, the demand for making houses is increased, so construction suppliers also increase the rate.

suppose, a cost increase of making houses is about $100 million

so now boom time, their cost is about $200 million

so you can give a loan as per the 60% rule, which is about $130 million

while properties value in boom time is $200 million but their actual price is about $100 million

so $100 million is 60% is about $60 million and you give the loan on that properties is about $130 million means your debt given that properties are not safe, and logically they did not come in 60% rule of properties.

Because, when the value of properties comes to their original fair price, then you are already paying more loan than their fair price of whole properties and loan criteria is up to 60% but you give the $130 million means more 113% of properties.

so debt is based on excessive construction costs, you have to consider this.

5) Weakness of specialized buildings:

In this people make the mistake is that the apartment house, office, storehouse, clubs, the church building

so in this people make the mistake is, they don’t differentiate between them but they have different values.

so in this, you have to treat differently because in this we can not dispose of easily while considering same value

or

this value depends on those companies they have it and they become successful, or not depends on their own value.

those are apartment buildings, they do not depend on that company, because this any can use.

for this, you have to ask for the maximum margin of safety

so for this is good that 50% margin of safety on properties on the loan amount,

in this, you have to ask for a 100% margin of safety.

so this is important is that you have to consider the weakness of specialized buildings.

6) Value-Based on initial rental misleading:

At some time, we take the initial rent for valuing properties, but those are new building their rental obviously is more

so instead of that we have to think like that while considering the new building rent instead that we have to consider after this building is old, what are the rent of this building and that rent we have to consider.

and we can approve.

because initial rent is not for the long term.

 

7) Lack of financial Information:

In real estate financing, the main character is, they sell the bond to the public but, they hold the stocks privately.

so companies issue, the bond, then they forgot about the bond and bondholders.

and they do not offer any financial data to the bondholder.

so this end some exception and some special case

after that author give their own suggestions

The Author suggestion:

  • The amount of loan is never over 66.675 of the value of the property (2/3)
  • Value of property must not reflect recent speculative inflation ( booming value consideration not allowed, what come after long term that only allowed)

or you can see, how much you pay for buying that  or any other experience buyer and lender, how much pay for that

  • the property value is more than 50% of the loan value.
  • Income account you have to see in that you know when vacancy is available and what is losses or rental rate decline what happen building when they become old.
  • The income coverage ratio is twice and income is after consideration depression.
  • You have to consider depression, because, the property becomes depressed or not any reason like this does not charge or they firstly spend on that so this is not considered the reason. so this type of stupidity doesn’t do.
  • buy when bond, then borrower must agree to supply bondholder with regular operating and financial statement.

If those are company that deals with the hotel, garage

so for this, you have to provide loan when this hotel is running well. if they are new so don’t make the deal

if they have a successful record then only give.

  • Investor should be satisfied with the location and type of building

These are the most important things, the large loss probability in unfavorable conditions.

for this point, understanding the author gives the example

In 1933 after conditions going to improve, but those are a financial district of new york, their activity is less and that reason people gets loses and rental rate also decline so location matters most.

  • the author also talks about financial instruments i.e. first leasehold Mortage

In this, the land has another owner and we build the building on that land.

but we pay regular payment to the landowner

so those companies build the building on that land, this land is the first mortage bond for that company.

but this is not actually the first mortage for you because first mortage of ground to the company is not for you and ground rent this company have to pay

interest coverage ratio = ground rent + interest expenses of the building increases the cost

 

so this is all bout the bond real estate and also chapter 10 of the security analysis book.

Investment Grade Corporate Bonds

Hello friends, in today’s article we see Investment Grade Corporate Bonds and their specific standard for bond investment ( criteria 3, 4 & 5) from chapter 9 of the Security Analysis book. so let’s see one by one criterion

Previous Chapter 8

Investment Grade Corporate Bonds
Specific Standard for Bond Investment continued ( criteria 3, 4, and 5):-Investment Grade Corporate Bonds

In this chapter we see the three types of criteria and what told by the New York statute and Benjamin Graham what advice us. so let’s start with this

Criteria 3: Provision of Issues :-Investment Grade Corporate Bonds

In these provision means, what are the Characteristics of Bonds, and what condition that affect the interest rate and what happens effect of maturity on bond character and their price.

so those things come in bond Indenture that come also inn this means provision of issues

and What is the seniority of bond, and what are their mortgage debenture, so this all comes in the provision of issues.

Those are the New York Statute, that we talk earlier,

so they only allow mortgage secure bonds from public utility groups and not allowed debentures.

so debentures are allowed only for railways but not a public utility.

On this point, the author says, ” Unsecured bond issues of any groups without any reason, reject them is not right, whatever the lien on the company, so nothing happen.”

The debenture is also one type of liens like unsecured debt, and junior lien, and above this, the mortgage bond is also present. (Investment Grade Corporate Bonds)

then the author says, ”  those are investors they are more attachment with maturity debt. so those are short maturity”

they are safer Because your maturity comes near, and those are long maturity people they are a risky bond investment.

but the author says, ” this type of thinking is very wrong”

Because, of that, so those are short maturity, they have to refinance and the company needs good cash to repay for those are short maturity that comes as an obligation to the company.

or if they have strong financial and good earning power, then they can issue new bonds and raise the fund.

so some companies do issue short maturity because they don’t have a good credit rating to issue long-term maturity bonds. (Investment Grade Corporate Bonds)

so this type of company, most of the time gets the trouble for investors.

then author discusses some examples in that author takes the short and long issue of the same bond.

For Examples.

In 1932,

the Bond is First 5s, this bond short maturity in 1934 and long term maturity in 1944.

so in this bond, only maturity difference occurs all rating and coupon rates are the same.

First 5s means,  they are first in seniority of bonds, and 5s means 5% coupon rate, if 5s instead that 6s means 6% coupon rate.

Debenture means, they are unsecured

So Due to 1934 means, maturity in 1934

Due to 1944 means, maturity in 1944

I hope basic terminology you understand

let’s come with examples

so those short bonds which mature in 1934, their price is $96.5, and those 1944 long term mature bond price is $35.

means those are mature in 1934, they, you can buy on $96.5 and those are mature in 1944 their price, so you can buy is $35. (Investment Grade Corporate Bonds)

so what happened in 1934, the company pay off the short-term maturity bonds by the company.

so those issue of 1944, their price increases up to $91.

so this long-term bond ( 1944) is a good opportunity because in this principle profit we get.

the author gives another example

Secured 6.5s, and their maturity in 1933 and secured 6.5s, their maturity for the long term in 1935.

The price of the short-maturity bond is $94 and

Long maturity bond price is $43

so this both issues, company payoff at maturity

so in this also long term issue is a good opportunity to investment

because you get the cheap price of a long-term maturity bond.

Other issues

In 1938 First 5s bond, price is $99.88 and they mature in 1944

First 5s bond, for long term maturity in 1954 bond price is $45

so both are default in 1939, before his maturity. (Investment Grade Corporate Bonds)

those are price is $99.88 decrease to $36

and the price of long term maturity bonds decreases to $20

so those are very expensive and short term maturity bonds, their price is highly falling than long term maturity bonds.

so like this author gives the two and three examples

the author also says, ” Is this is not meaning to buy maturity bond that is cheap and long term bond, just because they are cheap.”

so seeing Safety is important, if safety standards, we have to satisfy, if the company does not satisfy with the safety standard, then we don’t have to buy that bond, because we are not benefiting and taking the risk of losing principal.

this is all come in criteria 3

so let’s see criteria 4

Criteria 4: Record of interest and Dividend payments :-Investment Grade Corporate Bonds

so start with as per the New York Statutes

  • The bonds of state say, ” those are bond, they don’t have to be default in a single year of a 10-year lifespan
  • The Municipalities says, ” Not default for previous 25 years.”
  • The bond of Railroads says, ” Not defaulted for previous 6 years”
  • The bond of Public Utilities says, ” not defaulted for previous 8 years”

So after this new york statute rules, then the author says, ” suppose there are new municipalities establish, then according to them then, don’t get the finance, and they can’t wait for 25 years, so those are new states, they can’t wait for 10 years if they follow the rules of New York statutes. means, they don’t get finance.”

So those default in 10 years or 25 years, then they don’t get the finance if we follow the new york statutes.

Then for this, The author says, ” This is the different stringent rule, so what is a solution or so for this, buy the high coupon rate bond, then you have the risk of principal loss. (Investment Grade Corporate Bonds)

So the author says, “this is not a good idea just like before say so many times”

so right way is the author says, ” you have to stringent your own standard because those happen failure in 25 years of companies part to compensate with them your stringent standard.”

Like see this thing,

the city or state what if they rehabilitate, their and reduce the expenditure and increases the Tax rate to collect maximum revenue and also minimize the debt and reorganization of corporate in companies.

so this thing you have to see to invest in their bonds,

So then you ask for a higher yield is not because you have a loss of principle instead that to satisfy yourself.

So before is bad, and I take high yield, so this listening looks, weird.

but the author says, that

so let’s talk about dividend Record

Dividend Record:

Dividend record is company pay the dividend record before 5 years, in past.

so the myth is that those are companies that pay the dividend, they are strong companies

so this looks logically good, because if the company has money, then only they pay the dividend.

