Nhà đầu tư chứng khoán Warrent Buffet - Người giàu thứ 3 thế giới học đầu tư từ đâu ? Bản tiếng Anh

Đầu tư chứng khoán - Benjamin Graham Warren Buffett được cả thế giới công nhận là nhà đầu tư vĩ đại nhất của mọi thời đại, nhưng nếu bạn hỏi ông xem ai là nhà đầu tư vĩ đại nhất thì câu trả lời nhận được sẽ là: Benjamin Graham! Cây đại thụ trong giới đầu tư cổ phiếu đã không ngần ngại tự nhận: “Trong tôi có đến 85% là Benjamin Graham”. Benjamin Graham còn có 8 phương châm về đầu tư giá trị và một công thức tính giá trị cổ phiếu mang dấu ấn riêng của ông. Tác giả Janet Lowe, trong cuốn sách viết về tiểu sử của Benjamin Graham, đã tổng kết 8 phương châm như sau: 1 - Hãy là một nhà đầu tư, đừng là một nhà đầu cơ. Benjamin Graham định nghĩa nhà đầu tư là người mua và sở hữu cổ phiếu dài hạn, trong khi nhà đầu cơ tìm kiếm lợi nhuận ngắn hạn 2 - Quan trọng nhất là mua với giá bao nhiêu. Mua cổ phiếu của một công ty tốt nhất thị trường về hoạt động, về các chỉ số tài chính vẫn có thể là một đầu tư sai hoặc không hiệu quả nếu chúng ta mua với giá quá cao. 3 - Truy tìm những cơ hội giá hời. Thị trường sẽ luôn có lỗi trong việc định giá cổ phiếu. 4 - Luôn thận trọng với những con số tài chính do công ty cung cấp. Thỉnh thoảng vẫn có những công ty cố tình không đạo đức. 5 - Đa dạng hoá đầu tư. Đừng quá tập trung vào một số ít cổ phiếu. 6 - Hãy thực hiện quyền cổ đông của mình. Nhiều nhà đầu tư đã không thực hiện quyền cổ đông của mình mà bỏ ngỏ công ty cho các nhà điều hành. Nhà điều hành đôi khi hành động theo lợi ích của họ, hay lợi ích của một nhóm cổ đông nào đó, mà không hoạt động vì lợi ích của cả công ty. 7 - Hãy kiên nhẫn. Phương châm này củng cố phương châm 1. 8 - Phải có tính kỷ luật. Chỉ mua cổ phiếu khi thị giá thấp hơn giá trị được xác định theo công thức sau: Giá trị = EPS x (2 x tốc độ tăng trưởng năm + 8,5) x Lãi suất TPCP/lãi suất trái phiếu AAA

PRAISE FOR THE SIXTH EDITION OFSECURITY ANALYSIS

“The sixth edition of the iconic Security Analysis disproves the adage ‘’tisbest to leave well enough alone.’ An extraordinary team of commentators,led by Seth Klarman and James Grant, bridge the gap between the sim-pler financial world of the 1930s and the more complex investment arena

of the new millennium Readers benefit from the experience and wisdom

of some of the financial world’s finest practitioners and best informedmarket observers The new edition of Security Analysis belongs in thelibrary of every serious student of finance.”

David F SwensenChief Investment Officer

Yale Universityauthor of Pioneering Portfolio Management

and Unconventional Success

“The best of the past made current by the best of the present Tiger Woodsupdates Ben Hogan It has to be good for your game.”

Jack MeyerManaging Partner and CEO

Convexity Capital

“Security Analysis, a 1940 classic updated by some of the greatest financialminds of our generation, is more essential than ever as a learning tooland reference book for disciplined investors today.”

Jamie DimonChairman and CEOJPMorgan Chase

be made even better Seth Klarman’s preface should be required readingfor all investors, and collectively, the contributing editors’ updates makefor a classic in their own right The enduring lesson is that an understand-ing of human behavior is a critical part of the process of security analysis.”

Brian C RogersChairman

T Rowe Price Group

“A classic has now been updated by some of the greatest and most

thoughtful investors of our time The book was a must read and has nowbeen elevated to a new level.”

Daniel S OchSenior Managing MemberOch-Ziff Capital Management Group

“Readers will find the updated version of Graham and Dodd’s SecurityAnalysis to be much improved from earlier editions While the timelessadvice from two of the greatest value investors continues to resonate, theessays that are contributed by some of the world’s top value investors addimmeasurably to the read These investors practice what they preach intheir essays and combine to make this edition the best ever! I highly rec-ommend this volume to all investors—old and young—who will benefitfrom the tried and true principles of the past and the updated applica-tions to today’s turbulent markets!”

Morris SmithPrivate InvestorFormer ManagerFidelity Magellan Fund

“No book empowers you with better tools for intelligent investing thanSecurity Analysis Seth Klarman and his fabulous team have produced anonpareil edition of Ben Graham’s classic for the new millennium.”

Mason HawkinsChairman, Longleaf PartnersSoutheastern Asset Management

“The ideas of Graham and Dodd have withstood all kinds of market ditions and 75 years of scrutiny—making them ever more relevant formodern-day investing The essays by Klarman and other storied valueinvestors lucidly illustrate that while the capital markets landscape may

con-be vastly changed from years past, basic investor traits are not, and plined application of the principles of Security Analysis continues to pro-vide an important edge in investing.”

disci-André F PeroldGeorge Gund Professor of Finance and Banking

Harvard Business School

S ECURITY A NALYSIS

Graham and Dodd: Security Analysis, First Edition (1934)Graham and Dodd: Security Analysis, Second Edition (1940)Graham and Dodd: Security Analysis, Third Edition (1951)Graham, Dodd, Cottle, and Tatham: Security Analysis, Fourth Edition (1962)

Graham, Dodd, Cottle, Murray, Block, & Leibowitz: Security Analysis, Fifth Edition (1988)

S ECURITY A NALYSIS Principles and Technique

BENJAMIN GRAHAM Investment Fund Manager;

Lecturer in Finance Columbia University

AND

DAVID L DODD Associate Professor of Finance Columbia University Sixth Edition

New York Chicago San Francisco Lisbon London Madrid Mexico City Milan New Delhi San Juan Seoul

Singapore Sydney Toronto

States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher

0-07-164293-5

The material in this eBook also appears in the print version of this title: 0-07-159253-9.

