Stig Brodersen  07:27

Yeah. So, the way that… Initially, I looked at “Security Analysis” when Preston and I came up with this amazing idea that we should write a summary of the “Security Analysis.” He said that “That’s literally the case for me, because in nine months from now, I’ll be moving to Korea, and I don’t know how to say anything in Korean.” And I’m very worried about that. And I guess that’s the same feeling that people have when they opened up “Security Analysis.” I know at least from my perspective, I felt like I was a foreigner in a new land.

And this was definitely not the first investment book I read, “Security Analysis,” but it was by far the hardest then because not only was he using as a lot of words that I had no clue what those meant, 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 *additional 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, then it was the income statement or income account, or the profit and loss or whatnot.

So, I just remembered, I was very confused. And remember back then you said that, “You know, Stig, I know that we are going to write this book, and I’m sure it would be a great book, but just know that I don’t want to buy this.” You told me that dividends were that would grow your knowledge. And definitely the latter is true.

Preston Pysh  08:54

Well, so he’s exactly right. When we wrote this summary guide, it was a little bit more for ourselves. Then selling it to be quite honest with you, because we wanted to basically ensure that every word in every chapter of 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 and be like, “Oh, this is just like a different term that’s been used in the past or something basic.” But that’s the big hurdle here.

And it was nice, and it talks about how ambitious I can sometimes be 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, I, as the person who’s just maybe a little over-ambitious at times, was like, “Oh, well, that’s simple. I’m going to buy that book and read it and totally understand it.”

So, I buy “Security Analysis” 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 good because it created this enormous challenge for me to try to figure out what this book was all about. And so, for me, finally writing this summary with Stig on “Security Analysis.” It’s called “The Hundred Page Summary of Security Analysis.” When we were done, it wasn’t even close to being a 100-page summary, it was like 220 pages or something like that. And let me tell you, we summarized the living pulp out of this book, and it was still a 200-page summary.

Stig Brodersen  10:32

It’s still called a hundred-page summary.

Preston Pysh  10:34

That’s right. It is. But just so people know that our intent in writing that was to make the language of this book more understandable, and just more comprehensible.

Now, where we weren’t able to go into a lot of detail. The thing that you will learn about “Security Analysis,” Ben Graham was like the master of using real-world examples to demonstrate an idea. So, he would come up with an idea about, say, something on the income statement. What Ben Graham would do is he’d go out and you’d find 5 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 real-world examples, companies on the market today back in the 1930s.” And he would represent those ideas with real-world examples. And that’s what I think set Ben Graham apart from any other financial investment author out there. He did some hard work showing quantifiable facts backing up his opinions.

So that’s where I think Stig, in our summary, we didn’t cover the examples. And I think when you cut a lot of those examples out, you free up a lot of space. And you just get to the idea, and that’s what we were trying to capture in our writing and trying to understand this.

Stig Brodersen  11:49

Yeah, and I think it is a good point, Preston, because some of these examples are complicated. I mean, 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 accounted for in their financial statements, which is, by the way, different accounting rules that you use today.

But I think it is interesting because, Preston and I, what we’re doing right now is we’re reading a book called “Buffett: The Making of an American Capitalist,” a great book, by the way. It’s a long book, but it’s a great book. And what you can see in that book is that Warren Buffett did the same thing. And I think he got that idea off “Security Analysis.” He was buying another company that had this huge investment portfolio and forced that company to sell all those securities, and distribute that as dividend to the shareholders, just as he had read in “Security Analysis.”

I just want to say that this is not an easy process to do, to value this investment portfolio than to take control of the company and start distributing out to the investors. I think that was an amazing accomplishment from Warren Buffett. I almost feel like it was not a Warren Buffett type of deal. It is more like Carl Icahn’s thing, like an activist approach. But in that sense, I also think that Ben Graham had an activist style of doing it. And that was something that Warren Buffett did in his early years.

Preston Pysh  13:05

So, what I want to do at this point is just talk 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 here. We do that in the summary, but to talk about it over the podcast is going to be very difficult to make any sense. But what I want to do is I want to break out and talk about the different parts of the book is broken down into, so you can understand what’s inside of it and what there is.

So, the book starts off, there’s part one, it’s five chapters long, and it’s called “Survey and Approach.” And this is where Ben Graham lays down the law from a very high-level sight picture, where he talks about this idea of intrinsic value, talks about these ideas of risk, talks about the different asset classes, whether you’re talking about stocks, which is also called equities, or fixed income, which is commonly referred to as bonds. And he basically shows the reader where that fall.