So the company has money and they issue a bond, and bond investment is also good.

so then the author says, ” company pays the dividend regularly, then we only know that companies financial strength is good, but those are bondholder,

they don’t have any direct benefit instead that they got the loss because, companies resources are used by the common stockholder, and companies cash is payable to the stockholder,

so in future, some difficulties come, then companies don’t have the cash to pay for bondholders.

so this thing, you can know from companies balance sheet that company is sound, so that necessary to pay a dividend, so they have money to pay dividend bu they not paying, so this thing is better than paying a dividend.

so in dividend-paying companies have this advantage is, if company cancel the dividend, then we know companies in the future have some difficulties so that line company concern the dividend because, their problem in future performance. (Investment Grade Corporate Bonds)

But, in this have difficulty is if some company perform bad and condition is weak bu they pay the dividend because, their credit rating is going low so this is very dangerous things, we have to stay attentive on that.

so summary of dividend criteria is those companies pay the dividend, they have some condition, we have to see that condition, and what benefited to the bondholder, then only you have to invest in that companies bond.

so let’s talk about criteria 5

Criteria 5: Relation of Earnings to interest requirement

This is also, interest coverage ratio, and this is also interest earing multiple)

to this is important, so this called as Margin of safety.

So what say New York Statutes

Railroad ( Mortage bonds):

on this, the New York Statute says, 1.5X of earning interest charges in past 6 years out 5 individuals year.

so means, In the past 6 years, in 5 years the interest coverage ratio is 1.5X

or

The recent year is important and there are the first year and remaining 5 years in that any 4 years.

so those are debentures or income bonds of railroads. (Investment Grade Corporate Bonds)
(on income bond we can talk later when we talk about the preferred stock)

so in this multiple is 2X in the latest year ( previous first year) and in past 5 years in that 4 years of any four years.

Those are Public utilities:- their earning is 2X in past 5 years average of interest charges

so we talk about in railroads of individuals year of past years,

but in public utility, we take an average of years.

So get the value of interest coverage ratio, you have to know about three things

* 3 things to consider for interest coverage ratio:

so for this author give the three things that help you to consider interest coverage ratio, so let’s see

  1. Methods of computation of interest coverage ratio
  2. amount of courage required
  3. The period required for the test ( time period)

so let’s see the Method of computation of interest coverage ratio: in this author give three methods that people used in previous past time, and also suggest which is best

a) Prior deduction method

b) Commutative deduction method

c) Total deductions method aka. Overall methods

so all methods discussed while taking examples

a) Prior deduction Method

Suppose A company, $10 million worth of First Mortage 5% bond, and Debentures worth $5 million.

and companies average earning is $1,400,000

so the company have to pay interest on the first mortgage is 5% of $10 million is equal to $500,000

so coverage ratio is = $1,400,000/$500,000 = 2.8X

and remain is = $1,400,000 – $500,000 = $900,000

so those are junior debentures for this they have to pay 6% on $ 5 million of debenture

so interest on 6% = $300,000

so coverage ratio = $900,000 / $300,000 = 3X

The stupid thing is

those are senior bonds their coverage ratio is 2.8X and those are junior bonds and their coverage ratio is 3X

it means that junior issue is more protected than senior issues. (Investment Grade Corporate Bonds)

So these things are very stupid, 

Because obviously those are senior bonds they have more protection than the junior bond and they got first money when the company is failing. but in that not happen like that so

this method is a useless method and misleading method, but so many companies use this ratio in past and they fool the investor and investors also do stupid things and don’t think about this and they only see quantitative but not see qualitative.

So people forgot the figure and people go in calculation and say, this value is original whatever they come.

They forget also, whatever value comes, they are not checked for is sensible or not.

b) Commutative Deduction method:

In these, those are the first mortgage, and they are the same as above mentioned

because, on that method, no one is  superior

so the ratio is  for the First 5s = 2.8X is coverage ratio ( calculate above)

so come for a debenture,

for debenture, in this method, First of all, you have to pay first mortgages

so $800,000 , total interest charges

so debenture 6% ratio = $1,400,000/ $500,000 + $300,000   =1.75X

so this method is good, than the first method, because, it looks sensible

but the author says, ” we have to use the third method i.e. Over all method or total reduction method.”

This means whatever, you buy ( senior or junior) total debt safety is required.

so for both ( first and debenture 6s also)

for this, you have to add junior and senior interest charged i.e. $500,000 + $300,000

then ratio is = $1,400,000/ 800,000 = 1.75X

for both

because, if junior lien default, then, his effect also happens on senior in coming future.

If you buy senior issues ( mortgage bonds), they can also use this method

Add junior and senior interest charge for ratio

if you consider your own interest expense  then you get more than good things and have added in advantage

but don’t use that rule. (Investment Grade Corporate Bonds)

so for total, this rule and added advantages

now let’s talk about other points

2) Amount of coverage required:

in this author give the specif coverage ratio for each and every category

  1. for public utility ratio is = 1.75X
  2. for railroads ratio is = 2X
  3. for industrials ratio is = 3X

so this ratio author gives from his experience and their practices and also see companies history in depression also.

3) Period Required for Test:

So New York Statutes says, you have to take a period of five years and also says, for utility take an average of five years and for railroads take an independent year of 4 in past and immediate precious year not in taht.

so for this author says, 7 years period is better than 5 years period

and we can also modify it by increasing or decreasing year by seeing previous year performance

Suppose, we invest in 1940,  in that time you can take 7 years, but year 1933 is in depression so for this, you can take only 6 years, by modifying according to the situation and that is very helpful.

If you invest in 1934 or 1935, so in this time, you can’t help with 7 years period, because in that 3 years in the depression, so for this you have to take 10 or 12 years of the time period to unusual things is average out the depression time freme. (Investment Grade Corporate Bonds)

so in this, you have two kind situation

in the first situation, you can take the actual earning in depression(whatever come -ve) year for interest coverage ratio, but interest coverage ratio is come very less, so for this author says, ” take the Zero earning of those years that are in a depression instead that taking whatever is coming.

and consider time period for 12 years and take their average and after that found the ratio ( coverage ratio)

so this author recommends, instead of separate,

the author says, after this all, we have to see other points also

” We have to see what are the average trends and minimum figure and also the current figure.”

so suppose earning profit increases means, a rising trend is going, then this is good and current showing figure is also good, then better and you get the good margin on that then also better in a rising trend.

If earning Trend is Unfavorable ( downward trend,) then you don’t have to accept until the first thing is the earning ratio is required maximum.

The second thing is the earning trend is downward, then you have to confirm that this trend is temporary ( instead is not only I think so it’s not like this reason) you have to good conviction reason why goes high this trend.

so these are all things we have to conclude while investing in bonds.

What is a bond? and their specific standard for bond

hello friends, in today’s, article, we see the specific standard for bond investment from chapter 8 of the security analysis book and also what is a bond, how we invest in them, and what are the problems come while investing in bonds.

Previous Chapter 7

What is a bond
Principle 4: Definite standard of safety must be applied:-What is a bond

In principle 4, we talk about those states, they have their own laws and rules on those that are saving banks that can invest in specific areas.

or

they have to satisfy their criteria of states

So the author (Benjamin graham and David dodd’s) use the New York Status, because, he thinks it’s a good point to start.

After that, whatever its criteria, the author criticism them and if need to neglect them or reject them also and they modified them if required.

So there are 7 criteria prescribed by New York Statutes:

In the Coming 4 chapters we explain the 7 criteria in this, we see only two criteria.

So firstly the author explains, what the new york statute says, and what author explains his own view if they are right or wrong

General criteria prescribed by New York Statute:-(what is a bond)

  1. Nature and location of business or government business
  2. Size of enterprise, or the Issues
  3. Terms of the issues
  4. Record of solvency and dividend payments
  5. Relation of earnings to interest requirement
  6. Relation of the value of property to funded debt
  7. Relation of stock capitalization to funded debt.

Criteria 1: Nature and Location

1 ) New York Statute says, ”  You can invest in U.S. government bond, state bonds, municipal bond”

but You can not invest in foreign government and foreign corporation bonds.

2) You can invest in Railroad, gas, and telephone industry, b

but you can not invest in street railway and water companies and also in debentures of public utilities.

3) You can invest in the first mortgage on a real estate bond,

but you can not invest in all industrial bonds and also financial companies’ bonds, investment trust, and credit concern companies also.

so for this author give some problems with New York statutes

Problems with New York Statute on Criteria 1:

1 ) In any industry, we can’t invest, so this is not talking about practically way because, in the industry also, there are some companies that perform well in bad times also and we can select them.

If we neglect whole industry segment then, what remain only railroads and public utility and government bond according to the New York Statutes.

So it’s happening,  if we can’t find good then don’t go for bad.

so this is like we are doing narrow and it’s not right, so we can include the industrial also.

2) Water companies neglect the public utility by the New York Statutes and don’t give a good reason and other states include the water company and we also include them.

3) In 1938, One commitment that happens in the banking sector is in that they do the consortium of banks can waive as many rules as it sees fit, and they decide which criteria can remain and eliminate and also do modifications according to them by doing a simple variation.

so for this, the author says, ” Until now there is not any problem of consortium bank, but happen problem in future.”

so we don’t have to take tension because, nowadays, no consortium bank, that told us to do this or that.

4) Foreign government restriction is a good restriction according to the author, because, the foreign government pays or does not pay. If they don’t pay you, so you can’t force them to pay and you can’t take their asset, and revenue source,

the author gives examples of some countries that full fill the obligation and some more countries that don’t fulfill the obligations.

like those fulfill obligation country are Canada, Holland, and Switzerland, etc.

after that, the author talks about foreign company bond investment.

So many cases, present there, those fulfill the obligation by a foreign company but not that time government doesn’t fulfill it.

but sometimes the company is able to pay but the government restricts them.

So sometimes exchange is restricted on the company by the government.

so the foreign company has the ability to pay but they can’t pay, because the government does not allow it.