All trademarks are trademarks of their respective owners Rather than put a trademark symbol after every occurrence of a trademarked name, we use names in an editorial fashion only, and to the benefit of the trademark owner, with no intention of infringement of the trademark Where such designations appear in this book, they have been printed with initial caps

McGraw-Hill eBooks are available at special quantity discounts to use as premiums and sales promotions, or for use in corporate training programs For more information, please contact George Hoare, Special Sales, at george_hoare@mcgraw-hill.com or (212) 904-4069

TERMS OF USE

This is a copyrighted work and The McGraw-Hill Companies, Inc (“McGraw-Hill”) and its sors reserve all rights in and to the work Use of this work is subject to these terms Except as per- mitted under the Copyright Act of 1976 and the right to store and retrieve one copy of the work, you may not decompile, disassemble, reverse engineer, reproduce, modify, create derivative works based upon, transmit, distribute, disseminate, sell, publish or sublicense the work or any part of it without McGraw-Hill’s prior consent You may use the work for your own noncommercial and per- sonal use; any other use of the work is strictly prohibited Your right to use the work may be termi- nated if you fail to comply with these terms

licen-THE WORK IS PROVIDED “AS IS.” McGRAW-HILL AND ITS LICENSORS MAKE NO GUARANTEES OR WARRANTIES AS TO THE ACCURACY, ADEQUACY OR COMPLETE- NESS OF OR RESULTS TO BE OBTAINED FROM USING THE WORK, INCLUDING ANY INFORMATION THAT CAN BE ACCESSED THROUGH THE WORK VIA HYPERLINK OR OTHERWISE, AND EXPRESSLY DISCLAIM ANY WARRANTY, EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE McGraw-Hill and its licensors do not warrant or guarantee that the functions contained in the work will meet your requirements or that its operation will be uninterrupted or error free Neither McGraw-Hill nor its licensors shall be liable to you or anyone else for any inaccuracy, error or omission, regardless of cause, in the work or for any dam- ages resulting therefrom McGraw-Hill has no responsibility for the content of any information accessed through the work Under no circumstances shall McGraw-Hill and/or its licensors be liable for any indirect, incidental, special, punitive, consequential or similar damages that result from the use of or inability to use the work, even if any of them has been advised of the possibility of such damages This limitation of liability shall apply to any claim or cause whatsoever whether such claim or cause arises in contract, tort or otherwise

DOI: 10.1036/0071592539

We hope you enjoy this McGraw-Hill eBook! If you’d like more information about this book, its author, or related books and websites,

please click here.

Professional

Want to learn more?

theory and practice of investing with the 1934 tion of Security Analysis The nation, and indeed the rest

publica-of the world, was in the grips publica-of the Great Depression, aperiod that brought unprecedented upheaval to thefinancial world In 1940, the authors responded with acomprehensive revision The second edition of SecurityAnalysis is considered by many investors to be the defini-tive word from the most influential investment philoso-phers of our time

Around the world, Security Analysis is still regarded asthe fundamental text for the analysis of stocks and bonds

It is also considered to be the bible of value investing Tocommemorate the 75th Anniversary of Security Analysis,McGraw-Hill is proud to publish this sixth edition.Using the text of the 1940 edition, this new editionfeatures lively and practical essays written by a stellarteam that includes today’s leading value investors, aprominent academic, and leading financial writers Theresult is a contemporary bible of value investing

The sixth edition, with a new design that payshomage to the original 1940 design, includes a CD ofthe entire original 1940 second edition This book wasprinted and bound by R.R Donnelley in Crawfordsville,Indiana

“Many shall be restored that now are fallen, and many shall fall that now are in honor.”

HORACE—ARSPOETICA

C ONTENTS

Preface to the Sixth Edition | The Timeless Wisdom of Graham and

P REFACE TO THE S ECOND E DITION xli

P REFACE TO THE F IRST E DITION xliii

Introduction to the Sixth Edition | Benjamin Graham and Security

I NTRODUCTION TO THE S ECOND E DITION 21

PARTI

SURVEY AND APPROACHIntroduction to Part I | The Essential Lessons

by Roger Lowenstein 39

Graham and Dodd chapters:

1 T HE S COPE AND L IMITS OF S ECURITY A NALYSIS T HE C ONCEPT OF I NTRINSIC

FIXED-VALUEINVESTMENTSIntroduction to Part II | Unshackling Bonds • by Howard S Marks 123

Graham and Dodd chapters:

6 T HE S ELECTION OF F IXED - VALUE I NVESTMENTS 141

7 T HE S ELECTION OF F IXED - VALUE I NVESTMENTS : S ECOND AND T HIRD P RINCIPLES 151

8 S PECIFIC S TANDARDS FOR B OND I NVESTMENT 169

9 S PECIFIC S TANDARDS FOR B OND I NVESTMENT (C ONTINUED ) see accompanying CD

10 S PECIFIC S TANDARDS FOR B OND I NVESTMENT (C ONTINUED ) 180

11 S PECIFIC S TANDARDS FOR B OND I NVESTMENT (C ONTINUED ) see accompanying CD

12 S PECIAL F ACTORS IN THE A NALYSIS OF R AILROAD AND P UBLIC - UTILITY B ONDS see accompanying CD

13 O THER S PECIAL F ACTORS IN B OND A NALYSIS see accompanying CD

14 T HE T HEORY OF P REFERRED S TOCKS see accompanying CD

15 T ECHNIQUE OF S ELECTING P REFERRED S TOCKS FOR I NVESTMENT 190

16 I NCOME B ONDS AND G UARANTEED S ECURITIES 202

17 G UARANTEED S ECURITIES (C ONTINUED ) 215

18 P ROTECTIVE C OVENANTS AND R EMEDIES OF S ENIOR S ECURITY H OLDERS 229

19 P ROTECTIVE C OVENANTS (C ONTINUED ) 242

20 P REFERRED - STOCK P ROTECTIVE P ROVISIONS M AINTENANCE OF J UNIOR C APITAL

23 T ECHNICAL C HARACTERISTICS OF P RIVILEGED S ENIOR S ECURITIES 299

24 T ECHNICAL A SPECTS OF C ONVERTIBLE I SSUES 313

25 S ENIOR S ECURITIES WITH W ARRANTS P ARTICIPATING I SSUES S WITCHING AND

H EDGING see accompanying CD

26 S ENIOR S ECURITIES OF Q UESTIONABLE S AFETY 323

THEORY OFCOMMON-STOCKINVESTMENT

THEDIVIDENDFACTORIntroduction to Part IV | Go with the Flow • by Bruce Berkowitz 339

Graham and Dodd chapters:

27 T HE T HEORY OF C OMMON - STOCK I NVESTMENT 348

28 N EWER C ANONS OF C OMMON - STOCK I NVESTMENT 366

29 T HE D IVIDEND F ACTOR IN C OMMON - STOCK A NALYSIS 376

30 S TOCK D IVIDENDS see accompanying CD

PARTV

ANALYSIS OF THEINCOMEACCOUNT THEEARNINGS

FACTOR INCOMMON-STOCKVALUATION

Introduction to Part V | The Quest for Rational Investing

by Glenn H Greenberg 395

Graham and Dodd chapters:

