Security Analysis : Sixth Edition, Foreword by Warren Buffett: Additional Aspects of Security Analysis. Discrepencies Between Price and Value

things go the other way, a very large part of the investment would soon be dissipated.
    Should the Public Finance New Ventures? Fairly complete observation of new-enterprise financing registered with the S.E.C. since 1933 has given us a pessimistic opinion as to its soundness and its economic value to the nation. The venturing of capital into new businesses is essential to American progress, but no substantial contribution to the upbuilding of the country has ever been made by new ventures
publicly
financed. Wall Street has always realized that the capital for such undertakings should properly be supplied on a private and personal basis—by the organizers themselves or people close to them. Hence the sale of shares in new businesses has never been a truly reputable pursuit, and the leading banking houses will not engage in it. The less fastidious channelsthrough which such financing is done exact so high an over-all selling cost—to
the public—
that the chance of success of the new enterprise, small enough at best, is thereby greatly diminished.
    It is our considered view that the nation’s interest would be served by amending the Securities Act so as to prohibit the public offering of securities of new and definitely unseasoned ventures. It would not be easy to define precisely the criteria of “seasoning,”—
e.g.
, size, number of years’ operation without loss—and it may be necessary to vest some discretion on this score with the S.E.C. We think, however, that borderline and difficult cases will be relatively few in number (although our second example above belongs, perhaps, in this category). We should be glad to see the powers and duties of the S.E.C. diminished in many details of minor significance; but on this point of protecting a public incapable of protecting itself, our view leans strongly towards more drastic legislation.
    Blue-sky Promotions. In the “good old days” fraudulent stock promoters relied so largely upon high pressure salesmanship that they rarely bothered to give their proposition any semblance of serious merit. They could sell shares in a mine that was not even a “hole in the ground” or in an invention the chief recommendation for which was the enormous profit made by Henry Ford’s early partners. The victim was in fact buying “blue sky” and nothing else. Any one with the slightest business sense could have detected the complete worthlessness of these ventures almost at a glance; in fact, the glossy paper used for the prospectus was in itself sufficient to identify the proposition as fraudulent.
    The tightening of federal and state regulations against these swindles has led to a different type of security promotion. Instead of offering something entirely worthless, the promoter selects a real enterprise that he can sell at much more than its fair value. By this means the law can be obeyed and the public exploited just the same. Oil and mining ventures lend themselves best to such stock flotations, because it is easy to instill in the uninitiated an exaggerated notion of their true worth. The S.E.C. has been concerning itself more and more seriously with endeavors to defeat this type of semifraud. In theory a promoter may offer something worth $1 per share at $5, provided he discloses all the facts and adds no false representations. The Commission is not authorized to pass upon the soundness of new securities or the fairness of their price (except in the case of public-utility issues which come under the terms of the Public Utility HoldingCompany Act of 1935). Actually, it appears to be doing its best, by various pressures, to discourage and even prevent the more grossly inequitable offerings. But it is essential that the public recognize that the Commission’s powers in this respect are severely limited and that only a sceptical analysis by the intending buyer can assure him against exploitation.
    Promotional activities are attracted especially to any new industry that is in the public eye. Profits made by those first in the field, or even currently by the enterprise floated, can be given a fictitious guise of permanence and of future enhancement. Hence gross overvaluations can be made plausible enough to sell. In the liquor flotations of 1933 the degree of overvaluation depended entirely upon the conscience of the sponsors. Accordingly, the list of stock offerings showed all gradations from the thoroughly legitimate down to the almost completely fraudulent. 7 A