benjamin graham school of value investing pdf

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.

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.

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