Criteria 2: Size of company

The author says those are a small company that is very much vulnerable at unexpected changes.

so those are big companies, they can go easily and unexpected harsh condition goes easily. means, they can pass easily in dangerous situations also.

Because, they have good relation with bank and they have lots of resources, that deals with that situation.

so New York statute, what say, about this criterion is

In railroad, in that much amount of mine is spread over the area, and in municipal bonds, that much amount of population is required and in public utility, they say different types of criteria, but in this point that much is not important, if you want to know about them then, buy a book by clicking above image of book.

So come here directly and what author reconnects

The author says, ” buy municipality bonds when the population is 10 thousand or by public utility when gross revenue is about $2 million and on the railroad, the gross revenue is $3 million

and lastly, in the industrial, the gross revenue is $5 million.

Industrial is not included in New York statute, because they don’t say, to b buy or avoid them

and author says, ” invest in industrial also.”

So large size does not mean to have safety

so it’s may happen those are the largest companies that are the weakest company.

if they have maximum debt.

So large size criteria are not affected in this municipality, railroad, and public utility,

so small and large both are the same.

but in industrial, have an effect, those are large size, they are more stable than small size.

So this is all about the two criteria for specific standards for bond investment.

How to invest in bonds from security analysis book

Hello friends, in today’s, article, we see how to invest in bonds, from chapter 7 of Security analysis. while investing in bonds, you can consider some principles of that, in we see the two principles( second and third) of investing in bonds, from chapter 7 of security analysis.

so let’s see one by one steps of investing in bonds.

Previous Chapter 6 on Investment bonds

How to invest in bonds
The Selection of Fixed-Value Investments Second and Third principles:-How to invest in bonds

This explains the two principles of investing in bonds.

so let’s see one by one

Principle 2: Bonds should be bought on a depression basis.

In Good conditions, every bond performs the great, but when depression comes, then we know which bond is strong or weak.

So in depression, the bond will be safe or not

on these two views come forwards

Two Views:

  1. The character of Industry e.g. Water, electricity
  2. Amount of protection e.g. Steel, automobiles companies

so you have a question What is the means of Character of the industry?

it means, Company comes in those industries, that industry has some immunity in depression condition.

for example, Light companies, Water supply companies, the telephone company. (How to invest in bonds)

and another question, What are the means of Amount of Protection?

it means, having a good Margin of Safety

means, Margin of Safety is high as much as that can not affect depression also.

In bond Context, the Margin of Safety is the Interest Coverage ratio ( times interest earned, Earning multiples)

so in this chapter whenever word comes coverage ratio, that means earning multiple, interest coverage ratio.

The Amount of Protection required those companies like steel companies, Automobiles, etc.

You need a maximum amount of protection because they fluctuate more.

So The author ay,s ” Those companies are good companies that perform well in depression also.”

The author says, ” Character of Industry is more important than the Amount of Protection because those companies perform good in depression, then minimum safety is considered as good.

Because In depression Maximum safety is also eroded.

So the author also, says, ” Not any industry is resistance to the depression, so the quest on is how much difference occurs in that industry’s company.”

That much percentage of the company is stable in depression as compared to competitors, then we can get maximum protection also. (How to invest in bonds)

This means the Minimum coverage ratio is sufficient for us

So if Maximum unstable company, then that much amount of earning multiple then, we ask for a good margin of safety.

If in some companies the Instability is more then, don’t buy this companies bond, whatever the maximum coverage ratio.

so Coverage ratio calculated formulae are

          Coverage ratio = Earning before interest Tax / Interest expense ( interest charges)

Suppose a company pays $1 interest on a bond, and company earnings are $10 so then the coverage ratio is 10.

or Earning multiple 10.

Means, How much multiple companies generate the earning on an interest basis. so the company does a maximum coverage ratio then the company is safe and they give the regular payment of bonds.

The character of Industry reflects the difference in stability and required coverage ratio.

so the author says, there are three types of company, we can classify

  1. Public Utility
  2. Railroads
  3. Industrials

These are different, because, these companies have different stability

1 ) Public utility is stable, and the railroad is less stable than public utility and Industrials is very less stable than Railroads.

So in these three types, we required different coverage ratios, that much minimum required to buy that company, so that’s why they are different. (How to invest in bonds)

So Public Utilityis more stable, so for this less Coverage ratio is sufficient

The railroad is only stable, then they required more coverage ratio, than a public utility.

Industrial companies required a maximum coverage ratio than railroad companies because they are unstable.

Then, The author talks about industries, why bonds collapse in depression

so which companies bond collapse in depression,

so let’s talk about public utility.

Reasons for bond Collapses during the depression:

  1. Public Utility was failed not because earnings disappeared, but because of Excessive debt on companies. so Interest charges were maximum and the coverage ratio is very less, that debt was not handled the small fluctuations, those companies do not have maximum debt, and their coverage ratio is maximum and they perform well in depression also.
  2. Railroads: In railroad stability of Earning was overrated and margin of safety also decreases because insufficient in depression. So the author says, ” People have to observe before, for example, Country grow in 1920 but railroad, companies did not increase the earnings, so this is clear that industry was weak. so this reason, Investors have to increases the margin of safety criteria minimum requirements. In railroads cases, those people getting the same minimum requirement criteria of margin of safety and they know after they failed in depression.
  3. Industrial: in industries, the sudden disappearance of earnings even for companies with a high Margin of Safety and also doubt on business survive or not in this depression. so in this, the author says, How much margin of safety whatever let’s consider 50, then in depression companies have problem with operation cost, then all are going erode. (How to invest in bonds)

the author observed that the large size companies, that do a good deal in depression time, then small companies so small and mediocre companies do very bad in depression.

so in big companies in their problem is, large-size companies present very little. and their debt outstanding is not more because they retire the bond issues.

So is that not means, if you don’t get the good company, then buy bad companies bonds.

Public says, ” those are secondary companies, how they get capital, if you only buy large companies bonds and finance them, so this activity affect the small and mid-size companies.”

so for this, the author says, ” We don’t take their responsibility and save them while sacrificing our capital, so in this type of securities not take in this type of securities not come in Class I of Fixed-value type investment.

If they want funds from us, then they have to give us a good chance of making profits on principal money, if we have principle loss risk.

So on bond financing, people view as following

  1. Bond issues, when supposing as weakness of the company and that’s why bond issued.
  2. The company doesn’t issue stocks, that why issues bonds.

that’s both are generally accepted views of people.

so from this, we get the message is only weak companies have to issue the bond.

so for this message, the author says, ” If only a weak company issues the bond, then we don’t have to buy that bond.”

then the author told, their view on Bond Financing

  • if a Business is profitable, then they get the profits while issuing bonds, because business profits give an infinite percentage and only little percentage have to pay on bonds, means fixed payment and whole profit of that company. If we are stockholders, then only we can participate in profits.
  • So bond issues, the benefit is very cheaply you raise the capital

so let’s understand with examples, (How to invest in bonds)

Suppose loan is 2, 3% and you make the 20 and 30%, then you can easily ready to take a loan, so just like that of the company also.

the company gets the bond for 4,5% and they make 50 or 60% profits.

After that, the author talks about unsound practices that are followed in the industry.

1 ) Railroad company issues bonds because their earning is poor and then stock, sales fluctuate, then the author says,” don’t buy this type of Bonds.

2) Some strong companies, issue bonds to pay the debt. so during this activity management problem is solved, but shareholders’ problems increases and their dilution starts, and companies free from debt.

So from this principle 2

we learn two things

  1. If we don’t get good companies bond, then don’t go for bad companies bond so this is no good reason then don’t buy, if not available.
  2. The industrial segment buys the bond of those that have the dominant size and have a good margin of safety ( means earning multiple has maximum.)

so let’s talk about principles 3

Principle 3: Unsound to sacrifice for yield

means, if some companies bonds, have risk to lose principle, but company give you high coupon rate and give you high yield but you can lose principal money.

so buying this type of bond is not good.

Because there is no relation between yield and risk.

Because, that the risk of loss is indefinite and no one is predicting and you can’t says, while seeing that past to handle risk. (How to invest in bonds)

Just like Life insurance, fire insurance in that you can see the previous data and people’s mortality rate and doing actual computation and from that, we can say, about the relation of risk and yeild.

but in this we can’t  says about risk and yeild relation.

because in this the loss is not defined uniformly they are concentrated at particular intervals, like depression everyone gets lost.

And the author says, ” while accepting principle lose, instead of high coupon rate just like become an insurance company.

In an insurance company, you pay the premium and if you have lost like, fire in the house some life-death, so then you get the payment from another side.

you can say like principles because you pay the premium on that.

so if lose events happen then only you get the money.

So in this situation, you become the insurance company and the company pays you a premium on a risky bond, and they take your principle money first, and then they give you a premium on each 6 month interval time.

and if you have lost, then forgot the principles money.

so the author says, ” this is not a good idea, because those are individual then, can’t distribute money like an insurance company. if they distribute like an insurance company but when college, they lose everything in depression. (How to invest in bonds)

so that’ why not good idea

then the author says, ” If you have to take the principle to lose risk, then you can’t offset by the high coupon rate instead of that, offset of risk, you have to get a good chance on that principles to get good profits.

For example, ‘ if you buy bond then buy very much at a discount of par value.

so in this, you have profits possibility and also have lost possibility.

both have a chance or instead that but the conversion bond that converts in stocks, in future.

For example, if you invest $100, and you can lose $100, so in this situation, you have to be possible is that $100 becomes $1000, then only benefited, if not benefited.

