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

averages used in the financial press. Some of the services or experts confine their aim to predicting the longer term trend of the market, purporting to ignore day-to-day fluctuations and to consider the broader “swings” covering a period of, say, several months. A great deal of attention is given also to prophesying the market action of individual issues, as distinct from the market as a whole.
    Market Analysis as a Substitute for or Adjunct to Security Analysis. Assuming that these activities are carried on with sufficient seriousness to represent more than mere guesses, we may refer to all or any of them by the designation of “market analysis.” In this chapter we wish to consider the extent to which market analysis may seriously be considered as a substitute for or a supplement to security analysis. The question is important. If, as many believe, one can dependably foretell the movements of stock prices without any reference to the underlying values, then it would be sensible to confine security analysis to the selection of fixed-value investments only. For, when it comes to the common-stock type of issue, it would manifestly be more profitable to master the technique of determining when to buy or sell, or of selecting the issues that are going to have the greatest or quickest advance, than to devote painstaking efforts to forming conclusions about intrinsic value. Manyother people believe that the best results can be obtained by an analysis of the market position of a stock in conjunction with an analysis of its intrinsic value. If this is so, the securities analyst who ventures outside the fixed-value field must qualify as a market analyst as well and be prepared to view each situation from both standpoints at the same time.
    It is not within our province to attempt a detailed criticism of the theories and the technique underlying all the different methods of market analysis. We shall confine ourselves to considering the broader lines of reasoning that are involved in the major premises of price forecasting. Even with this sketchy treatment it should be possible to reach some useful conclusions on the perplexing question of the relationship between market analysis and security analysis.
    Two Kinds of Market Analysis. A distinction may be made between two kinds of market analysis. The first finds the material for its predictions exclusively in the past action of the stock market. The second considers all sorts of economic factors,
e.g.
, business conditions, general and specific; money rates; the political outlook. (The market’s behavior is itself only one of these numerous elements of study.) The underlying theory of the first approach may be summed up in the declaration that “the market is its own best forecaster.” The behavior of the market is generally studied by means of charts on which are plotted the movements of individual stocks or of “averages.” Those who devote themselves primarily to a study of these price movements are known as “chartists,” and their procedure is often called “chart reading.”
    But it must be pointed out that much present-day market analysis represents a combination of the two kinds described, in the sense that the market’s action alone constitutes the predominant but not the exclusive field of study. General economic indications play a subordinate but still significant role. Considerable latitude is therefore left for individual judgment, not only in interpreting the technical indications of the market’s action but also in reconciling such indications with outside factors. The “Dow theory,” however, which is the best known method of market analysis, limits itself essentially to a study of the market’s behavior. Hence we feel justified in dealing separately with chart reading as applied exclusively to stock prices.
    Implication of the First Type of Market Analysis
. It must be recognized that the vogue of such “technical study” has increased immensely during the past fifteen years. Whereas security analysis suffered a distinctloss of prestige beginning about 1927—from which it has not entirely recovered—chart reading apparently increased the number of its followers even during the long depression and in the years thereafter. Many sceptics, it is true, are inclined to dismiss the whole procedure as akin to astrology or necromancy, but the sheer weight of its importance in Wall Street requires that its pretensions be examined with some degree