Security Analysis by Benjamin Graham and David Dodd was first published in 1934. It is a fundamental book for serious students of value investing.
In the book introduction, Mr. Graham and Mr. Dodd thought about investment standards that could be applied to various securities. In the first chapter, the authors talk about applying standards to facts while doing security analysis. They introduce the concept of Intrinsic value and its role in security analysis. In the latter part of the chapter, obstacles faced by the analyst are discussed.
The writers think the success of the investment analysis is dependent not only on scientific methods but also on individual skill and luck.
The outcome of the analysis should be driven by the Intrinsic Value which is dependent on facts such as assets, earnings, dividends, and prospects of the enterprise. Intrinsic value is not a definite value. It was earlier thought to be book value but was later related to earning power of the business. (Earning power is related to normalized results the business can expect in the future with high certainty). The basic purpose of security analysis is to determine whether Intrinsic value is adequate to buy the security or whether it is considerably higher or lower than the market price of the security. Mr. Graham and Mr. Dodd use various examples to demonstrate this point. They mention Intrinsic value could be determined within a range. If the market price is below the low end of the range, it is worth considering investing. In arbitrage or hedging operations, Intrinsic value is easier to determine compared to other investment operations in securities.
Per the authors, a security analyst faces three obstacles: (i) Incorrect data; (2) Uncertain future; and (3) Irrational market behavior. On the last point, the market frequently misprices securities and but over a time period these discrepancies correct themselves.
The authors go on to compare Investment and Speculation. They emphasize the value of the analysis declines as the element of chance increases. Mr. Graham and Mr. Dodd end the chapter by summarizing the critical aspects of security analysis in relation to standards applied to facts. They also emphasized analyzing management and their actions.
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