The three important parts of Warren Buffett’s precious book, "Security analysis"
Warren Buffett has said so numerous times. One of his most prized possessions is an investment book he read while studying at Columbia University. The book “Security Analysis” presents the basic principles underlying investment decisions and this book was written by none other than Benjamin Graham and David Dodd, two of the most famous financial investment authors of all time. Any investor who is serious about investing in stocks should read the book to understand how stock analysis works.
The first part of the book is essentially about providing guidance on how investors should make their decisions regarding stocks. The book identifies that investing in stocks should be made after conducting a thorough analysis of the future profitability of the corporation. However, this is not enough and an investor must also consider a certain margin of safety and all decisions must be governed by established investment principles. The book also emphasizes the use of the price-earnings ratio as a measure to determine the value of an investment. Graham stated that the P / E ratio should be a maximum of 20 and no more, as the P / E ratio greater than 20 suggests speculative stocks that are likely to lose value for the foreseeable future. He stressed that the P / E ratio should not be the only measure on which investment decisions are based. Rather, the investor must consider the internal workings and management of the organization before undertaking the investment.
The book also focuses on the ideology that investors generally adopt when investing in stocks. The authors identify that the traditional method of security analysis is based solely on profit and this is subject to errors. After criticizing that method adopted by investors in general, the book aims to highlight security analysis methods that have been tested by the authors themselves. It states that investing in stocks should not be based on guesswork and speculation, but on sound analysis that takes into account the company’s past, present and future conditions. The book suggests that investors should invest in stocks of high-growth companies and offers ways for investors to identify companies that have great growth prospects. However, it is repeatedly emphasized that an investor should not pay an extremely high price for stocks based on calculations. This is because if the growth projections did not come out as predicted, the investor would actually be at a loss by paying more for the stock than it is worth.
Finally, Graham introduces the concept of “margin of safety” and how a normal investor might do it. Graham emphasizes that an investor buying stocks at a lower-than-intrinsic value is practicing the concept of margin of safety. However, he emphasized again that the calculation of intrinsic value is subject to error and is not absolute. However, he asserted that an investor who can buy stocks at a price much lower than their true value can actually incorporate sound investment techniques into the investment strategy.