In the foreword of Security Analysis Warren Buffett says that it’s one of the books that have changed his life. It’s packed with high level investing information that is as relevant today as ever. Preston and Stig couldn’t agree more. Actually they found the book so interesting that they decided to write their own 220 page summary of the book, and make it accessible for the investing community. Below is an example from the first chapter of Preston and Stig’s summary guide.

  • In this episode, you’ll learn:
    • Why Security Analysis is one of Warren Buffett’s three favorite books
    • Real case studies where Warren Buffett has directly applied skills acquired from Security Analysis
    • The highlights for each of the 7 major parts in Security Analysis
    • The difference in opinion between Benjamin Graham and Warren Buffett when it comes to dividends

Tweet your comments about this episode directly to Preston, Stig, and the rest of The Investor’s Podcast Community using #TIPMoney.

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PODCAST TRANSCRIPT SUMMARY

Preston: [00:00:00] We study billionaires and this is Episode 62 of The Investor’s Podcast. We’re broadcasting from Bel Air, Maryland.
This is The Investor’s Podcast. We read the books and summarize the lessons. We test the waters and tell you the best actionable investing strategies.
Hey! How’s everybody doing out there? This is Preston Pysh. I’m your host for The Investor’s Podcast and as usual, I’m accompanied by my co-host, Stig Brodersen, out in Denmark.
Stig and I are reading a really long book right now and we just finished up our last episode talking about Charlie Munger and we’re reading a really long book. And so we needed a little bit of extra time to be able to get through that book and so Stig and I was saying you know which books have we read in the past that we could do an episode on and the one book that kind of came to mind was this book called security analysis. I know there’s a lot of people out there that are always hearing us talk about the book security analysis but today’s episode we’re actually going to go into a little bit of depth to talk about what we actually know about this book. So before we start diving in and talking about this particular book I think it’s really important for us to give the proper amount of context for people to understand what it is that we’re about to talk about today. Warren Buffett has a quote saying that security analysis the intelligent investor in The Wealth of Nations were three very, very influential books shaping his life.

Preston: [00:01:34] He also has another one that he’s read called common stock and uncommon profits by Phil Fisher. He says that that makes up about 15 percent of his investing philosophy is he broke that down into a percent. But the one that we’re really going to focus on as I said is security analysis so I want to start off by reading the forward in security analysis which is written by Warren Buffett.

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The book starts off and it’s four or five paragraphs here so I’m just going to read the whole thing and let you guys hear directly from Warren Buffett’s quote. So this is Warren Buffett’s forward. There are four books in my overflowing library that I particularly treasure. Each of them was written more than 50 years ago although would still be of enormous value to me if I were to read them today for the first time. Their wisdom endures through their pages fade. Two of those books are first editions of The Wealth of Nations by Adam Smith and that was written in 1776 and the Intelligent Investor by Benjamin Graham written in 1949. A third is an original copy of the book you hold in your hands. Benjamin Graham and David Dud’s security analysis. I studied from security analysis while I was at Columbia University in 1950 and 1951 when I had an extraordinary good luck to have Ben Graham and David Dodd as teachers. They gather the book and the men changed my life so he keeps going into. He keeps going here.

Preston: [00:02:54] There’s a little bit more but at the very end he says in the fourth book was a very special edition that David Dodd’s daughter gave to Warren Buffett that it was the original handwritten notes that David Dodd had of this book so that just shows you how much this book really means to Warren and it’s pretty amazing to know that he got the original copy written by David thought so a lot of people don’t know David Dodd’s influence on the book. But David Dodd was basically like a teacher’s assistant to Benjamin Graham. He assisted Benjamin Graham and when Benjamin Graham was giving his lectures in Class David Dodd was really going to do the nug work and working very hard to write down everything and make sure it was all captured. And then it was compiled into this book. So that was really David Dodd’s role. A lot of the thoughts and a lot of the ideas of how Bram thought those were all Graham’s ideas really for the most part from my understanding those were Graham’s thoughts and David was more of a scribe. Whenever you look at security analysis now I’m sure David Dodd had some of his own thoughts that he put in here. But for the most part, a lot of people out there attribute most of the ideas in this book to Benjamin Graham. So that’s kind of really the start. Now the book that I purchased whenever I first started learning in my poor book here is literally falling apart. And that can attest I’m showing it to him over the screen.

