Among the “few prudent principles” that investors forgot were such market clich
- Graham detested warrants, as he makes clear on pp. 413
September 4th, 2009 — Investment Strategies
Among industrial bond issues the long term record has been different. Although the industrial group as a whole has shown a better growth of earning power than either the railroads or the utilities, it has revealed a lesser degree of inherent stability for individual companies and lines of business. Thus in the past, at least, there have been persuasive reasons for confining the purchase of industrial bonds and preferred stocks to companies that not only are of major size but also have shown an ability in the past to withstand a serious depression.
Few defaults of industrial bonds have occurred since 1950, but this fact is attributable in part to the absence of a major depression during this long period. Since 1966 there have been adverse developments in the financial position of many industrial companies.
Considerable difficulties have developed as the result of unwise expansion. On the one hand this has involved large additions to both bank loans and long term debt; on the other it has frequently produced operating losses instead of the expected profits. At the beginning of 1971 it was calculated that in the past seven years the interest payments of all nonfinancial firms had grown from $9. billion in 1963 to $26.1 billion in 1970, and that interest payments had taken 29% of the aggregate profits before interest and taxes in 1971, against only 16% in 1963.
September 4th, 2009 — Investment Strategies
Among industrial bond issues the long term record has been different. Although the industrial group as a whole has shown a better growth of earning power than either the railroads or the utilities, it has revealed a lesser degree of inherent stability for individual companies and lines of business. Thus in the past, at least, there have been persuasive reasons for confining the purchase of industrial bonds and preferred stocks to companies that not only are of major size but also have shown an ability in the past to withstand a serious depression.
Few defaults of industrial bonds have occurred since 1950, but this fact is attributable in part to the absence of a major depression during this long period. Since 1966 there have been adverse developments in the financial position of many industrial companies.
Considerable difficulties have developed as the result of unwise expansion. On the one hand this has involved large additions to both bank loans and long term debt; on the other it has frequently produced operating losses instead of the expected profits. At the beginning of 1971 it was calculated that in the past seven years the interest payments of all nonfinancial firms had grown from $9. billion in 1963 to $26.1 billion in 1970, and that interest payments had taken 29% of the aggregate profits before interest and taxes in 1971, against only 16% in 1963.
September 4th, 2009 — Investment Strategies
We do not consider it necessary or appropriate to traverse the same ground in this chapter, especially since the emphasis in the present article is on principles and attitudes rather than on information and description. Let us pass on to two basic questions underlying the selection of investments. What are the primary tests of safety of a corporate bond or preferred stock? What are the chief factors entering into the valuation of a common stock?
Bond Analysis
The most dependable and hence the most respectable branch of security analysis concerns itself with the safety, or quality, of bond issues and investment grade preferred stocks. The chief criterion used for corporate bonds is the number of times that total interest charges have been covered by available earnings for some years in the past. In the case of preferred stocks, it is the number of times that bond interest and preferred dividends combined have been covered.
The exact standards applied will vary with different authorities.
Since the tests are at bottom arbitrary, there is no way to determine precisely the most suitable criteria. In the 1961 revision of our textbook, Security Analysis, we recommend certain “coverage” standards, which appear in Table 11 1.* Our basic test is applied only to the average results for a period of years. Other authorities require also that a minimum coverage be shown for every year considered. We approve a “poorest year” test Security Analysis for the Lay Investor
- In 1972, an investor in corporate bonds had little choice but to assemble
his or her own portfolio. Today, roughly 500 mutual funds invest in corporate bonds, creating a convenient, well diversified bundle of securities. Since it is not feasible to build a diversified bond portfolio on your own unless you have at least $100,000, the typical intelligent investor will be best off simply buying a low cost bond fund and leaving the painstaking labor of credit research to its managers. For more on bond funds, see the commentary on Chapter 4.as an alternative to the seven year average test; it would be sufficient if the bond or preferred stock met either of these criteria.
September 4th, 2009 — Investment Strategies
Moral: Nothing important on Wall Street can be counted on to occur exactly in the same way as it happened before. This repre208 The Intelligent Investor
- By what Graham called “the rule of opposites,” in 2002 the yields on longterm U.S. Treasury bonds hit their lowest levels since 1963. Since bond
yields move inversely to prices, those low yields meant that prices had risen-making investors most eager to buy just as bonds were at their most expensive and as their future returns were almost guaranteed to be low. This provides another proof of Graham’s lesson that the intelligent investor must refuse to make decisions based on market fluctuations.1902 low 1920 high 1928 low 1932 high 1946 low 1970 high 1971 close
S & P AAA Composite
4.31% 6. 4. 5. 2. 8. 7.
S & P Municipals
3.11% 5. 3. 5. 1. 7. 5. 1905 high 1920 low 1930 high 1932 low 1936 high 1939