Security Analysis 6th Edition

Preface

Chapter Summary

A brief, clear, concise definition of what value investing is and what it is not. By debunking modern day theories of so
called "investment" best practices and theories Seth Klarman accurately defines what constitutes a class of investment
bargains.

By outlining various simple value analysis techniques and ways to identify undervalued businesses the commentator
adequately separates true investing from speculation.

Details

The classic text of the original un-edited 1934 edition of Security Analysis is re-iterated and brought up to date and made
applicable to today's financial markets.

The chapter starts with a simple definition of value investing: "Value Investing is the practice of purchasing securities or
assets for less than they are worth- the proverbial dollar for 50 cents."

Various points went on to be made throughout the chapter of what constitutes both value investing and speculation which
you can see below:

Speculation

- Often people approach the stock market with a focus on making money quickly. This is defined as someone looking to
profit from short term trading (days to weeks time horizon)

- Paying little or no attention to downside risk, especially in bull markets.

- Many investors make the mistake of thinking about performance of asset classes as if they are permanent. (Returns are not
inherent to any asset class; they result from the fundamentals of the underlying businesses and the price paid by investors
for the related securities)

- Alternative investments such as venture capital and leveraged buyouts are pure speculation. (Due to the fact that no margin
of safety is present and the potential upside very seldomly justifies the inherent risk and downside)
Investing

- Entails performing in-depth fundamental analysis, pursuing long term investment results (months to years time horizon)
limiting risk and resisting crowd psychology.

- Investors regard securities not as speculative instruments but as fractional ownership in, or debt claims on, the underlying
businesses.

- Investors can be defined as patient, disciplined, risk averse individuals.

Concepts/Ideas/Useful Examples

Concept

While there is no such thing as a particular asset class that performs well indefinitely, there are however particular
investment vehicles that due to a lack of a clear way to analyze the underlying investments to determine whether the
potential return justifies the risk are deemed as purely speculative.

Investments falling under this class of purely speculative vehicles are:

- Venture Capital Funds

- Leveraged Buyout Funds
- Private Equity Funds

Secondarily, some common investment vehicles such as particular mutual funds and index funds can also be considered
purely speculative due to their investment mandate to only apportion capital to certain industries, classes of companies or
market indexes regardless of investment merit or any fundamental analysis.

Concept II

The second prominent concept brought forth in this chapter, was the fact that value investing as a practice is global in nature
and applicable to many different investment vehicles outside the realm of publicly traded equities, preferred's and bonds.

The various ways of ascertaining the fundamental value of an investment can be applied to the following:

- Options (Typically put and call options are analyzed via the Black Scholes model, but they can be looked at using value
investing precepts such as upside potential - downside risk and the likelihood that various possible scenarios will occur)

- Derivatives

- Direct real estate investments (Can be analyzed using value investing precepts such as fundamental value and price paid
for the asset)
Practical Application

The practical application of the concepts and ideas previously shown can simplify everyone's investment decisions and
almost without exception can increase one's return on investment over the long term.

Below is a brief summary of how one may apply this chapter's lessons.

1. Invest (time horizon months/years) & do not speculate (time horizon days/weeks)

2. Analyze investment opportunities using value investing precepts such as fundamental analysis (financial analysis) price
paid for asset, business analysis (wide moat, abundant growth possibilities, free cash flow)

3. Do not invest in speculative investment vehicles, such as venture capital funds, LBO funds, most mutual funds, market
indexes, private equity funds.

4. Do not succumb to herd/crowd psychology by speculating in "hot" industries or stocks. This is easy to do if you learn to
begin placing more emphasis on existing facts and figures rather than future "estimates" and expectations.

3 Quotes

-"In heady times, few are sufficiently disciplined to maintain strict standards of valuation and risk aversion, especially when
most of those abandoning such standards are quickly getting rich. After all it is easy to confuse genius with a bull market."

- "Those who view the market as a weighing machine - a precise and efficient assessor of value - are part of the emotionally
driven herd. Those who regard the market as a voting machine - a sentiment driven popularity contest - will be well
positioned to take proper advantage of the extremes of market sentiment."

- "It is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately with people or it doesn't take
at all. It's like an inoculation. If it doesn't grab a person right away, i find you can talk to him for years and show him
records, and it doesn't make any difference.

3 Questions

1. What is value investing?

2. How does one go about determining what constitutes a good value investment and what does not?

3. As determined by the value investment criteria established in this chapter what are some good investments that you have
made? Why are they good? What are some bad investments that you have made? Why are they bad?