So, when you’re buying equity, you’re buying stock. That sits lower than the architecture of owning a bond. You have a higher stake or a higher claim inside of that architecture if the business would go bankrupt.

14:21

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 and darkest part of the Great Depression, you’re talking about those early 1930s. 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 timeframe 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?” 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 lose their money, in the grand scheme of things, is the person holding the stock. The next person is the preferred shareholders, the next person is the bond. And then you get into the banknotes and things like that.” It takes shape from this big idea of you got these companies and you got intrinsic value, you got inherent risk, you got these different asset classes, he breaks that down in the first five chapters.

Stig Brodersen  15:30

What I took away from this first part was how he distinguished between investment and speculation. And I also think that we have to talk about the concept, as you were talking about before, Preston, because this was just right after the Great Depression. He would say like multiple times that even cautious investors might be looked at as speculators. This was a concept that he addressed, again and again, different editions. Also, that depending on the *mind conditions, sometimes speculators are almost looked at as investors.

And then times like in 1934,  when he published “Security Analysis,” even a very cautious investor like Benjamin Graham, who was by the public considered almost like a gambler, because he was saying something called stocks and bonds, and then the public opinion just suddenly shifts. And I think that’s 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 are just considered geniuses, because they borrowed a lot of money, bought a real estate. And then you couldn’t say that you were investing in bonds or stocks or real estate after the crash, because then you were a speculator and it was so dangerous what you did.

Preston Pysh  16:42

You were an idiot. And 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. That’s a fantastic point. That’s a 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.

That is a key concept that he, either you agree with him or you don’t agree with him… And 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 had never occurred before this 1934 edition came out, where people were very speculative. Like, “Well, that’s going to go up.”

Here’s a couple of reasons why Benjamin Graham was saying, “Hey, you’ve got this thing called the balance sheet. And then you got this thing called the income statement. And then you’ve got bonds,” which in the way he describes and fits and pieces all of this together. For anybody that’s watched the videos that I made for the Buffett’s books, that’s where all those videos came from 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 that understand how Benjamin Graham had pieced all those together.

17:58

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 in the book if I remember right, he starts in 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 individual investor? Why wouldn’t I look at it through the same context?”

And so, he uses that as a framework. He goes in and he basically dissects how this big bank uses their risk management to invest in bonds and then he takes that on as an individual investor. And what’s interesting is he says, “This, I totally agree with. This, I don’t agree with and these are all the reasons why and these are all the examples why.” And he just gives us the overflowing amount of information describing why he does or doesn’t agree with their approach to valuing a bond in a particular manner. It’s quite comprehensive. It is amazing to go through.

As I said, it’s hard at first if you don’t understand the terminology. But once you get that terminology, you will have such a deep appreciation for what he’s doing and how in-depth he’s going on in that analysis.

19:18

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, you’re off to the wrong footing and the wrong step. And you don’t have the foundation to step in there and 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.

Stig Brodersen  19:41

Now, I’m worried about going to another country. But you know, so I was completely blown away when I saw the second part of this book because I knew what a bond was, and I was like, that might be a chapter or two. But as Preston was saying, that was 15 chapters and he’s not just talking about bonds. He’s talking about all types of fixed income, maturities, and how that deviates and how that’s different in the railroad business, how that’s different from the utility business. And he is so comprehensive in everything in this chapter.

But I think I will point out two things about the second part. The first one is that he talks about how the issue of fixed income security is the whole key here. You need to be able to dissect and to understand who is issuing that, the security, and then figure out what’s the risk? He talked a lot about risk. And it’s so important because you don’t get any of the upsides whenever you have a bond. If you’re lucky, you get the coupon for that bond. It’s not like if the business is doing well, you’ll get more money. So, he talks a lot about that and he’s very philosophical and he attacks this from many angles.

So, he’s saying well, is it safer for a company if it issues the bond and a low-interest rate because then your coverage ratio *inaudible? Meaning, that the cost that they will have to the debt would be lower. Does that mean now it’s the safer bond? I think it’s so important to understand when you buy a bond, it is an IOU. And if you don’t understand with issuers, and fully grasp that, you’re just starting off on the wrong foot. And you should always look at the risk for you. You’re thinking about the return.

Preston Pysh  21:12

A topic that comes up a lot about this book, and I get asked this question a lot, “Is that book even still relevant? It was written back in the 1930s. Why do I need to read that? It’s so out of touch with the current markets today.” And, boy, I’ll tell you, I couldn’t disagree with that idea more. When I look at books today, and new modern versions of this book, I’ll tell you, folks, my opinion is that this book is so relevant today. I just so disagree with that. I’m curious to hear your opinion, Stig. I’m assuming you agree with me.

