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

perhaps, is the broad distinction of size and prominence that can be drawn between seasoned and unseasoned securities. The larger companies are generally the older companies, having senior issues long familiar to the public. Hence unseasoned bonds and preferred stocks are for the most part issues of concerns of secondary importance. But we have pointed out, in our discussion of industrial investments (Chap. 7), that in this field dominant size may reasonably be considered a most desirable trait. It follows, therefore, that in this respect unseasoned issues must suffer as a class from a not inconsiderable disadvantage.
    Unseasoned Industrial Issues Rarely Deserve an Investment Rating
. The logical and practical result is that unseasoned industrial issues can very rarely deserve an investment rating, and consequently they should only be bought on an admittedly speculative basis. This requires in turn that the market price be low enough to permit of a substantial rise;
e.g.
, the price must ordinarily be below 70.
    It will be recalled that in our treatment of speculative senior issues (Chap. 26), we referred to the price sector of about 70 to 100 as the “range of subjective variation,” in which an issue might properly sell because of a legitimate difference of opinion as to whether or not it was sound. It seems, however, that in the case of unseasoned industrial bonds or preferred stocks the analyst should not be attracted by a price level within this range, even though the quantitative showing be quite satisfactory. He should favor such issues only when they can be bought at a frankly speculative price.
    Exception may be made to this rule when the statistical exhibit is extraordinarily strong, as perhaps in the case of the Fox Film 6% notes mentioned in the preceding chapter and described in Appendix Note 67,page 835 on accompanying CD. We doubt if such exceptions can prudently include any unseasoned industrial preferred stocks, because of the contractual weakness of such issues. (In the case of Congoleum preferred, described above, the company was of dominant size in its field, and the preferred stock was not so much “unseasoned” as it was inactive marketwise.)
    Discrepancies in Comparative Prices. Comparisons may or may not be odious, but they hold a somewhat deceptive fascination for the analyst. It seems a much simpler process to decide that issue
A
is preferable to issue
B
than to determine that issue
A
is an attractive purchase in its own right. But in our chapter on comparative analysis we have alluded to the particular responsibility that attaches to the recommendation of security exchanges, and we have warned against an overready acceptance of a purely quantitative superiority. The future is often no respecter of statistical data. We may frame this caveat in another way by suggesting that the analyst should not urge a security exchange unless either (1) the issue to be bought is attractive, regarded by itself, or (2) there is a definite contractual relationship between the two issues in question. Let us illustrate consideration (1) by two examples of comparisons taken from our records.
    Examples: I. Comparison Made in March 1932
.

    * Including guaranteed stock.
    In this comparison the Ward Baking issue made a far stronger statistical showing than the Bethlehem Steel bonds. Furthermore, it appeared sufficiently well protected to justify an investment rating, despite the high return. The qualitative factors, although not impressive, did not suggest any danger of collapse of the business. Hence the bonds could be recommended either as an original purchase or as an advantageous substitute for the Bethlehem Steel 5s.
    II. Comparison Made in March 1929
.

    In this comparison the Spear and Company issue undoubtedly made a better statistical showing than Republic Iron and Steel Preferred. Taken by itself, however, its exhibit was not sufficiently impressive to carry conviction of investment merit, considering the type of business and the fact that we were dealing with a preferred stock. The price of the issue was not low enough to warrant recommendation on a fully speculative basis,
i.e.
, with prime emphasis on the opportunity for enhancement of principal. This meant in turn that it could not consistently be recommended in exchange for another issue, such as Republic Iron and Steel Preferred.
    Comparison of Definitely Related Issues. When the issues examined are definitely related, a different situation