Preston: [00:04:13] I see the pages are literally falling out because I reference this thing so much and I’ve got so many handwritten notes to do this thing. I just love this book. This is hands down one of my most favorite and prized possessions but aside from that when I got my first book I got the sixth edition of this book and that was kind of a mistake. To be quite honest with you I didn’t know any better. And in the sixth edition, they took out a bunch of the chapters in this book. I don’t even know how many chapters were taken out. But it’s a lot. And that was one of the things that I didn’t know whenever I purchased this that they had removed a lot of the chapters from the original book and the book is still huge I don’t know how many pages. Seven hundred and sixty-six pages and they’re probably just two the that you know one read or the end all these ones on the speculative features and that kind of stuff they just totally axe them out of the book. Now what you’ll find is they gave an accompanying CD that came with the book I’m looking here and part two there’s one two three four five six like six chapters that aren’t even included out of you call it 10 or 15 chapters for that section. So that’s really frustrating to me that you don’t have a hard copy of that now where it really came in useful though is they gave you a CD that’s attached to the book.

Preston: [00:05:32] The CD comes with the book and it’s a PTF of the entire book. It doesn’t have those chapters removed off of the disk that you got. And so in a way that’s where the sixth edition I really liked that because I could search for terms through the PTF file. I could search for things that really saved me a ton of time instead of trying to flip through the book or find where I tap that for certain notes. So that’s one nice feature about the sixth edition so there’s the give and take. If you’re trying to decide which version of security analysis to buy. So anyway stick it I a lot of people might not know this but Stig and I wrote an executive summary of this book because it is so difficult. I remember the first time I tried reading this I was like What in the world is in this book. And it was very difficult for me and to be honest with you the first time I tried to read it I didn’t read it at all. I was really struggling and knew there was really important information in it but I didn’t understand the terminology and I think that that’s probably the most important thing I tell a lot of young investors when I’m talking to people is I tell them to learn the terminology stick. You like to use the reference of traveling to another country and not knowing the language. And I think that’s a fantastic example. Let’s say you know it’s a great example.

Stig: [00:06:52] Yes so the way that initially I looked at security analysis when they were pressed and came up with this amazing idea that we should write a summary of this security analysis. He said that yes. And that’s literally the case for me because in nine months from now I’ll actually be moving to Korea and I don’t know how to say anything Korean. And so I’m very worried about that. I guess that’s the same feeling that people have whenever they open up a church analysis. I know at least from my perspective I felt like I was following in a new land and this was definitely not the first that I read security analysis but it was by far the hottest part time because not only was he using like a lot of words that I had no clue what men but he was also using a lot of different words for the same thing which is not what you’re looking for when you’re looking at this book and I don’t know if it’s just me but he was not consistent about which words that you would use for the income statement the income statement or income account or the profit loss or what not so just obviously very confused. And remember back then, you said that you know steak I know that we will go to write this book and I’m sure it would be a great book but just know that no one wanted to buy this. He told me that the evidence was really that would grow your knowledge and that’s the difference. The latter is true.

Preston: [00:08:19] Well so he’s exactly right. When we wrote this summary guy there was a little bit more for ourselves than really selling it to be quite honest with you because we wanted to basically ensure that every word and every chapter this book is something that we fully understood. And I know when I was going through this and I’m writing a summary guide to help people break this down into simple and plain English there were many times I was looking up terminology saying wow I don’t even know what this term is. And I would have to look it up like oh this is just like a different term that’s in Houston but there’s something really basic but that’s the big hurdle here. And what was really nice and it talks about how ambitious I can with myself. I’m reading about Warren Buffett and I read this line that says Warren Buffett learned everything he knows from this book security analysis and so the person who’s just maybe a little over-ambitious at times like oh well that’s simple to buy that book and read it and totally understand it. So I biosecurity analysis it comes and I start going through it and I’m like what in the world is this saying and you know what in a way that was really good because it created this enormous challenge for me to actually try to figure out what this book was all about. And so for me finally writing this summary with Steg on security analysis it’s called the 100 page summary of security analysis it’s on Amazon if any of you guys are interested in it. But when we were done it wasn’t even close to being a 100-page summary.

