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

composition of the market-leader group has varied greatly from year to year, especially in view of the recent shift of attention from past performance to assumed prospects. Ifwe examine the list during the decline of 1937–1938, we shall find quite a number of once outstanding issues that sold at surprisingly low prices in relation to their statistical exhibits.
    Example
: A startling example of this sort is provided by Great Atlantic and Pacific Tea Company common, which in 1929 sold as high as 494 and in 1938 as low as 36. Salient data on this issue are as follows:

    The balance sheet of January 31, 1938, showed cash assets of 85 millions and net current assets of 134 millions. At the 1938 low prices, the preferred and common together were selling for 126 millions. Here, then, was a company whose spectacular growth was one of the great romances of American business, a company that was without doubt the largest retail enterprise in America and perhaps in the world, that had an uninterrupted record of earnings and dividends for many years—and yet was selling for less than its net current assets alone. Thus one of the outstanding businesses of the country was considered by Wall Street in 1938 to be worth less as a going concern than if it were liquidated. Why? First, because of chain-store tax threats; second, because of a recent decline in earnings; and, third, because the general market was depressed.
    We doubt that a better illustration can be found of the real nature of the stock market, which does not aim to evaluate businesses with any exactitude but rather to express its likes and dislikes, its hopes and fears,in the form of daily changing quotations. There is indeed enough sound sense and selective judgment in the market’s activities to create on most occasions some degree of correspondence between market price and ascertainable or intrinsic value. In particular, as was pointed out in Chap. 4, when we are dealing with something as elusive and nonmathematical as the evaluation of future prospects, we are generally led to accept the market’s verdict as better than anything that the analyst can arrive at. But, on enough occasions to keep the analyst busy, the emotions of the stock market carry it in either direction beyond the limits of sound judgment.
    Opportunities in Normal Markets
. During the intermediate period, when average prices show no definite signs of being either too low or too high, common stocks may usually be found that seem definitely under-valued on a statistical basis. These generally fall into two classes: (1) Those showing high current and average earnings in relation to market price and (2) those making a reasonably satisfactory exhibit of earnings and selling at a low price in relation to net-current-asset value. Obviously, such companies will not be large and well known, or else the trend of
    G ROUP
A
. C OMMON S TOCKS S ELLING AT THE E ND OF 1938 OR 1939 AT L ESS T HAN 7 T IMES
P AST Y EAR’S E ARNINGS AND A LSO AT L ESS T HAN N ET C URRENT A SSET V ALUE

    earnings will not have been encouraging. In the appended table are given a number of companies falling in each group as of the end of 1938 or 1939, at which times the market level for industrial stocks did not appear to be especially high or especially low.
    G ROUP
B
. C OMMON S TOCKS S ELLING AT THE E ND OF 1938 OR 1939 AT T WO-THIRDS,
OR L ESS, OF N ET C URRENT A SSET V ALUE AND A LSO AT L ESS T HAN 12 T IMES E ITHER
P AST Y EAR’S OR A VERAGE E ARNINGS

    It is not difficult for the assiduous analyst to find interesting statistical exhibits such as those presented in our table. Much more difficult is the task of determining whether or not the qualitative factors will justify following the quantitative indications—in other words, whether or not the investor may have sufficient confidence in the company’s future to consider its shares a real bargain at the apparently subnormal price.
    On this question the weight of financial opinion appears inclined to a generally pessimistic conclusion. The investment trusts, with all their facilities for discovering opportunities of this type, have paid little attention to them—partly, it is true, because they are difficult to buy and sell in the large quantities that the trusts prefer, but also because of their conviction that however good the statistical exhibit of a secondary company may beit is not likely to prove a profitable purchase
unless there is specific ground for