Stig Brodersen  21:56

Well, yeah, generally I agree with you. I think the book is irrelevant for some types of investors, I definitely think that the “Intelligent Investor,” which is more, let’s call it a more simplified version of “Security Analysis,” that’s important to understand for all investors. Like 100% of all investors out there.

The thing 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 these things. If you’re a passive investor, or what Benjamin Graham calls a defensive investor, you might be okay by only reading the “Intelligent Investor.” At least, that’s my opinion. You need to have profound knowledge about investing before starting “Security Analysis.” That’s for sure.

Preston Pysh  22:37

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 an interesting one for me because 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 and subscription-based bonds, and preferred shares. So, it’s something that a lot of people don’t talk about and don’t understand.

I think that this section here was important for me to just read and try to understand for the first time, and it was quite an interesting as you go through it, what’s 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 going into and to tell you, it’s helped me out as a business leader and as a business manager. 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 a business might progress.

23:58

Something that’s quite interesting whenever I watch a show like Shark Tank, and you’re watching these guys who are definitely on their A-game. Structuring business and structuring the equity of, I’ll do this as venture debt and I want a convertible into equity, that’s what they’re doing. That’s what they’re setting this up for where they’re minimizing their risk. And they’re setting it up so that the founder of the business might have an advantage upfront, but then they lose that advantage as time progresses. And they show maturity and show growth within the company to produce revenue and net income on their bottom line.

So quite fascinating read and I think that it’s probably something that people will struggle with whenever they would try to do this initially, but as maybe their knowledge progresses, it’s going to be something that they value and look at a lot more.

Stig Brodersen  24:45

I’m happy to hear when you said the last thing, Preston, because I don’t know of any author of the book that discouraged potential buyers the book as much as we’re doing. So, what I took away from the third part was first of all, how advanced it was, to be quite honest, but also how Warren Buffett has applied a lot of the same principles today. And the first thing that comes to mind is his investment in Bank of America.

So, what Warren Buffett did with Bank of America was that he bought 5 billion worth of preferred stock. Preferred stock, that’s something that’s between a stock and a 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 to link a video where Preston explains this a lot better. It has better examples.

But just think about somewhere in between. And think about it like that you’re getting a coupon. So, Warren Buffett, he’s getting 6% of those 5 billion, but at the same time, he has the right, or this is called a warrant by the way. It’s something that’s issued by the company. So, Bank of America gives him warrants to buy 700 shares of Bank of America at an exercise price of $7.14. So, at any point in time, he converts this to enterprise $7.14 to Bank of America.

Preston Pysh  26:08

I love that point, Stig, and I got the same exact opinion whenever I did this. And we’ve never talked about this before. But I 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. And the example that … I remember was Goldman Sachs.

So, he locked that in, and then they were paying a 10% dividend on that preferred stock. So, he’s collecting that dividend, then he has the option to convert it into common stock. And I think he had the hold to preferred, I think the convertibility could occur at five years. So, the beauty behind this move that he did back in 2008 because people 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 $115 a share. That was his opinion, I’m assuming.

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% dividend, which just so 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 this preferred stock, and it’s not the same but it is close to being the same. So, for simplicity’s sake, that’s the probably the best way for you to understand it, but he purchased this, if I remember right, the book value that he purchased the preferred stock at was $115 a share. If you go back and you look at the book value of the common stock on Goldman Sachs at that particular point in time back in 2008, if I remember, right, it was around $115 a share.

27:42

He didn’t know how long it was going to take for it to get there. But he knew it was going to ultimately eventually get back to a value above that 115 marks, but he didn’t know when it was going to occur. So, his opinion is, “Hey, let me lock in a 10% dividend over the next five years. If the stocks start going crazy and start going higher, well, I’m holding that value, but it’s being masked behind that preferred stock value or that dividend that I’m receiving that 10% dividend, but I can convert it into common stock at any point in time.” So, I don’t know what Goldman Sachs is at right now. I would assume it’s well over $200 a share. I could look it up.

Stig, are you looking it up? It looks like you are.

And so, what he did is he was able to lock in that equity growth on the common stock. Yeah, he’s nodding his head. What is it, Stig? I’m curious.

Stig Brodersen  28:30

Well, $197.

Preston Pysh  28:31

That was close, $3 off. Okay. So, he locked in that price. And he was able to convert that over to common stock when he felt that was right in the time it was necessary, but think about that. He locked in at a 10% dividend on $5 billion. So, he’s making $500 million a year on the dividend, as he sits around and waits for the equity to mature and he bought these for $115 apiece. I believe that was the price. You’d have to go back and look, but I think that was the price.