Preston: [00:09:46] It was like 220 pages or something like that. And let me tell you we summarized the life in pulp out of this book and it was still a 200-page summary. But, it’s still a call for some reason. That’s right. That’s right. It is. But people know that our intent in writing that was really to make the language of this book more understandable just more comprehensible now where we kind of wasn’t able to go into a lot of detail is the thing that you’ll learn about security now. Ben Graham was the master of using real-world examples to demonstrate an idea. So he would come up with an idea about saying something on the income statement what Ben Graham would do is he go out and you’d find five to 10 to 15 different companies and he’d say these are all the points that I’m trying to make. But you’re seeing it through a real-world example. Companies on the market today back in the 1930s and he would represent those ideas with real-world examples and that’s what really I think set Ben Graham apart from any other financial investment author out there is he did some really hard work showing quantifiable facts backing up his opinions. So that’s where I think Stigand our summary we really didn’t cover the examples and I think when you cut a lot of those examples out and you free up a lot of space and you just get to the idea. And that’s what we were really trying to capture and our writing and trying to understand this.

Stig: [00:11:13] And yeah and the thing is a good point for us because some of these examples are really complicated. I mean really really complicated. So, for one thing, he talks about how to value the investment portfolio of another company and how that is measured how that is accounting for their financial statements which are by the way different the kind of rules that you use today. What I think is really interesting because what we are doing right now I was reading a book called Buffett the making of an American capitalist a great book by the way. It’s a long book. It’s a great book. And what you can see in that book is that Buffett actually did the same thing and I think he actually got that idea off security analysis he was actually buying and now the company that had this huge investment portfolio and force that company to sell all those securities and distributes that into the shell hole. Just as he had read in security analysis and just going to say this is not an easy process to do to value this investment full you then to take control of the company and start distributing out the investors. I think that was an amazing comment from Buffett. I almost feel like it was not a war buffet type of deal is more like Icahn kind of thing like an activist approach. But in that sense, I also think that Bill Bradley had really the activist style of doing it and there was something that Warren Buffett didn’t. Oh yes.

Preston: [00:12:30] So what I want to do at this point is really kind of just talking about the key points that are found in this book and the layout that Benjamin Graham chose to go through this book. There’s no way we can get into the specifics of some of the ideas that are discussed in here we do that in the summary. But to talk about it over the podcast is going to be very difficult to make any kind of sense. But what I do want to do is I want to break out and talk about the different parts that the book is broken down into so you can kind of understand what’s inside of it and what there is. So the book starts off. There’s part 1 it’s five chapters long and it’s called survey and approach and this is where Ben Graham really kind of lays down the law from a very high-level sight picture where he really talks about this idea of intrinsic value. Talks about these ideas of risk talk about the different asset classes whether you’re talking about stocks which are also called equities or fixed income which is commonly referred to as Bonnes. And he basically shows the reader where those fall so when you’re buying equity or you’re buying a stock that sits lower than the architecture of owning a bond you have a higher stake or a higher claim inside of that architecture in the event that the business would go bankrupt.

Preston: [00:13:46] So what’s important as you’re talking about bankruptcy because that comes up a lot with Benjamin Graham and the reason it comes up is that this book was published in 1934. So let’s think about the context of what Benjamin Graham was writing about because you talk about the deepest darkest part of the Great Depression you’re talking about those early 1930s really specifically I think the deepest was 1933 when they came off the gold standard. So you think about when they would have been writing this they would have literally been writing this book right in that time frame when it gets published in 1934. So that’s where he was seeing the world is hey how can you protect your interest in whatever you’re investing in. And so he would talk about hey if you own a bond and you own stock and the company goes bankrupt guess what. The first person to really lose their money in the grand scheme of things is the person holding the stock next person is the preferred shareholders the next person is the boss. Then when you get into the bank notes and things like that it really kind of takes shape from this really big idea of you’ve got these companies and you’ve got intrinsic value got inherent risk. You’ve got these different asset classes.

Stig: [00:14:53] He breaks that down and really the first five chapters what I really took away from this first part was how we distinguish between best speak collation and to actually also think that we have to talk about the concept as you were talking about before pressing because this was just right after the Great Depression. And he would sing like multiple times that even cautious investors might be looked at as speculators and this was actually a concept that you addressed again and again different that is also that depending on my condition sometimes speculators were almost looked at as investors and then times like 1934 when they were published accurate analysis even though very cautious best of like me Graham it was considered almost like a gambler because he was something called stocks bonds and then the public opinion just suddenly shifts. And the thing that’s really interesting also because that is basically what you see today. I’m sure that most of us remember what happened before the financial crisis like so many people were just considered geniuses because they borrowed a lot of money lots of real estates. And then you couldn’t say that you were investing in bonds or stocks or real estate after the crash because then you were no a speculator and you were so dangerous. But you did. You were an idiot.

