The following is our critique of a passage of the investment "bible" Security Analysis by Graham, Dodd, and Cottle. This book is credited with providing Warren Buffett with the knowledge and background on how to accurately assess stocks. Although we know this book is basically about number crunching, our concern is how this book treats the question of timing of the purchase of stocks. In this regard, Security Analysis says the following:
“Timing Consideration in Investment Policy- The old rule for the ordinary investor was that he should buy sound securities when he had funds available. If he waited for lower prices he would be losing interest on his money; he might “miss his market,” even if prices declined, in any case, he was turning himself into a stock trader or speculator. Much of this view retains its validity. However, the time when the investor should clearly not buy common stocks is during the upper range of a bull market. (Benjamin Graham, David L. Dodd. Sidney Cottle. Security Analysis, Fourth Edition. 1962. Page 70.).”
The first sentence essentially says that a person should buy stocks when they have the money irrespective of values. To this point the word “sound” securities is not clear. We guess that a “sound” security is one that is not expected to go out of business based on “traditional” valuation methods.
The second sentence says that a person who “waits” for lower prices would be losing interest on his money even if prices decline. By waiting, the prospective investor would become a trader or speculator. However, Graham and Dodd then go on to say that an “investor” should not buy in the “upper range of a bull market.” By trying to determining the “upper range of a bull market,” isn’t this the same as what they said a speculator or traders does?
Anyway, how does one know what the upper range of a bull market is if they aren’t familiar with technical analysis? This suggests that a person must be familiar with technical analysis first and then apply fundamental analysis afterwards provided that the market isn’t in the upper range of a bull market. Strangely, this approach requires an investor to analysis the market at a time when values and earnings are most uncertain. Furthermore, stocks at this point are more susceptible to rumors and hope rather than facts and realistic expectations.
Another challenge is the fact that middle and lower ranges of a bull market is when the fewest individual investors participate. This is the equivalent to the first and second stage of a three stage bull market. The last stage or third phase of a bull market, characterized as the “upper range,” is distinctly known for individual investor activity and participation. For this reason, Graham and Dodd ask the impossible of the individual investor by telling them not to buy in the “upper range” of a bull market.
If the recommendation is that timing doesn’t matter then Graham and Dodd should stick to this position. By following up their remark that timing doesn’t matter with a suggestion of times not to buy based on the level of the market leaves a mixed message. They should say, “don’t worry about the market, instead worry about the valuation of the company. Valuation will always suggest when to buy.” This would have re-enforced the message rather than confuse or misinform the reader.
Since we know the book Security Analysis is considered the “bible” of value investing this issue is certainly secondary but it does point to the overwhelmingly subjective way that the matter of timing of investment purchases is treated. However, the fact that timing is discussed at all, with their own view as to the best time to buy, is an indication that timing really does matter. If nothing else but to determine when not to buy.
Interestingly, when Graham and Dodd say that you should avoid buying in the “upper ranges of a bull market” it requires that you know where the middle and lower ranges are. So what method do you suppose using to determine this? If, somehow, you can determine the upper, middle and lower ranges of a bull market then why would you necessarily care about valuations? Wouldn’t you just throw all of your money in at the lower end and sell once reaching the upper end?