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

aircraft concerns in 1938–1939 is very striking.
    Relationship of the Analyst to Such Situations
. The analyst can deal intelligently and fairly successfully with situations such as Wright Aeronautical, Bangor and Aroostook, Firestone and Butte and Superior at the periods referred to. He could even have formed a worth-while opinion about Mullins early in 1927. But once this issue fell into market operators’ hands it passed beyond the pale of analytical judgment. As far as Wall Street was concerned, Mullins had ceased to be a business and had become a symbol on the ticker tape. To buy it or to sell it was equally hazardous; the analyst could warn of the hazard, but he could have no idea of the limits of its rise or fall. (As it happened, however, the company issued a convertible preferred stock in 1928 which made possible a profitable hedging operation, consisting of the purchase of the preferred and the sale of the common.) Similarly with the airplane issues in 1939, the analyst could go no further than to indicate the obvious hazard that lay in treating as permanent a source of business that the whole world must necessarily hope was essentially temporary.
    When the general market appears dangerously high to the analyst, he must be hesitant about recommending unfamiliar common stocks, even though they may seem to be of the bargain type. A severe decline in the general market will affect all stock prices adversely, and the less active issues may prove especially vulnerable to the effects of necessitous selling.
    Market Exaggerations Due to Factors Other than Changes in Earnings:
Dividend Changes
. The inveterate tendency of the stock market to exaggerate extends to factors other than changes in earnings. Overemphasis is laid upon such matters as dividend changes, stock split-ups, mergers and segregations. An increase in the cash dividend is a favorable development, but it is absurd to add $20 to the price of a stock just because the dividend rate is advanced from $5 to $6 annually. The buyer at the higher price is paying out in advance all the additional dividends that he will receive at the new rate
over the next 20 years
. The excited responses often made to stock dividends are even more illogical, since they are in essence nothing more than pieces of paper. The same is true of split-ups, which create more shares but give the stockholder nothinghe did not have before—except the minor advantage of a possibly broader market due to the lower price level. 1
    1 In the Atlas Tack manipulation of 1933 an effort was made to attract public buying by promising a split-up of the stock, 3 shares for 1. Obviously, such a move could make no real difference of any kind in the case of an issue selling in the 30s. The circumstances surrounding the rise of Atlas Tack from 1½ to 34¾ in 1933 and its precipitous fall to 10 are worth studying as a perfect example of the manipulative pattern. It is illuminating to compare the price-earnings and the price-assets relationships of the same stock prior to 1929.
    Mergers and Segregations
. Wall Street becomes easily enthusiastic over mergers and just as ebullient over segregations, which are the exact opposite. Putting two and two together frequently produces five in the stock market, and this five may later be split up into three and three. Such inductive studies as have been made of the results following mergers seem to cast considerable doubt upon the efficacy of consolidation as an aid to earning power. 2 There is also reason to believe that the personal element in corporate management often stands in the way of really advantageous consolidations and that those which are consummated are due sometimes to knowledge by those in control of unfavorable conditions ahead.
    2 See, for example, Arthur S. Dewing, “A Statistical Test of the Success of Consolidations,” published in
Quarterly Journal of Economics
, November 1921 and reprinted in his
Financial Policy of Corporations
, pp. 885–898, New York, 1926. But see Henry R. Seager and Charles A. Gullick,
Trust and Corporation Problems
, pp. 659–661, New York, 1929, and
Report of the Committee on Recent Economic Changes
, Vol. I, pp. 194 ff., New York, 1929.
    The exaggerated response made by the stock market to developments that seem relatively unimportant in themselves is readily explained in terms of the psychology of the speculator. He wants “action,” first of all; and he is willing to contribute to this action if he can be