Security Analysis Series: Chapter 5 Summary

“Classifications of Securities”

Chapter Summary

  • 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.
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