Security Analysis: Introduction (Part 1)
The introduction to Security Analysis is a treasure trove of Grahamian thought. It is impossible to fully plumb the depths of this Grahamian gold mine in a single post. Therefore, I have separated my comments into two posts. This post explores the opening paragraph of the introduction with special attention to Graham’s style.
We should begin with the most general point made in Graham’s introduction: It is impossible to completely separate analysis and action, theory and practice. Therefore, while the title of Graham’s book is Security Analysis, the scope is necessarily wider:
Although, strictly speaking, security analysis may be carried on without reference to any definite program or standards of investment, such specialization of functions would be quite unrealistic. Critical examination of balance sheets and income accounts, comparisons of related or similar issues, studies of the terms and protective covenants behind bonds and preferred stocks – these typical activities of the securities analyst are invariably carried on with some practical idea of purchase or sale in mind, and they must be viewed against a broader background of investment principles, or perhaps of speculative principles.
This is vintage Graham. In many ways, it is a sort of cold open into the book and the mind of the man who wrote it. He begins with a logical and overly literal opening sentence; to Graham, “strictly speaking” means speaking strictly – nothing more or less. He adds a word we wouldn’t think necessary – “definite” – but in Graham’s mind it is a necessary and meaningful modifier. Finally, he interjects his personality with the word “quite”, which we will see repeated again and again throughout Security Analysis (Graham was born in Britain).
Next, we have a catalogue. The activities Graham lists are all activities he’ll cover in Security Analysis. If you wonder what Graham means by security analysis, look no further than these lines. He lists three main activities: “critical examination” of corporate financial statements, “comparisons of related or similar issues”, and finally “studies of the terms” of senior securities.
This is an especially excellent introduction for the modern reader, because we learn just how different Graham and his book are from what we might expect – and we learn our lesson well within the first few sentences.
What is the most unusual feature of this paragraph? Can you find the words almost no other writer would have included?
I’ll give you a hint. In Graham’s list of activities undertaken by the security analyst, there are two words that stick out like a sore thumb – a seemingly redundant sore thumb – can you find them?
Here they are:
“Critical examination of balance sheets and income accounts, comparisons of related or similar issues, studies of the terms…”
These two words tell you more about Graham and Security Analysis than anything else in that opening paragraph.
Because they are peculiar. What tells most is often what is said least. The appearance of these extra words in this sentence is something almost no one but Graham would ever insist upon.
Graham thinks these words are necessary; otherwise, he wouldn’t have included them. Related and similar are not synonyms. Similar means “alike”; related means “connected”. Connections do not necessitate similarities or vice versa.
For instance, there can be no doubt that airlines and railroads are related (as transports). But are they similar? In some ways yes; but, other industries that are not closely related are at least as similar to one or the other when we drill down into the micro-economics of each.
Graham knows this.
He loves comparisons. Comparing two or more different stocks or bonds was always one of his favorite activities; he did it over and over again in class after class. He used comparisons in his teaching and in his writing. Sometimes these comparisons used similar issues, sometimes related issues, and sometimes random issues (as in the Intelligent Investor).
Choosing random issues (e.g., by taking stocks that are listed together in alphabetical order) allows the security analyst the greatest opportunity to see each stock in the sharpest relief. Looking only at related issues can be very useful (and is a common practice, especially when putting a valuation on a stock or a company); however, such comparisons can cause tunnel vision.
One phrase in this introduction will come back to haunt many readers – as it foreshadows what will quickly become their least favorite part of Security Analysis – “studies of the terms and protective covenants behind bonds and preferred stocks”.
Oh how some of you will come to hate that phrase!
There are a lot of reasons for Graham’s focus on senior securities. Some are peculiar to the time he was writing; most are not. Graham’s own personal history made him a sucker for a good, long exploration of every aspect of senior securities.
Here is a passage from Graham’s memoirs, describing his activities when he first arrived on Wall Street:
Even in my spare time I took the job of self-education very seriously. I got myself a small looseleaf notebook, and on each page I wrote the salient data about a given bond issue in convenient form to be memorized. After all these years I can still remember the appearance of that black notebook and some of the entries in it. The first was: “Atchison, Topeka, & Santa Fe, General 4s, due 1995: 150 mil.” There must have been a hundred different issues entered; I memorized their size, interest rate, maturity date, and order of lien. Why I wanted to memorize facts that could be readily obtained from manuals or my notebook I am at a loss to explain…After making what I thought was wonderful progress with these studies, I found all the different issues hopelessly mixed up in my mind, and I gave up the exercise as a bad job. But I was surprised to realize some months later that the figures had somehow straightened themselves out. I had becoming something of a walking Railroad Bond Manual.