Then the author says, ” while selecting bond how people select and how we have to select.

How people select bonds:

So they start with a first-lien bond( senior security) and they think, this is very safe and after that, they see the taking risk of the percentage that increases yield.

so this is not the right way

because the first lien, you think it’s safe.

so the author says, ” The right way  to select”

The company has to satisfy the minimum standard of safety, after that, we consider which have to choose.

If the lowest seniority (highest yield) bond is not secure and the minimum required of safety not satisfy, then you don’t have to see that company bond and issues failing to meet the minimum required should be disqualified.

means don’t buy that company bonds.

so you have to see from the bottom of the bonds hierarchy and overall debt of the company are satisfy the minimum requirement. (How to invest in bonds)

if they do, then you have to see above of bond seniority for additional safety and you have sacarifying yield.

so we have to do like this, not like people way.

so this is all about how to invest in bonds from chapter 7 of the security analysis book

Investment bonds from security analysis chapter 6

Hello friends, in today’s, article we see the investment bond from chapter 6 of the security analysis book is The Selection of Fixed-value Investment. In this chapter, the authors give the perfect theory of The selection of investment bonds ( Fixed-value).

In the previous chapter, we see the classification of securities, so there are three classes of Securities. let’s recap, Class I, has the safety on principle money and has a steady income. Class II,  they are divided into two types.

Type A: is have principle safety and has the conversion feature to make the possibility of profit.

Type B: In this, you can lose principle and you get lots of profits on Principles.

Class III, is about Common stocks.

so from this Part-2 of this book is begin, in this part-2 also have the five chapter so let’s start

Investment bond from securities analysis book
So Part-2 is whole about the Class I securities ( fixed-value investment)

The Selection of Fixed-Value Investment: (Investment bonds)

So we talked about in the previous chapter is that we should classify securities on the basis of characters rather than on the basis of title.

In Fixed-Value type Include: (Investment bonds)

1) High-Grade straight bonds and Preferred stocks

2) High-Grade Privileged Issues.

3) Common Stocks having guarantee or Preferred status.

So It’s not fixed is that the fixed value type is only investment bonds as financial instruments.

This whole thing depends on its characteristic for they qualify for Fixed-Value Issues.

So most of the bonds are frequently associated with safety by the peoples, but they have to say like that Instead of safety is Associated with Limited return.

there was safe or not is the whole thing depends on company strength and earning power.

So let’s see what difference between bonds and preferred stocks.

  • Bondholders have the first claim on companies earnings and company make them promises of payment in regular interval of time. (Investment bonds)
  • So Preferred stocks also have claims but don’t have any promised with regular interest payments. So director decides to give dividends or not to the preferred stocks. there is neither priority nor Promise is assurance that of the safety of Principles.
  • this depends on the company’s strength to fulfill the company obligation., so this thing is only known from the Balance sheet of companies previous year records and his execution plan and future perspective about the company.
  • so from them, you know your issue is safe or not.

so the bond selection is just not like search and acceptance, it’s like a process of exclusion and rejection.

The author gives the four Principles of Selection of Fixed Value-type Securities (Investment bonds)

4 principles for selection of Fixed-Value Types Securities:

1) Safety does not depend on how many senior issues, means not by Specific lien, so lien like are the seniority of bond-like 1,2,3,4, preferred stocks and lastly common stocks.

So just like that those who hire high seniority, they have a maximum priority claim on companies asset.

The author here, try to say, ” Safety does not depend on seniority (whatever their rank) but they depend on those companies ae issue this bonds, that company have the strength to defeat their obligation.”

 

2) This Ability of the company to pay the interest payment. for checking this, we have to consider depression time, instead of that good time(prosperity time).

Because any mediocre company do well in prosperity time and fulfill the obligation of the company

3) If there is no safety of bonds, then given them a high coupon rate and compensation is not possible (worth it)

4) The selection of all bonds for investment purposes should be subject to rules of Exclusion and to specific quantitative tests corresponding to those prescribed by status to govern investment of saving bonds.

means the bond selection is like the government make the investment like that we have to make and our purpose is simply to make the interval of time regular income. (Investment bonds)

So in this chapter, we see only Principle 1

Principle I: Safety is not Measured by Lien, but by the ability to Pay.

So in these, there are two views on safety points.

Two views:

1) character and supposed value of the property on which bonds hold a lien,( First people think like safety

is measure by how much asset is a mortgage against that issue. so depends on seniority, so those who have the first lien against him, keep mortgage of asset means if the company is not paying their interest of first-lien seniority bond, this first lien seniority bondholder take the asset of the company under him.

so whatever is property value on that we have to buy,

So this type of people thinking on bond or senior lien

2) Strength and Soundness of obligor Enterprises ( means the safety depends on enterprises strength, so the company can pay their bills not depends on asset value.)

So in the first view, we think, they are claiming against on property.

In the Second view bond is a claim against the business. (Investment bonds)

So in this which is right,

Now you think, if the company can’t pay, then bondholders take over the companies assets and sell them and pay for themselves.

but this is not happening, so in this, there are three types of problems.

Three problems with the first view:

1 ) When businesses fail, then properties values also shrink. so companies value depends on companies earning power. If a company fails then fixed asset value also goes down.

so understanding this point the author gives the examples

Cardboard all Florida railway company, this company first mortgage is going down from 25 million to 250K dollar when the company is failing.

so the value of companies is going down when businesses fail.

the second problem is

2) You(bondholder) get the legal right with bonds, legal like You can sell the property of company, but you can’t enforce them when the company failed.

Because Court does not allow you for this.

So those are a junior lien, what they get if first lien holder sells the property and distribute themself because, the business value goes down, that why only first-lien can get money, so no money for second or third lien holder, so that’s why the court does not allow for this. (Investment bonds)

the third problem is

3) If you are allowed to take over the property by the court, so in this situation also take the lots of time and spend much money for advocate and other expense, and takes lots of delays occurred to solve the problem.

Bondholders’ motive is to avoid trouble not to found in trouble and how to goes from that troubles.

So from these principles what we learn

the first thing we learn is

Corollaries from Principle-I:

1) So there is no difference between senior or junior lien: If a company is strong then its debentures(unsecured debt) also strongs.

This debenture is a junior form of debt.

If the company strong then, their debenture also wonderful as like a first-lien bond.

So the author says, ” Strong companies debenture is better than the weak companies first lien.”

The second thing we learn is

2) Buy the highest yield: means those are a sound company or strong company, this type of company bonds, we can buy the junior bond for highest yield and you get the highest yield on that bond.

so regarding safety is all of them, not only for the first-lien bond and not for the last one lien.

This thinking present only in theory but not in practice mode, people only buy the low yield bond with the first-lien category.

The author tries to say, ” If companies junior bond is not safe then, their senior bond is also not safe so we don’t need to buy their first-lien bond.”

If a company is weak so its high-grade bond is also not safe, means if their high-grade bond is also like the low-grade bond value. (Investment bonds)

The third thing we learn is

3) If junior bonds yield and senior bond yield have the maximum difference then buy the Junior bond, If there is no difference in senior bond and junior bond, this type buy the senior bond, without taking any risk.

So buying senior bonds, they have to the protection but the yield is same, just use common sense.

What to buy in any situation, for this author give the examples

Suppose a junior lien of company X and the First mortgage bond of Company Y.

So in these two cases come forward, if we prefer the junior lien bond than the senior lien mortgage bond.

  1. Company X has adequate protection of total debt and the yield of junior lien bond is substantially higher than that of company Y senior lien bond.
  2. Buy junior lien not a senior lien, If suppose, there is not any difference between junior yield and senior yield, but the total debt protection company is more than company Y, so we can buy the junior lien.

so protection is more than those are fixed charged on bonds, which means, the Interest coverage ratio of Company X is more than the Company Y.

We can prefer the junior lien of Company X whatever not have the maximum difference between in yield.

so lastly the author says for the understanding bond. so this is the exception to the above-mentioned rules)

lastly, says the author, “Investors are not involved in this issues because they are far beyond the competence of investors and investors have to stick with this rules is the strong company has strong bonds.”

whatever we learn and use common sense to buy the junior and senior bond.

 

So this is all about the Investment bond from chapter 6 of security analysis.

Classification of Securities: Chapter 5

Hello friends, in today’s article we see the classification of securities from chapter 5 of the Security Analysis book. In this chapter, the author explains how people classify securities and how they wrong and the author gives the specific reason and accurate classification.

The Previous chapter 4

Classification of Securities from chapter 5 of Security Analysis book:

Classification of Securities

In this, the author gives the how the grouping of securities is mention by people

let’s see

Conventional Grouping of Securities:

So these securities grouped in two parts i.e. Bond and Stocks

In stocks contain two stocks one is preferred stocks and the other are common stocks.
Classification of Securities

So we all know those are bonds and the bondholder has the first claim on the company.

If they don’t get the interest on that bond then they have the first claim on the company Asset.

But those are stocks holders they assume that whatever the profits go on that basis they get the maximum profits on shares. (Classification of Securities)

If the shares go down or the company files for bankrupt then they lose the all money because those are bondholders who take the first claim on the company asset.

So the author says, this conventional grouping of securities is not in the right way.

So for the above conventional groups, the author gives the three objections.

  1. Preferred Stocks is grouped with common stocks (diagram image) instead that they have to group with bond.

Because Preferred stocks get the fixed income, so they one side they are a technical legal partner of a company but actually, they are like bondholder, then that type of results they got also.

This means they can not participate in the profits of the company (dividends), which means they get what is fixed, on that preferred stocks, that much amount only get them. (Classification of Securities)

2. Another problem is people compare the Bond with safety, but this is a big mistake.

So you can say, bond as a whole instrument because they have the first claim on company asset.

