Lesson 1 of 8
Before Graham
What security analysis was before 1934, in a market with no federal disclosure rules, no audited filings on demand and a bond-holder's habit of mind.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Before the Securities Act of 1933 and the Securities Exchange Act of 1934 there was no federal requirement to file audited annual accounts, so the raw material of analysis was not reliably available.
- The habit of mind that existed was the bond holder's: ask what the assets cover, not what the earnings might become.
- Graham and Dodd wrote in 1934, the same year the disclosure system was created, which is why their method leans on the balance sheet.
Security analysis needs two things before it can begin: a statement of what the company owns and owes, and a reason to believe the statement. In the United States the second one arrived by federal law in 1933 and 1934, which is exactly when the first textbook of the subject was published.
The two Acts, and the book written in the same year
- 1933The Securities ActGoverns the registration of securities when they are offered and sold. The obligation attaches to the offering.
- 1934The Securities Exchange ActCreates the Commission and the continuing reporting obligation. The annual and quarterly reports an analyst reads today descend from it.
- 1934Security AnalysisGraham and Dodd publish the first systematic textbook of the subject, written in the middle of the worst decade on record for US equities.
Why the balance sheet came first
A bond holder asks one question: if this goes wrong, what is there to pay me from. That question is answered by assets and claims, and it can be answered from a balance sheet without forecasting anything.
An equity holder's question, what will this business earn in future, cannot be answered that way. It needs a forecast, and a forecast needs a record to forecast from. In a market where a company might publish an annual statement or might not, where the statement might be audited or might not, and where there was no filing archive to compare it against, the forecast had almost nothing to stand on.
So the first method the tradition produced was a bond holder's method applied to shares. Count the assets, subtract every claim, and see what is left against the price. That is not a stylistic preference. It is the only question the available evidence could answer.
What the Acts actually changed
The 1933 Act governs the offering. The 1934 Act governs everything after it: registration of the security on an exchange, and periodic reporting from then on. Together they turned disclosure from something a company chose into something it owed.
The practical effect for an analyst is the one this product depends on. A figure can be traced to a specific document, filed on a specific date, by a named registrant, and that document can be compared against the one filed last year. Every lesson in this academy that names an accession number is spending the inheritance of 1934.
The conditions Graham and Dodd wrote in
The book appeared in 1934. The decade around it is the worst stretch in the record of US equity returns, and the authors were writing for people who had just watched the case for optimism fail in public.
That matters for reading them. A method built to survive that decade puts its weight on what can be counted now rather than on what might be earned later. When a later chapter of the tradition moves weight back towards future earnings, it is not correcting an error. It is answering a different question in a market with more evidence in it.
What this does not mean
It does not mean nobody valued businesses before 1934. Buyers of whole companies had always looked at earnings. It means that the public market for fractional interests lacked the standardised, dated, auditable record that makes a written method teachable, and that the method which emerged first is the one that needed the least of it.
Check yourself
Why did the first systematic method lean so heavily on the balance sheet?
- Because earnings are unimportant to an equity holder
- Because the balance sheet could be read without a forecast, and the record needed for a forecast was often missing
- Because balance sheets are audited and income statements are not
Show the answer
Answer: B.
A claim on assets can be assessed from what is reported now. A claim on future earnings needs a reliable history, which a market without mandatory reporting did not supply.Which Act created the continuing obligation to report periodically?
- The Securities Act of 1933
- The Securities Exchange Act of 1934
- Neither: periodic reporting has always been voluntary
Show the answer
Answer: B.
The 1933 Act governs the offering of securities. The 1934 Act created the Commission and the continuing reporting obligation behind the annual and quarterly filings.What does the year 1934 tell you about how to read Security Analysis?
- That its authors had access to a deep archive of comparable filings
- That it was written as the disclosure system was being built, in the decade its readers had just lost money in
- That its conclusions were about bonds only
Show the answer
Answer: B.
The book and the reporting system arrived together. A method written then has to work on thin evidence, which is part of why it counts assets before it forecasts earnings.Sources
- The Securities Act of 1933: registration of securities offered and sold.
- The Securities Exchange Act of 1934: the Commission, registration of securities on an exchange, and periodic reporting.
- Graham and Dodd, Security Analysis, 1934.
What this leaves out
- This lesson describes the disclosure framework and the publication date. It does not reconstruct what any individual analyst did before 1934, because that is not a record this academy holds.
- The worked example uses invented round numbers and is labelled illustrative.
- The disclosure framework described is the US one; other markets regulate disclosure under their own law.
- Nothing here is advice about any security.