Modern Security Analysis: Understanding Wall Street Fundamentals

Modern Security Analysis......Page 3
Contents......Page 9
Acknowledgments......Page 17
CREDITWORTHINESS......Page 19
THE APPRAISAL OF MANAGEMENTS......Page 20
ACCESS TO CAPITAL MARKETS AND WEALTH CREATION......Page 21
THE AVOIDANCE OF INVESTMENT RISK......Page 22
MARKET EFFICIENCY?......Page 23
DEBUNKING MYTHS......Page 24
YOU NEED A LOT MORE THAN KNOWLEDGE OF ALGEBRA ANDTHE ENGLISH LANGUAGE TO UNDERSTAND OUR APPROACH.......Page 25
OTHER TOPICS WE COVER IN THE BOOK......Page 26
PART One The Foundations of Modern Business and Security Analysis......Page 27
CHAPTER 1 The Scope of Fundamental Finance, Investing, and the Investor Landscape......Page 29
INVESTING VERSUS SPECULATING......Page 30
The Type of Security Does Not Define What an Investment Is......Page 31
The Method of Purchase and the Holding Time Horizon......Page 32
For Income or for Total Return......Page 33
Safety of Principal as the Avoidance of Investment Risk......Page 34
THE OPMI DEFINED......Page 35
SUMMARY......Page 36
CHAPTER 2 A Short Introduction to the Going Concern and Resource Conversion Views of Businesses......Page 37
METHODS OF WEALTH CREATION......Page 38
THE PURE GOING CONCERN VIEW......Page 39
THE RESOURCE CONVERSION VIEW......Page 41
SUMMARY......Page 43
CHAPTER 3 Substantive Consolidation and Structural Subordination......Page 45
SUBSTANTIVE CONSOLIDATION NOT OF PRIME IMPORTANCE......Page 47
THE ACCOUNTING FOR STOCK OPTIONS CONTROVERSY IN LIGHT OF THE SUBSTANTIVE CONSOLIDATION DOCTRINE......Page 50
STRUCTURAL SUBORDINATION NOT A SIGNIFICANT FACTOR......Page 55
LACK OF PROGRESS IN EUROZONE CRISIS RESOLUTION: THE FAILURE TO USE SUBSTANTIVE CONSOLIDATION......Page 58
SUMMARY......Page 59
CHAPTER 4 The Substantive Characteristics of Securities......Page 61
CONTROL VERSUS NON-CONTROL SECURITIES......Page 62
CONTROL AND NON-CONTROL PRICING AND ARBITRAGE......Page 63
TERMS OF SECURITIES AS OPTIONS......Page 67
WHAT A SECURITY IS DEPENDS ON WHERE YOU SIT......Page 68
SUMMARY......Page 73
CHAPTER 5 Primacy of the Income Accountor Wealth Creation? What Are Earnings, Anyway?......Page 75
WEALTH OR EARNINGS?......Page 77
INFLUENCE OF REPORTED EARNINGS ON COMMON STOCK PRICES......Page 79
THE LONG-TERM EARNINGS RECORD......Page 81
PARSING THE INCOME ACCOUNT......Page 82
SUMMARY......Page 86
CHAPTER 6 Net Asset Value: The Static and Dynamic Views......Page 87
THE GRAHAM AND DODD VIEW ON NAV......Page 89
THE FINANCIAL ACCOUNTING VIEW ON NAV......Page 90
OUR VIEW ON NAV......Page 91
THE USEFULNESS OF NAV IN SECURITY ANALYSIS......Page 93
THE IMPORTANCE OF NAV DYNAMICS......Page 96
NAV AS ONE MEASURE OF RESOURCES......Page 101
NAV AS ONE MEASURE OF POTENTIAL LIQUIDITY......Page 102
LIMITATIONS OF NAV IN SECURITY ANALYSES......Page 107
LARGE PREMIUMS OVER BOOK VALUE USUALLY MEAN HIGH P/E RATIOS: IT DEPENDS ON ROE......Page 111
NET NETS REDEFINED......Page 112
OPMI INVESTING IN COMPANIES WITH GROWING NAVS......Page 114
SUMMARY......Page 119
CHAPTER 7 Creditworthiness......Page 121
CREDITWORTHINESS FROM THE BORROWING ENTITY POINT OF VIEW......Page 123
CAPITAL STRUCTURE FROM THE CORPORATE PERSPECTIVE......Page 125
Accessing Equity Markets......Page 126
Dividend Policy......Page 127
Constituency Conflicts with Corporate Feasibility......Page 128
Capitalization in Resource Conversion......Page 129
The Composition and Characteristics of Assets......Page 130
The Needs and Desires of the Several Classes of Creditors......Page 131
The Needs and Desires of Regulators......Page 132
Custom and Usage......Page 133
