Introduction
Chapter 11 of The Intelligent Investor: Security Analysis for the Lay Investor – General Approach
Security analysis, or how we like to called it, Fundamental Analysis, is the study of basics of a security. Security Analyst are the people responsible to conduct these research on investment avenues and predict the future prospects of security.
As the author puts it, “The Security Analyst deals with the past, the present and the future of any given security issue. He describes the business, he summarises the operating results and financial positions, he sets forth its strong and weak points, its possibilities and risk, he estimates its future earning power under various assumptions.” 1
Understanding Security Analysis
In the chapter 11 of The Intelligent Investor, the author has divided the segment into 3 parts:
- Bond Analysis
- Common Stock Analysis
- Industry Analysis
Bond Analysis
The author wants to conclude from the segment of Bond Analysis is that, Bonds are safer and much respectable branch of security analysis.
The chapter 11 of The Intelligent Investor talks about a study that was conducted where a group of Bonds Securities were selected and their 7 year returns were compared to the worst years of the market.
It was concluded that the returns yielded in the worst years were not less than 2/3rd of the returns it yielded in the average 7 years.
Analysis of Bond Securities
- Size of the enterprise
- Stock/Equity ratio
- Property value
Size of the enterprise
The size of an enterprise is an important factor when investing in debt instruments and bond securities.
Public companies and Government securities that have been present in the market for decades. These entities hold a higher credibility to reward their investors with the promised returns.
Stock / Equity Ratio
The stock equity ratio is defined as the market value of a stock to the total face value of the bond. The author believes that this ratio is a drop it measure on the protection of the investment value.
Property value
The property value is defined as the asset value that is shown on the balance sheets.
The authors experience that, most investment in bonds are safe if the valuation of these bonds are backed by assets. This also provides a security for the investors in case the companies default on their debt.
Common Stock Analysis
- General long term prospects
- Management
- Financial strength and capital structure
- Dividend record
- Current dividend ratio
General long term prospects
The author believes that no one actually knows what happens in the future course of stock markets. There are security analyst or financial advisors who can only predict or put forth a point of view on the growth potential depending on its current prospects. These views / forecast are very important for investors to analyse the future potential of the company.
Management of the company
Management is defined as the key personnel responsible for decision making on behalf of the company. These are the people responsible for its growth and profitability
A good management drives the companies profitability to a much greater height from the past records. The author believes that, the management factor is more important than we think it is. A management of the company is usually under estimated.
Good management backed in the company is very important for the companies growth. A management to the company acts like a driver to the car, which when directed in the right direction can take you to a better destination.
It is fair to assume that an outstandingly successful company has unusually good management 2
Financial Strength and Capital Structure
“Stock of a company with a lot of surplus cash and nothing ahead of the common is clearly a better purchase then another one with the same polisher earning but large bank loans and senior securities” 3.
The company needs to have a sizeable amount of surplus reserves in its portfolio to mitigate risk. This risk could majorly include the in times of recessions.
Dividend Record
The author believes that one of the most persuasive test for high quality stock is the record of dividend payments.
One should consider the record of continuous dividend payment so the last 20 years. This data signifies the companies quality rating this is a great investment opportunity.
For a defensive investor, it is a great investment opportunity, who can benefit from capital appreciation as well as periodic dividend payouts.
Current Dividend Ratio
In this chapter, the author states that every company needs to have a policy called standard dividend policy. This policy should outline the guidelines on the rate of dividend payout in terms of their revenue and profitability.
The valuation of the company can also be compared to the annual dividend returns and other investment opportunities that provide similar annual returns.
However, certain growth companies would like to reinvest the profits back into the company. This is done with a believe that the shareholders interest will be better served by retaining the profits for future expansions.
This scenario requires careful distinction between selecting a growth company and a stable company depending on the type of investing strategy of the investor.
Industry Analysis
Industry Analysis is the process of studying the economic growth of the country, with its sector and then of a company.
Security analyst pay a lot of attention not just on the company’s future prospects but on how the sector will perform, and in general how the economy will grow with time.
Conclusion
There is no factor that will accurately determine the price of a future stock just by merely studying its past records and fundamentals.
The security analysis is nothing but just a prediction / calculated risk reward statement that be used to likely predict the future event based on present scenario.
It in just as estimate and it does not guarantee that research developed by the security analyst will derive the desired results.
Also Read: 5 Effective Ways To Avoid Losing Money In Stock Market
