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 chapter 7, the authors explain the second and third principles for selecting fixed-value investments.Per the second principle, the author says criteria for selecting bonds should be based on depression-area standards. While this may sound excessive it ensures the safety of the principal. The authors highlight three areas that could lead to unsatisfactory results by utilizing railroads, public utilities, and industrial industries.
1) Inadequate interest coverage (likely from the bad capital structure)
2) Instability of earning power, and
3) Extended operating losses in certain industries during the depression.
Per the third principle, Mr. Graham and Mr. Dodd, while challenging the traditional wisdom, say that a higher yield on a bond can't compensate for the higher risk. That is because there is no clear mathematical relationship between higher yield and risk. Rather, popularity, familiarity, and marketability affect bond prices. While selecting fixed value investments, an intelligent investor should first look at the satisfaction of minimum standards before doing more work.
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