看电视里采访蔡琴，她说以前一直不敢唱这首歌，因为会哭得唏哩哗啦。《点亮霓虹灯》，看过她给杨德昌写的告别信的人都能看出比爱情还感人的善良。难怪她说自己是女人中的极品。她说她喜欢《恰是你的温柔》里面的一句歌词“我们却都没有哭泣”，是不是因为“才明白人间的聚散 是不能全放在心上”？总觉得蔡琴和Maria Callas外貌上有一点神似，连同她们那“离心而同居”的爱情(原谅我篡改了如此浪漫的"同心而离局，忧伤以终老")。

 

 

 

披星戴月看完了<Security Analysis>Part 5: Income Statement Analysis. 包括31章—41章。除了Part 2: fixed value investment有15章以后，就是Part 5最长了。以前曾经尝试在没有学习Part1 –4的情况下直接看Part 5，因为这一个章节看上去能最快产生效果。现在重温这一节，只能说：以前以为重要的，现在依然重要；以前以为无足轻重的，现在变得很重要。

---

Chapter 39 Price-earning ratios for common stocks. Adjustments for changes in capitalization

1. Exact appraisal impossible

2. Limited functions of the analyst in field of appraisal of stock prices.  

a.) he may set up a basis for conservative or investment valuation of common stocks, as distinguished from speculative valuations.

b.) he may point out the significance of:

l         The capitalization structure

l         The source of income
as bearing upon the valuation of a given stock issue

c.) he may find usual elements in the balance sheet which affect the implications of the earning picture.

3. A suggested basis of maximum appraisal for investment

a.) average earnings: >5 years

b.) P/E < 16
earnings/price < 6%, it is hard to justify the price paid for the conservative investment.

4. Higher prices may prevail for speculative commitments

5. Other requisites for common stocks of investment grade

l         Reasonable P/E < 16

l         The company must be satisfactory also in its financial set-up, its management, and its prospects.

l         An attractive common-stock investment is an attractive speculation

l         Common-stock investment operations, lying b/w low price issues which are speculative because of doubtful quality and well-entrenched issues which are speculative, none the less, because of their high price

l         In summary, test for common stock investment quality:

n         Stability of earnings

n         Reasonable P/E

n         Conservative financial set-up and strong position in WC

6. Allowances for changes in capitalization
--- per-share earnings restated for capitalization including:

n         split-ups, stock dividends.

n         Sale of additional stock at a comparatively low price (subscription rights or warrants)

n         Conversion of senior issues

n         Participating interests

 

---

Chapter 40 Capitalization Structure

1. Principle of optimum capitalization structure:

--- the optimum capitalization structure for any enterprise includes senior securities to the extent that they may safely be issued and bought for investment. (like in most private business, where it is recognized as profitable and proper policy to use a conservative amount of banking accommodation for seasonal needs rather than to finance operations entirely by owner’s capital)

2. Corporate practices resulting in shortage of sound industrial bonds – avoidance of bonded debt by the strongest industrial companies

a)         Restrict new industrial-bond financing to companies of weaker standing.

b)        Drive investors into the Pref which prove unsatisfactory investment media in the long run.

c)        The elimination of senior issues in strongest companies adds the investment quality of their common stocks, but it has added even more to the investor’s demand for these common stocks. It has thus supplied a superficial justification for the speculation of blue chips.

3. Appraisal of Earnings where capital structure is top-heavy

a.) the minimum margin of safety behind bond issues must be set high enough to avoid the possibility that safety may even appear to be achieved by a mere lowering of the interest rate. The same reasoning would apply of course to the dividend rate on preferred stocks.

4. The factor of leverage in speculative capitalization structure

a.) there is tendency for speculatively capitalized enterprises to sell at relatively high values in the aggregate during good times or good markets

b.) Conversely, they may be subject to a greater degree of undervaluation in depression. There is, a real advantage in the fact that such issues, when selling on a deflated basis, can advance much further than they can decline.

c.) In a speculatively capitalized enterprise, the common stockholders benefit at the expense of senior security holders

d.) Speculation suggestion

l         The purchase of speculatively capitalized common stocks must be considered under general market conditions which are supposedly normal, i.e. under those which are not obviously inflated or deflated.

l         Diversification & reasonably good judgment in selecting companies with satisfactory prospects

n         Preferred to these firms in which most of the senior capital is in the form of Pref rather than bonds.

 

---

Chapter 41 Low-priced common stocks. Analysis of the source of income

Low priced stocks

1. some reasons why most buyers of low-priced issues lose money

a.) the bulk of the low-priced purchases made by the public are of the wrong kind, i.e. they do not provide the real advantages of this security type.

b.) the reason may be

l         Either because the companies are in bad financial condition

l         Or because the common stock is low-priced in appearance only and actually represents a full or excessive commitment in relation to the size of the enterprise.

c.) A genuinely low-priced common stock will show an aggregate value for the issue which is small in relation to the company’s assets, sales, and past or prospective profits.

d.) observation will show that the stocks of companies facing receivership are likely to be more active than those which are very low in price merely because of poor current earnings.

l         This phenomenon is caused by the desire of insiders to dispose of their holdings before the receivership wipes them out, thus accounting for a large supply of these shares at a low level.

2. Low price coupled with speculative capitalization
-- wherever the market value of the common issue represents a small amount of money in relation to the size of the business, regardless of how it is capitalized (it looks to mean the ratio = MV of common/sales or current assets is too high?????)
---fixed rental obligations is like bonds prior to Common in the company’s financial set-up.

3. Large volume and high production cost equivalent to speculative capital structure

-- another example for speculatively situated common stock

a.) Speculative situation:

l         whenever earnings available for common stock < subnormal figure, and therefore MV (common) goes to subnormal level against the volume of business

l         Unusually high operating or production costs have the identical effect as excessive senior charges in cutting down the % of earnings available for common.

n         High production volume & high operating cost = Speculative capital structure
when sales price is about to rise very soon, the stocks of high-cost producers are more logical commitments to those the low-cost producers

 

Sources of income

-- the source of income must be studied in relation to specific assets owned by the company, instead of in relation merely to the general nature of the business, requiring a transfer of attention from the income account figures to certain related features revealed in the balance sheet.

Chapter 36 Reserves for depletion, other amortization charges and contingencies

1. Depletion of ore reserves

Principle: where the life of a property is limited, the stated dep charge should also be ignored and the “investor’s amortization” charged against the earnings before dep. The three factors to be considered are:

a)         the price paid for the mining property (total price less cash assets)

b)        the earnings before depreciation and depletion

c)        the minimum life the mine, and, alternatively, its probable life.

2. Amortization of patent
Principle: more as business hazards than as a matter of accounting

a)         charges for amort of patents as given in corporate reports should be ignored in analyzing the earning power, and the paten item be considered only when trying to determine what price for the enterprise these earnings will justify.

3. Amortization of leaseholds and leasehold improvements

Conditions: if the rental payments are considerably less then the use of the property is worth, and if the arrangement has a considerable period to run, the leasehold may have a substantial value.

Tricks: charge against surplus instead of income, or by writing down the entire capital investment to $1.

4. Contingency and similar reserves

l         A threefold purpose:

a. to permit losses to be charged against surplus instead of against income

b. to gloss over the actual taking of the loss

c. in some cases to lay the groundwork for inflated earnings in subsequent years.

l         In accounting book: loss charged to surplus rather against NI

a)         NI: marginal deficit

b)        B/S: Surplus Drop whilst CL increases

l         More complicated device (3 steps)

a)         Xfer of a large amount from Capital to Surplus

b)        Xfer of various amount from Surplus to Reserves

c)        Charging of various losses against theses Reserves, and of other losses directly against Surplus

 

---

Chapter 37 Significance of the earnings record
-- the utility of this past record as an indicator of future earnings.

-- this is at once the most important and the least satisfactory aspect of security analysis

l         The most important:
because the sole practical value of our laborious study of the past lies in the clue it may offer to the future.

l         The least satisfactory
because this clue is never thoroughly reliable and it frequently turns out to be quite valueless

1. The concept of earning power

a.) Definition:
it combines a statement of actual earnings, shown over a period of years, with a reasonable expectation that these will be approximated in the future, unless extraordinary conditions supervene.

b.) why a number of years?
-- first because a continued or repeated performance is always more impressive than a single occurrence

--secondly because the average of a fairly long period will tend to absorb and equalize the distorting influences of the business cycle.

c.) A distinction b/w “normal average” and “modal average”

2. Quantitative analysis should be supplemented by qualitative considerations
Principle: Quantitative data are useful only to the extent that they are supported by a qualitative survey of the enterprise

a.) a company’s business to be regarded as reasonably stable only both:

l         Past record shows stability

l         The nature of the undertaking must be such as to indicate an inherent permanence of earning power.
(there may be considerable variation in yearly earnings, but a reasonable basis nevertheless for taking the average as a rough index at least of future performance)

3. Current earnings should not be the primary basis on appraisal.

4. Average vs. Trend of earnings.

a.) Trend of earnings

l         The supposed trend might prove deceptive

l         Valuations based on trend obey no arithmetical rules and therefore may too easily be exaggerated

b.) Attitude of analyst where trend is upward

l         Analyst valuation: More liberal multiplier * past average of NI.

l         Market valuation: Much More liberal multiplier * current average of NI. (speculative component paid not for demonstrated but for expected results)

c.) Attitude of analyst where trend is downward

l         A qualitative study of the company’s situation and prospects is essential to forming an opinion as to whether at some price, relatively low, the issue may not be a bargain, despite its declining earnings trend

l         The viewpoint of the analyst with that of a sensible business man looking into the pros and cons of some privately owned enterprise.

