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

Power Company common when the $7 Cumulative Second Preferred was selling at 11 in April 1933 was clearly unwarranted. A similar remark may be made of the price of 21½ for Chicago Great Western Railroad Company common in February 1927, against 32½ for the 4% preferred stock on which dividends of $44 per share had accumulated.
    It is true that if extraordinary prosperity should develop in situations of this kind, the common shares might eventually be worth substantially more than the preferred. But even if this should occur, the company is bound to pass through an intermediate period during which the improved situation permits it to resume preferred dividends and then todischarge the accumulations. Since such developments benefit the preferred stock directly, they are likely to establish (for a while at least) a market value for the senior issues far higher than that of the common stock. Hence, assuming any appreciable degree of improvement, a purchase of the preferred shares at the low levels should fare better than one made in the common stock.
    Discrepancies Due to Special Supply and Demand Factors. The illogical relationships that we have been considering grow out of supply and demand conditions that are, in turn, the product of unthinking speculative purchases. Sometimes discrepancies are occasioned by special and temporary causes affecting either demand or supply.
    Examples
: In the illogical relationship between the prices of Interboro Rapid Transit Company 5s and 7s in 1933, the operations of a substantial sinking fund, which purchased the 5s and not the 7s, were undoubtedly instrumental in raising the price of the former disproportionately. An outstanding example of this kind is found in the market action of United States Liberty 4¼s during the postwar readjustment of 1921–1922. Large amounts of these bonds had been bought during the war for patriotic reasons and financed by bank loans. A general desire to liquidate these loans later on induced a heavy volume of sales which drove the price down. This special selling pressure actually resulted in establishing a lower price basis for Liberty Bonds than for high-grade railroad issues, which were, of course, inferior in security and at a greater disadvantage also in the matter of taxation. Compare the following simultaneous prices in September 1920.

    This situation supplied an excellent opportunity for the securities analyst to advise exchanges from the old-line railroad issues into Liberty Bonds.
    A less striking disparity appeared a little later between the price of these Liberty Bonds and of United States Victory 4¾s, due 1923. This state of affairs is discussed in a circular, prepared by one of the authorsand issued at that time, a copy of which is given in Appendix Note 68 on accompanying CD, as an additional example of “practical security analysis.”
    United States Savings Bonds Offer Similar Opportunity. For the investor of moderate means the disparity between United States government and corporate obligations has reappeared in recent years. The yield on United States Savings Bonds (available to any one individual to the extent of $10,000 principal amount each year) is 2.90% on the regular compound-interest basis of calculation and 3.33% on a simple-interest basis. This yield is definitely higher than that returned by best-rated public-utility and industrial issues. 3 In addition to their safety factor, which at present must clearly be set higher than that of any corporate issue, the United States Savings Bonds have the minor advantage of exemption from normal income tax and the major advantage of being redeemable
at the option of the holder
at any time, thus guaranteeing him against intermediate loss in market value.
    3 The average yields for such bonds for the first 3 months of 1940, carrying A1 + ratings of Standard Statistics Company, were only 2.62% and 2.44%, respectively.
Chapter 52

M ARKET A NALYSIS AND
S ECURITY A NALYSIS
    F ORECASTING SECURITY PRICES is not properly a part of security analysis. However, the two activities are generally thought to be closely allied, and they are frequently carried on by the same individuals and organizations. Endeavors to predict the course of prices have a variety of objectives and a still greater variety of techniques. Most emphasis is laid in Wall Street upon the science, or art, or pastime, of prophesying the immediate action of the “general market,” which is fairly represented by the various