“Classifications of Securities”
- “Safety depends upon and is measured entirely by the ability of the debtor corporation to meet its obligations.” (pg 113).
- Safety is not dependant on the title of a security, or the obligations themselves, but rather on the ability of the entity to meet those obligations.
- Expanding on the idea above, bonds in a brand new business are just as risky as the common stock of that same business. Again, it is not the investment vehicle that determines risk and safety. (pg 113).
- Graham goes on to define bonds, common-stock, and preferred-stock. (pg 114).
- He then suggests a reclassification of securities in the following way. (pg 116):
- 1. Fixed Value Securities (high-grade stock, preferred stock)
- 2. Senior Securities of Variable-Value Type
- A. Well Protected Issues with Profit Possibilities (convertible bonds)
- B. Inadequately Protected Issues (lower grade bonds/preferred stock)
- 3. Common-Stock Type (Common Stock)
- The purpose of this reclassification is to enhance the idea that a securities owner should not pay for what he is “legally entitled to demand”, but rather “what he is likely to get”. (pg 119).
Chapter Analysis and Thoughts
- The singular driving theme of this entire chapter is the idea that there is a difference between legal title and expected outcomes in reality. The intelligent investor should not rely on the names or entitlements of securities, but the predicted outcome.
- This is the final chapter in the “Survey and Approach” section of Security Analysis. And its theme serves well to the overall value-investing approach. An intelligent investor can not be lazy in refusing to do proper due diligence on the terms, title, and expected outcome of a security.