31 A NALYSIS OF THE I NCOME A CCOUNT 409

32 E XTRAORDINARY L OSSES AND O THER S PECIAL I TEMS IN THE I NCOME A CCOUNT 424

33 M ISLEADING A RTIFICES IN THE I NCOME A CCOUNT E ARNINGS OF S UBSIDIARIES 435

34 T HE R ELATION OF D EPRECIATION AND S IMILAR C HARGES TO E ARNING P OWER 453

35 P UBLIC - UTILITY D EPRECIATION P OLICIES see accompanying CD

36 A MORTIZATION C HARGES FROM THE I NVESTOR ’ S S TANDPOINT see accompanying CD

37 S IGNIFICANCE OF THE E ARNINGS R ECORD 472

38 S PECIFIC R EASONS FOR Q UESTIONING OR R EJECTING THE P AST R ECORD 487

39 P RICE - EARNINGS R ATIOS FOR C OMMON S TOCKS A DJUSTMENTS FOR C HANGES IN

Graham and Dodd chapters:

42 B ALANCE - SHEET A NALYSIS S IGNIFICANCE OF B OOK V ALUE 548

43 S IGNIFICANCE OF THE C URRENT - ASSET V ALUE 559

44 I MPLICATIONS OF L IQUIDATING V ALUE S TOCKHOLDER - MANAGEMENT

R ELATIONSHIPS 575

45 B ALANCE - SHEET A NALYSIS (C ONCLUDED ) 591

PARTVII

ADDITIONALASPECTS OFSECURITYANALYSIS

DISCREPANCIES BETWEENPRICE ANDVALUE

Introduction to Part VII | The Great Illusion of the Stock Market and

Graham and Dodd chapters:

46 S TOCK - OPTION W ARRANTS see accompanying CD

47 C OST OF F INANCING AND M ANAGEMENT 633

48 S OME A SPECTS OF C ORPORATE P YRAMIDING 644

49 C OMPARATIVE A NALYSIS OF C OMPANIES IN THE S AME F IELD 654

50 D ISCREPANCIES BETWEEN P RICE AND V ALUE 669

51 D ISCREPANCIES BETWEEN P RICE AND V ALUE (C ONTINUED ) 688

52 M ARKET A NALYSIS AND S ECURITY A NALYSIS 697

PARTVIII

GLOBALVALUEINVESTING

A PPENDIX see accompanying CD

About This Edition 725

Acknowledgments 727

About the Contributors 729

About the Authors 733

Index 735

B Y WA R R E N E BU F F E T T

There are four books in my overflowing library that I particularly

treasure, each of them written more than 50 years ago All,though, would still be of enormous value to me if I were to readthem today for the first time; their wisdom endures though their

pages fade

Two of those books are first editions of The Wealth of Nations (1776),

by Adam Smith, and The Intelligent Investor (1949), by Benjamin Graham

A third is an original copy of the book you hold in your hands, Grahamand Dodd’s Security Analysis I studied from Security Analysis while I was atColumbia University in 1950 and 1951, when I had the extraordinarygood luck to have Ben Graham and Dave Dodd as teachers Together, thebook and the men changed my life

On the utilitarian side, what I learned then became the bedrock uponwhich all of my investment and business decisions have been built Prior

to meeting Ben and Dave, I had long been fascinated by the stock market.Before I bought my first stock at age 11—it took me until then to accumu-late the $115 required for the purchase—I had read every book in theOmaha Public Library having to do with the stock market I found many ofthem fascinating and all interesting But none were really useful

My intellectual odyssey ended, however, when I met Ben and Dave,first through their writings and then in person They laid out a roadmapfor investing that I have now been following for 57 years There’s been noreason to look for another

[xi]

Copyright © 2009, 1988, 1962, 1951, 1940, 1934 by The McGraw-Hill Companies, Inc Click here for terms of use

Beyond the ideas Ben and Dave gave me, they showered me withfriendship, encouragement, and trust They cared not a whit for reciproca-tion—toward a young student, they simply wanted to extend a one-waystreet of helpfulness In the end, that’s probably what I admire mostabout the two men It was ordained at birth that they would be brilliant;they elected to be generous and kind.

Misanthropes would have been puzzled by their behavior Ben andDave instructed literally thousands of potential competitors, young fel-lows like me who would buy bargain stocks or engage in arbitrage trans-actions, directly competing with the Graham-Newman Corporation,which was Ben’s investment company Moreover, Ben and Dave woulduse current investing examples in the classroom and in their writings, ineffect doing our work for us The way they behaved made as deep animpression on me—and many of my classmates—as did their ideas Wewere being taught not only how to invest wisely; we were also beingtaught how to live wisely

The copy of Security Analysis that I keep in my library and that I used atColumbia is the 1940 edition I’ve read it, I’m sure, at least four times, andobviously it is special

But let’s get to the fourth book I mentioned, which is even more cious In 2000, Barbara Dodd Anderson, Dave’s only child, gave me herfather’s copy of the 1934 edition of Security Analysis, inscribed with hun-dreds of marginal notes These were inked in by Dave as he prepared forpublication of the 1940 revised edition No gift has meant more to me

T H E T I M E L E S S W I S D O M O F

B Y SE T H A KL A R M A N

Seventy-five years after Benjamin Graham and David Dodd wrote

Security Analysis, a growing coterie of modern-day value investorsremain deeply indebted to them Graham and David were twoassiduous and unusually insightful thinkers seeking to give order to themostly uncharted financial wilderness of their era They kindled a flamethat has illuminated the way for value investors ever since Today, SecurityAnalysis remains an invaluable roadmap for investors as they navigatethrough unpredictable, often volatile, and sometimes treacherous finan-cial markets Frequently referred to as the “bible of value investing,” Secu-rity Analysis is extremely thorough and detailed, teeming with wisdom forthe ages Although many of the examples are obviously dated, their les-sons are timeless And while the prose may sometimes seem dry, readerscan yet discover valuable ideas on nearly every page The financial mar-kets have morphed since 1934 in almost unimaginable ways, but Grahamand Dodd’s approach to investing remains remarkably applicable today.Value investing, today as in the era of Graham and Dodd, is the prac-tice of purchasing securities or assets for less than they are worth—theproverbial dollar for 50 cents Investing in bargain-priced securities pro-vides a “margin of safety”—room for error, imprecision, bad luck, or thevicissitudes of the economy and stock market While some might mistak-enly consider value investing a mechanical tool for identifying bargains,

Copyright © 2009, 1988, 1962, 1951, 1940, 1934 by The McGraw-Hill Companies, Inc Click here for terms of use

it is actually a comprehensive investment philosophy that emphasizesthe need to perform in-depth fundamental analysis, pursue long-terminvestment results, limit risk, and resist crowd psychology.

