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.
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 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
- The market price of stocks is misaligned with the actual price.
- 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.