Security Analysis : Sixth Edition, Foreword by Warren Buffett: Additional Aspects of Security Analysis. Discrepencies Between Price and Value

Notes, which traded as low as 15 cents on the dollar. At that price, the
current yield
was close to 66%. AES was a complex company with assets all over the world. Furthermore, it was financed in a nontraditional way with a combination of project-specific debt as well as corporate debt of different levels of seniority. The high degree of leverage combined with the complexity of the asset base caused the market to be concerned that the company would be forced into bankruptcy. Our analysis led us to the conclusion that there was more than sufficient value and cash flow to cover the debt. As it turnedout, we were correct. These bonds never missed a payment and were called at par within a year of hitting their lows. Talk about a windfall! Surely, Ben Graham would have marveled at the bond market’s temporary insanity in the summer of 2002.
    As I continued reading through Part VII , I was particularly and delightedly struck by the authors’ use of the English language. Their ability to express ideas cogently and clearly has seldom been matched in the field of finance, with the exception of perhaps their best and most famous student, Warren Buffett. After all, it was Graham and Dodd who created the parable of a manic Mr. Market, the gentleman who may be your friend or your enemy but who is someone whose advice you should never accept. A great example of their effective use of language is found in the discussion of the shortcomings of “market analysis.”
    It was also Graham and Dodd who coined the term “margin of safety,” which has special relevance for the investment professionals who contributed to this edition of the book. All of us are fundamental analysts who examine securities one at a time, weighing the risk and reward characteristics of each investment at a particular price. While we may, from time to time, have views on where the stock market is headed, we generally do not make bets on its direction. Our reasons are many, but I think Graham and Dodd said it best when they wrote in Chapter 52 :
    In market analysis there are no margins of safety; you are either right or wrong, and if you are wrong, you lose money. (p. 703)
    That really sums it up nicely, doesn’t it? Yet, all these years later, many investors are still consumed with formulating their own market view. Wall Street’s finest firms employ market strategists, and many investors, professional and otherwise, are eager to hear those views. This, I submit, is simply more evidence that the Great Illusion persists.
    In the very last chapter, Graham and Dodd offer advice to different groups of market participants, among them the small investor, thewell-heeled investor, and the institutional investor. How has their advice held up?
    For the small investor interested in income, the authors felt that the only suitable investment was U.S. government savings bonds. The securities performed as promised, of course, but there were a couple of developments that Graham and Dodd did not and could not foresee. First and foremost were the ravaging effects of inflation in the late 1970s and early 1980s. The inflationary spiral ultimately led to higher interest rates and large losses for bond investors. Second was the expansion of the fixed income markets and the proliferation of innumerable fixed income securities that created opportunities for value investing in the bond market for those willing to sift through vast numbers of similar instruments in search of anomalous pricing.
    Graham and Dodd advised profit-seeking investors, both large and small, to purchase securities trading below their intrinsic value, and they suggested that investors submit their analytical work for critique by others. In essence, they were recommending that investors should all become part-time security analysts. Writing in the aftermath of the 1929 crash and ensuing Great Depression, the prospect of the kind of financial market profitability we’ve seen in recent years was unimaginable. In today’s hypercompetitive world, it may be possible to succeed as a part-time investor, but it’s not something I’d recommend. And if you don’t want to devote yourself full-time to researching investments, you’re probably better off engaging some professional assistance.
    The prolific pair also advised institutions to invest solely in fixed income investments, if doing so would fulfill their needs. Fortunately, for universities such as Harvard, Yale, and Princeton, men such as Jack Meyer, David