There are two general types of issues that do not lend themselves satisfactorily to the intrinsic value approach (Graham, Security Analysis 1951 edition):
1. The first are those that are essentially speculative in character, meaning thereby that their apparent value is almost entirely dependent upon the vicissitudes of the future.
- An extreme example would be the stock of a company controlling a promising but still undeveloped invention – such as Polaroid Corporation in 1940.
- In the same category belong shares of high-cost or marginal producers, which may have no earning power or else very high earnings according to the price-cost situation of the moment.
- The same situation may be created by a speculative capitalization structure, in which the senior securities are disproportionately large and the common stock becomes exceedingly sensitive to changes affecting earnings or value.
2. The other type is the common stock of a strong enterprise that is considered to have unusually favorable prospects of continued growth.
- The difficulty for the analyst here is to place a sound arithmetical valuation on an optimistic outlook. Since common stocks of this kind are favorites among both admitted speculators and self-styled investors, they present an unusually difficult area for the advisory function of security analysis.
Also read:
The Estimate of Future Earning Power