Preston: [00:16:09] But I’m not saying that. Honestly, I’m saying that because of the perception that a lot of people had at that point shifts like that. And that’s a fantastic point and that’s that’s a huge huge Benjamin Graham thing he talks about it at the start of this book. You go to the Intelligent Investor that’s the very first thing he talks about what’s investing versus what’s speculating and that is a key concept that he either you agree with him or you don’t agree with him and if you if you don’t agree with him you don’t want to read another word because it’s all based on that fundamental idea. And so that’s where he starts getting quantifiable which really had never occurred before this 1934 edition came out where people were very speculative is like well that’s going to go up and here’s a couple of reasons why we’re Benjamin Graham was saying hey you got this thing called the balance sheet. And then you’ve got this thing called the income statement and then you got bonds which in the way he describes in fits and pieces all of this together for anybody that’s watch the videos that I made for the Buffett’s books that’s where all those videos really came from I was reading this book fully understanding the ideas in this book and then trying to piece it together in some type of format that was comprehensible for people to really understand how Benjamin Graham had pieced all those together.

Preston: [00:17:23] So let’s go to the second part of the book. And in the second part of the book Benjamin Graham starts off talking about fixed value investments. So he’s talking about Bonds and how many chapters are there 15 chapters on bonds. And so he starts off with the book if I remember right he starts off with the book and he says you know what. One of the biggest banks in New York is using this method to basically value fixed income securities which are bonds. Why not use that same method as an investor as an individual investor why wouldn’t I look at it through the same context. And so he uses that as a framework he goes and he basically dissects how this big bank uses the risk management to invest in bonds. And then he takes that on as an individual investor and what’s really interesting is he says this. I totally agree with this. I don’t agree with and these are all the reason why and these are all the examples why he just gives this overflowing amount of information describing why he does or doesn’t agree with their approach into valuing a bond in a particular manner. And it’s quite comprehensive it is. It is amazing to go through. Like I said it’s hard at first if you don’t understand the terminology but once you get that terminology you have such a deep appreciation for what he’s doing and how in depth he’s going on that analysis.

Preston: [00:18:43] Just one more thing on the terminology thing Warren Buffett has a quote that says that accounting is the language of business. He says if you don’t know that language or you’re really off to the wrong footing and the wrong step that you don’t have the foundation to really step in there and really know what you’re talking about. So just one more emphasis on how important the terminology is to understand is you’re never going to tackle a book like this unless you understand the terminology. Now I’m really worried about going to another country. I don’t know. But you know so I was completely blown away whenever I saw the second part of this book because I knew what happened was and I was kind of like that might be a chapter or two but as present saying that was 15 chapters and he was not just talking about bombs he’s talking about all types of fixed income maturities and how the deviates and how that’s different in the railroad This is how that’s different in the utility business. And he is so comprehensive in everything and doesn’t this matter. But I think one to point out two things about the second part of the first one is that he really talks about how the issue of fixed income securities. It’s really a whole key need to be able to really understand who is the issue that the security and then figure out what’s the risk.

Preston: [00:19:58] You talked a lot about risk and it’s so important because you don’t get any of the upsides when you have a bond. If you’re lucky you actually get the coupon for that bond is nothing like the business do. Well, you get more money. So he talks a lot about that and he’s very philosophic. And really it takes this woman angle so he’s saying well is it actually safer for a company if it issues bonds or low-interest rate because then your coverage rates you higher meaning that you cost that out. But that would be lower. Does that mean it’s more safe bond? I think it’s so important really to understand what Emer you buy a bond. It’s really an IOU and if you don’t understand what the issue is really fully grasping that you’re just starting off on the wrong foot and you should always look at the risk for you. You think about the return of topic that comes up a lot about this book and I get asked this question a lot is is that book even still relevant. It was written back in the 1930s. Why do I really need to read that it’s so out of touch with the current markets today? Boy, I’ll tell you. I couldn’t disagree with that. The more I when I look at my books today in the new modern versions of this book I’ll tell you, folks, my opinion is that this book is so relevant today.