5. Deficits a qualitative, not a quantitative factor

6. Intuition not a part of the analyst’s stock in trade

7. analysis of the future should be penetrating rather than prophetic

 

---

Chapter 38 Specific reasons for questioning or rejecting the past record

-volume limits from reserves or mine

-future price changes

-upper limits on profit

Chapter 33 Misleading Artifices in the income account.  Earnings of Subsidiaries

1. Check upon the reliability of published earnings statements (B/S & Federal Tax)

a)         Appreciation of Leaseholds in NI

1.         leaseholds are essentially as much a liability as they are an asset.

2.         assuming leaseholds may acquire a capital value to the occupant, such value is highly intangible, and it is contrary to accounting principles to mark up above actual cost the value of such intangibles in a balance sheet.

3.         If the value of any capital asset is to be market up, such enhancement must be credited to capital surplus. By no stretch of the imagination can it be considered as income.

4.         If the leaseholds had really increased in value, the effect should be visible in larger earnings realized from these favorable locations. Any other recognition given this enhancement would mean counting the same value twice.

5.         Whatever value is given to leaseholds must be amortized over the life of the lease. The surprising truth of the matter, is that the effect of the appreciation of leasehold values – if it had occurred – should have been to reduce the subsequent operating profits by an increased amortization charge.

2. Subsidiary companies and consolidated reports

a)         Non-consolidated profits/losses:
-- <20% ownership, parent company only reports its dividends received from Sub

b)        Special dividends paid by sub
-- when earnings of non-consolidated subsidiaries are allowed to accumulate in their surplus accounts, they may be used later to bolster up the results of a poor year by means of a large special dividends paid over to the parent company

c)        Revision of Income Account should be made to allow for such items
--I/S: EPS
--B/S: write-down of book value of its holdings of sub

3. Suggested procedure for statistical agencies
-- transfer Parent’s surplus to Sub’s treasury
-- Sub paid dividends to Parent which book sub’s dividends as NI

 

---

Chapter 34 The relation of depreciation and similar charges to earning power  
-- Depreciation and kindred charges which do not signify a current and corresponding outlay of cash. They only represent the estimated shrinkage in the value of the fixed or capital assets due to wearing out, to using up, or to their approaching extinction for whatever cause.

1)        Dep. (and obsolescence), replacements, renewals and retirements

2)        Depletion or exhaustion

3)        Amortization of leaseholds and leasehold improvements

4)        Amortization of patents

 

1. Leading Questions relative to depreciation.---- dep rates & cost base

2. Depreciation charges represent an expense of operation

a)         It registers an actual diminution of capital values, for which adequate provision must be made if creditors or owners are to avoid deceiving themselves.

b)        Dep charges are eventually found to be related to actual cash outlays in the form of even large cash expenditures made for replacements or extensions.

3. Criticism of “its property was increasing so rapidly in value that no real dep was taking place at all”

a)         Whatever increases in value were taking place should have reflected themselves in the earning power after deduction of normal dep charges.

4. Another misleading practice
--- charging a part of the year’s amortization to income and the balance direct to surplus

5. A minimum adjustment of the published earnings
-- = GAAP tax – IRS tax

Reporting of Depletion Charges

6. Depletion in the oil industry

Dep of tangible assets

Depletion of oil and gas reserves, based upon the cost of the leases

Unprofitable leases written off

Intangible drilling costs

-- oli company profits can be made largely a matter of oil company bookkeeping. All deductions made on its books are shown in the earnings statements.

7. Adequacy of amortization Rates in Use:

As shown by listing statements

As shown by comparison with similar enterprises

8. Depreciation charges often an issue in mergers.

 

---

Chapter 35 Amortization charges from the investor’s standpoint
-- cost base, property value against which the dep/amort are applied

1. Irrationality of these valuations disclosed by the balance sheet

l         Dep in GAAP = Dep cash layout + Dep unspent

l         Dep unspent + NI = cash available for WC + Dividends = A

l         A – Dividend payment = cash added to net quick assets

2. Concept of “Expended Dep”

l         Dep Reserves of this year > Expended Depreciation Charges = PPE(ending period) – PPE (begin period)

l         The dep allowance > the average expenditures made on the property
The expenditures on property account, including new fixed assets, represent in effect the portion of the depreciation reserve which is not available in cash, and that portion should hence be considered as the minimum amount of depreciation must be allowed for in conducting the business

3. Long-term Depreciation a Form of obsolescence

a. the long-term depreciation factor is in reality overshadowed and absorbed by the obsolescence hazard. This risk is essentially an investment problem and not an accounting problem. It should not operate to reduce the earnings (as does a depreciation charge), but rather to reduce the price to be paid for an earning power subject to such a business risk.

b. The obsolescence hazard should be considered after the earnings are arrived at and not before.

4. Problems of valuing the earning power.

l         Eps = 7,

l         If assuming 20% of eps is required on the investment to cover risks of losses,

l         Price = 35

5. Inadequate allowance for Dep.

a. Approach:

l         wirte-off PPE & Surplus – reduce Dep

l         “Reserve for Replacement” charging against NI with understated dep allowance

6. Earnings manufactured from dep account

---As long as Net PPE (ending) > Net PPE (being)
it means that money spent for property extensions and replacements exceeds the total depreciation allowance charged against NI.

7．Summary

Rule 1. The Dep is accepted whenever both:

a.       they are based on GAAP applied to fair valuations of the fixed assets; and

b.       the net plant account has either increased or retained stationary over a period of years

Rule 2: The Dep is allowed to reduce if

Dep> the cash expenditures on the property, then

NI – average cash expenditures; the balance of Dep is included in the obsolescence hazard which tends to reduce the valuation of this average cash earning power

Rule 3: The Dep must be increased if

Dep < average cash expenditures on property and Dep < the reserved required by GAAP

Part 5 Analysis of the income account / the earnings factor in common-stock valuation

Chapter 31 Analysis of the income account

i.              Disadvantages of sole emphasis on earning power
-- (the meaning of any income statement cannot properly be understood except with reference to the balance sheet at the beginning and the end of the period)

a)         Instead of the twofold test of value afforded by both earnings and assets, he is relying upon a single and therefore less dependable criterion.

b)        These earnings statements on which he relies exclusively are subject to more rapid and radical changes than those which occur in balance sheets. Hence an exaggerated degree of instability is introduced into his concept of stock values.

c)        The earnings statement are far more subject to misleading presentation and mistaken inferences than is the typical balance sheet when scrutinized by an investor of experience.

2. Simplified statement of wall street’s method of appraising common stocks

Price = EPS * P/E multiple (quality coefficient), quality coefficient should reflect:

a)         The dividend rate and earnings record

b)        The standing of the company

c)        The type of business

d)        The temper of the general market

The truth is the quality coefficient is itself largely determined by the earnings trend, which in turn is taken from the stated earnings over a period.

3. Earnings not only fluctuate but are subject to arbitrary determination

The EPS may at the choice of those in control by made to appear either larger or smaller

a)         By allocating items to surplus instead of to income, or vice versa. (current income Vs. charges/credit to the surplus account due to previous years’ operating result under “non-recurrent items”)

b)        By over- or understating amortization and other reserve charges

c)        By varying the capital structure, as between senior securities and common stock

d)        By the use made of large capital funds not employed in the conduct of the business

4. Significance of the foregoing to the Analyst
--- it is always good to know the truth but it may not always be wise to act upon it, particularly in wall street.

a)         It must always be remembered that the truth which the analyst uncovers is first of all not the whole truth and, secondly, not the immutable truth. The result of his study is only more nearly correct version of the past. His information may have lost its relevance by the time he acquires it, or in any event by the time the market place is finally ready to respond to it.

b)        The analyst work should be classified under 3 headings:

                         i.              The accounting aspect.
Leading Question: what are the true earnings for the period studied?

                       ii.              The business aspect.
Leading Question: what indications does the earnings record carry as to the future earning power of the company

                      iii.              The aspect of investment finance.
Leading Question: what elements in the earnings exhibit must be taken into account, and what standards followed, in endeavoring to arrive at a reasonable valuation of the shares?