Far too many people approach the stock market with a focus on ing money quickly Such an orientation involves speculation rather thaninvestment and is based on the hope that share prices will rise irrespec-tive of valuation Speculators generally regard stocks as pieces of paper

mak-to be quickly traded back and forth, foolishly decoupling them frombusiness reality and valuation criteria Speculative approaches—whichpay little or no attention to downside risk—are especially popular in ris-ing markets In heady times, few are sufficiently disciplined to maintainstrict standards of valuation and risk aversion, especially when most ofthose abandoning such standards are quickly getting rich After all, it iseasy to confuse genius with a bull market

In recent years, some people have attempted to expand the tion of an investment to include any asset that has recently—or mightsoon—appreciate in price: art, rare stamps, or a wine collection Becausethese items have no ascertainable fundamental value, generate no pres-ent or future cash flow, and depend for their value entirely on buyerwhim, they clearly constitute speculations rather than investments

defini-In contrast to the speculator’s preoccupation with rapid gain, valueinvestors demonstrate their risk aversion by striving to avoid loss A risk-averse investor is one for whom the perceived benefit of any gain is out-weighed by the perceived cost of an equivalent loss Once any of us hasaccumulated a modicum of capital, the incremental benefit of gainingmore is typically eclipsed by the pain of having less.1Imagine how you

[xiv] Preface to the Sixth Edition

1 Losing money, as Graham noted, can also be psychologically unsettling Anxiety from the financial damage caused by recently experienced loss or the fear of further loss can significantly impede our ability to take advantage of the next opportunity that comes along If an undervalued stock falls by half while the fundamentals—after checking and rechecking—are confirmed to be unchanged, we should relish the opportunity to buy significantly more “on sale.” But if our net worth has tumbled along with the share price, it may be psychologically difficult to add to the position.

would respond to the proposition of a coin flip that would either doubleyour net worth or extinguish it Being risk averse, nearly all people wouldrespectfully decline such a gamble Such risk aversion is deeply ingrained

in human nature Yet many unwittingly set aside their risk aversion whenthe sirens of market speculation call

Value investors regard securities not as speculative instruments but

as fractional ownership in, or debt claims on, the underlying businesses.This orientation is key to value investing When a small slice of a business

is offered at a bargain price, it is helpful to evaluate it as if the wholebusiness were offered for sale there This analytical anchor helps valueinvestors remain focused on the pursuit of long-term results rather thanthe profitability of their daily trading ledger

At the root of Graham and Dodd’s philosophy is the principle that thefinancial markets are the ultimate creators of opportunity Sometimes themarkets price securities correctly, other times not Indeed, in the shortrun, the market can be quite inefficient, with great deviations betweenprice and underlying value Unexpected developments, increased uncer-tainty, and capital flows can boost short-term market volatility, with pricesovershooting in either direction.2In the words of Graham and Dodd, “Theprice [of a security] is frequently an essential element, so that a stock may have investment merit at one price level but not at another.” (p 106)

As Graham has instructed, those who view the market as a weighingmachine—a precise and efficient assessor of value—are part of the emo-tionally driven herd Those who regard the market as a voting machine—

2 Over the long run, however, as investors perform fundamental analysis, and corporate ments explain their strategies and manage their capital structures, share prices often migrate toward underlying business value In particular, shares priced significantly below underlying value will attract bargain hunters and, ultimately, corporate acquirers, reinforcing the tendency toward longer- term share price efficiency This tendency, however, is always subject to interruption by the short- term forces of greed and fear.

manage-a sentiment-driven populmanage-arity contest—will be well positioned to tmanage-akeproper advantage of the extremes of market sentiment.

While it might seem that anyone can be a value investor, the essentialcharacteristics of this type of investor—patience, discipline, and risk aver-sion—may well be genetically determined When you first learn of thevalue approach, it either resonates with you or it doesn’t Either you areable to remain disciplined and patient, or you aren’t As Warren Buffettsaid in his famous article, “The Superinvestors of Graham-and-Doddsville,”

“It is extraordinary to me that the idea of buying dollar bills for 40 centstakes immediately with people or it doesn’t take at all It’s like an inocula-tion If it doesn’t grab a person right away, I find you can talk to him foryears and show him records, and it doesn’t make any difference.” 3,4IfSecurity Analysis resonates with you—if you can resist speculating andsometimes sit on your hands—perhaps you have a predisposition towardvalue investing If not, at least the book will help you understand whereyou fit into the investing landscape and give you an appreciation forwhat the value-investing community may be thinking

Just as Relevant Now

Perhaps the most exceptional achievement of Security Analysis, first lished in 1934 and revised in the acclaimed 1940 edition, is that its les-sons are timeless Generations of value investors have adopted theteachings of Graham and Dodd and successfully implemented themacross highly varied market environments, countries, and asset classes

pub-[xvi] Preface to the Sixth Edition

3 “The Superinvestors of Graham-and-Doddsville,” Hermes, the Columbia Business School magazine, 1984.

4 My own experience has been exactly the one that Buffett describes My 1978 summer job at Mutual Shares, a no-load value-based mutual fund, set the course for my professional career The planned liquidation of Telecor and spin-off of its Electro Rent subsidiary in 1980 forever imprinted in my mind the merit of fundamental investment analysis A buyer of Telecor stock was effectively creating an investment in the shares of Electro Rent, a fast-growing equipment rental company, at the giveaway valuation of approximately 1 times the cash flow You always remember your first value investment.

This would delight the authors, who hoped to set forth principles thatwould “stand the test of the ever enigmatic future.” (p xliv)

In 1992, Tweedy, Browne Company LLC, a well-known value ment firm, published a compilation of 44 research studies entitled,

invest-“What Has Worked in Investing.” The study found that what has worked

is fairly simple: cheap stocks (measured by to-book values, to-earnings ratios, or dividend yields) reliably outperform expensiveones, and stocks that have underperformed (over three- and five-yearperiods) subsequently beat those that have lately performed well Inother words, value investing works! I know of no long-time practitionerwho regrets adhering to a value philosophy; few investors who

price-embrace the fundamental principles ever abandon this investmentapproach for another

Today, when you read Graham and Dodd’s description of how theynavigated through the financial markets of the 1930s, it seems as if theywere detailing a strange, foreign, and antiquated era of economicdepression, extreme risk aversion, and obscure and obsolete businesses.But such an exploration is considerably more valuable than it superfi-cially appears After all, each new day has the potential to bring with it astrange and foreign environment Investors tend to assume that tomor-row’s markets will look very much like today’s, and, most of the time,they will But every once in a while,5conventional wisdom is turned onits head, circular reasoning is unraveled, prices revert to the mean, andspeculative behavior is exposed as such At those times, when today fails

to resemble yesterday, most investors will be paralyzed In the words ofGraham and Dodd, “We have striven throughout to guard the studentagainst overemphasis upon the superficial and the temporary,” which is