He almost had 100% growth on the equity. That’s what he learned from this third part in the book where you’re talking about the senior securities with speculative features. He read this book, he understands these ideas, and he applies these ideas. And it’s hard to find some of these investors that you see on TV. I’m not going to name people, but you don’t see people like that talking about these amazing. I mean, you can see why this guy is a prodigy at this stuff. And you don’t become a prodigy without reading this stuff.

And so Stig’s point is just so fantastic. And I am 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  digest.

29:46

So, with that said, we’re going to go ahead and move on to the next part because we’re getting a little long. And the fourth part of the book he goes into… The title of this is “Theory of common stock investment, the dividend factor.” There are four chapters for this, that are talked about in this section. And what Graham’s getting at here is he’s just talking about stocks that pay a dividend. And you know, Graham is big on only buying companies that have a dividend.

Now, Warren Buffett has 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. But Graham had a different approach. And Graham 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 that should be released back to the shareholders through a dividend. And so, he talks about some of those ideas in this fourth part.

Stig Brodersen  30:42

Well, I also think it was a safety issue because it’s hard to manipulate your financial statements if you’re paying a dividend. Well, you can still do that but if you are consistently paying a dividend, you have that safe amount of cash flow flowing out to you. And what you see not only in this section, but all the other sections are that Benjamin Graham tells you about how so many companies have been manipulating all their restatements, to appear like they have a lot of assets or have a lot of earnings, but they don’t have it.

So, I think that’s why he favors dividends. I don’t know if he lived today in the environment that we have today if he would favor it the same way. I just think it was a way of protecting himself. And I also want to say that at that point in time, the yield that you get on dividends was just phenomenal. He’s talking about very generous double digits, the dividend yield for you know, safe and stable companies, and you don’t see that today.

Preston Pysh  31:38

Yeah, 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, if they do need to go toe-to-toe with a competitor.

Back when Graham wrote this, I don’t think that that was necessarily the going concern and the going thought process. It was more pay the owners of the company, which are the shareholders and move out and keep, you know, sucking whatever earnings or profit that those assets can produce out of them.

32:33

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 Graham jumps from talking about basic bonds and fixed income and the speculative features of fixed income. And he’s making that jump over into common stocks. He does that around part four, part five of the book. So, just to give you an idea, that’s right around the 400-page mark of the sixth edition. If you were looking at the second edition where it’s the full length and all these chapters aren’t cut out, I’m sure it is 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 and 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 interesting to know that that wasn’t even available back when he wrote this.

33:37

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, okay? 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, but think of that, as your top line. That’d be 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 at the bottom line, that would be called your net income. And that’s the profit that the company has produced for the year. And that’s probably the easiest way and simplest way. I’m sure it’s not 100% a matchup as to what the income 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 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 percentage is, Stig, that people would? Or I’m sorry, not people, but companies would have a positive number for their income statement? I would guess 60%?

Stig Brodersen  34:37

Yeah, nothing wrong with that.

Preston Pysh  34:52

So out of all the companies on the stock exchange, only 60% of them would have a profitable bottom line. 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 and to even have something profitable.

Now, that doesn’t mean that they haven’t been profitable in the past. I’m just saying right now, the time now, you could probably look across the stock exchange and about 40% 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 that bottom-line number?

Stig Brodersen  35:27

I think if there’s one thing you can take away from this book, which you probably can find in the literature out there, at least that’s my experience, is how he looks at earnings and the very detailed approach that he has to figure out what’s the true earnings of this company.

I think, all the other content that’s out there, they’re saying something like, “Well, you should probably just take the average.” Well, that’s not good enough for Benjamin Graham. He’s talking about how to look at each line in the income statement or a cash flow statement, even though it wasn’t invented then. And see how can you figure out what’s the true earnings.

Now he is saying that still is a qualitative calculation you have to do. It’s not a finite calculation. But I think the way he approached this is worth buying “Security Analysis” because he’s so detailed about that. I do want to say one thing, though, 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 is more corrupt than you might think, in “Security Analysis.”

Preston Pysh  36:32

That’s a good point. And I want people to understand what Stig is talking about, as far as saying, what’s the real earnings? Okay, so let me give you a basic example: I’m looking at the hardware that we use to do this podcast. So, let’s say that our company produces $10 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 nice microphone. So, all that stuff costs money, let’s just say that it cost $5,000 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 $5,000 worth of equipment, would I get $5,000? First of all, and the answer is absolutely not because it’s used. So, let’s say I would only get $2,500 for that equipment.

