Analyzing security can be complex, but there are some core principles to guide investors. Today we will share the key insights from “Security Analysis” by Benjamin Graham and David Dodd to set you on the right path.
Book Review: “Security Analysis” by Benjamin Graham and David Dodd
May 2023About the author
David LeFevre Dodd was an economist, author, and investor who served as the protégé of legendary investor Benjamin Graham at Columbia Business School. Graham sought safer ways to invest after the Wall Street Crash of 1929 nearly wiped out his wealth, and Dodd, a young instructor at Columbia, offered to help transcribe Graham’s lessons. These notes became the basis of the 1934 book “Security Analysis,” which galvanized the concept of value investing. Widely considered the father of value investing, Graham’s writings have significantly influenced many investors, including Warren Buffett.
Check out our previous article “The Intelligent Investor: The Definitive Book on Value Investing” if you are keen to learn more about Graham’s life.
Key insights
1. Abnormally good or abnormally bad conditions do not last forever
Investors need patience, but only a healthy dose of it. Too much patience can swing too far into loss aversion. Having a permanent holding does not mean that you are investing, in the same way that using data and financial reports to make an investment decision based on a company’s potential is not necessarily speculating.
2. While a trend shown in the past is a fact, a “future trend” is only an assumption
Graham warns not to overemphasize trends. This is a common misconception and it can be the difference between investors and speculators. There is no guarantee that if a stock’s earnings per share (EPS) increases by 10% every year, that it will continue to do so. In fact, this trend is less likely to continue the longer it goes on. A balanced approach is needed. When there are positive trends, analysts should stay conservative and rely on earnings rather than putting their hope in the future potential of a stock. On a similar note, it wouldn’t be strategic to assume that a negative trend will continue. The reality is that the entire sector may have experienced a downturn but that one specific company is still the best investment choice.
3. In general, investors should spend significant time on the disclosures of the security under study and the reports of competitors
Contextualize the data as much as possible to get a true sense of the company’s standing before you decide to invest in it.
4. Invest in the highest-yielding obligation
According to Graham and Dodd: “Safety depends upon and is measured entirely by the ability of the debtor corporation to meet its obligations… High coupon rate is not adequate compensation for the assumption of substantial risk of principal.”
The value of a fixed asset can become worthless if a company defaults or is put into liquidation. Graham and Dodd therefore advised investors to only invest in a company if it demonstrates that it has a solid business model. They recommend purchasing that company’s junior unsecured bond that pays a higher yield, rather than its senior bond. Since stable companies can meet all of their financial obligations, investors are better off investing in what gets them the highest return on their investment. Know the company inside and out, and analyze that company’s fundamentals rather than the terms and conditions of the bond issue.
5. Regardless of how fantastic the prospects of stocks may be, focus on the data first
Graham and Dodd said: “If the earnings were not properly stated; if the balance sheet revealed a poor current position, or the funded debt was growing too rapidly; if the physical plant was not properly maintained; if dangerous new competition was threatening, or if the company was losing ground in the industry; if the management as deteriorating or was likely to change for the worse; if there was reason to fear for the future of the industry as a whole – any of these defects or some other one might be sufficient to condemn the issue from the standpoint of a cautious investor.”
Conclusion
As you embark on your investing journey, keep in mind these valuable insights from “Security Analysis” by Graham and Dodd:
- Extreme market conditions do not last long;
- Historical trends do not necessarily indicate a future trend;
- Investors should analyze securities and competitor reports;
- Invest in the highest-yielding obligation and focus on the data first.
These are the core principles and takeaways from Graham and Dodd’s investing companion book, so keep these in mind to help guide your own investment strategy.
