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

in the past, as shown by the statistical exhibit. An industrial group of this type may be called “homogeneous.” But, if the individual companies in the field are likely to respond quite variously to new conditions, then the relative showing must be regarded as a much less reliable guide. A group of this kind may be termed “heterogeneous.”
    With certain exceptions for traffic and geographical variations,
e.g.
, in particular, the Pocohantas soft-coal carriers, the railroads must be considered a highly homogeneous group. The same is true of the larger light, heat and power utilities. In the industrial field the best examples of homogeneous groups are afforded by the producers of raw materials and of other standardized products in which the trade name is a minor factor. These would include producers of sugar, coal, metals, steel products, cement, cotton print cloths, etc. The larger oil companies may be considered as fairly homogeneous; the smaller concerns are not well suited to comparison because they are subject to sudden important changes in production, reserves and relative price received. The larger baking, dairy and packing companies fall into fairly homogeneous groups. The same is true of the larger chain-store enterprises when compared with other units in the same subgroups,
e.g.
, grocery, five-and-ten-cent, restaurant, etc. Department stores are less homogeneous, but comparisons in this field are by no means far-fetched.
    Makers of manufactured goods sold under advertised trade-marks must generally be regarded as belonging to heterogeneous groups. In these fields one concern frequently prospers at the expense of its competitors, so that the units in the industry do not improve or decline together. Among automobile manufactures, for example, there have been continuous and pronounced variations in relative standing. Producers of all the various classes of machinery and equipment are subject to somewhat the same conditions. This is true also of the proprietary drug manufacturers. Intermediate positions from this point of view are occupied by such groups as the larger makers of tires, of tobacco products, of shoes, wherein changes of relative position are not so frequent. 2
    2 But significant changes do occur, of course. Note, for example, the phenomenal growth of Philip Morris, relative to its large competitors, the somewhat less spectacular development of
    The analyst must be most cautious about drawing comparative conclusions from the statistical data when dealing with companies in a heterogeneous group. No doubt preference may properly be accorded in these fields to the companies making the best quantitative showing (if not offset by known qualitative factors)—for this basis of selection would seem sounder than any other—but the analyst and the investor should be fully aware that such superiority may prove evanescent. As a general rule, the less homogeneous the group the more attention must be paid to the qualitative factors in making comparisons.
    More General Limitations on the Value of Comparative Analysis. It may be well once again to caution the student against being deluded by the mathematical exactitude of his comparative tables into believing that their indicated conclusions are equally exact. We have mentioned the need of considering qualitative factors and of allowing for lack of homogeneity. But beyond these points lie all the various obstacles to the success of the analyst that we presented in some detail in our first chapter. The technique of comparative analysis may lessen some of the hazards of his work, but it can never exempt him from the vicissitudes of the future or the stubborness of the stock market itself or the consequences of his own failure—often unavoidable—to learn all the important facts. He must expect to appear wrong often and to be wrong on occasion; but with intelligence and prudence his work should yield better over-all results than the guesses or the superficial judgments of the typical stock buyer.
Chapter 50

D ISCREPANCIES BETWEEN
P RICE AND V ALUE
    O UR EXPOSITION OF THE TECHNIQUE of security analysis has included many different examples of overvaluation and undervaluation. Evidently the processes by which the securities market arrives at its appraisals are frequently illogical and erroneous. These processes, as we pointed out in our first chapter, are not automatic or mechanical but psychological, for they go on in the minds of people who buy or sell.