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

analyst can be hopeful of success only upon the assumption that he will be more clever or perhaps luckier than his competitors.
    The work of the securities analyst, on the other hand, is in no similar sense competitive with that of his fellow analysts. In the typical case the issue that he elects to buy is not sold by some one who has made an equally painstaking analysis of its value. We must emphasize the point that the security analyst examines a far larger list of securities than does the market analyst. Out of this large list, he selects the exceptional cases in which the market price falls far short of reflecting intrinsic value, either through neglect or because of undue emphasis laid upon unfavorable factors that are probably temporary.
    Market analysis seems easier than security analysis, and its rewards may be realized much more quickly. For these very reasons, it is likely to prove more disappointing in the long run. There are no dependable ways of making money easily and quickly, either in Wall Street or anywhere else.
    Prophesies Based on Near-term Prospects. A good part of the analysis and advice supplied in the financial district rests upon the near-term business prospects of the company considered. It is assumed that, if the outlook favors increased earnings, the issue should be bought in the expectation of a higher price when the larger profits are actually reported. In this reasoning, security analysis and market analysis are made to coincide. The market prospect is thought to be identical with the business prospect.
    But to our mind the theory of buying stocks chiefly upon the basis of their immediate outlook makes the selection of speculative securities entirely too simple a matter. Its weakness lies in the fact that the currentmarket price already takes into account the consensus of opinion as to future prospects. And in many cases the prospects will have been given more than their just need of recognition. When a stock is recommended for the reason that next year’s earnings are expected to show improvement, a twofold hazard is involved. First, the forecast of next year’s results may prove incorrect; second, even if correct, it may have been discounted or even overdiscounted in the current price.
    If markets generally reflected only this year’s earnings, then a good estimate of next year’s results would be of inestimable value. But the premise is not correct. Our table on page 707 shows on the one hand the annual earnings per share of United States Steel Corporation common and on the other hand the price range of that issue for the years 1902–1939. Excluding the 1928–1933 period (in which business changes were so extreme as necessarily to induce corresponding changes in stock prices), it is difficult to establish any definite correlation between fluctuations in earnings and fluctuations in market quotations.
    In Appendix Note 70 (on accompanying CD), we reproduce significant parts of the analysis and recommendation concerning two common stocks made by an important statistical and advisory service in the latter part of 1933. The recommendations are seen to be based largely upon the apparent outlook for 1934. There is no indication of any endeavor to ascertain the fair value of the business and to compare this value with the current price. A thorough-going statistical analysis would point to the conclusion that the issue of which the sale is advised was selling below its intrinsic value, just because of the unfavorable immediate prospects, and that the opposite was true of the common stock recommended as worth holding because of its satisfactory outlook.
    We are sceptical of the ability of the analyst to forecast with a fair degree of success the market behavior of individual issues over the near-term future—whether he base his predictions upon the technical position of the market or upon the general outlook for business or upon the specific outlook for the individual companies. More satisfactory results are to be obtained, in our opinion, by confining the positive conclusions of the analyst to the following fields of endeavor:
    1. The selection of standard senior issues that meet exacting tests of safety.
    2. The discovery of senior issues that merit an investment rating but that also have opportunities of an appreciable enhancement in value.
    3. The discovery of common stocks, or speculative senior issues, that appear to be selling at far less than their intrinsic value.
    4. The