Safety does not depend on because they are bonds, it depends on this  the comapanies asset that defeats the obligation of the company ( means beat the bond interest payment and other companies problems)

so this point includes the real safety not on this to buy the bond and stay safe is not happen.

Because, if companies don’t have earnings and their asset not capable to pay the bond interest so without that bond is not a safe investment.

3. Title is not used rightly for accuracy purposes, saying anything to any securities just like the following example.

Preferred stocks look like stocks but actually, they work like bond and other deviation also present in financial instrument list like Convertible bond, purchase margin, Warrant, Participant preferred stocks, Non Voting stocks. so this all deviation and also other no voting stocks not we are put in this list that above mentions image, and they put in common stocks but they don’t work like that. (Classification of Securities)

Participant preferred stocks, so these are preferred stocks but we can’t put in preferred stocks, because they are participants.

So the author says, ” this all above classification is not the right way.”

So whatever the characteristics of financial instruments, they are not divided on their characterists.

then the author gives their own Classification.

So they divide them into three classes:

1. Class I (Fixed-value type)

2. Class II (Variable-Value type)

3. Class III ( Common Stock type)

 

  1. Class I ( Fixed-Value type): In this class, include the high-grade bond and preferred stocks.
  2. Class II ( Variable-Value type): In this class includes two types A) Well Protected issues with profit possibilities B) Inadequately protected issues.

A) Well Protected issues with profit possibilities: in this, the issue is well protected but has profit possibilities.

so that’s why they are variable values, e.g. High-Grade bond, Convertable bond.

B) Inadequately Protected Issues: In this have the profit, but they are not fully protected they have Inadequately protection issues, for example, lower-grade bonds or preferred stocks. (Classification of Securities)

So they have the profits chance because they are very cheap in price.

3. Common Stocks type: In this include share (stocks) that we talk about almost every time.

So now let’s talk about the advantages and disadvantages of these all classes.

  • Class I, in this the owner’s main purpose is the principle of safety and interest safety and we want steady income from these securities.
  • In Class II, the principle value changes regularly, so that why they have significance. so let’s see type A: in this, you get the safety and you have another possibility is conversion so that you can make a profit in that. let’s see type B: In this, your loss may be happening, in lots of forms and you also get lots of gain on principle.
  • In class III, In this compare with Class 2 type B

so in this difference is those are class II type B have the priority as compare to Class III and they have some protection in class II type B.

Another difference is those are Class II and type B have the profit possibilities, and in this, you get the substantial profit, so but class II type B have the limits so but in Class III in common stocks there is no limit on profits as compare to the class II type B.

So other says, ” those securities that have the characteristics of the common stock, they include in class three, whatever they name are, whatever those are like, common stocks or bonds or convertible bonds or any other financial instruments. (Classification of Securities)

lastly, the author says,” Do not classify securities on the basis of the title of the issue, but the practical significance of its specific terms, and status to the owner.”

So this is all about the classification of securities from chapter 5 of the security analysis book.

Difference between Investment and Speculation

Hello friends, in today’s article we see the difference between Investment and Speculation from chapter 4 of the security analysis book. so let’s see the Benjamin Graham point of view.

The Previous Chapter 3: Sources of Information

Difference between Investment and Speculation
What People think about It:-Difference between Investment and Speculation

Difference Investment and speculation

Bonds and stocks

so people say, ” Invest in bonds is an investment, and invest in stocks is called speculation.”

Outright purchase and purchase on margin( taking loan and buy security)

Some people say, ” We buy the outright purchases that investment and speculation when you purchase on margin ( means taking borrowed money and buy the stocks).

People say, ” Investment is permanent holdings and Speculation is for a quick return.”

other people say, ” Investment is for income and speculation is for profits”

Investment is in safe securities and speculation in risky issues. (Difference between Investment and Speculation)

so authors say, ” this all is bullshit whatever above peoples think.”

So Author starts with the first point and say,

” If you buy bonds that secure but companies earning is not sufficient, so those interest payment not fully paid by the companies, so this is also the speculation.”

so go on to the second point from the above table i.e. Outright Purchases and purchases on Margin

If you want to purchase security and this security is shit, so then this is not a good opportunity so whatever you buy on outright purchases, this also speculation.

or

If you get the wonderful stocks and you get the maximum discount and margin of safety but you buy on purchase on margin this is also Investment and this maybe becomes a good investment.

Temporary and permanent points

This is only the intention of purchase so If someone says, ” I buy this security and keep it so what is the benefit of that if they keep that security. so you have a purpose in buying that whatever your purpose i.e. Profits or income.

So in this, not any temporary or permanent,  If they reach at purpose in a short time or long term time, this doesn’t matter, the matter is that purpose is accomplished, whatever the time frame.

Income and Profits

Suppose you get the return whatever is 10, 20%

from where it comes, it doesn’t matter

they come in form of income or profits this all depends on your fundamental circumstance, which means you need every month money for maintaining your lifestyle or you need profits for long terms.

So we can’t say, ” income is investment and speculation is profits”

because of the above fundamental circumstances. (Difference between Investment and Speculation)

Safety and risky point

so safety and risky is dependent on the different points of view of people.

So if one man puts money on a racehorse and he thinks they will win the racing then in his point of view they think it’s a good investment and safe money.

so some people think in 1929, investors think to put money stocks is a safe investment and they think this stock has never gone down because now a new era is beginning and the stock goes high.

so whatever they pay the price, they are justifiable for that stocks in 1929.

This depends on the perspective to perspective so we can’t separate the investment and speculation.

So all this statement neglect by the author and they give his own point of view of definition of Investment and Speculation.

Definition of  Investment:

An investment operation is one which upon thorough analysis, promises safety of the principle and a satisfactory return.

If operators not meeting these requirements are speculations.

Thorough Analysis means studying the facts while applying standards of safety and value.

Safety of Principles means, Your principles are not going anywhere in normal circumstances.

Like lite situation happen in the market, except the stream events like recession, depression, etc so then there is no safety in this situation on investment principle, this told by the Benjamin Graham

Satisfactory Returns may be in any form like capital appreciation, dividends returns, or interest payments.

Lastly, investment operation called an investment instead of securities operation as investment operation.

Because any type of securities is an investment or any type of security is speculation. so this only depends on how much price you pay. (Difference between Investment and Speculation)

the author also define another form of Investment

An investment operation is one that can be justified on both qualitative and quantitative grounds.

after this author gives  Examples of Speculation.

In Dec 1934, General Electrics stocks were sold at 12 3/4 dollar and paid 6% on $10 pay.

It has one difficulty was they are callable on any dividend date at $11.

So the author says, ” Buying these preferred stocks at 12 3/4 is speculating and we put the 10% of our principal.

so how this happen explain below

Suppose if the issue is called on the very first date i.e. 15 April 1935, then you will get the $11 as call price plus a Dividend.

so how much dividends? for this
Annual dividend = 6% of $10 = $0.6

so for 4 month dividend = 0.6/3 = 0.2.

 

so, you will get $11 as call price and dividend is 0.2 means $11.02 which could result in a loss of 12%.

so now you think, this is a very simple calculation, so who do like this stupidity.

so, guys, everyone wants to become rich in the stock market and no one wants to do work for that that why we all do stupid things.

So the author says, ” buying these preferred stocks, you are doing speculations.”

You were wagering that issue would not be called for some years to come, therefore it is speculation.

so the author gives the Example of Investment:

In real-time, the same stocks of General Electrics, the issue was called that every month at $11 per share on 15 April 1935. so from this announcement. (Difference between Investment and Speculation)

The price promptly decreased to $11 so the author says, ” this is the investment opportunity.”

So let’s see how?

Now you have the opportunity for profitable short-term investment on margin investors buying.

Suppose, you buy the $11 stocks at on 15 Jan 1935 and you get the $10 per share borrowed money at 2% per annum interest.

so you buy the 1000 shares.

at $11  so net money = $11,000

On April, 15, 1935, you get the $11 plus dividend = $11,150

so this time you have to call the price and get dividends of $150. ( $0.6 per annum and 3 month dividend is 0.15 multiply by 1000 = $150)

so gross profits = $150

so you invest $11,000 and you get the $11,150, but on this, you have to pay borrowed money whatever their interest rates.

so for 3 month interest rat 2% per annum on $10,000 = $50

your net profits were = $100

so you invest $1000 and you take $10,000 as a loan (borrowed money).

The net profit of $100 on $1000 investment, in 3 months is equivalent to = 10% * 4

= 40% Annual return

so this type of return is very much best for an annual year.

Peoples say, that ” investment depends on the past and speculation is depends on the future.”

So after this example, the author gives the four types of investment

Types of  Investment:-(Difference between Investment and Speculation)

1) Business Investment: Your money put in any business

2) financial Investment: Your money put in any securities like bonds, stocks, etc.

3) sheltered Investment: In this, you buy those securities that have minimum risk and they have the first claim on company asset.

4) Analysis Investment: Analysis investment is that investment operation that going through the analysis and they give the promise statement about principle safety and also adequate returns.

So this is the list of types of investment, so this is not an exotic investment list, and about them not other any investment is not like that. and this put randomly without any relations. (Difference between Investment and Speculation)

Types of Speculation:

1) Intelligent Speculation

2) Unintelligent Speculation

1) Intelligent Speculation: Those are intelligent speculation, you only get those risks, you are justifiable on that because you do good studies and whatever your prose and cause on your decision.

