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

Island common was “intrinsically cheaper.” The speculative capitalization structure of the latter road made it highly vulnerable to unfavorable development, so that it was unable to withstand the post-1929 depression.
    Other Illustrations in Appendix. The practical approach to comparative analysis of railroad stocks (and bonds) may best be illustrated by the reproduction of several such comparisons made by one of the authors a number of years ago and published as part of the service rendered to clients by a New York Stock Exchange firm. These will be found in Appendix Note 66 on accompanying CD. It will be observed that the comparisons were made between roads in approximately the same class as regards capitalization structure, with the exception of the comparison between Atchison and New York Central, in which instance special reference was made to the greater sensitivity of New York Central to changes in either direction.
    C OMPARISON OF U NION P ACIFIC AND R OCK I SLAND C OMMON S TOCKS

FORM II. PUBLIC-UTILITY COMPARISON
    The public-utility comparison form is practically the same as that for railroads. The only changes are the following: Fixed charges (as mentioned in line 1 and elsewhere) should include subsidiary-preferred dividends. Line 2 should be called “Funded debt and subsidiary preferred stock,” and these should be taken from the balance sheet. Items 22 and 22 I.P., relating to net deductions, are not needed. Item 10 becomes “ratio of depreciation to gross.” An item, 10M, may be included to show “ratio of maintenance to gross” for the companies which publish this information.
    Our observations regarding the use of the railroad comparison apply as well to the public-utility comparison. Variations in the depreciation rate are fully as important as variations in the railroad maintenance ratios. When a wide difference appears, it should not be taken for granted that one property is unduly conservative or the other not conservative enough, but a
presumption
to this effect does arise, and the question should be investigated as thoroughly as possible. A statistical indication that one utility stock is more attractive than another should not be acted upon until (among other qualitative matters) some study has been made of the rate situation and the relative prospects for favorable or unfavorable changes therein. In view of experience since 1933, careful attention should also be given to the dangers of municipal or federal competition.
FORM III. INDUSTRIAL COMPARISON (FOR
COMPANIES IN THE SAME FIELD)
    Since this form differs in numerous respects from the two preceding, it is given in full herewith:
    A
. Capitalization:
    1. Bonds at par.
    2. Preferred stock at market value (number of shares × market price).
    3. Common stock at market value (number of shares × market price).
    4. Total capitalization.
    5. Ratio of bonds to capitalization.
    6. Ratio of aggregate market value of preferred to capitalization.
    7. Ratio of aggregate market value of common to capitalization.
    B
. Income Account (most recent year):
    8. Gross sales.
    9. Depreciation.
    10. Net available for bond interest.
    11. Bond interest.
    12. Preferred dividend requirements.
    13. Balance for common.
    14. Margin of profit (ratio of 10 to 8).
    15. % earned on total capitalization (ratio of 10 to 4).
    C
. Calculations:
    16. Number of times interest charges earned.
    16. I.P. Number of times interest charges plus preferred dividends earned.
    17. Earned on common, per share.
    18. Earned on common, % of market price.
    17. S.P. Earned on preferred, per share.
    18. S.P. Earned on preferred, % of market price.
    19. Ratio of gross to aggregate market value of common.
    19. S.P. Ratio of gross to aggregate market value of preferred.
    D
. Seven-year average:
    20. Number of times interest charges earned.
    21. Earned on common stock per share.
    22. Earned on common stock, % of current market price. (20 I.P., 21 S.P. and 22 S.P.—Same calculation for preferred stock if wanted).
    E
. Trend figure:
    23. Earned per share of common stock each year for past seven years (adjustments in number of shares outstanding to be made where necessary).
    23. S.P. Same data for speculative preferred issues, if wanted.
    F
. Dividends:
    24. Dividend rate on common.
    25. Dividend yield on common.
    24. P. Dividend rate on preferred.
    25. P. Dividend yield on preferred.
    G
. Balance sheet:
    26. Cash assets.
    27. Receivables (less reserves).
    28. Inventories (less proper