Some would prefer to skip everything Graham wrote about senior securities. You can read Security Analysis without reading Graham’s views of bonds and preferred stocks and still get something out of it. But, I wouldn’t recommend it. In a later commentary, I’ll defend the value of the parts of Security Analysis that deal with bonds and preferred stocks. For now, just know that they are there – and that you may not like them as much as those parts of the book that deal exclusively with common stocks.
Graham wrote about both for a reason. Luckily, much of what he says about senior securities will help us better understand his thinking on common stocks. But, for now, just brace yourself for reading (and reading and reading) about bonds.
Those of you with book in hand – or more likely, hands – know that Security Analysis is quite literally heavy reading.
There’s no getting around it: Security Analysis is one big book. It’s long. Too long for some modern readers – or at least long enough to give modern readers an excuse for eschewing Graham.
There are two kinds of long. There’s little-thing long and big-thing long.
The best illustration of the difference between little-thing long and big-thing long is Alfred Hitchcock’s The Man Who Knew Too Much (1956). This Jimmy Stewart movie features a climax many have seen even if they haven’t seen the movie (hint: it involves cymbals). This climactic sequence is little-thing long. It is a long, long sequence. It seems to get longer as you watch it. Every little thing is noted and adds to the suspense. Unfortunately, this climax is not near the end of the movie. In fact, it isn’t even the last climax of the movie. There’s another climax: a perfectly good one involving a song, a kidnapped child, and a gun. These two climactic sequences make The Man Who Knew Too Much big-thing long as well as little-thing long. The movie has a lot of big building blocks strung together – several different exotic locales, two climaxes, etc. Being big-thing long is very different from being little-thing long. A little-thing long movie is exhilarating and exhausting for the audience; a big-thing long movie can be either satisfying or sleep inducing depending on how it’s handled.
Security Analysis is big-thing long. It has lots of parts and chapters, sections and subsections. It covers a huge amount of material. It touches on a lot of different ideas and explores a lot of different arguments. But, when it does, it doesn’t do so in extraordinary depth. Graham doesn’t circle round a subject; he cuts right to the heart. Therefore, he can pick up and dispose of a subject or argument within a relatively short time. If you miss a paragraph of Graham, you may have missed a lot. There are nuggets in there – great scenes, real gems – but they aren’t especially long and Graham doesn’t make a big fuss about each and every one of them.
No where is this more obvious than in the introduction. In my next post, I’ll try to discuss some of the subjects Graham takes up in more detail. For now, just note how many different topics he picks up, scrutinizes, and then disposes of in a single introduction. Then, open up any other investment book and read that book’s introduction. Even if the number of words are equal, the number of ideas is likely to be less. Most investment writers circle more and cut less.
Finally, there’s the matter of Graham’s subversive style. In Security Analysis, the author is ubiquitous but not conspicuous. In one of my podcasts, I compared Graham to Tacitus. If that strikes you as a totally insane comparison, consider the close of Graham’s first paragraph:
“…they must be viewed against a broader background of investment principles, or perhaps of speculative principles.”
This kind of sentence is more common in Graham (and Tacitus) than in most writing. It maintains an objective tone, while injecting the author’s personality – or more accurately – his personal judgment. Using “or perhaps” and placing it after a complete thought that includes the word “must” suggests not so much uncertainty as deceit. In this case, Graham is honestly saying security analysis may be used either for investment or speculation.
However, he’s also saying – without really having to say it – that we often speculate and call it investment. We practice self-deceit. The way he’s constructed his sentence allows us to read either objective uncertainty (i.e., could be “a”, could be “b”, who knows?) or subjective subversion (we say it’s “a”, but you and I both know it’s often “b”).
Graham – like Tacitus – tends to subvert his own sentences.
His presentation of the facts and his willingness to explore all the facts – and all the possible explanations – is exceedingly honest and objective. However, he concomitantly conveys his own views to the reader, regardless of the objective textbook format in which he operates.
You get a real sense of Graham without his ever taking off the textbook writer’s mask, just as you get a real sense of Tacitus without his ever taking off the historian’s mask. In both cases, you feel you’re reading a very disinterested account written by a very interested party.
It’s an unusual experience.
I hope you enjoy it.