5. Criticism and restatement of the income account

these audited statements may require critical interpretation and adjustment, especially with respect to these three important elements:

a.       Non-recurrent profits and losses

b.       Operations of sub

c.       Reserves

6. General observation on the income account

l         Non-recurrent items:
accounting rules permit the management to decide whether to show these operations as part of the current income or to report them ad adjustments of surplus:

1.         P/L on sale of fixed assets

2.         P/L on sale of marketable securities

3.         Discount or premium on retirement of capital obligations

4.         Proceeds of life insurance policies

5.         Tax refunds and interest thereon

6.         Gain or loss as result of litigation

7.         Extraordinary write-downs of inventory.

8.         Extraordinary write-downs of A/R

9.         cost of maintaining non-operating properties

l         Operating of Sub
---though in most cases, consolidated reports are made so that such adjustments are unnecessary.

1.         >50% ownership: consolidated income

2.         >20%: consolidated earnings available for dividends

3.         <20%: dividends payment 

---there are many instances in which the statements are incomplete or misleading because either:

1.     they fail to reflect any part of the profits or losses of important subsidiaries

2.     they include as income dividends from sub which are substantially less or greater than the current earnings of controlled sub (stock dividends in sub < 20% or cash dividends in sub < 20%)

l         Reserves

7. Non-recurrent Items: Profits or Losses from sale of fixed assets –Credit to the Surplus

8. Profit fro sale of marketable securities
Banks, Investment Trusts, Insurance Companies:

l         The underwriting business shows a deficit, which is offset by interest and dividend income.

l         The profits and losses shown on security operations, including changes in their market value, exert a predominant influence upon the public’s attitude toward these stocks valuations.

9. Profits through repurchase of senior securities at a discount

l       Non-recurrent

l       Questionable profit: at the expense of the company’s own security holders
it was made possible by the disproportion that existed between the strong cash positions and the poor earnings of many enterprises. Because of the latter influence, the senior securities sold at low prices; and because of the former, the issuing companies were able to buy them back in large amounts.

 

---

Chapter 32 Extraordinary Losses and Other Special Items in the Income Account
-- to what extent should write-downs of inv and A/R be regarded as extraordinary deductions not fairly chargeable against the year’s operating results?

1. Manufactured Earnings

a)         Write-down Inv or A/R of ending P₀: --reduce the COGS of P₁

1.         Write-down surplus (or even capital ) of ending P_{0: --} report these same sums as income of P₁

b)        Write-down PPE has the same results

2. Losses on Inventories
--Except under quite extraordinary general business conditions write-downs of inventories to market value are regarded as properly chargeable against the year’s income and not against surplus

3. Idle-plant Expense
--the cost of carrying non-operating properties is almost always charged against income. – temporary feature

l         For the time being, the company elects to spend money to carry these assets along in the expectation that future value will justify the outlay, it does not seem logical to consider these assets as equivalent to a permanent liability, i.e. as a permanent drag upon the company’s earning power.

4. Deferred Charges
-- Expense applicable to a number of years following such as: organization expenses, moving expenses, development expense, and discount on obligations sold.
-- Deferred charges is written off by annual charges against current income.

n         In order to relieve the reported earnings of these annual deductions it has become common practice to write off such “expense applicable to future years” by a single charge against surplus.

5. Amortization of Bond Discount: no reason to charge against surplus

周末看完了<Security Analysis>Part 4: Theory of common-stock investment. The Dividend Factor,包括27章—30章。这部分相对比较容易，主要是投资理论的历史回顾和股息因素的考量。不过看了以后，还是理清了很多以前对stock dividend是似而非的理解。总体而言，我真的不愿意相信这本书是哥大商学院五六年代的教科书，因为这只能说明商学院的教育水平在不断退步，或者ucla商学院与东岸商学院之间在的差距是中国足球与巴西足球之间的差距？

---

Chapter 29  The dividend factor in common-stock analysis
-- 3 factors entering into the valuation of common stock:

a.       the dividend rate and record

b.       income-account factors (earning power)

c.       balance-sheet factors (asset value)

 

1. Established principle of withholding dividends

1)        it is considered proper managerial policy to withhold current earnings from the stockholders, for the sake of any of the following advantages:

1. To strengthen the financial (working capital) position
2. To increase productive capacity (new PPE)
3. To eliminate an original overcapitalization

2)  Policy of withholding dividends questionable

3)  Plowing back due to watered stock:

Many of our large industrial companies made their initial appearance with no tangible assets behind their common shares and with inadequate protection for their preferred issues. Hence it was natural that the management should seek to make good these deficiencies out of subsequent earnings.

This was particularly true because additional stock could not be sold at its par value, and it was difficult therefore to obtain new capital for expansion except through undistributed profits.

write-down surplus to reduce the goodwill which previously represented by common shares.

write-down overvaluation part of PPE via writing off surplus

4) Conclusions

1. What significance should be accorded the dividend rate as compared with the reported earnings?

a)         If the dividend is disproportionately small, an investment purchase will be justified only on an exceptionally impressive showing of earnings.

b)        On the other hand, an extra-liberal dividend policy cannot compensate for inadequate earnings, since with such a showing the dividend rate must necessarily be undependable.

c)        Dividend ratio/yield = $dividend paid/ mkt price of common
Earnings return = $ EPS/mkt price of common

2. What dividend policies should be considered as more desirable from the standpoint of the stockholders’ interest
3. Suggested Principle for dividend payments

a)         The dividend rate is seen to be important, apart from the earnings, not only because the investor naturally wants cash income from his capital, but also because the earnings which are not paid out in dividends have a tendency to lose part of their effective value for the stockholder.

                                     i.        If company earnings = 10, 3 paid in dividends, 7 retained and added to surplus. Undoubtedly the large addition to surplus will expand the value of the stock, but quite probably also this value will fail to increase at the annual rate of 7% compounded.

b)        Such “earnings” as must be retained to protect the company’s position are not true earinings at all.

                                     i.        They should not be reported as profits at all but should be deducted in the income statement as necessary reserves, with an adequate explanation.

                                   ii.        A compulsory surplus is an imaginary surplus.

1.       Summary
Far more frequently, the stockholders derive much greater benefits from dividend payments than from additions to surplus. This happens because either:

a)         The reinvested profits fail to add proportionately to the earning power

b)        They are not true “profits” at all but reserves which had to be retained merely to protect the business

 

---

Chapter 30 Stock Dividends.

Stock dividends have two forms: extraordinary and periodic 350

--Extraordinary stock dividend: capitalizes part of the accumulated surplus of past years, i.e. it transfers a substantial amount from the accumulated surplus to stated capital and gives the stockholders additional shares to represent the funds thus transferred.

--Periodic: capitalizes part of only the current year’s earnings

 

Extraordinary stock dividends

1. Reason for extraordinary stock dividends

1)        The only reason for such a dividend which is at once sound and practical is that it will adjust the market price of shares to a more convenient level.

2)        Split ups
During the recent bull market, reductions in par value were much more frequent than large stock dividends on stocks with par value because the rise in market price had so far outstripped the accumulated surplus that a distribution of the latter would have been insufficient for the purpose.

3)        Stock splits and stock dividends in no-par stock

u       In the case of common stocks of no-par value, a split-up or a stock dividend leads to exactly the same results, and to all practical purposes they are indistinguishable.

u       While a stock dividend requires the transfer of a certain sum on the books from surplus to capital, the infinite latitude in accounting permitted by no-par stock may make this transfer a purely nominal affair.

4)        Objections to extraordinary stock dividends and split-ups
(mainly capitalizing undistributed earnings at arbitrary times and in arbitrary amounts )

u       Stock dividends NOT　＝　income

u       Maybe forerunner of cash dividends

 

Periodic dividend payment

1. Merits of annual stock dividends

2. Objections to annual stock dividends

a)         Danger of vicious circle developing:

1.         market value (stock dividends) may be higher than stated dividend rate

2.         The higher the market price, the greater the apparent value of the stock dividends, which in turn will seem to justify a still higher market price. (With a 10% stock dividend the dividend return obviously remains at 10% regardless of how high the market price may climb.)

3.         Principle: value of stock dividends < value of earnings

4.         Vicious Pyramiding on stock dividends

a)         An operating company – Sub:
pay out stock dividends with a market value more than its current earnings

b)        A holding company – Parent:
--report these stock dividends as income in an amount equal to the market value
--market value this holding company based on this inflated artificial income figure to arrive at its valuation of this holding company.

c)        Suggested principle:
-- stock dividends at market value must not exceed the earnings available for dividends.

3. Advantages of stock dividends payable in pref. stock

a)         The theoretical advantage of this method is that the amount of dividend paid is clearly fixed at the effective par value of the pref. issued, thus obviating the complication presented by differences between book value and market value.

