Warren Buffett has said it numerous times. One of his most prized possessions is an investing book that read while studying at Columbia University. The book "Security Analysis" puts forth the basic principles underlying investment decisions and this book has been written by none other than, Benjamin Graham and David Dodd, two most famous financial investing authors of all time. Any investor that is serious about investing in stocks must read the book in order to grasp the workings of security analysis.
The first part of the book essentially deals with providing guideline on how investors should conduct their decisions regarding stocks. The book identifies that investment in stock must be made after conducting a thorough analysis of the future profitability of the corporation. However, this is not enough and an investor must also take into account a certain margin of safety and all decisions must be governed by stated principles of investment. The book also emphasizes the use of price earnings ratio as a measure of determining the worth of an investment. Graham stated that the P/E ratio should be a maximum of 20 and no more, as P/E ratio higher than 20 suggests speculative stocks that are likely to lose value in the foreseeable future. He emphasized that P/E ratio must not be the only measure on which investment decisions are based. Rather the investor must take into account the inner workings and management of the organization before undertaking the investment.
The book also focuses on the ideology that is generally adopted by the investors when investing in stocks. The authors identify that traditional method of security analysis is based on earnings only and this is subject to errors. After criticizing that method adopted by the investors at large, the book aims to highlight methods of security analysis that have been tried and tested by the authors themselves. He states that investment in stocks should not be based on guesses and speculation but rather on sound analysis that takes into account past, present and future conditions of the corporation. The book than suggests that investors must invest in stocks of high growth companies and offers ways of how the investors can identify companies that have high growth prospects. However, it is repeatedly emphasized that an investor must not pay an extremely high price for the stock based on calculations. This is because if the growth projections do not occur as predicted the investor would actually be at a loss by paying more for the stock than it's worth.
Lastly, Graham introduces the concept of "margin of safety" and how this might be practiced by a normal investor. Graham emphasizes that an investor that buys stocks at less than the intrinsic value is practicing the concept of margin of safety. However, he once again highlighted that the calculation of intrinsic value is subject to error and not absolute. Nonetheless, he stated that an investor who is able to buy stocks at a price that is far less than their actual worth is actually able to incorporate sound investment techniques within the investment strategy.
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