Preston: [00:21:15] I just so disagree with that. I’m curious to hear your opinions. I’m assuming you agree with me. Well yeah, generally I agree with you. I think the book is irrelevant for some types of investors. I definitely think that intelligent the best which is more let’s call them a more simplified version of security analysis that’s important to understand all of this. Like hundred percent of all this up. Or to think for security analysis. The way it’s written and all the points I think if you’re an active investor I think it’s important to understand all of these things if you’re a passive investor or what Grant cost defensive investor you might be OK but only reading intelligence the best of you. That’s my opinion you need to have a really profound knowledge about investing before starting security officers. That’s for sure. All right so let’s go ahead and move into the third part and the third part of the book is titled senior securities with speculative features. This part of the book has five chapters and this was a really interesting one for me because really you’re not exposed to a lot of this stuff when you’re talking about privileged issues and this is when you get into things that are convertible participating in subscription-based bonds and preferred shares. So it’s kind of something that a lot of people don’t talk about.

Preston: [00:22:30] A lot of people don’t really understand and I think that this section here was really important for me to just read and try to understand for the first time and it was really quite interesting as you go through it which is neat when you’re going through some of these more privileged type securities you get into combinations I guess is the best way to put it where you’re mixing equities with fixed income and you’re talking about how you can convert those from one to the other. And that’s what this is really getting into. And to tell you it’s really helped me out as a business leader and as a business manager and when I’m looking at things because I’m constantly trying to understand first of all how an asset is structured but more importantly how can I be more creative with the way that it’s set up so that it accounts for the time function the growth function and things like that as you’re looking through the progress of how business might progress. Something that’s really quite interesting when I watch a show like Shark Tank and you’re watching these guys who are definitely on their A-game structuring a business and structuring the equity of I’ll do this as venture debt and I want to convertible into equity. That’s what they’re doing. That’s what they’re really kind of setting this up for where they’re minimizing their risk and they’re setting it up so that the original founder of the business might have an advantage up front but then they lose that advantage as time progresses and they actually show maturity and show growth within the company to produce revenue and net income that their bottom line.

Preston: [00:23:56] So really quite fascinating read and I think that it’s probably something that people really struggle with whenever they try to do this initially but as maybe their knowledge progresses it’s going to be something that they really value and look at a lot more really happy you know you said the last thing because I don’t know of any author of that book that discourages potential buyers of the book as much as we’re doing right now. So what I really took away from the third part was first of all how advanced it was to be quite honest but also how Warren Buffet has applied a lot of the same principles. They and the first thing that comes to mind is an investment in Bank of America. So what Warren Buffett did with Bank of America was that he bought five billion worth of preferred stock preferred stock. That’s sort of something that’s between a stock and the bond so it’s something that would give you a coupon. But you will not necessarily get the same upside as you would for that stock. I’ll make sure it’s a linked video press Preston actually explains this a lot better and that’s what makes Apple wasn’t any better examples of what.

Preston: [00:25:02] But just think about somebody between and think about it like that you’re getting a coupon. So for Buffett, he’s getting 6 percent or 5 billion. But at the same time, he has rights or this is called a warrant boring other weights it’s something that’s issued by the company. So Bank of America can’t get borne out by seven hundred. Yes. A bank of America and an exercise price of seven dollars and 14 cents. So anytime you convert this to enterprise 7 goals that fortune sends to the bank of America. I love that point stick. And I got the same exact opinion whenever I did this and we’ve never talked about this before but I’ve got the same exact opinion when I was reading through this part of the book and I’m saying this is exactly what he did in 2008. An example that really kind of I remember was Goldman Sachs so he did a preferred stock buy from Goldman Sachs. I think he purchased about $5 billion worth of preferred stock that yielded a 10 percent dividend which people understand the simplicity of preferred stock. It works almost identical to a bond. It’s almost exactly the same as a bond. So he purchased preferred stock and it’s not the same but it’s really close to being the same. So for simplicity’s sake that’s the probably the best way for you to understand it.

Preston: [00:26:18] He purchased this if I remember right the book value that he purchased the preferred stock out was $115 a share. And if you go back and you look at the book value the common stock on Goldman Sachs at that particular point in time back in 2008 if I remember right it was around $150 a share. So he locked that in. And then they were paying a 10 percent dividend on that preferred stock. So he’s collecting that dividend then he has the option to convert it into common stock. I think he had to hold the preferred I think to convert ability could occur at five years. So the beauty behind this move that he did back in 2008 because people really didn’t understand what he was doing and why he was doing it that way as he had the opinion that Goldman Sachs was going to come back to being worth a whole lot more or a premium to that book value of $150 a share. That was his opinion I’m assuming. And so he didn’t know how long it was going to take for it to get there. But he knew it was going to ultimately and eventually get back to a value above that 115 Mark but he didn’t know when it was an occur. So his opinion is hey let me lock in a 10 percent dividend over the next five years. If the stock starts going crazy and starts going higher warm actually holding that value.