So this called Intelligent Speculation

2) Unintelligent Speculation:

In this, you take the risk, without reading that situation you just doing this, because you think these stocks going high.

Because you listen this is a popular company and lots of people talk about this company so this is all are bullshit.

Those are stocks price, and you are paying for that stocks, so we can divide them into two components.

Investment and Speculative components of Price:

e.g. In 1939, General Electric stocks $38

so analyst judgement says that the investment of that stocks price is $25.

and other remains $13 is that speculation price.

so they represent the stocks market appraisal and long term prospects may be good and peoples bias is that this company is very good and they include the other factor of specular component.

So any investor/buyers pay more than the $25, then they have to recognise, they are paying for speculative possible so the author doesn’t say that this is wrong thinking or right thinking.

they have to just recognise that they are paying for speculation price also and they have to remember this fact then only your mind is set

If you think this is justifiable to pay more than the $25 then, this is Bullshit Think.

and your brain is not set for investing.

lastly, the author gives the relationship between intrinsic value, investment value and speculative value

Relation: Intrinsic value, Investment Value and Speculative Value:

So those are intrinsic value they can include in the speculative value also, but only for Intelligent Speculation.

So Intrinsic value has two components

  1. Investment Value
  2. Intelligent speculation value

If stocks price is equal to Intrinsic value and If they have more than then they include the unintelligent Speculation Value.

so this is all about the Difference between Investment and Speculation from the Security analysis book, chapter 4.

Annual Reports of the company: Security Analysis

Hello friends, in today’s article we see chapter 3 of the security analysis book. this chapter depends on sources of information. in these sources include the Annual reports of the company also. so let’s see which type of source of information available.

Previous Chapter 2: Problems of stocks Analysis

Annual Reports of The company: Security Analysis
So where we get the information about the company, before that you have to know which type of information we need to analyze the company.

So the author says, ” Analysts required three types of information”

What is Information Required:-Annual Reports of the company: security analysis

I) Terms of Issue

II) Data of Company

III) Data of Industry

so whose try to buy securities what is his terms and what condition they are buying the security? this all question come in this. (Annual Reports of the company)

so let’s starts with the terms of the issue

I) Terms of Issue:- (Annual Reports of the company)

Regarding Bonds, for this, you have to read the Bond indenture ( Bond Indenture is the type of contract and on that, all each and every terms and condition is written.)

Regarding Stocks, Consult the Charter ( In this charter the articles of incorporation present together with by-law)

Those documents are available with the SEC and proper stocks exchange like NYSE

II) Data on Company:

in these, we see the different types of sources that give the information about the company

so let’s see one by one

1) monthly Statement:

In this, some companies show the monthly statement, some not show, so those show, let’s see what the logic behind that of publishing the monthly statement.

we have some problems, If some company performance is improved then they show the monthly statements and those company performance going bad then they close the monthly statement means they discontinuous with these monthly statements reports.

So very few companies only publish the monthly statement

2) Quarterly Statement:

The quarterly statement you can get easily on the stock exchange, In India, you can get on the BSE and NSE stocks exchange websites. (Annual Reports of the company)

So each and every company issues the Quarterly statements, but some businesses like the Sugar business, chemical industry, fertilizers, and agriculture. so this type of company issue the moving figure of 12 months.

Because in four months earning is going high, and in next four-month, the earning comes to zero so if you read this quarterly statements then you get confused with this earnings so for this they issue the moving average figure of 12 months. The Quarterly statement is issued every 3 months later.

3) Semi-Annual Reports:

in this, the semi-annual reports are not the standard procedure to issue every company.

But some company publish the semi-annual reports, in this also have to detail knowledge of half fiscal year.

4) Annual Reports of Company:

Annual reports, so this report is mandatory and you get the more knowledge about the company in this reports.

So in this reports also present the remarks of President of company and vicechairman of the company about how the company does well in past and how to do well in future also means, the outlook of future of the company.

In 1940, some companies only show income statements and some companies show the balance sheet, and some companies show both.

so those show the income statement they don’t show the sales figure of the company in the income statement.

In the balance sheet, tangible and intangible assets are put together and nothing is separate in that time to distinguish. (Annual Reports of the company)

So they don’t show the sales figure because they say, competitors know about their sales figure and their competitor harm the company or business.

But nowadays, this type of problem does not remain.

 

5) Periodic reports to Public Agencies:

The Railroad and Public Utility companies send the reports to the central and state commission.

So in this reports the data is very much detailed as much as they don’t give the detail to the shareholders also.

So those are commission they publish the report regularly and data discloses.

So The author gives some examples of Companies’ commissions that publish the reports on it.

Cram Auto Service, This company give the weekly figure of motor car companies

Vilatant and Gray, This company gives the reports of sugar companies and how much production happens in crop year. (Annual Reports of the company)

The Oil and Gas General, This company show the reports on how much oil and gas is produced.

The Welvag, this company give the detail reports on how much equipment is ordered by companies.

The Dow Jon’s Company, This company give the reports on how much production of steel in weekly basis.

6) Listing Application:

Those are stocks exchange and those are securities exchange, in that so many things are disclosed when the company is going listed.

Or This is not disclosed detailed to the investors and this listing is happening irregularly.

But nowadays this information gets easily.

7) Registration Statement And Prospectuses:

The Registration Statement is bulky and those are the prospectuses they also more than 100 pages.

so this material has some value, you can see them.

8) Miscellaneous Official Reports:

This government division includes like US coal Commission.

This division gives the reports on the coal company.

so this type of division discloses the data that the own company never disclose data before.

Because the company discloses the data. (Annual Reports of the company)

Just like trade commission, that include natural gas pipeline or whatever come in that commission.

9) Statistical and Financial Publications:

An agency like Standard and poor, Moodys

So they issue reports on the company and whatever the data in this they are accurate, but we can’t fully rely on that we have to see the Annual reports of the company.

10) Request for Direct Information from Company:

In this, you can take the direct information from the company.

In this, you have to visit companies website and see their about pages and call them and ask what information you want. (Annual Reports of the company)
So Benjamin Graham says, ” you are the owner of the company, this never forgot. So whatever the big officer are there, you are the employer of them. so act like that”

The authors say, ” If you force the company legally to know about information, sometimes it’s gone expensive or you have to face the Courts.”

But you can ask him about the information that other companies are giving and why not this company is not giving, then you can ask this, so most of the time you get the information.

so lastly we have to see the Which type of industry is

III) Data on Industry:

so what you need to know about the industry, following are some points that help to clarify the which type of industry is.

  1. Histroy Of Industry: IN this you can see the how much old are industry, like now tech industry, this industry is 20 years old, like that you know the history of that and also know the DoT Com bubble. This type of history you have to find.
  2. Current State of Industry: At this point, you have to see what now the industry is doing and what the current status. (Annual Reports of the company)
  3. The prospective state of Industry: At this point, you can see what the perspective of the industry means what is the outlook of the future of this industry, how well do in the future.
  4. Problems of the industry: In this, you have to see the current problem and also the future coming problems in the industry.
  5. Data regarding output, consumption, stocks unfilled order, etc.

so above all types of questions answer, you have to know.

so this is good points to known about industry and you can take the good decision because you know the basics of the industry.

This is all about the Security analysis book, chapter 3 sources of Information.

Benjamin Graham Security Analysis: Chapter 2

Hello friends, in today’s article we see chapter 2 of Benjamin Graham and David dodd book Security Analysis. Chapter 2 is all about the Fundamental Elements in the problem of analysis. Quantitative and qualitative Factors. So let’s see what is the problem of analysis from Benjamin Graham and David Dodd’s book i.e. Security Analysis chapter 2.

In Previous Chapter 1, we talk about the what is the analysis.

Benjamin Graham Security Analysis: #Chapter 2
Now Imagine, analysts start the work and how they approach the particular problem, and what is that?

The objective of Security Analysis of stocks:-

There are two objectives of security analysis, this objective has to be answered by the analyst.

1) What securities should be bought for a given Purpose?

Because in this we have to focus on what we need, and what is your purpose and also what result you expect on that basis you can buy the securities.

2) Should the issue of Security Be bought, Sold, or retained?

To find these two objectives, we have to consider four factors.

1) The Security

2) The Price

3) The Time

4) The Person

In account taking the above four-factor, we can rephrase the second objective just like

A particular Individual at Particular Security can buy, sell or Hold for a particular price and a Particular time.

So let’s go reverse the Sequence of Four factors to make security analysis simple.

I) The Person:-

The person to person what they want, like they want tax assumption upon that they can buy Security.

For Tax assumption, they can buy the Low yield Securities. (Benjamin Graham Security Analysis: Chapter 2)

Or If they can pay Tax, then they can be the High yield Securities.

So this determines the needs of that person’s decision on securities and your decision also depends on time.

So the question that comes to your mind is how on time, so let’s see

How on time, In 1931, the Average return on bonds was 4.3% and, the railroad companies’ high-grade bonds give the 5% yield, so this was an attractive opportunity at that time.

But this same bond becomes Unattractive after 6 months and yield increases up to 5.86% from 4.3%.

When in 1931. the yield of the bond was 4.3% at that time the bond is given 5.2% from the Railroad company. And this was fixed, Whatever the year of maturity of that bond in five years or 10 years.

But in the Market, we get the 5.86% and you get only 5.2%. you get the loss as compared to market rates is 5.86% so this same bond is one time is Attractive and other time is Unattractive.

So your decision also depends on Time.

II) The Price:-

The High-grade bond price was not important when you select high-grade bonds.

Because, their price was rarely high, this happen in 1940 by the author.

So the Most attention was given to this the bond was more Secure or not.

