Security Analysis by Benjamin Graham and David Dodd was first published in 1934. It is a fundamental book for serious students of value investing.
This chapter is the beginning of Part II of the book, wherein Mr. Graham and Mr. Dodd introduce the principles for analyzing fixed-value investments (the first set of investment types introduced in the prior chapter).
The basic idea that runs through the chapter is investment selection should be based on loss avoidance versus return potential. That is because fixed value investments have a cap on what bondholders can get paid regardless of business performance. Thus, the authors favor a "negative art" approach to find such securities.
For doing so, the authors lay out four principles for the selection. Importantly, a safe fixed value investment is not governed by the "secured" nature of the bond. Rather it should be judged based on the company's ability to fulfill its obligations. Part of the reason is that collateral's value shrinks if the business does poorly. In addition, in bankruptcy, creditors' legal rights have been not so successful especially if the value of the collateral exceeds the value of the claim.
This principle leads to giving less importance to the absence of lien and highest-yielding bond. The investor should look for bonds of strong enterprises that have the ability to fulfill their obligations, thus generating safe income for the holder.
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