Preston: [00:27:29] But it’s being masked behind that preferred stock value or that dividend that I’m receiving that 10 percent dividend. But I can convert it into common stock at any point time. So I don’t know what Goldman Sachs is at right now. I would assume it’s well over 200 dollars a share. I could look it up at and SIGAR you looking it up. It looks like you. Yeah. And so what he did is he was able to lock in that equity growth on the common stock. He’s on his head. What is at stake. I’m curious. Well. Hundred ninety-seven. The room that was closed that was closed $3 off. OK. So he locked in that price and he was able to convert that over to common stock whenever he felt was right in that time was necessary but think about what he’d locked in a 10 percent dividend on $5 billion. So he’s making $500 million dollars a year on the dividend as he sits around and waits for the equity to mature and he bought these for 115 dollars apiece. I believe that was the price you’d have to go back and look. But I think that was the price. And so he almost had a 100 percent growth on the equity. That’s what he learned from this third part in a book where you’re talking about these senior securities with speculative features.

Preston: [00:28:37] He read this book. He understands these ideas and he applies these ideas and it’s hard to really find some of these investors that you see on TV I’m not going to name people but you really don’t see people like that talking about these really amazing. I mean you can see why this guy’s a prodigy at this stuff and you don’t become a prodigy without reading this kind of stuff. And so Stig’s point is just so fantastic and I really am I’m so glad that he brought that up because that probably describes this part of the book probably better than anything else in a real example that people can really kind of digest. So with that said we’re going to go and move on to the next part because we’re getting a little long and the fourth part of the book he goes into with the title this is a theory of common stock investment. The dividend factor. And there are four chapters for this that are talked about in this section. And really what Graham’s getting at here is he’s just talking about stocks that pay a dividend. And you know Graham is really big on only buying companies that have a dividend. Now Warren Buffett has really ventured away from this idea where he doesn’t necessarily need to receive a dividend. In fact, I would say he might even prefer to not get a dividend because of the tax implications and things like that for the business.

Preston: [00:29:50] But Graham had a different approach and Gramm really favored the dividend. If a company was holding too much-retained earnings from what they had you know profited over the years he was a big proponent that should be released back to the shareholders through a dividend. And so he talks about some of those ideas in this fourth part. Well, I also think it was a safety issue because it’s really really hard to your financial statements if you’re paying a dividend Well you can still do that. But if you consistently paying a dividend you have that safe amount of cash flowing out to you and what you see not only in this section but all the other sections that Grant tells you about how so many companies have been manipulating all of their restatements to really appeal like they have a lot of assets. I have a lot of earnings but they really don’t have. So I think that’s why he favors dividend. I don’t know if you live today in the environment that we have today if you would favor it the same way. I just think it was a way of protecting myself. And I also want to say that that one time the yield that you get on dividends was just phenomenal. He’s talking about there generous double digits even for you know safe stable companies and you don’t see that should they.

Preston: [00:31:03] Yes I think there’s been a major change and we can talk about this real fast. I think there’s been a major shift in the thought of business which I agree with I think as a manager of a business you want to have a certain amount of retained earnings for that asset that you might need to purchase because the market is just so competitive these days if you don’t have that war chest at your disposal somebody could come in with a competitive advantage and knock you out of the race so fast and make your head spin. And I think that’s why you’ve seen this shift where it’s more acceptable for business leaders to retain a lot of their earnings on their balance sheet in the event that they do need to go toe to toe with a competitor back whenever. Graham wrote this I don’t think that that was necessarily the going concern, in the end, the going thought process was more hey hey the owners of the company which are the shareholders and move out and keeps you know sucking whatever earnings or profit that those assets can produce out of them. And at this point, we’ll go into the fifth part of the book which is the analysis of the income statement and the earnings factor in common stock valuation. So at this point in time, this is where 3M jumps from talking about basically bonds and fixed income and the speculative features of fixed income and he’s making that jump over into common stocks he does at around part 4 part 5 of the book.