If a bond price was high and then the bond adequately secure then also you have a maximum chance of lose, and also in common stocks have more chance of losing. (Benjamin Graham Security Analysis: Chapter 2)

if you paid the wrong price then you got the loss. This like following quote,

” Buying at wrong price stocks is as much as risky as buying wrong stocks.”

III) The Security:-

The Security and price both are going together.

the Author said, ” Aking this, Which security we have to invest and how much price were we pay for that, Instead that, you have to ask this was what enterprise, we have to invest and in which term we had to invest.”

In terms, not only price come, but they also include, stocks provision of issues and its status issues.

to understand these terms author given two examples,

(1) Commitment On Unattractive Term:-

In this we see, Before 1929, the Urban realistic value constantly increasing for a long time and this investment people think, it was safe, But those terms of issues were disadvantaged able.

Preferred stocks of New York Cities real estate, this provision of issue, was this ranking was junior and unqualified right is not available on dividends payment and status of issues is the New Building was constructing, for that this bond issued for raise money. (Benjamin Graham Security Analysis: Chapter 2)

This was so high-cost construction and there was no reserve for facing a hard time of the company.

Now let’s talk about the price. The price was that the dividend return was 6% and this return was very less than second mortgages but for taking this, there were plenty of advantages

so think these preferred stocks buy or not.

Let’s discuss the second commitment on Attractive terms.

(2) Commitment on Attractive Terms:

In 1932, Brooklyn railroad company sold the 5% yield bonds at $60 and 9.8% Yield of majority.

and the Railway industry is a takeover by the automobile industry.

So unattractive industry was, so let’s see what is the provision

the value of an investment for that this company was raising money, that value is more than that money was raised.

so this company stocks has stable and adequate earning power to pay interest payment and principle and this power is more time than this.

So let’s see the price so this companies bond price was very less than the other companies of subordinate bonds.

But this company price has to be high, generally, those are high-quality bonds, which has high price and yield is minimum, but

In this case, the price is low and the yield is high.

So this company yield was 9.3% and another company yield was 9% and this Brooklyn railroad companies bond also low quality. (Benjamin Graham Security Analysis: Chapter 2)

So author said, ” tell me which security, we have to buy or not”

So from these two examples, the main question was What was more beneficial and profitable.

In the Attractive company buy the security at unattractive terms.

in the unattractive company buy the security at attractive terms.

So the Attractive term was more important than the attractive company (enterprises) and Author also said, ” those were untrained buyers who don’t know how to buy for them, Buy the best and high-quality securities of reputable companies.

Because they don’t know about other things and they don’t have knowledge of other things.

But Those are expert buyers, this people sacrifice some quality because they don’t need that much quality. They buy that much quality for what they need and don’t need more quality.

just like that when you buy a watch, shoes or clothes. If this thing is looking good on you and have adequate quality then why you need the branded and expensive shoes just for looking good and for showing off for this you don’t need maximum quality, and also this is not like that every after the three-day watch is going stop and every time required the watchmaker, then this type of quality doesn’t need. we just need the adequate quality and look goods on us. Same like that those who need the maximum security then they can buy the expensive or high-grade bond of a popular company.

From this, we get the two principles

I) Untrained Security Buyer:

In this those are a weak company or unpopular, then untrained buyer can’t put money in this, because they do, they lose the money. So this is only for the untrained buyer.

II) Security Analysts:

In This point, the author says, ” Nearly every issue might be conceivably cheap in one price range and dear in another.”

So untrained buyers have to stick with that principle, which is the highest quality principle because they have a maximum risk for another place because they don’t have much knowledge of other places. so for those that are popular, that’s awesome good.

But for Analysts, this is not

If analysts think he is right in his judgment, then all world against him, they don’t have to leave that judgment. If their judgment is right, not like an egoist person and says my thinking is right.

Your thinking is wrong and you say, ” this is right so this type of behavior not expect. this like foolishness or stupidity. (Benjamin Graham Security Analysis: Chapter 2)

# Extent of Analysis:

How much we have to do analysis.

In this author says, ” Your practical judgment and your commonsense, how much you have to search deep.”

This author gives the examples

” One bond was that give 3% yield and other was those give 6% yield. So in a 3% yield bond, you have to do less analysis and in a 6% yield bond, you have to see this bond was well secure or not that gives a double return as compared to a 3% bond. so the most probability is that in maximum return the maximum risk in bonds.”

Then Author again says, ” What you do analysis depends on company to company and industry to industry, Like you see five years record of the railroad company and other company like chain store of Walmart. so you see in this company earning for five years, so that ok because this give the reasonable base of Safety.”

But you see oil Producing company and this company is not giving the reasonable bases of safety because this company business depends on external factor like the price of oil when they sell, and how much production in this year or future required this all depends on the external factor.

So they don’t produce maximum they have to produce whatever the demand of oil. If they do more, then the price is fall of that oil. (Benjamin Graham Security Analysis: Chapter 2)

So for this, you have to see which type of industry is also.

so the author says, there are two types of analysis

Types of Analysis:

I) Quantitative Analysis

II) Qualitative  Analysis

so let’s see Quantitative Analysis

I) Quantitative Analysis:

In this analysis, you have to see companies statistical data like ( Income statement, Balance sheet, Cashflow, etc)

For this analysis, the author gives the four things about quantitative Analysis

A) Capitalization

B) Earnings and Dividends

C) Assets and Liabilities

D) Operating Statistics

This four-point we see in another chapter because this book is all about the quantitative basis.

so let’s see the qualitative analysis

II) Qualitative Analysis:

In this, the author gives the five things in this analysis

A) Nature of Business

B) Relative position of the company in Industry

C) Geographical and Operating characteristics

D) Character of Management

E) Outlook for company, industry, business in General

so in this chapter, we see some factors of qualitative analysis.

so let’s see one by one

A) Nature of Business:

In this factor, some businesses perform well at some time, and at that same time, some businesses perform badly.

Like that, In 1923-1929, the Generous prosperity time was going on and there is no crash or anything.

Cans manufacture, Cigarette manufacture and chain stores, and also motion picture company, these four company do the well in this period of 1923-1929. (Benjamin Graham Security Analysis: Chapter 2)

But at that same time other companies of the Cotton industry, plumber, paper industry perform badly in this time.

so thinking like that Those companies perform badly at that time and they also perform badly in future also, and those companies perform well in past and also perform well in future, so this thinking is very wrong.

Those companies perform very well or those companies perform very badly in the past so understand that Now time is come to change.

For this, the author gives examples of company

The Public Utility

this company is Unpopular in 1919 when boom happen.

that time, bu tin 1927-1929, this public utility company become speculative

In 1933 the Cotton Industry, which are depressed for a long time, in this time grow very fast.

So you have to see the Nature of the Business factor.

 

B) Factor of Management:

This factor is double count by the Stock market.

Let’s see how ” those stocks price are earning increases that reflect the stocks, and those companies management is good they also consider in a stocks price.

so this double counting is this for those companies have high earning as compared to the other companies because they are high because they have good management. (Benjamin Graham Security Analysis: Chapter 2)

so management is good than the earning is high and that why we say, stock market double count the Management.

 

C) Future Earnings Trend:

So in past the earning record is good and increases in past; then this is a good sign but this is not like that in past perform good and they also perform well in future.

So in this what happen in past is fact and what happens in future is pure Assumptions

So we don’t know, what is the trend in the future.

But, we say, in past the average of earning in that may be near in future.

So that much we can say

We can’t say that these are trends that remain the same.

So in this, you are absolutely right or absolutely wrong.

for this author give the two examples

a) In 1929, those railroad companies’ earnings were 5 times more than the interest rate charges for the past 7 years.

So we can make sound judgment in this bond is this investment is good on this bond, but something happen like economic collapse and recession come or any other stream event happens so in this period also company may handle his problem.

In reality, the depression comes after 1929, this company performs well in this situation also.

b) In 1929, the Public Utility company show continuous growth in earnings but fixed charges were so heavy that they consumed nearly all net Income. (Benjamin Graham Security Analysis: Chapter 2)

But people think, This earning also continuous in future. so this prediction goes wrong and they got serious losses.

So people try to quantified the trends, often but it actually is a qualitative factor.

For this, The author says, ” Analysts have to consider future changes, this types of changes happen in future, but from that change, analysts don’t have to do profits from that

Instead of that, they have to guard the future changes

If you try to profits from that changes happen in the future, then you become optimistic, If you think to guard against changes, then you will become more alert.

 

D) Inherent Stability:

Inherent Stability is like Resistance to the change, which means They can resist the change.

If resist well then stability is good, which means those result in past, we can depend that result may be in future.

But stability is like a trend, People also do with this is quantified it.

but this is also the qualitative factor.

So this qualitative factor is derived by business nature, not a seeing statistical record, this is quantifiable.

So for this, the author gives the examples

E.g In 1932 the preferred stock issues of two companies one is Studebaker( this company sells the motors or manufactures them) and the other is First National Stores ( Grocery company). (Benjamin Graham Security Analysis: Chapter 2)

for previous 8 years

The earnings covered dividends of Studebaker by 26.2 times and that of first National stores by 6.3 times.

So tell me which is better

.

.

.

 

so obviously Studebaker is good because this company was stable and earnings was 26.6 times than Fixed charges.

But the answer is BiG NO

You are saying by just seeing the data and you quantified them.

Groceries business is more stable because they have stable demand and diversified location and inventory turnover are Rapid.

Those companies that making the Motor, in this has the maximum variation because this depends on popular trends, and also people can buy, in that situation, so we have to adjust as their demand is.

so the company doesn’t have any immunity to those things for this problem.