The Needs and Desires of Outside Passive Minority Investors and Their Representatives......Page 134
CONSERVATIVE CAPITAL STRUCTURES......Page 135
SUMMARY......Page 136
CHAPTER 8 What Matters Is Investment Risk......Page 137
THERE IS NO GENERAL RISK—ONLY SPECIFIC RISK......Page 138
THE COMPONENTS OF INVESTMENT RISK......Page 140
SUCCESSFUL PEOPLE AVOID INVESTMENT RISK......Page 141
METHODS TO AVOID INVESTMENT RISK......Page 143
SAFE AND CHEAP INVESTING AND MINIMIZING INVESTMENT RISK......Page 145
SUMMARY......Page 148
CHAPTER 9 Shareholder Distributions from the Company Point of View......Page 149
CASH DIVIDENDS OR RETAINED EARNINGS......Page 150
STOCK DIVIDENDS......Page 153
STOCK REPURCHASES......Page 156
LIQUIDATION......Page 159
SUMMARY......Page 160
CHAPTER 10 Roles of Cash Dividends in Security Analysis and Portfolio Management......Page 161
THE THREE CONVENTIONAL THEORIES......Page 163
CASH DIVIDENDS AS A FACTOR IN MARKET PERFORMANCE......Page 167
CASH DIVIDENDS AND PORTFOLIO MANAGEMENT......Page 169
CASH DIVIDENDS AND BAILOUTS......Page 172
THE GOALS OF SECURITIES HOLDERS......Page 174
SUMMARY......Page 175
CHAPTER 11 The Appraisal of Managements and Growth: GARP versus GADCP......Page 177
NEW FRAMEWORK FOR THE APPRAISAL OF MANAGEMENTS......Page 178
MANAGEMENTS ATTUNED TO OPMI INTERESTS......Page 179
MANAGEMENTS AS RESOURCE CONVERTERS......Page 180
TRADEOFFS......Page 183
GROWTH: GARP VERSUS GADCP......Page 184
GROWTH AT A REASONABLE PRICE (GARP)......Page 185
GROWTH AT DIRT CHEAP PRICES (GADCP)......Page 186
SUMMARY......Page 188
CHAPTER 12 The Significance (or Lack of Significance) of Market Performance......Page 191
MARKET PERFORMANCE AND THE CHARACTER OF A PORTFOLIO......Page 194
MARKET PERFORMANCE OF PORTFOLIOS VERSUS INDIVIDUAL SECURITIES......Page 195
OUTSIDERS, INSIDERS, AND MARKET PRICE......Page 197
PROFESSIONAL MONEY MANAGERS AND BEATING THE MARKET......Page 198
PERSPECTIVE ON BAILOUTS AND THE SIGNIFICANCE OF MARKET PERFORMANCE......Page 199
SUMMARY......Page 200
CHAPTER 13 How Much Diversification?......Page 203
PORTFOLIO DIVERSIFICATION VERSUS SECURITIES CONCENTRATION......Page 204
CORPORATE DIVERSIFICATION VERSUS CONCENTRATION......Page 208
SUMMARY......Page 209
CHAPTER 14 Toward a General Theory of Market Efficiency......Page 211
Characteristic II: Complexity......Page 213
Characteristic III: Time Horizons......Page 214
EXTERNAL FORCES INFLUENCING MARKETS EXPLAINED......Page 216
GREAT ECONOMISTS CAN LEARN A LOT FROM VALUE INVESTORS......Page 217
Merchant Bankers (Promoters of Leveraged Buyouts)......Page 224
Hedge-Fund Operators......Page 225
Securities Salespeople......Page 226
Money Management......Page 227
Top Corporate Managements......Page 228
MARKET EFFICIENCY AND FAIR PRICES IN TAKEOVERS......Page 229
SUMMARY......Page 231
PART Two Putting It All Together: Safe and Cheap Investing versus Conventional Approaches......Page 233
CHAPTER 15 Safe and Cheap Investing......Page 235
THE SAFE AND CHEAP APPROACH......Page 236
Investment-Risk-Resistant Commitments......Page 238
Confidence in Investment Commitments......Page 239
Activists and Safe and Cheap......Page 240
Missing of Attractive Opportunities......Page 241
Restricting the Investment Universe......Page 242
Dismissal of the Conventional Wisdom......Page 245
Understand Activities and Motivations of Activists......Page 247
SUMMARY......Page 249
CHAPTER 16 Graham and Dodd Placed in Context......Page 251
THE OPMI DEFINED......Page 253
THE OPMI PERSPECTIVE OF ANALYSIS......Page 254
PRIMACY OF THE INCOME ACCOUNT AND WEALTH CREATION......Page 256
