Saturday, 14 October 2017

Avoid buying these securities when available at full prices

In selecting investments, in terms of psychology as well as arithmetic, we are guided by three requirements of:

  1. underlying safety,
  2. simplicity of choice, and
  3. promise of  satisfactory results.
Using these criteria has led to the exclusion from the field of recommended investment a number of security classes which are normally regarded as suitable for various kinds of investors.


Advised against the purchase at FULL PRICES of three important categories of securities:
(a) foreign bonds;
(b) ordinary corporate bonds and preferred stocks, under present conditions of relative yield when the best grade issues yield little more than his US Savings Bonds;
(c) secondary common stocks, including, original offerings of such issues.

By full prices, we mean 
  • prices close to par for bonds or preferred stocks, and 
  • prices that represent about the fair business value of the enterprise in the case of common stocks.


The greater number of defensive investors are to avoid these categories REGARDLESS OF PRICE.


Enterprising investors are to buy them only when obtainable at BARGAIN PRICES - which is defined as prices not more than two-thirds of the appraisal value of the securities.


Why people buy and why they should avoid purchasing foreign Government bonds?  
  • They wanted "just a little more income."  The country seemed like a good risk - and that was enough.  The purchasers of the foreign Government bonds must have told themselves that the bonds are practically riskless, presumably on the ground that the country was a far different kind of debtor than other know riskier countries.  
  • At times, the buyer was obtaining just a slight percentage more on his money than the yield on AAA corporate bonds - and this hardly enough to warrant the assumption of a recognized risk.  
  • By what process of calculation could the buyers of the foreign Government bonds assure themselves that at no time before their maturity date, would that country suffer severe economic, or internal political, or international problems?  Also, the high interest rates themselves helped to make default inevitable, especially in distressed countries offering by high interest on their foreign Government bonds.

How to entice people to buy corporate bonds or preferred stocks?  
          For corporate bonds and preferred stocks to be bought, these would either 
  • have to increase their yields so as to offer a reasonable alternative to US Savings Bonds for individual investors or 
  • else would be bought solely by financial institutions - insurance companies, savings banks, commercial banks, and the like,  Such institutions have their own justification for buying corporate securities at current yields.

How and when to buy secondary common stocks?  
  • Secondary issues, for the most part, do fluctuate about a central level which is well below their fair value.  They reach and even surpass that value at times; but this occurs in the upper reaches of bull markets, when the lessons of practical experience would argue against the soundness of paying the prevailing prices for common stocks.  The aggressive investor should accept the central market levels which are normal for that class as their guide in fixing own levels for purchase.  Financial history says clearly that the investor may expect satisfactory results, on the average, from secondary common stocks only if he buys them for less than their value to a private owner, that is, on a bargain basis. 
  • [There is a paradox here, nevertheless.  The average well-selected secondary company may be fully as promising as the average industrial leader.  What the smaller concern lacks in inherent stability it may readily make up in superior possibilities of growth.  Consequently, it may appear illogical to many readers to term "unintelligent" the purchase of such secondary issues at their full "enterprise value."  ]

Intelligent Investor
Benjamin Graham

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