4. Summary:

a)         Reserves Vs. Surplus Profits:
If retention of profits is in any sense a matter of necessity rather than choice, the stockholders should be advised of this fact, and the amounts involved should be designated as “reserves” instead of as “surplus profits”

b)        Stock dividends < reinvested earnings available
Earnings voluntarily retained in the business should be capitalized in good part by the periodic issuance of additional stock, with current market value not exceeding such reinvested earnings. If the additional capital is subsequently found no longer to be needed in the business, it should be distributed to the shareholders against the retirement of the stock previously issued to represent it.

以前不是很into这个张朝阳,不过觉得他很有潜质成为中国的Donald Trump.不过后来在刚刚上市的企业里面做过一段时间，才明白他后面的那些经历。《另类总裁张朝阳：不断自我删除》是记者雷晓宇写的，一个正在日渐受到瞩目的商业女记者。

Chapter 25  Senior Securities with Warrants. Participating Issues. Switching And Hedging 

1. Sliding Scales of Both Types
As with convertibles, a sliding scale based on the “block” principle detracts greatly from the value of the privilege until the last block, i.e. the highest price, is reached, at which time it becomes an ordinary purchase option.

 

2. Methods of Payment

3. Advantage of option to pay cash

l         The bond or preferred, “ex-warrants” may be worth more than par, thus increasing the profit

l         The holder may be glad to retain his investment whilst realizing a cash profit on its speculative component

l         The warrant is likely to sell separately at a greater premium over its realizable value than a pure convertible.

4. Detachability

l         It is necessary to consider the characteristics of detachable stock-purchase warrants as an independent speculative medium. 

1.       Participating Issues

l         2 kinds of participation:

n         Most usual type: depends on the dividend paid upon the common

n         Less frequent type: determined by the earnings without reference to the dividend rate.

2.       Privileged issues compared with the related common issues

l         It is clear that a convertible issue selling on a parity with the common is preferable thereto, except when its price is so far above an investment level that it has become merely a form of commitement in the common stock.

n         It is generally worthwhile to pay some moderate premium in order to obtain the superior safety of the senior issue. This is certainly true when the convertible yields a higher income return than the common, and it holds good to some extent even if the income yield is lower.

l         Switching:
As a practical rule, holders of common stocks who wish to retain their interest in the company should always exchange into a convertible senior issue of the enterprise, whenever it sells both at an investment level on its account and also close to parity on a conversion basis.

6. Hedging

		Senior Issue		Common
When SI /Comm =Par		Buy	-100@120=12,000	Short	+300@40=12,000
Scenario A	Still rise to @45/comm	Convert	+300@45=13,500	Buy Back	-300@45=13,500
		Net Effect	+1,500		-1,500	0
Scenario B	Decline to @ 30/comm	Sell	+100@100 =10,000	Buy Back	-300@30=9,000
		Net Effect	-2,000		+3000	+1,000

l         An intermediate form of hedging

n         Purchasing a convertible issue & selling only part of the related common, say 50% amount receivable upon conversion. –P678 Note 39, wonderful example!

n         An ideal situation of this kind would meet the following 2 requirements:

u       A strongly entrenched senior issue which can be relied on to maintain a price close to par even if the common should drop precipitately. A good convertible bond, maturing in a short time, is an ideal type for this purpose.

u       A common in which the speculative interest is large and which is subject to wide fluctuations in either direction.

u       A senior issue is able to convert into the junior shares like comm.

 

---

Chapter 26 Senior Securities of questionable safety

1. Limitation of profit on low-priced bonds not a real drawback

2. Two viewpoint with respect to speculative bonds

l         A type: -in relation to investment standard and yield
whether the low price and higher income return will compensate for the concession made in the safety factor

l         B type:-in relation to its sort-of-like common-stock commitment
Does the smaller risk of loss involved in this low-priced bond, as compared with a common stock, compensate for the smaller possibilities of profit?

l         真的，看到上面这2个问题时，我觉得我头上的白头发肯定瞬间多了10根以上。可以肯定的是到目前为止，我并没有真的明白这二者的区别。但是出于达尔文日记的需要，我还是做了笔录。据说达尔文在环球考察的时候，在看到与他认为的应该出现的物种现象不一致的东西的时候，他强迫自己在30分钟以内纪录下来，以避免自己的原有的知识体系随便否定了自己亲眼看到但是不能用现有知识合理解释的东西。

3．Common-stock Approach (type B question )Preferable

l         Type B:

n         it carries with it a more thorough appreciation of the risk involved and therefore a greater insistence upon either reasonable assurance of safety, or upon especially attractive possibilities of profit, or both.

n         The field of sepcualtive values proper would commence somewhere near the 70 level (for bonds with a coupon rate of 5% or larger) and would offer max. possibilities of appreciation of at least 50% of the cost

n         In making such commitments, it is recommended that the same general attitude be taken as in the careful purchase of common.

1.       Important Distinctions b/w Common and Speculative Senior Issues.

a)         Low-priced bonds associated with corporate weakness

                         i.              Low-priced bonds are associated with corporate weakness, retrogression, or depression.

                       ii.              The enterprise must have been following a downward course

b)        Many undervalued in relation to their status and contractual position

                         i.              The unpopularity of speculative senior securities tends to make them sell at lower prices than common, in relation to their intrinsic value. With respect to their intrinsic position, speculative bonds,--and to a lesser degrees, pref stocks---derive important advantages from  their contractual rights.

c)        Contrasting Importance of Contractual Terms in Speculation and Investment

                         i.              From the investment standpoints:
the dependability of the dividend, the absence of an enforceable claims is a disadvantage as compared to bonds

                       ii.              From the speculation standpoints:
the possibility of dividends being continued under unfavorable conditions preferred stocks have certain semi-contractual claims which give them an advantage over common.

2.       Bearing of Working Capital on Safety of Speculative Senior Issues

a)         A large working capital, is much more directly advantageous to the senior securities than to the Common.

                         i.              Continuousness of interest/pref dividends.

                       ii.              Retirement of the principal, either at maturity or by sinking fund operations, or by voluntary repurchase.

1.Sinking fund either in bond or Pref is not found in the case common

b)        Importance of large net-quick-asset coverage: several times coverage whilst earnings deficit

                         i.              Conditions:

1.chance of profit > chance of loss

2.amount of profit > amount of loss

3.Group purchase based on risk diversification since the risk involved in each individual case is still so considerable.

c)        Limitations upon importance of quick-asset position

                         i.              Huge mistake to assume that whenever a bond is fully covered by net quick assets its safety is thereby assured.

                       ii.              The current assets shown in any balance sheet may be greatly reduced by subsequent operating losses.

                      iii.              We must distinguish between the mere fact that the working capital, as reported, covers the funded debt and the more significant fact that it exceeds the bond issue many times over.

3.       Speculative Pref. Stocks.

a)         Stages in their price history: 3 stages
Speculative Pref. stocks are more subject then speculative bonds to manipulative activity, so that from time to time such preferred shares are overvalued in the market in the same way as Comm

b)        The rule of “Maximum valuation for senior issues”
--- A senior issue cannot be worth, intrinsically, any more than a common stock would be worth if it occupied the position of that senior issue.
--this relationship holds true regardless of how high the coupon or dividend rate, the par value, or the redemption price of the senior issue may be, and, particularly, regardless of what amount of unpaid interest or dividend may have accumulated.

                         i.              rule of “Maximum valuation for senior issues”

1.assuming Company X = Company Y

2.Company X has Pref (P) and Common (C); Company Y has common only (Cy)

3.then it would appear that:
Value of P + Value of C = Value of Cy

4.Hence, Value of P < Value of Cy

c)        Excessive emphasis placed on amount of accrued dividends.

Part III                  Senior Securities with Speculative Features

Chapter 22 Senior issues at bargain levels.  Privileged issues.

--two types of bonds & Pref subjects to substantial change in principal value

A. those issues which are speculative because of inadequate safety

B. those issues which are speculative because they possess a conversion or similar privilege which makes possible substantial variations in market price

 

1. An intermediate type

l         If he has mastered the technique of the selection of sound fixed-value investments, he can apply his skill most effectively to the discovery of safe issues selling at low prices.

