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

security prices usually reached a bottom when blast furnaces in operation declined through 60% of the total and that conversely they usually reached a top when blast furnaces in operation passed through the 60% mark on the upswing in use thereof. 4 A companion theory of Colonel Ayres was that the high point in bond prices is reached about 14 months subsequent to the low point in pig-iron production and that the peak in stock prices is reached about two years following the low point for pig-iron production. 5
    4 See
Bulletin of the Cleveland Trust Company
, July 15, 1924, cited by David F. Jordan, in
Practical Business Forecasting
, p. 203n, New York, 1927.
    5 See
Business Recovery Following Depression
, a pamphlet published by the Cleveland Trust Company in 1922. The conclusions of Colonel Ayres are summarized on p. 31 of the pamphlet.
    This simple method is representative of all mechanical forecasting systems, in that (1) it sounds vaguely
plausible
on the basis of
a priori
reasoning and (2) it relies for its
convincingness
on the fact that it has “worked” for a number of years past. The necessary weakness of all these systems lies in the time element. It is easy and safe to prophesy, for example, that a period of high interest rates will lead to a sharp decline in the market. The question is, “How soon?” There is no scientific way of answering this question. Many of the forecasting services are therefore driven to a sort of pseudo-science, in which they take it for granted that certain time lags or certain coincidences that happened to occur several times in the past (or have been worked out laboriously by a process of trial and error), can be counted upon to occur in much the same way in the future.
    Broadly speaking, therefore, the endeavor to forecast security-price changes by reference to mechanical indices is open to the same objections as the methods of the chart readers. They are not truly scientific, because there is no convincing reasoning to support them and because, furthermore, really scientific (
i.e.
, entirely dependable) forecasting in the economic field is a logical impossibility.
    Disadvantages of Market Analysis as Compared with Security Analysis. We return in consequence to our earlier conclusion that market analysis is an art for which special talent is needed in order to pursue it successfully. Security analysis is also an art; and it, too, will not yield satisfactory results unless the analyst has ability as well as knowledge. We think, however, that security analysis has several advantages over market analysis, which are likely to make the former a more successful field of activity for those with training and intelligence. In security analysis the prime stress is laid upon protection against untoward events. We obtain this protection by insisting upon margins of safety, or values well in excess of the price paid. The underlying idea is that even if the security turns out to be less attractive than it appeared, the commitment might still prove a satisfactory one. In market analysis there are no margins of safety; you are either right or wrong, and, if you are wrong, you lose money. 6
    6 Viewing the two activities as possible professions, we are inclined to draw an analogous comparison between the law and the concert stage. A talented lawyer should be able to make a respectable living; a talented,
i.e.
, a “merely talented,” musician faces heartbreaking obstacles to a successful concert career. Thus, as we see it, a thoroughly competent securities analyst should be able to obtain satisfactory results from his work, whereas permanent success as a market analyst requires unusual qualities—or unusual luck.
    The cardinal rule of the market analyst that losses should be cut short and profits safeguarded (by selling when a decline commences) leads in the direction of active trading. This means in turn that the cost of buying and selling becomes a heavily adverse factor in aggregate results. Operations based on security analysis are ordinarily of the investment type and do not involve active trading.
    A third disadvantage of market analysis is that it involves essentially a battle of wits. Profits made by trading in the market are for the most part realized at the expense of others who are trying to do the same thing. The trader necessarily favors the more active issues, and the price changes in these are the resultant of the activities of numerous operators of his own type. The market