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

routine part of the analyst’s work. Such tabulations permit each company’s showing to be studied against a background of the industry as a whole. They frequently bring to light instances of undervaluation or overvaluation or lead to the conclusion that the securities of one enterprise should be replaced by those of another in the same field.
    In this chapter we shall suggest standard forms for such comparative analyses, and we shall also discuss the significance of the various items included therein. Needless to say, these forms are called “standard” only in the sense that they can be used generally to good advantage; no claim of perfection is made for them, and the student is free to make any changes that he thinks will serve his particular purpose.
FORM I. RAILROAD COMPARISON
    A
. Capitalization:
    1. Fixed charges.*
    2. Effective debt (fixed charges* multiplied by 22).
    3. Preferred stock at market (number of shares × market price).
    4. Common stock at market (number of shares × market price).
    5. Total capitalization.
    6. Ratio of effective debt to total capitalization.
    7. Ratio of preferred stock to total capitalization.
    8. Ratio of common stock to total capitalization.
    B
. Income Account:
    9. Gross revenues.
    10. Ratio of maintenance to gross.
    11. Ratio of railway operating income (net after taxes) to gross.
    12. Ratio of fixed charges * to gross.
    * Or net deductions if larger.
    13. Ratio of preferred dividends to gross.
    14. Ratio of balance for common to gross.
    C
. Calculations:
    15. Number of times fixed charges* earned.
    15. I.P. † Number of times fixed charges* plus preferred dividends earned.
    † I.P. for studying an investment preferred stock.
    16. Earned on common stock, per share.
    17. Earned on common stock, % of market price.
    18. Ratio of gross to aggregate market value of common stock (9 4).
    16. S.P. ‡ Earned on preferred stock, per share.
    ‡ S.P. for studying a speculative preferred stock.
    17. S.P. Earned on preferred stock, % of market price.
    18. S.P. Ratio of gross to aggregate market value of preferred stock (9 3).
    19. Credit or debit to earnings for undistributed profit or loss of subsidiaries (if important).
    D
. Seven-year average figures:
    20. Earned on common stock, per share.
    21. Earned on common stock, % of current market price of common.
    20. S.P. Earned on preferred stock, per share.
    21. S.P. Earned on preferred stock, % of current market price of preferred.
    22. Number of times net deductions earned.
    23. Number of times fixed charges earned.
    22. I.P. Number of times net deductions plus preferred dividends earned.
    23. I.P. Number of times fixed charges plus preferred dividends earned.
    E
. Trend figure:
    24 to 30. Earned per share on common stock each year for past seven years. (Where necessary, earnings should be adjusted to present capitalization.)
    24. S.P. to 30. S.P. Same data for speculative preferred stock, if wanted.
    F
. Dividends:
    31. Dividend rate on common.
    32. Dividend yield on common.
    31. P. Dividend rate on preferred.
    32. P. Dividend yield on preferred.
    Observations on the Railroad Comparison. 1 It has formerly been the custom to base earnings studies on the figures for the previous calendar years, with certain references to later interim reports. But since complete figures are now available month by month, it is more logical and effective practice to ignore the calendar-year division and to use instead the results for the twelve months to the latest date available. The simplest way to arrive at such a twelve months’ figure is to apply the
change
shown for the current year to date to the results of the previous calendar year.
    1 Reference is made to earlier chapters for explanation of the terminology and the critical tests referred to in this discussion.
    Example:
    G ROSS E ARNINGS OF P ENNSYLVANIA R AILROAD S YSTEM FOR
12 M ONTHS E NDED J UNE , 1939

    Our table includes a few significant calculations based on the seven-year average. In an intensive study, average results should be scrutinized in more detail. To save time, it is suggested that additional average figures be computed only for those roads which the analyst selects for further investigation after he has studied the exhibits in the “standard form.” Whether the period of averaging should cover seven years or a longer or shorter time is largely a matter for individual judgment. In theory it should be just long enough to cover a full cyclical fluctuation but not so long