“at once the delusion and the nemesis of the world of finance.” (p xliv) It

5 The credit crunch triggered by subprime mortgage losses that began in July 2007 is a recent and dramatic example.

is during periods of tumult that a value-investing philosophy is larly beneficial.

particu-In 1934, Graham and Dodd had witnessed over a five-year span thebest and the worst of times in the markets—the run-up to the 1929peak, the October 1929 crash, and the relentless grind of the GreatDepression They laid out a plan for how investors in any environmentmight sort through hundreds or even thousands of common stocks, pre-ferred shares, and bonds to identify those worthy of investment Remark-ably, their approach is essentially the same one that value investorsemploy today The same principles they applied to the U.S stock andbond markets of the 1920s and 1930s apply to the global capital markets

of the early twenty-first century, to less liquid asset classes like real estateand private equity, and even to derivative instruments that hardlyexisted when Security Analysis was written

While formulas such as the classic “net working capital” test are essary to support an investment analysis, value investing is not a paint-by-numbers exercise.6Skepticism and judgment are always required Forone thing, not all elements affecting value are captured in a company’sfinancial statements—inventories can grow obsolete and receivablesuncollectible; liabilities are sometimes unrecorded and property valuesover- or understated Second, valuation is an art, not a science Becausethe value of a business depends on numerous variables, it can typically

nec-be assessed only within a range Third, the outcomes of all investmentsdepend to some extent on the future, which cannot be predicted withcertainty; for this reason, even some carefully analyzed investments fail

to achieve profitable outcomes Sometimes a stock becomes cheap forgood reason: a broken business model, hidden liabilities, protracted liti-

[xviii] Preface to the Sixth Edition

6 Graham and Dodd recommended that investors purchase stocks trading for less than two-thirds of

“net working capital,” defined as working capital less all other liabilities Many stocks fit this criterion during the Depression years, far fewer today.

gation, or incompetent or corrupt management Investors must alwaysact with caution and humility, relentlessly searching for additional infor-mation while realizing that they will never know everything about acompany In the end, the most successful value investors combinedetailed business research and valuation work with endless disciplineand patience, a well-considered sensitivity analysis, intellectual honesty,and years of analytical and investment experience.

Interestingly, Graham and Dodd’s value-investing principles applybeyond the financial markets—including, for example, to the market forbaseball talent, as eloquently captured in Moneyball, Michael Lewis’s 2003bestseller The market for baseball players, like the market for stocks andbonds, is inefficient—and for many of the same reasons In both investingand baseball, there is no single way to ascertain value, no one metric thattells the whole story In both, there are mountains of information and nobroad consensus on how to assess it Decision makers in both arenas mis-interpret available data, misdirect their analyses, and reach inaccurateconclusions In baseball, as in securities, many overpay because they fearstanding apart from the crowd and being criticized They often makedecisions for emotional, not rational, reasons They become exuberant;they panic Their orientation sometimes becomes overly short term Theyfail to understand what is mean reverting and what isn’t Baseball’s valueinvestors, like financial market value investors, have achieved significantoutperformance over time While Graham and Dodd didn’t apply valueprinciples to baseball, the applicability of their insights to the market forathletic talent attests to the universality and timelessness of this

approach

Value Investing Today

Amidst the Great Depression, the stock market and the national omy were exceedingly risky Downward movements in share prices and

econ-business activity came suddenly and could be severe and protracted.Optimists were regularly rebuffed by circumstances Winning, in a sense,was accomplished by not losing Investors could achieve a margin ofsafety by buying shares in businesses at a large discount to their under-lying value, and they needed a margin of safety because of all the thingsthat could—and often did—go wrong.

Even in the worst of markets, Graham and Dodd remained faithful totheir principles, including their view that the economy and marketssometimes go through painful cycles, which must simply be endured.They expressed confidence, in those dark days, that the economy andstock market would eventually rebound: “While we were writing, we had

to combat a widespread conviction that financial debacle was to be thepermanent order.” (p xliv)

Of course, just as investors must deal with down cycles when ness results deteriorate and cheap stocks become cheaper, they mustalso endure up cycles when bargains are scarce and investment capital isplentiful In recent years, the financial markets have performed exceed-ingly well by historic standards, attracting substantial fresh capital inneed of managers Today, a meaningful portion of that capital—likelytotaling in the trillions of dollars globally—invests with a value approach.This includes numerous value-based asset management firms andmutual funds, a number of today’s roughly 9,000 hedge funds, and some

busi-of the largest and most successful university endowments and familyinvestment offices

It is important to note that not all value investors are alike In theaforementioned “Superinvestors of Graham-and-Doddsville,” Buffettdescribes numerous successful value investors who have little portfoliooverlap Some value investors hold obscure, “pink-sheet shares” whileothers focus on the large-cap universe Some have gone global, whileothers focus on a single market sector such as real estate or energy

[xx] Preface to the Sixth Edition

Some run computer screens to identify statistically inexpensive nies, while others assess “private market value”—the value an industrybuyer would pay for the entire company Some are activists who aggres-sively fight for corporate change, while others seek out undervaluedsecurities with a catalyst already in place—such as a spin-off, asset sale,major share repurchase plan, or new management team—for the partial

compa-or full realization of the underlying value And, of course, as in any fession, some value investors are simply more talented than others

pro-In the aggregate, the value-investing community is no longer the verysmall group of adherents that it was several decades ago Competitioncan have a powerful corrective effect on market inefficiencies and mis-pricings With today’s many amply capitalized and skilled investors, whatare the prospects for a value practitioner? Better than you might expect,for several reasons First, even with a growing value community, there arefar more market participants with little or no value orientation Most man-agers, including growth and momentum investors and market indexers,pay little or no attention to value criteria Instead, they concentratealmost single-mindedly on the growth rate of a company’s earnings, themomentum of its share price, or simply its inclusion in a market index.Second, nearly all money managers today, including some haplessvalue managers, are forced by the (real or imagined) performance pres-sures of the investment business to have an absurdly short investmenthorizon, sometimes as brief as a calendar quarter, month, or less A valuestrategy is of little use to the impatient investor since it usually takestime to pay off

Finally, human nature never changes Capital market manias regularlyoccur on a grand scale: Japanese stocks in the late 1980s, Internet andtechnology stocks in 1999 and 2000, subprime mortgage lending in

2006 and 2007, and alternative investments currently It is always difficult

to take a contrarian approach Even highly capable investors can wither

under the relentless message from the market that they are wrong Thepressures to succumb are enormous; many investment managers fearthey’ll lose business if they stand too far apart from the crowd Somealso fail to pursue value because they’ve handcuffed themselves (orbeen saddled by clients) with constraints preventing them from buyingstocks selling at low dollar prices, small-cap stocks, stocks of companiesthat don’t pay dividends or are losing money, or debt instruments withbelow investment-grade ratings.7Many also engage in career manage-ment techniques like “window dressing” their portfolios at the end of cal-endar quarters or selling off losers (even if they are undervalued) whilebuying more of the winners (even if overvalued) Of course, for thosevalue investors who are truly long term oriented, it is a wonderful thingthat many potential competitors are thrown off course by constraintsthat render them unable or unwilling to effectively compete.