PRIMACY OF THE INCOME ACCOUNT AND THE APPRAISAL OF MANAGEMENTS......Page 258
PRIMACY OF THE INCOME ACCOUNT AND DIVERSIFICATION......Page 259
MARKET RISK VERSUS INVESTMENT RISK AND MARGIN OF SAFETY......Page 260
THE IMPORTANCE OF MARKET PERFORMANCE......Page 261
USES AND LIMITATIONS OF FINANCIAL ACCOUNTING......Page 262
DO STOCK MARKET PRICES REFLECT CORPORATE VALUES?......Page 263
MODERN CAPITAL THEORY VERSUS GRAHAM AND DODD......Page 265
SUMMARY......Page 266
CHAPTER 17 Academic Finance: Modern Capital Theory......Page 267
THE MCT POINT OF VIEW......Page 271
EQUILIBRIUM PRICING IS UNIVERSALLY APPLICABLE......Page 272
THE OUTSIDE PASSIVE MINORITY INVESTOR IS THE ONLY RELEVANT MARKET......Page 278
DIVERSIFICATION IS A NECESSARY PROTECTION AGAINST UNSYSTEMATIC RISK......Page 279
VALUE IS DETERMINED BY FORECASTS OF DISCOUNTED CASH FLOWS......Page 280
COMPANIES ARE ANALYZED BASICALLY AS GOING CONCERNS; INVESTORS IN MARKETABLE SECURITIES ARE ANALYZED AS INVESTMENT COMPANIES......Page 282
INVESTORS ARE MONOLITHIC: THEIR UNITARY GOAL IS RISK-ADJUSTED TOTAL RETURN, EARNED CONSISTENTLY......Page 284
MARKET EFFICIENCY MEANS AN ABSENCE OF MARKET PARTICIPANTS WHO EARN EXCESS RETURNS CONSISTENTLY OR PERSISTENTLY......Page 285
GENERAL LAWS ARE IMPORTANT......Page 287
RISK IS DEFINED AS MARKET RISK......Page 289
MACRO CONSIDERATIONS ARE IMPORTANT......Page 290
FREE MARKETS ARE BETTER THAN REGULATED MARKETS......Page 291
MARKETS ARE EFFICIENT OR AT LEAST TEND TOWARD AN INSTANTANEOUS EFFICIENCY......Page 293
SUMMARY......Page 294
CHAPTER 18 Broker-Dealer Research Departments and Conventional Money Managers......Page 295
HOW RESEARCH DEPARTMENTS AND CONVENTIONAL MONEY MANAGERS THINK......Page 297
The Difficulty of Forecasting Earnings......Page 300
The Likelihood That It Is Impossible to Do Top-Down Analysis Rationally......Page 301
Fighting for the Heavyweight Championship with One Hand Tied behind Your Back: Predicting Future Earnings whileIgnoring the Existing Balance Sheet......Page 302
Lack of Awareness of the Relationship between Income Account Numbers and Balance Sheet Numbers and of Analytic Conflicts between and among Related Numbers......Page 303
Use of an Approach Antithetical to Those Used by Private Business people and Control Buyers Not Seeking Immediate Access to Equity Markets for New Capital......Page 305
Analyses That Focus on Base Case Forecasts Rather than Alternative Scenarios......Page 306
The Difficulty of Concentrating on Operating Ratios Based on Financial Accounting Statistics......Page 308
Heavy Reliance on Perceptions of What Others Think......Page 309
SUMMARY......Page 310
PART Three Real-World Considerations......Page 313
CHAPTER 19 Uses and Limitationsof Financial Accounting......Page 315
THE CONVENTIONAL APPROACHES......Page 317
FINANCIAL ACCOUNTING REPORTS AS OBJECTIVE BENCHMARKS......Page 320
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AS DEFINING REALITY FOR CERTAIN SPECIFIC PURPOSES......Page 327
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AS A ROAD MAP FOR DUE DILIGENCE AND LESS THOROUGH INVESTIGATIONS......Page 328
SUMMARY......Page 337
CHAPTER 20 Company Disclosures and Information: Following the Paper Trail in the United States......Page 339
NARRATIVE DISCLOSURES IN THE UNITED STATES......Page 340
Stereotypical Filings with the SEC......Page 341
THE DOCUMENTS AND HOW TO READ THEM......Page 345
WHAT THE PAPER TRAIL DOES FOR THE OUTSIDE INVESTOR......Page 346
WHAT THE PAPER TRAIL DOESN’T DO......Page 349
HOW GOOD IS THE PAPER TRAIL?......Page 352
SUMMARY......Page 353
