Book Review: Security Analysis – Principle and Technique by Graham, Dodd, and Cottle, 1962

I am very partial to the 1962 edition of this classic.  Even though only the first 97 pages are relevant to security analysis today, what a great 97 pages they are.  The editions published since Graham’s death in 1976, can best be characterized as garbage.  In many cases the new authors have so badly mischaracterized Graham’s work that it is unrecognizable.  Graham’s own writing in the editions before 1962, are a reasonable substitute, but the 1962 edition is by far the best.

Since this book has been reviewed in so many places, I am going to attempt to tell you 4 things that you might not already know from the first 97 pages.

  1. Graham is often thought of as the champion of intrinsic value, or in today’s terms the absolute value of the security.  However, way back in 1962 Graham relalized that the relative valuation method was also valid. Very few realize he said of relative valuation, “This approach is valid when employed in connection with capital committed to permanent full investment in common stocks, a commitment which now appears to be accepted for many investment funds. p. 27”  Of course, today the asset allocation decision is even more likely to be separated from the stock selection decision. Graham saw merits in both absolute and relative methods of valuation.
  2. Graham has several paragraphs about what he calls, “The Critical Function of Security Analysis” p. 34 Do you really know what that critical function of security analysis is? Are you sure? The critical role that Graham explains is the analyst’s responsibility as a financial statesman.  He discusses the important role of the analyst in the capital allocation process.  If Ben Graham were alive today watching Jim Cramer jump around trading stocks and making cow noises, do you suppose that is what he had in mind when he called for all analysts to be financial statesmen. I doubt it.
  3. How often have I seen just about any quantitative approach to investing characterized as a “Graham and Dodd” approach? Way too often.  Nothing could be further from the truth.  Graham has an entire chapter entitled, “Quantitative and Qualitative Factors In Security Analysis.” p. 85 Even in 1962 Graham realized that qualitative factors were very important.  He says, “Figures alone are not sufficient, they may be completely vitiated by qualitative considerations of an opposite import.” This chapter is so critical that it should be reread every few years. Modern financial texts have nothing that comes close to the insights Graham had in this chapter.
  4. Graham studied the classics of literature extensively. He had countless verves to use as his book’s dedication.  He chose the Greek poet Horace, “Many shall be restored that are now fallen and many shall fall that are now held in honor”.  Let these words ring in your ears even time you pick a stock.

Of course, there are many other important concepts discussed in these first 97 pages.  Graham’s discussion of the “margin of safety” approach is a central focus of this website. Many of us in the investment business read this text early in our career and then put it on shelf. This is a mistake. Please take a moment to read it again.

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Comments

  1. Christopher Allen says:

    Hi, I was wondering what this meant? “This approach is valid when employed in connection with capital committed to permanent full investment in common stocks, a commitment which now appears to be accepted for many investment funds. p. 27”

  2. Gregg Jahnke says:

    Christopher,

    The above comment is important because 99% of those who study the the methods of Ben Graham mistakenly believe that he only advocated “absolute” analysis of a stock’s value. Absolute analysis involves comparing the estimated future cash flows from a stock to the available returns on fixed income securities. At points of extreme market valuation (perhaps like the current conditions), the absolute analyst might conclude that few, if any, stocks should be owned and that bonds should be owned instead. In practice there are many investors who claim to use this method in their marketing materials. However, in actuality it is extremely difficult to employ.

    What Graham admits in this one key statement is that it acceptable to arrive at a stock’s value by comparing it to other stocks, and not fixed income alternatives. Many argue that this “relative” approach violates the basics tenants of value investing. I firmly believe that Graham clearly states that this relative approach is just as valid as the the absolute approach.

    Most professional investors do not control the asset allocation decision. Their job is to find the best stocks available. Relative valuation analysis is the best way to accomplish this goal. Graham recognized this in 1962. Few seem to understand it even today.

    Thanks for your question. gj

  3. I would still recommend starting with the 1934 edition. Buffett always says, go back to the original. People focus too much on whether or not certain examples used in the book are relevant to today’s markets. This exposes their real intent in reading financial texts: getting rich quick. The 1934 edition has principles in place to guide investors against the hazards of the investing future. It’s particularly helpful as it was written in the aftermath great stock market deluge. And make no mistake, markets will do wild things in the future. 1962 was probably the middle of the great 50-60s boom. While useful, I can’t help but recall the saying “just tell me the bad news, The good news will take care of itself.” Start with the 1934 edition.