Another reason that greater competition may not hinder today’svalue investors is the broader and more diverse investment landscape inwhich they operate Graham faced a limited lineup of publicly traded U.S.equity and debt securities Today, there are many thousands of publiclytraded stocks in the United States alone, and many tens of thousandsworldwide, plus thousands of corporate bonds and asset-backed debtsecurities Previously illiquid assets, such as bank loans, now trade regu-larly Investors may also choose from an almost limitless number ofderivative instruments, including customized contracts designed to meetany need or hunch

Nevertheless, 25 years of historically strong stock market ance have left the market far from bargain-priced High valuations and

perform-[xxii] Preface to the Sixth Edition

7 Another sort of constraint involves the “prudent man rule,” which is a legal concept that divides missible from impermissible investments In the mid- to late 1970s, many interpreted this rule to pre- clude meaningful exposure to equities Since then, prudence has become a moving target as investors, gaining comfort over time from the actions of their peers, have come to invest in more exotic and increasingly illiquid asset classes.

per-intensified competition raise the specter of lower returns for valueinvestors generally Also, some value investment firms have becomeextremely large, and size can be the enemy of investment performancebecause decision making is slowed by bureaucracy and smaller opportu-nities cease to move the needle.

In addition, because growing numbers of competent buy-side andsell-side analysts are plying their trade with the assistance of sophisti-cated information technology, far fewer securities seem likely to fallthrough the cracks to become extremely undervalued.8Today’s valueinvestors are unlikely to find opportunity armed only with a Value Lineguide or by thumbing through stock tables While bargains still occasion-ally hide in plain sight, securities today are most likely to become mis-priced when they are either accidentally overlooked or deliberatelyavoided Consequently, value investors have had to become thoughtfulabout where to focus their analysis In the early 2000s, for example,investors became so disillusioned with the capital allocation procedures

of many South Korean companies that few considered them candidatesfor worthwhile investment As a result, the shares of numerous SouthKorean companies traded at great discounts from prevailing internationalvaluations: at two or three times the cash flow, less than half the underly-ing business value, and, in several cases, less than the cash (net of debt)held on their balance sheets Bargain issues, such as Posco and SK Tele-com, ultimately attracted many value seekers; Warren Buffett reportedlyprofited handsomely from a number of South Korean holdings

Today’s value investors also find opportunity in the stocks and bonds

of companies stigmatized on Wall Street because of involvement in

pro-8 Great innovations in technology have made vastly more information and analytical capability able to all investors This democratization has not, however, made value investors any better off With information more widely and inexpensively available, some of the greatest market inefficiencies have been corrected Developing innovative sources of ideas and information, such as those available from business consultants and industry experts, has become increasingly important.

avail-tracted litigation, scandal, accounting fraud, or financial distress Thesecurities of such companies sometimes trade down to bargain levels,where they become good investments for those who are able to remainstalwart in the face of bad news For example, the debt of Enron, per-haps the world’s most stigmatized company after an accounting scandalforced it into bankruptcy in 2001, traded as low as 10 cents on the dollar

of claim; ultimate recoveries are expected to be six times that amount.Similarly, companies with tobacco or asbestos exposure have in recentyears periodically come under severe selling pressure due to the uncer-tainties surrounding litigation and the resultant risk of corporate finan-cial distress More generally, companies that disappoint or surpriseinvestors with lower-than-expected results, sudden management

changes, accounting problems, or ratings downgrades are more likelythan consistently strong performers to be sources of opportunity.When bargains are scarce, value investors must be patient; compro-mising standards is a slippery slope to disaster New opportunities willemerge, even if we don’t know when or where In the absence of com-pelling opportunity, holding at least a portion of one’s portfolio in cashequivalents (for example, U.S Treasury bills) awaiting future deploymentwill sometimes be the most sensible option Recently, Warren Buffettstated that he has more cash to invest than he has good investments Asall value investors must do from time to time, Buffett is waiting patiently.Still, value investors are bottom-up analysts, good at assessing securi-ties one at a time based on the fundamentals They don’t need the entiremarket to be bargain priced, just 20 or 25 unrelated securities—a num-ber sufficient for diversification of risk Even in an expensive market,value investors must keep analyzing securities and assessing businesses,gaining knowledge and experience that will be useful in the future.Value investors, therefore, should not try to time the market or guesswhether it will rise or fall in the near term Rather, they should rely on a

[xxiv] Preface to the Sixth Edition

bottom-up approach, sifting the financial markets for bargains and thenbuying them, regardless of the level or recent direction of the market oreconomy Only when they cannot find bargains should they default toholding cash.

A Flexible Approach

Because our nation’s founders could not foresee—and knew they couldnot foresee—technological, social, cultural, and economic changes thatthe future would bring, they wrote a flexible constitution that still guides

us over two centuries later Similarly, Benjamin Graham and David Doddacknowledged that they could not anticipate the business, economic,technological, and competitive changes that would sweep through theinvestment world over the ensuing years But they, too, wrote a flexibletreatise that provides us with the tools to function in an investmentlandscape that was destined—and remains destined—to undergo pro-found and unpredictable change

For example, companies today sell products that Graham and Doddcould not have imagined Indeed, there are companies and entire indus-tries that they could not have envisioned Security Analysis offers noexamples of how to value cellular phone carriers, software companies,satellite television providers, or Internet search engines But the bookprovides the analytical tools to evaluate almost any company, to assessthe value of its marketable securities, and to determine the existence of

a margin of safety Questions of solvency, liquidity, predictability, ness strategy, and risk cut across businesses, nations, and time

busi-Graham and Dodd did not specifically address how to value privatebusinesses or how to determine the value of an entire company ratherthan the value of a fractional interest through ownership of its shares.9

9 They did consider the relative merits of corporate control enjoyed by a private business owner sus the value of marketability for a listed stock (p 372).

ver-But their analytical principles apply equally well to these different issues.Investors still need to ask, how stable is the enterprise, and what are itsfuture prospects? What are its earnings and cash flow? What is thedownside risk of owning it? What is its liquidation value? How capableand honest is its management? What would you pay for the stock of thiscompany if it were public? What factors might cause the owner of thisbusiness to sell control at a bargain price?