2. Senior issues with speculative privileges

l         Three types of privileges:

n         Convertible

n         Participating

n         Subscription

l         Their investment record---Under-performance, Reasons:

n          Firstly, only a small fraction of the privileged issues have actually met the rigorous requirements of a sound investment. (The conversion feature has most often been offered to compensate for inadequate security)

u       Before the crash in 1929, the strongly entrenched industrial enterprises raised money through sales of common, while the weaker or weakly capitalized undertakings resorted to privileged senior securities.

n         Secondly, the conditions under which profit may accrue from the conversion privilege is quite limited.

u       There is a very limitation on the amount of profit which the holder may realize whilst still maintaining an investment position.

u       After a privileged issue has advanced with the common, its price soon becomes dependent in both directions upon changes in the stock quotation; and to that extent the continued holding of the senior issue becomes a speculative operation.

l         The unlimited profit possibilities of a privileged issue are in an sense illusory.

n         Practically speaking, the range of profit possibilities for a convertible issue, while still maintaining the advantage of an investment holding, must usually be limited to somewhere between 25-25% of its face value.

l         Principle for selecting privileged senior issues

n         A privileged senior issue, selling approximately at or above face value, must meet the requirements either at a straight fixed-value investment, or of a straight common-stock speculation  and it must be ought with one or the other qualification clearly in view. (Generally speaking, there should be no middle ground. Secondly, privileged issues selling at substantial discounts from par are not in general subject to this principle, since they belong to the 2dn category of speculative senior securities)

u       It may be bought as a sound investment with an incidental chance of profit through an enhancement of principal

u       Or it may be bought primarily as an attractive form of speculation in the common.

 

---

Chapter 23 Technical characteristics of privileged senior securities
--- considerations common to all three types of privileges; conversion, participation (sort of like income bond), and subscription like warrant
--- the relative merits of each type, as compared with the others
--- technical aspects of each type, considered by itself.

 

1. Considerations generally applicable to privileged issues.

l         Profit-sharing feature is depended on 2 major but entirely unrelated factors:

n         Terms of the arrangement

n         The prospects of there being profits to share

l         How to deal with these 2 factors

n         It is undoubtedly true that it is more profitable to select the right company than to select the issue with the most desirable terms.

n         But in analyzing privileged issues of the investment grade, the terms of the privileges must receive the greater attention, not because they are more important, but because they can be more definitely dealt with.

n         Where the speculative approach is followed, i.e. where the issue is bought primarily as a desirable method of acquiring an interest in the stock, it would quite logical to assign dominant weight to the buyer’s judgment as to the future of the company.

l         3 elements in the Terms

n         The extent of the profit-sharing or speculative interest per dollar of investment

u       Speculative interest = # of stock per privilege * current mkt price per common share / 1000

u       In the case of convertible bonds: = current mkt price per common / (a bond selling at part is convertible into stock at 50)

u       Significance of call on large number of shares at low price:
A speculative interest in a large number of shares selling at a low price is technically more attractive than one in a smaller number of shares selling at a high price.

l This is because low-priced shares are apt to fluctuate over a wider range percentagewise than higher priced stocks.

l Hence if a bond is both well secured and convertible into many shares at a low price, it will have an excellent chance for very large profit without being subject to the offsetting risk of greater loss through a speculative dip in the price of the stock.

n         The closeness of the privilege to a realizable profit at the time of purchase

n         The duration of the privilege:

u       Conversion price = price of common (when 1 Pref = 1.67 Comm, 1.67*P = 100*1, P=$60 )

u       Conversion parity or Conversion Level --- 转换平价
mkt price for Pref = $90, conversion parity = 60* 90% = $54
Common (A, 60) ; Pref (90, 90) ------- A=$54

u       Common (Mkt Price, Conversion Price)
Senior Issue (Mkt Price, Conversion Parity)

2. Comparative merits of the three types of privileges.
-- Participating:
unlimited in time and possible amount – is the most desirable type of profit-sharing privilege. This arrangement enables the investor to derive the specific benefit of participation in profits (viz., increased income),  without modifying his original position as a senior-security holder.
-- Conversion & Subscription:
their real advantage consists only of the opportunity to make a profit through the sale of the convertible issue at the right time.

l         Merits and Disadvantages of Participating Feature

n         Merits:

u       The investor is able to participate in the surplus profits of the common stock in good years while maintaining his preferred position, so that when the bad years came, he lost only his temporary profit/

u       Had the issue been convertible instead of participating, the investor could have received his higher dividends only through converting, and would later have found the dividend omitted on his common shares and their value fallen far below his original investment.

n         Disadvantages

u       They may behave less satisfactorily in a major market upswing than do convertible or subscription-warrant issues.

l         Relative Price Behavior of Convert & Warrant-bearing issues.

n         Under favorable market situation, the best results are obtained by holders of senior securities with detachable stock-purchase warrants.

n         Premium (purchase warrant) > Premium (convert)

u       Their speculative components (i.e. the subscription warrant itself) can be entirely separated from their investment component (i.e. the bond or preferred stock ex-warrants).

u       Speculators greatly prefer buying the option warrants to buying a corresponding convertible bond, because the latter requires a much larger cash investment per share of common stock involved.

n         2^nd advantage of warrant-bearing issues: callable provisions in convert & participating features.

u       In the case of issues with stock-purchase warrants, the subscription privilege almost invariably runs its full time even though the senior issue itself may be called prior to maturity.

n         3^rd advantages of warrant-bearing issues:
He may dispose of his warrant at a cash profit and retain his original security, ex-warrants.

 

1.       Summary:

a)         From long-pull holding
a sound participating issue represents the best form of profit-sharing privilege (but need to take call provision under consideration)

b)        From the standpoint of maximum price advance under favorable market conditions:

                         i.              a senior issue with detachable stock-purchase warrants is likely to show the best results.

                       ii.              Furthermore, subscription-warrant issues as a class have definite advantages in that the privilege is ordinarily not subject to curtailment through early redemption of the security

                      iii.              They permit the realization of a speculative profit while retaining the original investment position.

 

---

Chapter 24  Technical aspects of convertible issues

1． Protection against Dilution Not Complete

l         The effect of these provisions is to preserve only the principal or par value of the privileged issue against dilution

l         If a convertible is selling considerably above par , the premium will still be subject to impairment through additional stock issues or a special dividend.

n         When a large premium or market profit is created for a privileged issue, the situation is vulnerable to sudden change. While prompt action will always prevent loss through such changes, their effect is always to terminate the effective life the privilege.

2. Sliding scales designed to accelerate conversions.

l         Sliding scale based on time Intervals.

l         Sliding scale based on extent privilege is exercised

n         The sliding-scale privilege on a “block” basis belongs to the objectionable category of devices which tend to mislead the holder of securities as to the real nature and value of what he owns.

n         The competitive pressure to take advantage of a limited opportunity introduces an element of compulsion into the exercise of the conversion right which is directly opposed to that freedom of choice for a reasonable time which is the essential merit of such a privilege.

3. Issues Convertible into Preferred Stock

l         There are bond issues convertible into either preferred or common, or into a combination of certain amounts of cash. While any individual issue of this sort may turn out well, in general it may be said that complicated provisions of this sort should be avoided (both by issuing company or by security buyers) because they tend to create confusion.

4. Bonds Convertible at the Option of the Company

l         “convertible at the option of the company” is nothing more than a pref stock masquerading as a bond.

Chapter 19   Protective Covenants

1. Prohibition of Prior liens.

2. Equal-and ratable security clause: p219

3. Working capital requirements:

4. Protective provisions for investment-trust issues

l         Such bonds are essentially similar to the collateral loans made by banks on marketable securities.

l         A very effective measure of protection may be assured by means of the covenant to maintain the market value of the portfolio above the bonded debt.

l         Most of them do require a certain margin of asset value over debt as a condition to the sale of additional bonds.

5. Sinking Funds

l         In its modern form a sinking fund provides for the periodic retirement of a certain portion of a senior issue through payments made by the corporation. In the case of many bond issues, the bonds acquired by the sinking fund are not actually retired but are “kept alive”, i.e., they draw interest and these interest sums are also used for sinking-fund purchases, thus increasing the latter at a compounded rate.

l         Two-fold benefits

n         Continuous reduction in the size of the issue makes for increasing safety and the easier repayment of the balance at maturity

n         Repeated appearance of a substantial buying demand

l         Indispensable in some cases in which the chief backing of the issue consists of a wasting asset.

n         Bonds on mining properties invariably have a sinking fund

n         Real-estate mortgage bonds also have sinking fund

n         Bonds secured by the lease of the properties

u       The theory is that the annual depletion or depreciation allowances should be applied to the reduction of the funded debt.

1.       Serial Maturities as an alternative

2.       Conclusions:
While the protective covenants we have been discussing do not GUARANTEE the safety of the issue, they nevertheless ADD to the safety, and are therefore worth insisting upon.

 

---

Chapter 20 Pref stock protective provisions. Maintenance of junior capital

1. Protection against creation of unsecured debt desirable

2. Pref. stock sinking fund

3. Maintenance of adequate junior capital

l         Principle: such junior capital in an indispensable condition for any sound fixed-value investment. It is very dangerous that the corporation law permits the withdrawal of substantially all the capital and surplus after the loan has been made.

l         Danger in the right to reduce stated capital:

n         Operating loss ---- Reduce stated capital of $100 --- Write-down assets $60 + Transfer from capital to Surplus $40.

n         To deal satisfactorily fro the Pref. stockholders’ standpoint with conditions resulting in a profit-and-loss deficit is a difficult matter.