Now, as I would carry that loss because it’s now it was worth $5,000, I sold it for $2,500. So, I’d carry that loss over to my income statement because all those numbers, that $5,000 and that $2,500, that was sitting on my balance sheet. That was not sitting on my income statement, because I would sell that that then moves off of my balance sheet onto my income statement, and it materializes it actualizes onto my income statement.

So, as we said, the 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 $2500. So, now it looks like I lost $2,490 for the year. You see where that happens. So, the profit was added to the negative there. And so, it looks like I had this big loss. But in all actuality, that’s not the flow of my business that’s creating that value. That was something that an asset that I previously owned.

38:21

So what he talks about, in this section of the book, where he’s analyzing the income statement, he’s going into detail talking about, “Hey, although the company might have had earnings this year of this amount in the following year, this amount, this is how you get down to what is the flow of money that is flowing through this company, which we commonly refer to now as what’s the cash flow of the business? What’s the free cash flow of the business?” And that’s what Ben Graham was trying to get at, back in the 1930s. And this concept and this idea wasn’t something that was readily available or anyone was even talking about it. But back then, Graham was,

Stig Brodersen  38:55

I just have a super quick comment here. So, you might be thinking so how would that apply to a big corporation today? I think the best example I come up with was Starbucks back in 2013. They had a huge lawsuit from Kraft back then and then raised basically all of their profits from that year. And what Benjamin Graham is talking about is that one is a one-time charge and what is a part of the general business? You need to be able to distinguish between those two.

If you only look at the bottom line, listed businesses, you’re heading for trouble. You must understand how are these earnings derived. So, it was just a super brief example, if you want to look at that on Starbucks, it would have been 2013. I will definitely review it. It is an interesting case. But just to see how you can just find earnings disappear from one year to the other, and then be highly profitable the next year. That’s all accounting, basically.

Preston Pysh  39:46

So, as we go into the sixth part of the book, this one has… looks like another four or five chapters for this one. And this is all about the balance sheet.

So, the first one, you talked about the income statement, I briefly talked a little bit about the balance sheet there. So, those are ideas that would then be mashed into this six-part of the book. Then as we go into the seventh part of the book, this is additional aspects of “Security Analysis.” And what he was talking about this section is the discrepancy between price and value. So, he has another seven chapters in this section. And that’s an important part because that’s where he’s throwing out all these examples of what’s this company worth with these different dimensions on their income statement and balance sheet?

I think a lot of people would not know, and a lot of people would think, is that there’s some intrinsic value calculation found inside of this book. I think that surprises a lot of people. But with that said, I think everyone can agree. I mean, you can pull up Warren Buffett’s shareholder letters. In the fine print, he says that there’s a discount cash flow analysis that’s done for him to determine the valuation of his equities or his stocks.

So, we know that the discount cash flow calculation is what he’s doing. We teach two different methods for the discount cash flow on the Buffett’s books website. So, if you go there, you can look that up.

41:01

But here’s the thing, there are a lot of different ways that people can calculate the intrinsic value through discounted cash flow models. There are textbooks out there that just talk about different techniques for calculating intrinsic value. So, I would highly encourage people to go out there, see what works for you. And in some cases, it’s dependent on the company that you’re looking at. You might have a company that’s growing like a weed. Well, you got to look at that a little bit differently than a company that has a lot of stability, which is how Warren Buffett likes to value companies.

So, there’s a lot of different methods and I think for people just to get fixated on one probably isn’t good for you. I think it’s important for you to learn all the different methods and all the different ways to do that discount cash flow analysis. But yeah, our website on buffettsbooks.com has two calculators that you can use for that. We also have calculators for figuring out the value of a bond, figuring out the value of a preferred stock that’s callable, all sorts of things like that. So, we highly encourage you to use those tools.

41:57

So, that’s all that we have for our review of “Security Analysis.” Just an amazing, absolutely amazing book. And you have to understand the terminology to do it. That’s what we tried to accomplish with the summary guide that we wrote. If there’s a new term that’s identified in the book, we try to describe what that term is, or at least we like to try to explain things in a very simple language that’s understandable for people because, you know, although Ben Graham was brilliant, a prodigy at this stuff, I would say that his writing style is not the most conducive for people to try to learn if you don’t have a very large and robust foundation of understanding to start with.

All right, well, that concludes our episode this week. We want to thank everyone for joining us, and we’ll see you guys next week.

Outro  44:56

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