CHAPTER 21 Buying Securities in Bulk......Page 355
Cash Purchases in the Open Market......Page 356
Cash Purchases in Private Transactions......Page 357
Cash Tender Offers......Page 358
Cash Mergers through the Use of Proxy Machinery......Page 359
Voluntary......Page 361
Mandatory......Page 362
ACQUISITION OF CONTROL WITHOUT ACQUIRING SECURITIES BY USING THE PROXY MACHINERY......Page 363
SUMMARY......Page 364
PART Four Understanding Resource Conversion......Page 365
CHAPTER 22 A Short Primer on Resource Conversion......Page 367
LONG-TERM ARBITRAGE BETWEEN OPMI PRICES AND CONTROL VALUES......Page 368
MERGER AND ACQUISITION ACTIVITY......Page 373
The 1970s through 2012......Page 374
The Emergence of the Shark Repellent......Page 375
Tax Shelter (TS), Other People’s Money (OPM), and Something off the Top (SOTT)......Page 377
The Example......Page 378
SUMMARY......Page 386
CHAPTER 23 Restructuring Troubled Companies......Page 387
Truth 1: No One Can Take Away a Corporate Creditor’s Right to a Money Payment Outside of Chapter 11 or Chapter 7 Unless Individual Creditor Consents......Page 388
Truth 2: Chapter 11 Rules Influence All Troubled Company Reorganizations......Page 393
Truth 3: Substantive Characteristics of Securities......Page 395
Truth 4: Restructurings Are Costly for Creditors......Page 397
REHABILITATION OF TROUBLED ENTITIES......Page 398
Reorganizations......Page 399
Section 363 Sales......Page 406
Capital Infusions......Page 408
SUMMARY......Page 409
CHAPTER 24 The Role of Government in Reorganizations......Page 411
BAILOUTS OR CAPITAL INFUSIONS?......Page 412
TOO BIG TO FAIL IS A PHONY CONCEPT......Page 413
THE GOVERNMENT AND PRIVATE SECTOR ARE IN PARTNERSHIP WHETHER THEY LIKE IT OR NOT......Page 414
TAXPAYER BAILOUTS ARE A PHONY CONCEPT......Page 416
STRICT REGULATION OF FINANCIAL INSTITUTIONS IS ABSOLUTELY NECESSARY......Page 417
SUMMARY......Page 418
PART Five Active Investors Buy and Sell Common Stocks on an Advantageous Basis......Page 419
CHAPTER 25 The Economics of Private Equity Leveraged Buyouts......Page 421
SUPER-ATTRACTIVE ACCESS TO CAPITAL MARKETS......Page 422
CASH PAYMENTS TO SPONSORS AND SPONSOR-CONTROLLED FUNDS......Page 427
SPONSORS CONTROL OF HERTZ......Page 428
SPONSORS ATTUNED TO THE NEEDS OF BANKERS AND THEWALL STREET UNDERWRITING COMMUNITY......Page 429
QUESTIONS ABOUT LBOS......Page 430
SUMMARY......Page 431
THE CASE......Page 433
THE POSTSCRIPT......Page 445
INVESTMENT LESSONS......Page 446
THE APPRAISAL OF MANAGEMENT......Page 448
SPOTTING DOABLE DEALS......Page 449
SUMMARY......Page 450
CHAPTER 27 The Use of Creative Finance to Benefit Controlling Stockholders......Page 451
THE BACKGROUND OF THE DEAL......Page 453
DISCOUNT PURCHASES OF RESTRICTED CORPORATE STOCK......Page 455
The Purchase Agreement......Page 458
Financing the Acquisition......Page 459
Corporation’s Debt Securities Described......Page 461
Mandatory Redemption Provisions......Page 462
Voluntary Redemption Provisions......Page 463
Protective Provisions......Page 464
Other Distinguishing Features......Page 465
Arranging the Public Offering......Page 466
The Selling Stockholders......Page 467
Brewing’s Executive Employees......Page 472
The Commercial Bank Providing Bridge Financing......Page 474
The Wall Street Promoters......Page 475
The Underwriters of the Public Issue and Their Securities Salesmen......Page 477
The Institutional Lenders Providing Long-Term Financing......Page 480
The Public Investors......Page 483
SUMMARY......Page 485
Glossary of Acronyms......Page 487
About the Authors......Page 489
Index......Page 491