Similarly, the pair never addressed how to analyze the purchase of anoffice building or apartment complex Real estate bargains come aboutfor the same reasons as securities bargains—an urgent need for cash,inability to perform proper analysis, a bearish macro view, or investordisfavor or neglect In a bad real estate climate, tighter lending standardscan cause even healthy properties to sell at distressed prices Grahamand Dodd’s principles—such as the stability of cash flow, sufficiency ofreturn, and analysis of downside risk—allow us to identify real estateinvestments with a margin of safety in any market environment

Even complex derivatives not imagined in an earlier era can be nized with the value investor’s eye While traders today typically priceput and call options via the Black-Scholes model, one can instead usevalue-investing precepts—upside potential, downside risk, and the likeli-hood that each of various possible scenarios will occur—to analyze theseinstruments An inexpensive option may, in effect, have the favorablerisk-return characteristics of a value investment—regardless of what theBlack-Scholes model dictates

scruti-Institutional Investing

Perhaps the most important change in the investment landscape overthe past 75 years is the ascendancy of institutional investing In the1930s, individual investors dominated the stock market Today, by con-

[xxvi] Preface to the Sixth Edition

trast, most market activity is driven by institutional investors—largepools of pension, endowment, and aggregated individual capital Whilethe advent of these large, quasi-permanent capital pools might haveresulted in the wide-scale adoption of a long-term value-orientedapproach, in fact this has not occurred Instead, institutional investinghas evolved into a short-term performance derby, which makes it diffi-cult for institutional managers to take contrarian or long-term positions.Indeed, rather than standing apart from the crowd and possibly sufferingdisappointing short-term results that could cause clients to withdrawcapital, institutional investors often prefer the safe haven of assuredmediocre performance that can be achieved only by closely followingthe herd.

Alternative investments—a catch-all category that includes venturecapital, leveraged buyouts, private equity, and hedge funds—are the cur-rent institutional rage No investment treatise written today could fail tocomment on this development

Fueled by performance pressures and a growing expectation of low(and inadequate) returns from traditional equity and debt investments,institutional investors have sought high returns and diversification byallocating a growing portion of their endowments and pension funds toalternatives Pioneering Portfolio Management, written in 2000 by DavidSwensen, the groundbreaking head of Yale’s Investment Office, makes astrong case for alternative investments In it, Swensen points to thehistorically inefficient pricing of many asset classes,10the historically highrisk-adjusted returns of many alternative managers, and the limited

10 Many investors make the mistake of thinking about returns to asset classes as if they were nent Returns are not inherent to an asset class; they result from the fundamentals of the underlying businesses and the price paid by investors for the related securities Capital flowing into an asset class can, reflexively, impair the ability of those investing in that asset class to continue to generate the anticipated, historically attractive returns.

perma-performance correlation between alternatives and other asset classes Hehighlights the importance of alternative manager selection by noting thelarge dispersion of returns achieved between top-quartile and third-quartile performers A great many endowment managers have emulatedSwensen, following him into a large commitment to alternative

investments, almost certainly on worse terms and amidst a more

competitive environment than when he entered the area

Graham and Dodd would be greatly concerned by the commitment

of virtually all major university endowments to one type of alternativeinvestment: venture capital The authors of the margin-of-safety

approach to investing would not find one in the entire venture capitaluniverse.11While there is often the prospect of substantial upside in ven-ture capital, there is also very high risk of failure Even with the diversifi-cation provided by a venture fund, it is not clear how to analyze theunderlying investments to determine whether the potential return justi-fies the risk Venture capital investment would, therefore, have to becharacterized as pure speculation, with no margin of safety whatsoever.Hedge funds—a burgeoning area of institutional interest with nearly

$2 trillion of assets under management—are pools of capital that varywidely in their tactics but have a common fee structure that typicallypays the manager 1% to 2% annually of assets under management and20% (and sometimes more) of any profits generated They had their start

in the 1920s, when Ben Graham himself ran one of the first hedge funds.What would Graham and Dodd say about the hedge funds operating

in today’s markets? They would likely disapprove of hedge funds thatmake investments based on macroeconomic assessments or that pursue

[xxviii] Preface to the Sixth Edition

11 Nor would they find one in leveraged buyouts, through which businesses are purchased at lofty prices using mostly debt financing and a thin layer of equity capital The only value-investing ration- ale for venture capital or leveraged buyouts might be if they were regarded as mispriced call options Even so, it is not clear that these areas constitute good value.

speculative, short-term strategies Such funds, by avoiding or even ing undervalued securities to participate in one or another folly, inadver-tently create opportunities for value investors The illiquidity, lack oftransparency, gargantuan size, embedded leverage, and hefty fees ofsome hedge funds would no doubt raise red flags But Graham andDodd would probably approve of hedge funds that practice value-ori-ented investment selection.

sell-Importantly, while Graham and Dodd emphasized limiting risk on aninvestment-by-investment basis, they also believed that diversificationand hedging could protect the downside for an entire portfolio (p 106)This is what most hedge funds attempt to do While they hold individualsecurities that, considered alone, may involve an uncomfortable degree

of risk, they attempt to offset the risks for the entire portfolio throughthe short sale of similar but more highly valued securities, through thepurchase of put options on individual securities or market indexes, andthrough adequate diversification (although many are guilty of overdiver-sification, holding too little of their truly good ideas and too much oftheir mediocre ones) In this way, a hedge fund portfolio could (in theory,anyway) have characteristics of good potential return with limited riskthat its individual components may not have

Modern-day Developments

As mentioned, the analysis of businesses and securities has becomeincreasingly sophisticated over the years Spreadsheet technology, forexample, allows for vastly more sophisticated modeling than was possibleeven one generation ago Benjamin Graham’s pencil, clearly one of thesharpest of his era, might not be sharp enough today On the other hand,technology can easily be misused; computer modeling requires making aseries of assumptions about the future that can lead to a spurious preci-sion of which Graham would have been quite dubious While Graham was

interested in companies that produced consistent earnings, analysis in hisday was less sophisticated regarding why some company’s earnings might

be more consistent than others Analysts today examine businesses butalso business models; the bottom-line impact of changes in revenues,profit margins, product mix, and other variables is carefully studied bymanagements and financial analysts alike Investors know that businesses

do not exist in a vacuum; the actions of competitors, suppliers, and tomers can greatly impact corporate profitability and must be

cus-considered.12

Another important change in focus over time is that while Grahamlooked at corporate earnings and dividend payments as barometers of acompany’s health, most value investors today analyze free cash flow This

is the cash generated annually from the operations of a business after allcapital expenditures are made and changes in working capital are con-sidered Investors have increasingly turned to this metric becausereported earnings can be an accounting fiction, masking the cash gener-ated by a business or implying positive cash generation when there isnone Today’s investors have rightly concluded that following the cash—

as the manager of a business must do—is the most reliable and ing means of assessing a company

reveal-In addition, many value investors today consider balance sheet sis less important than was generally thought a few generations ago.With returns on capital much higher at present than in the past, moststocks trade far above book value; balance sheet analysis is less helpful

analy-in understandanaly-ing upside potential or downside risk of stocks priced at