So many times in quantitative we have to see them from a qualitative point of view to get the proper sense.

and qualitative things, if we try to quantify them and then you don’t have to depend on that

So lastly author says for decision making.

A statistical exhibit is a necessary though by no means a sufficient condition for a favorable decision by the analysts.

So this is all about chapter 2 of benjamin Graham and David Dodd’s book of security analysis.

Benjamin Graham Security Analysis: Chapter 1

hello friend, in today’s article we see chapter 1 of Benjamin Graham’s book is Security analysis. In chapter 1 Benjamin Graham explains the scope and limitations of Security Analysis and the concept of intrinsic value. so let’s start chapter 1 of Benjamin Graham Security analysis book.

Previous Chapter: Introduction of Security Analysis book

Benjamin Graham Security Analysis: Chapter 1
Part -I: Survey and Approach:-benjamin graham security analysis

In this book, this is divided into five parts, in this first part include the five chapter,

then let’s start with the first chapter

Chapter 1: The scope and limitations of Security Analysis. The Concept of Intrinsic Value:

Firstly Benjamin Graham define the Analysis

What is Analysis: Careful study of available facts with the attempt to draw conclusions therefrom based on established principles and sound logic behind that.

Some part of Security Analysis is Scientific and another part is Art and Chance.

In the stock market, you will be successful on the basis is decided by the Scientific method and your art and your destiny also.

So Benjamin Graham develops this method and warren Buffett uses this method and use their own art and become the world’s richest person and greatest investor of all time.

This means this method is also dependent on Art. How people handle this method artfully is also important.

These three things of combination decide you fail or succeed in the market. (benjamin graham security analysis)

The author says, ” People do analysis up to the 1927 year after that New Era starts and people don’t do any analysis.

the author also says, ” If they do proper analysis, then people know in 1937, the price of stocks is high and in 1938 the price of stocks is low of GEneral Electrics company. ( we talk in the previous Chapter)

The author says, ” There are three functions of Analysis.”

1) Descriptive

2) Critical

3) Selectives

1) Descriptive functions:

In this function, we study the companies’ important information, and we present this information in a very sensible way.

From this, we know, the company’s strong point and weak point and we compare this point to other companies’ points.

2) Critical Functions:

The critical function is, those investment finance principles and corporate finance methods, both are used to analysis of securities analysis.

We take analytical judgement on Security analysis, which is applied on both principles and method of corporate, so that why this is a critical function of analysis.

3) Selective Functions:

Express specific judgments of its own determination in this function.

Whether an issue should be bought, sold, retained, or exchanged for some other.

so author give some examples for judgments

let’s see one by one (benjamin graham security analysis)

1) In 1928, the company was Louis-San Francisco Railway. this company issued 6% Non-cumulative preferred stocks, but from the company record, we know that there was in the companies history, companies earnings, never go 1.5 times of Fixed charges.

Fixed charges are those charges we have to pay, whatever happens in the company in the form of Interest payment or lease payment.

So the author asks us, this company we have to buy or not.

the answer is Not to buy

So this judgment was just like that not to use the brain, just apply common sense.

2) In 1932, The company name was Owens-Illinois Glass company. this company bonds at 5% trade at $70 in market place and 11% yield to maturity in 1939.

This companies earnings were much time more than the fixed charges.

Up to in depression in this also the earning is more than the fixed charges.

The bond issue was well covered by companies asset. (benjamin graham security analysis)

This means the Current asset Value is secure in the bond issue.

This means this is more than sufficient for paying fixed charges.

So this company, we have to buy or not

Answer: In this company, we get the security we can buy this company, and we are benefited from this company.

3) In 1922, the company Wright Aeronautical corporation, this company stock trade at $8 in the market place and $1 is paying a dividend.

And earning per share is $2 and company cash asset is more than $8 per share.

So this company we have to buy or not.

Answer: Definitely buy,

Because $8 was the cash asset and they trade also at $8 and their earning also $2. so in this we know don’t have to do anything, just buy this company.

4) In 1928, Wright Aeronautical corporation, this companies stocks goes to $280 in just 6 years. means (35X) the companies earning were $9 per share and Dividends were $2 per share.

NAV( Net Asset Value) was less than $50 per share.

So this company, we have to buy or not?

Answer: Not to Buy

Because suppose $50 was Net Asset Value and Earnings is 8, so take P/E ratio 20 the highest ratio.

The $160 form earings, and $50 form NAV and both get $210 and we assume the highest P/E ratio. So this stock price is $280, so we required more than $70. So this is maximum so don’t have to buy this company. (benjamin graham security analysis)

5) In 1933, Interborough Rapid Transport selling 5% and 7% notes of two types at the same price.

So those were each 7% note was secured by $1736 face amount than 5% notes.

Individually both were $1,000 whatever that was 5% notes or 7% notes.

So those Were 5% which had a Price was $1000 and they are secured at a %1736 face amount.

Obviously in these 7% notes is better than 5% and the rate is the same, so buying 7% notes is more beneficial than 5%.

6) In 1936, Paramount Picture, this company sells the Convertibles preferred stocks at $113, and Common stock was selling at 15 7/8 dollar.

So in past, there was a share price shown in a fraction and people can buy this fraction amount of share.

So this companies preferred stock was can be converted into 7 common shares and they had accumulated dividends of $1 per share.

Common stocks holder could have exchanged their shares for 1/7th as many preferred stocks, and they gain in both dividends and principal value also.

then the author says, ” so many people think book value was intrinsic value, so they were very wrong on this point. (benjamin graham security analysis)

Because not a companies earning value or not companies stocks. the market price is not related in any way.

So after this, the new thinking born. ” those are intrinsic value is determined by earning power.

so from this also intrinsic value have a definite figure. so this is also no a reliable way to find intrinsic value.

Because, the intrinsic value is not anyone known or not anyone finds, but we can take the range( between two points) of whatever the intrinsic price range, this is the highest maximum work for finding intrinsic value.

7) J. I company, this case, in 1933, selling at %80 and Asset value per share $176 and not paying any dividend.

And the average earnings for the past 10 years were equaled to $9.5 per share so this is in 1933, happening and the author talks about this timeline of 1933.

But the result of the previous year in 1932, the loss of $17 per share. so those we take the average earning of previous 10 past years is $9.5 found.

In these 10 years, the recently previous 3 years having losses continuously and those last 3 years of 10 years, also have loses but only good profit at in a middle year.

So the author says, tell me these stocks buy or not.

Answer: So in this author give the explanation is those we figure out the $9.5 average per share, is not reliable, this is because Earning is maximumly fluctuated so this average not represent company condition.

Instead, that 10 years was positive returns continuously, but this not happen. this company’s first 3 past years is negative and last three years of 10 years in past also the negative returns, and in middle, they give the positive returns. so from this, we can not conclude that what will happen in the future would positive or negative. (benjamin graham security analysis)

So from this, we can not find anything so this makes us confuse and doubtful about the future.

If companies price is $10 per share, then this company is showing a buy indication.

But we were not sure to buy at $30 because this earning is not gives a reliable estimate.

Benjamin Graham says, ” we don’t have to find out the exact value of intrinsic value.”

We just have to find out the intrinsic value is adequate. Because this just justify to buy and they are considered high or not on the market price of stocks.

So the author says, ‘ this is very simple.’

because, we can easily say, which women are eligible for the vote or not only just seeing that women. so whatever the age of that women, we don’t need to know that women’s exact age.

or for Man

We can easily say, which man has overweight than his actual weight, so we don’t need to find out the exact weight of that man.

we don’t need to find out the BMI

So just like that, we can find out the intrinsic value is more than the market price or minimum than market price.

after this author says, ” there are three obstacles to face analyst”

Three Obstacles to Success of Analyst:

1) Inadequacy or Incorrectness of data:

This means, the information has the analyst they are not accurate, they are wrong, then the analysis also goes wrong.

So authors say, ” Very few companies are that give the wrong data or mistake data, they can miss a change or hide so one data but or not give mistake data. so those are very few companies. (benjamin graham security analysis)

Because nowadays, the rules, and regulation is more and analyst can also find by simply applying their skill.

2) Uncertainties of Future:

so the author says, ” Future is uncertain and unpredictable in this there is no doubt?”

But, some companies are like that we can predict past and future also, like some stable companies business in normal condition. but in depression or recession time this companies we can’t predict.

So then all future prediction is meaningless.

3) Irrational behavior of Market:

In this we have problem is the company is staying undervalued for a long time and we buy that stocks at undervalued and these stocks never come at a fair price.

So we trapped in there, so this can happen, or most time happen in past. (benjamin graham security analysis)

Or like this may be happening is the stock is overvalued and never come in their fairvalue.

In Value Investing We take the two assumptions

  1. The market price of stocks is misaligned with the actual price.
  2. So Market have inheritance Tendencies to do the right things. ( those desperate in market price and actual value stocks between them)

So this corrects by the market and it has an inheritance quality of the market.

So this may happen tomorrow, next month, or next year, but happen definately correct.

So these two assumption we take, the author then says, ” The relation is between intrinsic value and market stock price is

A market is a Voting machine in the Short term and a Weighting machine in the Long run.

So those who do speculation and those who do analysis in speculation are also the stupidity things.

Because in speculation, the most important factor is luck or chance, and that why the analysis value is minimum this also the same in r00lay games there are odds is opposite to you.

So we have to treat analysis as Auxillary and additional things, not a guide while doing speculation in time.

This is all about Chapter 1 of Benjamin Graham’s security analysis book. The scope and limitation of security analysis and the basic concept of intrinsic value.