 

---

Chapter 21. Supervision of investment holdings. 

Chapter 16  Income Bonds and Guaranteed Securities

Income Bonds (adjustment bond)

1. Interest payments sometimes wholly discretionary

2. Low investment rating of income bonds as a class:

l         Almost all income bonds have connections with corporate restructuring

l         The very fact that the interest payments are dependent on earnings implies that likelihood that the earnings may be insufficient. Pref. dividends are equally dependent on earnings, but the same implication is not associated with them.

l         Income-tax saving advantages of income bond vs. Pref.

3. Calculations of Margins of safety for Income Bonds

l         Technique is identical with that for a Pref.

l         Interest coverage:

 

Guaranteed Issues

1. Status of guaranteed issues

2. Exact terms of guarantee are important

l         A guaranty of interest only is likely to be much less significant than a guaranty of principal.

3. Joint and several guarantees

l         Such guarantees are given by more than on e company to cover the same issue, and each company accepts responsibility not only for its pro rata share but also for the share of any other guarantor who may default. In other words, each guarantor concern is potentially liable for the entire amount of the issue.

l         It would seem good policy for investors to favor the bonds of this types, which carry the guaranty of a number of substantial enterprise, in preference to the obligations of a single company. 

 

---

Chapter 17 Guaranteed securities – guaranteed real-estate mortgages and mortgage bonds

1. 2 types of guarantees:

l         Given by the corporation engaged in the sale of the mortgages or mortgage participations (or by an affiliate) – Countrywide, Wells Fargo, Fannie

l         Given by an independent surety company, which assumes the contingent liability in return for a fee— MBIA

2. Successful factors for REITs

l         The mortgage loans are conservatively made in the first instance

l         The guaranty or surety company is large, well managed, independent of the agency selling the mortgages, and has a diversification of business in fields other than real estate

l         Econ conditions are not undergoing fluctuations of abnormal intensity.

3. Leasehold obligations equivalent to guarantees

l         Guaranteed Issues frequently undervalued

n         The strength of a guaranteed bond may be very much greater than that of the corporation issuing it, because that strength rests upon the dual claim of the holder against both the issuing corporation and the guarantor.

l         Inclusion of guarantees and rentals in the calculation of fixed charges

n         Lease liabilities generally overlooked

4. Subsidiary company bonds

l         Common method: Consolidated Income account
all the sub bond interest appears as a charge against all the combined earnings, ranking ahead of the parent company’s Pref and common stocks.

l         However, if the parent concern is not contractually responsible for the sub’s bonds, by guaranty or lease, this form of statement may prove to be misleading.

l         Separate analysis of subsidiary interest coverall essential
Just as investors are prone to under-estimate the value of a guaranty by a strong company, they sometimes make the opposite mistake and attach undue significance to the fact the a company is controlled by another.

l         Conclusions

n         Investors in bonds of a holding company:
insist upon a consolidated income account, in which the sub interest- whether guaranteed or not – is shown as a prior charge

n         Investors of unguaranteed sub bonds:
cannot accept such consolidated reports as a measure of their safety;
must require a statement covering the subsidiary alone.

 

---

Chapter 18   Protective Covenants and remedies of senior security holders

Chapter 13 Other Special Factors in Bond Analysis

1. “Parent Company Only” vs. Consolidated Return

l         Investors should pay NO attention to the “Parent Company Only” figures, and insist on a completely consolidated income account because:

n         “Parent Company Only” does not show the subsidiaries’ interest and preferred dividend payments to the public.

n         The interest coverage shown by the income account of the “parent company only” is an example of the prior deductions method.

2. Dividends on Preferred Stocks of subsidiaries.

	Holding company	Subsidiary
Pay-out	Sub’s pref dividends Holding company’s bond interest	Sub’s bond interest Dividends on its common
Receive	Dividend on sub’s common stock	Dividends on Holding company’s Pref.

The fixed charges for holding company system, in order:

l         Sub’s bond interest

l         Sub’s pref. dividends: Ben thinks it is prudent and necessary to include important sub’s pref dividends & sub’s bond interests as the fixed charges to the holding company as shown in the example in Pg158

l         Parent company’s bond interest

3. Fixed charges should include any annual rentals paid for leased property which are equivalent to bond interest or guaranteed dividends.

4. Minority Interest in Common Stock of Sub:

l         Unlike most professional, Ben prefers to subtract the minority interest BEFORE calculating the interest coverage.

5. “Capitalization of Fixed Charges” for railroads and utilities.

l         Representations of Debt

n         Bond issues

n         Guaranteed stock

n         Annual rental obligations

n         Nonguaranteed Pref. Stock of operating sub.

l         Capitalization of Fixed Charges – good approximation of the principal amount of all these obligations (we call this “effective debt” vs. the bond titles appearing in the book)

n         Railroad: 5% vs. 20 * annual fixed charges

n         Utility: 5.5% vs. 18 * annual fixed charges

n         “Net Deductions” or “Fixed Charges”, whichever is larger

n         Ratio: Stock/Effective Debt

1.       The working-capital factor in the analysis of industrial bonds

l         The current-asset position rather than the carrying fixed assets has an important bearing upon the financial strength of nearly all industrial enterprises.

l         Three requisites with respect to working capital

n         That the cash holdings are ample

n         That the ratio of quick assets to current liabilities is a strong one

n         That the working capital bears a suitable proportion to the funded debt.

l         Suggested standard

n         WC = bonded debt

 

---

Chapter 14  The theory of preferred stock

-- This form of straight investment is fundamentally unsound.

1. Essential difference b/w Pref. And bond:

The contractual obligation of interest payments vs. dividend payments contingent on director’s discretion.

 

1.       Risk Vs. Price:

l         It is not sound procedure to purchase a preferred stock at an investment price (e.g. close to par) when the presence of a substantial irks to principal is recognized, but when this risk expected to be offset by an attractive dividend return  

l         It would follow from this principle that the only preferred stock which can properly be bought for investment would be one which in the purchaser’s opinion carries no appreciable risk of dividend suspension.

2.       Qualifications of high-grade Pref.

l         Meet all the minim. Requirements of a safe bond

l         It must exceed these minim. Requirements by a certain added margin to offset the discretionary feature in the payment of dividends

l         The stipulation of inherent stability in the businesses itself must be more stringent than in the case of a bond investment.

3.       Sound Pref. issues exceptional

l         In order that a pref. stock may be thoroughly sound, the burden it imposes must be so light that the company may just as readily carry that burden in the form of a bond obligation.

l         The Pref. stock Form lacks basic justification, from an investment standpoint, in that it does not offer mutual advantages to both the issuer and the owner.

4.       High-grade Pref. usually seasoned issues.

l         High-grade industrial pref. issues have almost always reached this position as the result of many years of prosperous growth by the enterprises after the pref. was first created.

l         Public-utility company: prefer to carry a portion of their senior financing in the form of pref. due to the law’s requirement.

l         Conclusion: the practical rule that the purchase of new industrial preferred stock offerings on an investment basis is almost pref. offering on an investment basis is almost invariably a mistake of judgment, for it is a rare phenomenon to find such an offering thoroughly well secured.

5.       Origin of the Popularity of Pref. stocks

l         The pref. holder had a satisfactory investment only while the common stock was proving a profitable speculation. --- the case of “Heads, the common stockholder wins; tails, the pref. holder loses”

l         One of the basic principles of investment is that the safety of a security with limited return must never rest primarily upon the future expansion of profits.

 

---

Chapter 15 Technique of selection of pref. for investments.

1. More stringent requirements required

l         The increase to the minimum earnings coverage; P 175

l         No need to make corresponding increase in the size of enterprise and the stock-value ratio, because of the secondary importance of these tests are compared with the earnings coverage.

2. Mere presence of funded debt does not disqualify pref for investment

3. Total-deduction basis of calculation recommended

l         Bond interests + Pref dividends = fixed charges

l         The real point is that where a company has both bonds and pref. stock, the pref. stock can be safe enough only if the bonds are much safer than necessary.

