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1-Page Summary of Security Analysis
What Is Security Analysis?
In order to determine which securities are worthy investments, we must first analyze them. True investments keep the money safe and yield a reasonable return. Any purchase that does not meet these criteria is speculation.
Security analysis has three functions. The first is the descriptive function, which presents relevant facts in an understandable manner and compares different securities. The second is the selective function, which judges whether an investor should buy, sell or hold onto a security. Finally, the critical function monitors corporate policies, management and company structure on an ongoing basis so that changes can be made if necessary.
Market analysis, unlike security analysis, attempts to predict the direction of the market without referencing individual companies. One type of market analysis is called technical analysis and it relies on past prices in order to predict future values. A second type of market analysis uses economic indicators outside the market that supposedly influence security prices. Neither kind has been proven effective and both essentially promote speculation over reasoned investment decisions.
Intrinsic value is a very important concept in security analysis. It refers to the actual worth of an asset, as opposed to what it’s currently valued at by the market. The intrinsic value can be calculated by examining factors such as assets, earnings, dividends and prospects for growth. However, there are so many variables involved that calculating an exact intrinsic value is impossible. Therefore careful examination of securities that appear undervalued compared to their intrinsic values can lead to profitable investments.
Securities are traditionally divided into two categories, stocks and bonds. This is inadequate because it focuses on the form of the security rather than its safety and purpose. The various types of securities can be better classified into three groups: fixed-value securities, including high-grade bonds and preferred stocks; variable-value senior securities, including speculative bonds and preferred stocks; common stock.
Criteria for Investing in Fixed-Value Securities
A bond is not necessarily a safe investment because of its structure. Rather, the soundness of an investment depends on whether the company can pay its debts. This in turn depends on how strong the company is financially. Therefore, when considering purchasing a bond it’s important to ask yourself: Is this business worth more than what I’m investing? Can this business survive even if there’s a recession or depression?
No company is immune to the effects of a depression. However, large companies with healthy earnings and high bond ratings are more resilient than smaller ones. Bonds that don’t meet these requirements aren’t considered investment grade even if their yields are higher than average.
Preferred stocks are an attractive investment that combines the limited return of bonds with the instability of common stocks. To make sure you don’t lose money on preferred stock, they must have a very high margin of safety and be stable enough to meet the same requirements as bonds. Preferred stocks are safe investments if those two conditions are met.
Income bonds are subject to the same criteria as preferred stocks. Even though they’re fixed value investments, investors should periodically evaluate their holdings. There is no such thing as a permanent investment.
Although some bonds and preferred stocks are not of high quality, there may be some that are worth buying. However, investors must make sure they’re not purchasing them for the wrong reasons. For example, if a company is in financial trouble or has other issues, it could sell at a discount.
