Book Review: Modern Security Analysis
Modern Security Analysis: Understanding Wall Street Fundamentals. 2013. Martin J. Whitman and Fernando Diz.
Despite its title, Modern Security Analysis: Understanding Wall Street Fundamentals is not a didactic explanation of techniques for evaluating securities. Like many books in the Wiley Finance series, it presents a concentrated view of a particular subject. In this case, the subject is longtime money manager Martin Whitman’s views on value investing, with an assist from Fernando Diz. The coauthor of what appears to be part of Whitman’s professional swan song, Diz is a professor of finance at the Martin J. Whitman School of Management at Syracuse University and Whitman’s long-time collaborator in overseeing that university’s student-run Orange Value Fund. The book incorporates updated material from Whitman’s three previous books and excerpts from several shareholder letters of his Third Avenue Value Fund. This breezily written work will appeal most strongly to aficionados of one particular style of investing. Those who do not share the authors’ enthusiasm for investing almost exclusively in deep-value situations will find some useful nuggets of information throughout the book’s pages, but they will also find many statements of fact and opinion with which they strongly disagree.
In the brief introduction, Whitman and Diz lay out the purpose of the book and note some of their core beliefs about such topics as creditworthiness, wealth creation, investment risk, and market efficiency. They explain that their volume differs from other investment and finance texts in that it examines these topics from the viewpoint of a corporate owner rather than that of a person who merely buys and sells pieces of paper representing such ownership. Suggesting that their views on a particular type of value investing are more relevant than ever, the authors note that during the 2008 – 09 financial meltdown, neither modern portfolio theory nor classic Graham–Dodd value techniques seemed to deliver the anticipated results.
Whitman and Diz state at the outset their view that businesses are engaged in both “going concern” and “resource conversion” activities. The former involves all the actions aimed at generating revenue and profits in the near term. The latter involves not only those traditional business activities but also the completion of transactions that can generate long-term wealth (e.g., acquisitions, spinoffs, buyouts, financings, recapitalizations, liquidations, and other change-of-control events).
In his shareholder communications, Whitman has long described most investors as OPMIs — outside passive minority investors. This latest pronouncement asserts that most OPMIs invest only in common stocks and that they judge managements solely on their ability to conduct traditional business activities (i.e., increase margins, reduce costs, and generate earnings and cash flow). OPMIs ignore other types of corporate securities — such as options, credit instruments, preferreds, and other equity instruments with control provisions—instead devoting an inordinate amount of time and effort to the question, What will this stock sell for in the future? Investors who follow the Whitman – Diz prescription will attribute greater importance to a management team’s ability to maximize the value of the company’s assets, which involves using the aforementioned resource conversion activities to generate sustained long-term wealth. These investors will spend less time trying to predict near-term earnings and the temporal movements of stock prices and more time ascertaining and documenting the answer to the more fundamentally relevant question, What will this business be worth in the future?
Modern Security Analysis is full of useful discussions of such standard topics as creditworthiness, market efficiency, diversification, and financial accounting. But it also includes descriptions of more controversial ideas about the overriding importance of tangible net asset value, the shortcomings of the Graham–Dodd approach to value investing, and the irrelevance of both modern capital theory and broker/dealer research. Its illustrations of leveraged buyouts, creative takeover financings, corporate restructurings, and other techniques used by activist investors are too dated to be instructive.
Perhaps this review is too harsh in its criticism of Whitman and Diz’s defense of a successful investment rationale. But it seems just as harsh for the authors to display a total lack of respect for investing in growth stocks, opportunities in emerging markets, the concept of total return, and other notions about money management that have also been used successfully by competent professionals.
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