Security Analysis Series: Introduction to Part V Summary

“The Quest for Rational Investing”, by Glenn H. Greenberg

Chapter Summary

  • Globalization has brought intensified competition, and modernization has brought industry disrupting technologies, increasing the challenges in determining future earning power. (pg 397).
  • Greenberg’s investing process involves a calculation of a company’s expected rate of return. That includes the somewhat obvious steps of analyzing competitors, margins, capital structure, and asking questions that need to be answered in order for the business to grow. (pg 397).
  • Today, free cash flow (cash flow – capital expenditures), as opposed to earnings, is the primary metric used to evaluate a company’s investing merits.
    • Earnings are “seldom synonymous with cash available for shareholders”, which is essentially the fundamental aspect of investing. “How much cash will I get back, and how fast?” (pg 398).
  • Greenberg cites a company his firm purchased, Ryanair, that had declined 30% since the initial investment. He argues that “nothing has happened that makes us believe that long-term value of our investment has diminished.” Moreover, the difficult business conditions should serve to force out other competitors, and discourage new entrants. (pg 399).
  • Accounting adjustments are absolutely crucial to valuation. Stock options being accounted for as a current expense, even when out of the money, is one example.
    • Other examples include derivatives, hedging, pensions, leases, and profit recognition. (pg 400).
  • After analyzing the historical record, the true challenge lies in determining how useful that record is to determine future earnings. IE, Graham’s qualitative aspect. (pg 400-401).
  • Greenberg believes “aversion to boredom, a tendency for emotions to overwhelm reason, and greed” are the reason Graham’s wisdom is generally ignored. Naturally, the intelligent investor must avoid these. (pg 404).

Chapter Thoughts and Analysis

  • In my opinion, Greenberg doesn’t add much in the way of original thought in this introduction as compared to other introductions.
  • His list of accounting adjustments in his valuation process is quite useful as a lead to potentially investigate. Finding those balance sheet/income statement discrepancies is a simple, surefire way to contribute to a margin of safety.
  • The modern use of “free cash flow” as compared to earnings is the other key aspect of this introduction that is valuable. I would be curious to see to what extent successful modern value investors involve earnings in valuation, and how transferrable Graham’s lessons in the following chapters (which focus on earnings) are to free cash flow.
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