4. Noncumulative issues

Chapter 10 The relation to the value of the property to the funded debt

1. Special types of obligations:

l         Equipment obligations: the value of alternatives to realize the pledged value

n         The holder of equipment-trust certificates has two separate sources of protection, the one being the credit and success of the borrowing railway, the other being the value of the pledged rolling stock.

n         The protection accorded the equipment-trust holder has been diminished

u       Reproduction cost < original cost

u       Reduced demand for equipment

l         Collateral-trust bonds

l         Real-estate bonds:

n         The values behind real-estate mortgages are going-concern values. i.e., they are derived fundamentally from the earning power of the property, either actual or presumptive. In other words, the value of the pledged asset is not something distinct from the success of the enterprises (as is possibly the case with a railroad equipment trust certificate), but is rather identical therewith.

u       Abnormal rentals used as basis of valuations: 50% in excess of its actual cost. In other words, when the average profit margin for real estate developers >30%, it brings to oversupply issue.

u       Debt based on excessive construction costs:

l Original construction cost: 10,000

l Appraisal property value: 15,000

l 2/3 appraisal value as the collateral to the loan under the name of construction cost: 10,000

u       Weakness of specialized building

l Hotel, hospital, club, factory which loses the quality of rapid disposability

l Its value becomes bound up with the success of the particular enterprise for whose use it was originally intended.

 

2. Suggested rules for real-estate mortgage bonds

l         In the case of single-family dwellings.

n         The amount of the loan < 2/3 of the value of the property

u       Either by actual recent cost

u       Or fair value which an experienced buyer is willing to pay

n         This cost or fair price does not reflect recent speculative inflation and does not exceed the price levels existing for a long period previously.

l         In the case of bonds for apartment house and office building

n         Ignore the appraisal value circulated

n         The actual cost, fairly presented, should exceed the amount of the bound issue by least 50%

n         Estimated income account

u       Reflect losses through vacancies

u       Decline in the rental scale as the building grows older

u       Forecast a margin of at least 100% over interest charges, after deducting for earnings a depreciation allowance to be actually expended as a sinking fund for the gradual retirement of the bond issue.  

l         Real-estate loans should not be made on buildings erected for a special or limited purpose, such as hotels, garages, shopping mall.

 

---

Chapter 11 the relation of stock capitalization to the funded debt

---single criterion of the margin of earnings over interest charges would seem to be a dangerous over-simplication of the problem.

1. Under New York Law

l         All mortgaged debt < 60% value of the mortgaged value

l         BV of equity > 2/3 of the mortgaged debts

 

2. Ben’s recommendations for Industrial bonds selections

l         Interest charges

l         MV of equity / funded debts: Tables in p137

l         To apply stock-to-debt ratio to Utility and Railroads: capitalizing the fixed charges!!!!!! Vs. what customary accounting book presents.

 

3. Summary of minimum quantitative requirements suggested for fixed value investment: p142

 

---

Chapter 12  Special factors in the analysis of railroad and public-utility bonds.  

1. Recommend procedure for railroad bonds

l         Study two factors:

n         The coverage of fixed charges (with due attention to the trend of earnings and the adequacy of maintenance expenditures)

n         The amount of the stock equity

l         Methods of computing fixed-charge overage

n         Test A: X times “fixed charges”

u       Fixed charges = gross income – net income
Times fixed charges = Gross income / (Gross Income – Net Income)
(Net income= balance available for dividends)
(Gross income= Net after rents+ Other income= EBIT – Taxes + Other Income)

n         Test B: X times “Net Deductions” are earned

u       Net deductions  = Operating Income – Net Income
Coverage = Operating Income / (Operating Income – Net Income)

n         I feel like that Net Deductions method is more stringent criterion.  

2. Other factors for railroad bonds

l         Maintenance ratio: should be in the normal range

l         Nonrecurring dividends receipt:
The effect of receiving special dividends payment from subsidiaries is to overstate the actual earning power of the parent company for the year in which the subsidiary’s special dividend was received.

3. Excessive Maintenance and Undistributed earnings of subsidiaries.

l         Matters of this kind of considerable interest in the analysis of stock values, but the bond buyer’s concern with such factors is of secondary character.

l         In general he should not permit them to reverse an otherwise unfavorable verdict as to the safety of the bond, but he should recognize that their presence gives added attractiveness to bond issues which show adequate security without taking them into account.

Public – Utility bond analysis

1. Abuse of the term “Public Utility”:

l         The most important idea associated with a public utility is that of stability, based:

n         Firstly upon the rendering of an exclusive and indispensable service to a large number of customers

n         And secondly, upon the legal right to charge a rate of compensation sufficient to yield a fair return on the invested capital.

n         Bear in mind that this stability is relative rather than absolute, since it is not immune fro basic changes or unexpected vicissitudes.

2. Use of the prior-deduction method

3. Omission of Depreciation charges in calculating coverage.

4. Recommended procedure for public utility bonds.

Chapter 7. Selection of fixed-value investment : Principle 2 & Principle 3

Principle 2: Test of depression period
-- to identify where is the source of safety? The character of the industry or the sufficient margin of safety?

1. Various causes for bond collapse.

A.        Excessive funded debt of utilities

l         Normally capitalized company withstands a relatively moderate setback

l         However, many holding companies with pyramided capital structures which had absorbed nearly every dollar of peak-year earnings for fixed charges and so had scarcely any margin available to met a shrinkage in profits.

B.        Stability of railroad earnings overrated.

C.        Perennial instability of industrial earnings

l         There is an inherent lack of stability in the small or medium-sized industrial enterprise, which makes them ill-suited to bond financing.

l         Bonds of smaller industrial companies are not well qualified for considerations as fixed-value investments. (--- dominant size & sufficient margin of safety for industrial bond)

D.       Red Flag: issue stock to retire debt

l         1929: low cost equity/high stock price --- issue stock to retire debt --- bank eliminated most of the good commercial borrowers and replaced them by second –grade business risks and by loans on stock collateral.

 

Principle 3: Unsound to sacrifice safety to yield

1. No mathematical relationship b/w Risk and Yield:

l         Bond prices and yields are NOT determined by any exact mathematical calculation of the expected risk, but they depend rather upon the popularity of the issue.

l         Partly because investment losses are not distributed fairly evenly in point of time, but tend to be concentrated at intervals, i.e. during periods of general depression.

2. Self-insurance not possible in investment

l         Pay premium for extra risk = the opposite of self insurance. Additional $50 from higher yields = extra risk involved. However, you cannot afford to take even a small chance of losing 100% principal in return for an extra $50 of income.

l         Such procedure would be the direct opposite of the standard procedure of paying small annual sums to protect property values against loss by fire.

3. Risk and Yield are incommensurable

l         Acknowledging that risks of losing principal should not be offset merely be a high coupon rate, but can be accepted only in return for a corresponding opportunity for enhancement of principal, e.g. though

n         The purchase of bonds at a substantial discount from par

n         Possibly obtaining an unusually attractive conversion privilege (exactly like WB investment in ChinaPetro’s pref.)

n         Psychological difference: fully mental prepared for low-priced bond buyers vs. those purchase high-yield bond at par.

 

---

Chapter 8 Specific Safety Standards for Bond

--- Principle 4: definite safety standard must be applied

1. New York statute as the starting checking points

       1. The nature and location of the business of government

       2. the size of the enterprise or the issue

       3. the terms of the issue

       4. the record of solvency and dividend payments

       5. the relation of earnings to interest requirements

       6. the relation of the value to the property to the funded debt

       7. the relation of stock capitalization to the funded debt.

2． Size

l         It is conceivable that a general stabilization of industrial conditions in the United States may invalidate the conditions derived from the recent period of extreme variations. But until such a tendency in the direction of stability has actually demonstrated itself we should favor a highly exacting attitude toward the purchase of industrial bonds at investment levels.

l         Large size alone no guarantee of safety:
the biggest company may be the weakest if its bonded debt is disproportionately large.

l         Against predominant importance is attached to bond’s marketability associated with large size issues.

 

---

Chapter 9 The terms of the bond issue.
--- to discuss the features as the security of the bonds, the conditions affecting interest payments, the maturity. Conversion and similar privileges, do not enter into the determination of standards for the selection of fixed-value investment.

--- Under law:

l         Mortgaged debt for public utilities

l         Debenture(Unsecured) debt meeting stiffer requirements than those for mortgage debts

l         Income bonds (those on which the obligation to pay interest is dependent upon earnings) on the same basis as debentures.  

1. Ben’s objection to NY’s statue.

l         Income bond’s interest payment is under director’s discretion. Income bonds are allied more closely to preferred stocks than to ordinary fixed obligations.

 

2. Standards of safety should not be relaxed because of early maturity.

l         A near maturity means a problem of refinancing for the company as well as a privilege of prepayment for the investor.

l         The company must either have the cash available (which happens relatively seldom) or else an earning power and financial position which will permit it to raise new funds.  

l         Corporations frequently sell short-term issues because their credit is too poor at the time to permit of a long-term flotation at a reasonable rate.

 

3. Record of interest payment and dividend payments

l         The evidence given by the balance sheet and income account must be regarded as a more dependable clue to the soundness of an enterprise than is the record of dividend payments. It seems best to dispense with all hard and fast rules on the latter point in determining the suitability of bond issues for straight investment.

l         The failure of a company to pay dividends when the earnings appear satisfactory should properly cause an intending bond buyer to scrutinize the situation with more than usual care, in order to discover whether the policy of the directors is due to weak elements in the picture not yet reflected in the income account.

l         The bonds of dividend-paying companies possess a certain mechanical advantage in that their owners may receive a definite and perhaps timely warning of impending trouble by the later passing of the dividend.