Preston: [00:32:18] So just to give you an idea that’s right around the 400-page mark of the six the dish and if you were looking at the second edition where it’s the full length in all these chapters aren’t cut out. I’m sure to be even deeper into the book just to give you an idea of how much he talks about fixed income securities before he even gets to. Common stock. So when we get to the fifth part this is where he talks about the income statement so anyone that’s gone through our Buffett’s books videos they know that we’ve got the income statement we’ve got the balance sheet and we’ve got the cash flow statement. The cash flow statement wasn’t something that even existed when Benjamin Graham wrote this book so it’s not even discussed. You know I love talking about the cash flow statement so it’s kind of interesting to know that that wasn’t even something that was available back when he wrote this. But here in the fifth part that’s whenever he starts talking about the income statement so let me break down the income statement for anybody out there listening that doesn’t know what this is the income statement is like looking at your checking account. OK. You could look at all the money that’s come in and that would be your top line and that would be called your revenue or your sales it has some different terminology and that’s where things get a little bit tricky.

Preston: [00:33:24] But think of that as your top line that all the money flowing into your checking account. And then if you could take all those receipts and everything that you’ve spent coming in and out of that checking account and you added all that up what was left that the bottom line that would be called your net income and that’s really the profit that the company has produced for the year and that’s probably the easiest way simplest way I’m sure it’s not 100 percent match up both to what the income actually represents but it gives people an idea of what an income statement is for a business. As you would look at how they function. So it’s really important as you look across all the companies on the Stock Exchange right now and you were able to pull up all their income statements what would you say the percentages that people would. I’m sorry not people but companies would actually have a positive number for their income statement. I would guess 60 percent on there something. Yeah. So out of all the companies on the stock exchange, only 60 percent of them would have a bottom line that’s actually profitable. And I think for a lot of people that might blow their mind they might not even realize that but that just shows you how difficult and how competitive it is out there to turn a profit to even have something that’s profitable.

Preston: [00:34:35] Now that doesn’t mean that they haven’t been profitable in the past. I’m just saying right now time now you could probably look at the cross the stock exchange and about 40 percent of companies aren’t even turning a profit. So that’s what the income statement is it’s telling you is this company profitable and if they are what’s that number what’s the bottom line number. I think if there is one thing you can really take away from this book which you probably can find out there. That’s my experience is how he looks at earnings and the very detail approach to figure out what the true earnings of this company. I think all the other content that’s out there they’re saying like well you should probably just take the average. Well, that’s not good enough for me. He’s really talking about how each line in the income statement or the cash flow state even though it wasn’t invented by them and see how can you figure out what the true earnings. Now he is saying that still it is a qualitative calculation to do it’s not a finite calculation but I think the way he approaches this is really worth buying curch analysis for because he’s so detailed about that. I do want to say one thing though.

Preston: [00:35:44] If you’re reading the original version a lot of the prices that he’s criticizing that’s not legal anymore. So don’t think that corporate America a more corrupt than you might think in its analysis. That’s a good point. And I want people to understand what sticks talking about us are saying what’s the real earnings. OK so let me give you really basic examples I’m looking at the hardware that we use in order to do this podcast. So let’s say that our company produces 10 dollars of profit on the income statement. So that’s the bottom line there’s $10 there. Now in the past, we have purchased like I’m looking at an iPad that does the sound at the beginning. I’ve got a big screen TV thing set up here I’ve got a mixer board we got a really nice microphone so all that stuff costs money let’s just say that it cost $5000 to have all this recording equipment. Now let’s say I wanted to sell all this equipment and I wanted to do something else with my company. So if I sold that $5000 worth of equipment would I get $5000. First of all and the answer is absolutely not because it’s used so let’s say I would only get $2500 for that equipment. Now as I would carry that loss because it’s now it was worth five thousand I sold it for 2500. So I would carry that loss over to my income stream because all those numbers the 5000 that 2500 that was actually sitting on my balance sheet that was not sitting on my income statement is I would sell that that then moves off of my balance sheet onto my income statement and it materializes at actualise is on my income statement.

Preston: [00:37:18] So like we said net income the profit was $10. Well, now I have a huge loss that I’ve got to write off onto that income statement of twenty-five hundred dollars. So now it looks like I lost two thousand four hundred ninety dollars for the year. You see where that haplessly the profit was added to the negative. And so i