[xxx] Preface to the Sixth Edition

12 Professor Michael Porter of Harvard Business School, in his seminal book Competitive Strategy (Free Press, 1980), lays out the groundwork for a more intensive, thorough, and dynamic analysis of busi- nesses and industries in the modern economy A broad industry analysis has become particularly necessary as a result of the passage in 2000 of Regulation FD (Fair Disclosure), which regulates and restricts the communications between a company and its actual or potential shareholders Wall Street analysts, facing a dearth of information from the companies they cover, have been forced to expand their areas of inquiry.

such levels The effects of sustained inflation over time have also

wreaked havoc with the accuracy of assets accounted for using historiccost; this means that two companies owning identical assets couldreport very different book values Of course, balance sheets must still becarefully scrutinized Astute observers of corporate balance sheets areoften the first to see business deterioration or vulnerability as inventoriesand receivables build, debt grows, and cash evaporates And for

investors in the equity and debt of underperforming companies, balancesheet analysis remains one generally reliable way of assessing downsideprotection

Globalization has increasingly affected the investment landscape,with most investors looking beyond their home countries for

opportunity and diversification Graham and Dodd’s principles fullyapply to international markets, which are, if anything, even more subject

to the vicissitudes of investor sentiment—and thus more inefficientlypriced—than the U.S market is today Investors must be cognizant of therisks of international investing, including exposure to foreign currenciesand the need to consider hedging them Among the other risks arepolitical instability, different (or absent) securities laws and investorprotections, varying accounting standards, and limited availability ofinformation

Oddly enough, despite 75 years of success achieved by value

investors, one group of observers largely ignores or dismisses this pline: academics Academics tend to create elegant theories that purport

disci-to explain the real world but in fact oversimplify it One such theory, theEfficient Market Hypothesis (EMH), holds that security prices always andimmediately reflect all available information, an idea deeply at odds withGraham and Dodd’s notion that there is great value to fundamentalsecurity analysis The Capital Asset Pricing Model (CAPM) relates risk toreturn but always mistakes volatility, or beta, for risk Modern PortfolioTheory (MPT) applauds the benefits of diversification in constructing an

optimal portfolio But by insisting that higher expected return comesonly with greater risk, MPT effectively repudiates the entire value-invest-ing philosophy and its long-term record of risk-adjusted investment out-performance Value investors have no time for these theories and

generally ignore them

The assumptions made by these theories—including continuousmarkets, perfect information, and low or no transaction costs—are unre-alistic Academics, broadly speaking, are so entrenched in their theoriesthat they cannot accept that value investing works Instead of launching

a series of studies to understand the remarkable 50-year investmentrecord of Warren Buffett, academics instead explain him away as an aber-ration Greater attention has been paid recently to behavioral economics,

a field recognizing that individuals do not always act rationally and havesystematic cognitive biases that contribute to market inefficiencies andsecurity mispricings These teachings—which would not seem alien toGraham—have not yet entered the academic mainstream, but they arebuilding some momentum

Academics have espoused nuanced permutations of their flawed ories for several decades Countless thousands of their students havebeen taught that security analysis is worthless, that risk is the same asvolatility, and that investors must avoid overconcentration in good ideas(because in efficient markets there can be no good ideas) and thus diver-sify into mediocre or bad ones Of course, for value investors, the propa-gation of these academic theories has been deeply gratifying: thebrainwashing of generations of young investors produces the very ineffi-ciencies that savvy stock pickers can exploit

the-Another important factor for value investors to take into account isthe growing propensity of the Federal Reserve to intervene in financialmarkets at the first sign of trouble Amidst severe turbulence, the Fedfrequently lowers interest rates to prop up securities prices and restore

[xxxii] Preface to the Sixth Edition

investor confidence While the intention of Fed officials is to maintainorderly capital markets, some money managers view Fed intervention as

a virtual license to speculate Aggressive Fed tactics, sometimes referred

to as the “Greenspan put” (now the “Bernanke put”), create a moral ard that encourages speculation while prolonging overvaluation So long

haz-as value investors aren’t lured into a false sense of security, so long haz-asthey can maintain a long-term horizon and ensure their staying power,market dislocations caused by Fed action (or investor anticipation of it)may ultimately be a source of opportunity

Another modern development of relevance is the ubiquitous cabletelevision coverage of the stock market This frenetic lunacy exacerbatesthe already short-term orientation of most investors It foments the viewthat it is possible—or even necessary—to have an opinion on everythingpertinent to the financial markets, as opposed to the patient and highlyselective approach endorsed by Graham and Dodd This sound-bite cul-ture reinforces the popular impression that investing is easy, not rigorousand painstaking The daily cheerleading pundits exult at rallies andrecord highs and commiserate over market reversals; viewers get theimpression that up is the only rational market direction and that selling

or sitting on the sidelines is almost unpatriotic The hysterical tenor isexacerbated at every turn For example, CNBC frequently uses a format-ted screen that constantly updates the level of the major market indexesagainst a digital clock Not only is the time displayed in hours, minutes,and seconds but in completely useless hundredths of seconds, the num-bers flashing by so rapidly (like tenths of a cent on the gas pump) as to

be completely unreadable The only conceivable purpose is to grab theviewers’ attention and ratchet their adrenaline to full throttle

Cable business channels bring the herdlike mentality of the crowdinto everyone’s living room, thus making it much harder for viewers

to stand apart from the masses Only on financial cable TV would a

commentator with a crazed persona become a celebrity whose

pronouncements regularly move markets In a world in which the

differences between investing and speculating are frequently blurred, thenonsense on financial cable channels only compounds the problem.Graham would have been appalled The only saving grace is that valueinvestors prosper at the expense of those who fall under the spell of thecable pundits Meanwhile, human nature virtually ensures that there willnever be a Graham and Dodd channel

Unanswered Questions

Today’s investors still wrestle, as Graham and Dodd did in their day, with

a number of important investment questions One is whether to focus onrelative or absolute value Relative value involves the assessment thatone security is cheaper than another, that Microsoft is a better bargainthan IBM Relative value is easier to determine than absolute value, thetwo-dimensional assessment of whether a security is cheaper than othersecurities and cheap enough to be worth purchasing The most intrepidinvestors in relative value manage hedge funds where they purchase therelatively less expensive securities and sell short the relatively moreexpensive ones This enables them potentially to profit on both sides ofthe ledger, long and short Of course, it also exposes them to double-barreled losses if they are wrong.13

It is harder to think about absolute value than relative value When is astock cheap enough to buy and hold without a short sale as a hedge?One standard is to buy when a security trades at an appreciable—say,30%, 40%, or greater—discount from its underlying value, calculatedeither as its liquidation value, going-concern value, or private-market

[xxxiv] Preface to the Sixth Edition

13 Many hedge funds also use significant leverage to goose their returns further, which backfires when analysis is faulty or judgment is flawed.