 

4. The relation of earnings to interest requirements

l         3-phrases of interest coverage computation

n         Method of computation:

u       Prior-deductions method is objected.

u       Total-deductions method applied: the number of times that all interests are all covered. This would mea that the same earnings ratio should be used in analyzing all the bonds of any company, wither they are senior or junior lines.

n         The amount of coverage required: The period required for the test

Chapter 4 Distinctions between investment and speculation

---So you really believe that “an investment is a successful speculation and a speculation is an unsuccessful investment” ?

1.       Standards of safety
the concept of safety can be really useful only if it is based on something more tangible than the psychology of the purchaser. The safety must be assured, or at least strongly indicated, by the application of definite and well-established standards.

2.       Definitions of investment:
an investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculations.

a)         Investment operations rather than investment issue/issues:

                         i.              The price is frequently an essential element, so that a stock may have investment merit at one price level but not at another

                       ii.              An investment might be justified in a group of issues, which would be sufficiently safe if made in any one of them singly. ---Diversification is an important element in investment operations.

                      iii.              Certain types of arbitrage and hedging: element of safety is provided by the combination of purchase and sale.

                     iv.              (In summary, standard of safety may be satisfied by means of bargain purchase, diversification & rebalancing and arbitrage & hedging.)

3.       Three elements in investment operations: thorough analysis, test of safety, satisfactory return.

a)         Thorough analysis: study the facts in the light of established standards of safety and value.

b)        Safety: means protection against loss under all normal or reasonably likely conditions or variation.

c)        Satisfactory return: the investor willing to accept, provided he acts with reasonable intelligence.

 

---

Chapter 5 Classification of securities.

1.       Pref. belong with bonds

2.       Safety of bonds:
safety depends on and is measured entirely by the ability of the debtor corporation to meet its obligations.

3.       Classifications

a)         Group I: Investment bonds and pref.

                         i.              All straight bond and pref. of high quality selling at a normal price

                       ii.              High grade privileged issues, where the conversion level is too remote to enter as a factor in the purchase (similarly for participating or warrant-bearing senior issues)

                      iii.              common stocks which through guaranty or preferred status occupy the position of high grade senior issue.

                     iv.              Class A or prior-common stocks occupying the status of a high-grade, straight pref.

b)        Group II: Speculative bonds and pref.

                         i.              Conv.

                       ii.              Low-grade senior issues

c)        Group III: Common

4.       Classifications by characters

a)         Its basis is not the title of the issue, but the practical significance of its specific terms and status to the owner

b)        Nor is the primary emphasis placed upon what the owner is legally entitled to demand, but upon what he is likely to get under conditions which appear to be probable at the time of purchase.

 

---

Part II  Fixed-value Investment

Chapter 6 The selection of fixed-value investment  

1.       Bond form inherently unattractive:
Neither priority nor promise is itself an assurance of payment. This assurance rests in the ability of the enterprises to fulfill its promise and must be looked for in its financial position, record and prospects.

2.       General Approach ---Major emphasis on avoidance loss:

l         Bond selection is primarily a negative art. It is a process of exclusion and rejection, rather than of search and acceptance. Because an investor may reject any number of good bonds with virtually no penalty at all. (Remember: here we are referring to Group I: investment-grade fixed value type! Hence this general approach apparently does not apply to any speculative bond in which it is so easy for your to find out the reason to decline. The prospective buyer of a given common is influenced more or less equally be the desire to avoid loss and the desire to make a profit. Remember WB said: Rule No.1—Do not lose money, Rule No.2 – Do not forget Rule No.1 Firstly you need to learn how to intelligently exclude and reject, which leaving sufficient room for the margin of safety, then there is possibility you may wisely accept one specific common stock.)

3.       Four principles of fixed-value type selection

a)         Principle 1: Safety is measured not by specific lien or other contractual rights, but by the ability of the issuer to meet all of its obligations

b)        Principle 2: This ability should be measured under conditions depression rather than prosperity

c)        Principle 3: Deficient safety cannot be compensated for by an abnormally high coupon rate

d)        Principle 4: The selection of all bonds for investment should be subject to rules of exclusion and to specific quantitative tests corresponding to those prescribed by statute to govern investments of savings banks.

4.       Safety not measured by lien but by ability to pay: Claim against lien Vs. Claim against business

a)         The failure of claim against mortgaged property due to:

                         i.              The shrinkage of property values when the business fails

                       ii.              The difficulty of asserting the bondholder’s supposed legal rights

                      iii.              The delays and other disadvantages incident to a receivership

 

5.       Principle 1: Safety Measure

a)         Absence of lien is of minor consequence.

                         i.              The debenture unsecured, obligations of a strong corporation, amply capable of meeting its interest charges, may qualify for acceptance almost as readily as a bond secured by mortgages.

                       ii.              The debenture of a strong enterprise are sounder investment than the mortgage issues of a weak company. (first time to know that the term “debenture” in American financial practice has the accepted meaning of “unsecured bond or note”. )

b)        The theory of buying the highest yielding obligation of a sound company

                         i.              If a company’s junior bonds are not safe, its first-mortgage bonds are not a desirable fixed value investment. For if the second mortgage is unsafe the company itself is weak, and generally speaking there can be no high-grade obligations of a weak enterprise.

                       ii.              Procedure of bond investment:

l First to select a company meeting every test of strength and soundness

l Then to purchase its highest yielding obligation which would usually mean its junior rather its first-lien bonds.

n         This rule applies to all cases where a first-mortgage bond sells at a fixed-value price (e.g. close to par) and junior issues of the same company can be bought to yield a much higher return.

l Senior liens are to be favored, unless junior obligations offer a substantial advantage.

                      iii.              Summary
a junior lien of Company X may be selected in preference to a first-mortgage bond of Company Y, on one of two bases:

1.the protection for the total debt of Company X is adequate and the yield of the junior lien is substantially higher than that of the Company Y issue; or

2.If there is no substantial advantage in yield, then the indicated protection for the total debt of Company X must be considerably better than that of Company Y.

 

没有电视的一个好处就是不用凑热闹，只是在网上看看奥运的精彩镜头。窃以为如果奥运精神能扎根我的身上，让我天天能坚持锻炼，就不枉自己为3000亿的奥运开幕式贡献的税金。最酷的看奥运的人是这个唐老鸭，他也是一个只说不练的家伙，不过我看他这个说的水平也可以参加奥运会了，没有几个国家电视台的解说员能赶上他。还有就是开幕式那个道具是叫手卷，但是cctv的解说是卷轴，不知道哪个正确。

---

这是第2.5遍读Benjamin Graham的1934年版的《Security Analysis》. 好久以前第一次看，看了不到一半就读不下去了，一则由于里面的英文对于我这个半吊子来说太难，二则就是看懂了英文也没有明白它在讲什么，有点像读Havard Business Review. 当时的看法是此书一点不像MBA丛书，直接告诉你什么ratio analysis, financial statement analysis, portfolio management。全部讲的是公司债券的分析，看不出对于股票分析有用的地方。

后来，很偶然的机会，读了Benjamin Graham自己写的自传类文字《Benjamin Graham: The Memoirs of the Dean of Wall Street》本来原名是《那些我能记得的事》。一本非常诚恳的回忆录，里面提到了他在ucla anderson business school里面担任了15年的董事，这个我是第一次知道。让我有点不好意思，觉得如果不把这本《Security Analysis》读完，就好像以前读书时没有完成作业就坐在教室里听教授上课一样难受。于是又翻开了这本700页的书。还好，这次读完了，除了发现老本的英文之美，也有一点点明白书里面所讲的逻辑。34年版的也有中文版，我买来作为对照来看，结果看了英文再来读中文，觉得本书的中文翻译的直接错误不多，经管没有能翻译出英文书写的那种逻辑思路，最害人的可能在于排版校对，把原书当中引用的exhibit当中的数字和名称张冠李戴，或者干脆一些exhibit就全部漏掉。所以看中文版，估计想撞墙的人不少。

前不久，和别人争论book value的定义，又折回到这本书的一些章节。明白自己其实不过理解了全书的5%不到，于是狠狠心重新再读，附带作笔记。虽然读第一遍的时候也take notes,不过都是cut and paste, 没有自己的理解。希望在第二遍的笔记中有点进步，括号里面蓝色字是自己很傻很天真的想法。这本书，既是一本英文教材，也是一本讲逻辑的书，真的适合理科生或者工科生来读。像我这样一个文科生背景的MBA来说，也许说看过老本的书，就像披了一张忽悠别人的老虎皮，重要的是这张皮，不是老虎的筋骨。

---