Security Analysis: Chapter 21

This chapter serves as the final chapter of Part II, and leads into the next section of the book which deals with investing in senior issues at bargain levels. The authors make some final notes about fixed-income investing, discussing: whether the time and effort is worth the nominal income gains, some switching strategies, notes about investor psychology, and sources of investment counsel.

The authors believe the concept of investing without worry for long periods of time does not exist. All issues should be reviewed periodically (for the criteria described in earlier chapters). Graham and Dodd recognize that the investor's required effort is substantial not only in finding fixed-income investments as per their advice, but also in reviewing them. As such, an argument may be made that the benefit of a small increment in income (say 5% instead of 3.5% earned in a savings account) along with the added risk of principal loss is just not worth the hassle. However, the authors recognize the psychology of investors. They will go for that extra return, and therefore this section has served as their guide.

When an issue no longer meets the requirements set out in earlier chapters, an investor should switch into a security that does, and the investor should be prepared to take small losses in doing so. If the investor does not possess the psychological ability to fathom such a loss, he should buy securities with even larger margins of safety. In such a case, should earnings coverage drop, the investor will have confidence in the income stream despite a small drop in the value of the security. Should earnings coverage evaporate and the instrinsic value of the bond suffer a dramatic decline, perhaps the investor would be willing to exchange into securities trading at bargain prices, the subject of the next section!

The authors list numerous sources of advice for the investor: his commercial bank, an investment bank, a stock exchange firm, an advisory firm, and independent counsel. A commercial banker, however, can hardly be expected to put in the time and effort to be able to be of worthwhile assistance. An investment bank will be happy to provide this service, but since this firm has incentives to sell its inventory, its information comes not without bias. While a stock exchange firm also receives commissions from sales, the authors believe its incentives lie not so much in profits from investors, but in maintaining sound reputation. Advisory firms and counsel provide the most impartiality, but their drawback is that their services require pecuniary recompense.

Time to learn how to invest in debt for the purpose of capital appreciation, starting in Chapter 22!