TITLE : SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT. 4TH ED

PREFACE

This book is about investing in securities. It is aimed at providing a comprehensive introduction to the areas of security analysis and portfolio management. The text approaches investing as a rational decision-making process in which the investor attempts to select a package or portfolio of securities that meets a predetermined set of goals. These investor goals are usually expressed in terms of return and the degree of uncertainty about the return or risk. More return is desirable; more uncertainty or risk is undesirable.

Special attention has been directed throughout to clarity of exposition. We have tried to make the contents as readable, understandable, and nonmathematical as possible. Only simple algebra and some elementary statistics are used in the book. For those who dread mathematics, even the algebra and the statistics are explained in lay terms.

In the past several decades the fields of security analysis and portfolio management have changed from a completely descriptive institutional body of literature to a highly formalized quantitative area of study. We have attempted to blend the best and most relevant pieces from the evolving field of endeavor into a meaningful, cohesive framework of analysis that would be of interest to the student of business and finance, the practitioner in the field, and the informed investor.

The text starts with the premise that the reader has no knowledge of investments but some knowledge of economics and accounting. As such, it should serve for an introductory course in investment analysis at either the undergraduate or graduate level. The material builds in difficulty as the chapters progress. The text is designed to be followed as presented; however, some users will prefer to cover Chapters 16 to 22 early in the course. This can be done without loss in continuity. All chapters end with comprehensive questions and/or problems that apply the material presented in the chapter.

An innovation of this work is the inclusion of a comprehensive continuing illustration of the application of the techniques of security analysis and portfolio management to a real stock and a real portfolio. Each chapter that presents tools of analysis includes an application of the tools to the food service industry and to McDonald's (Corperation. This permits the reader to see the transference of explicated theory to a tangible real-life situation.

The book is divided into seven parts. Part I, The Investment Environment, contains three chapters. Chapter 1 surveys alternative investment vehicles, their more salient attributes, and the relative supply and demand for these investment types in the recent past. The functioning of major securities markets, or how an investor goes about buying and selling particular security types, is also examined (Chapter 2). Finally, the impact of differential taxes and transaction costs is explored, for these costs are a very real part of the investment decision (Chapter 3).

Part II, Framework of Risk Return, sets forth in detail the theoretical tenets and practical dimensions of how security prices are determined and the manner in which returns are measured (Chapter 4). Equally important, we develop the notion of risk, what creates it, and techniques for stating risk in explicit quantitative terms (Chapter 5).

In Part III, Common-Stock Analysis, a detailed systematic approach to estimating future dividends and prices for common stocks is developed. The framework for the approach is an economic-industry-company analysis. The strong link between economic activity and security prices requires that the investor forecast the direction and degree of change in economic activity (Chapter 6). Key sectors of overall economic activity influence particular industries in different ways; the investor must link forecasts of economic activity to the prediction of relative movements in specific industries and analysis of selected industries (Chapter 7). From the industry level to the level of individual companies, the investor must examine and analyze factors that influence earnings, dividends, and stock prices of companies (Chapters 8-10).

Bonds and preferred stocks represent less exciting, but, nonetheless, important alternatives to common-stock investing. The systematic sources of risk affecting bonds, particularly inflation, and changes in the level and structure of interest rates, are key areas in bond analysis that are examined first (Chapter 11). In addition, unsystematic risk and other nonrisk factors that influence required yields on bonds are explored in depth (Chapter 12). The final chapter in Part IV, Bond Analysis, probes specific passive and active strategies used to manage bond portfolios.

The chapters (14 and 15) in Part V, Options and Futures, examine various forms of security options and futures that might be purchased or sold. These options and futures represent rights to underlying common shares as well as fixed-income securities.

The approach detailed in Parts 111 and IV is best described as fundamental analysis. Considerations of economic-industry-company analysis are linked in order to reach considered estimates of return and risk on individual securities. In Part Vl we also develop the rationale and explore the methods employed by so-called technical analysis (Chapter 16). This approach concentrates on supply and demand relationships in the market and on historical price and volume relationships to predict the movement of the market as well as the movement of prices of individual securities. The last segment of Part Vl is devoted to the idea of efficient markets and the theory of random walk. The efficient markets notion questions the validity of technical analysis and also raises some questions about fundamental analysis (Chapter 17).

The risk-return output of security analysis is the raw material for portfolio management. Part Vll, Portfolio Analysis, Selection, and Management, deals systematically with the procedures involved in portfolio management. Using modern methods for analyzing portfolios and packaging securities in such a way as to achieve diversification of risk is the first task to be accomplished (Chapter 18). The selection of the one best portfolio from those available to the investor is stage two of portfolio management (Chapter 19). Chapter 20 introduces capital market theory and extends the idea of diversification to include international securities. Following the analysis and selection of a portfolio, the investor must be attentive to revising it as economic conditions and the prospects for individual securities change (Chapter 21). The final chapter in the text (Chapter 22) explores the ways in which an investor might place his funds in the hands of professionals for management, and how portfolios managed individually, or by others, might be evaluated for performance over time.

This edition of the text has some significant revisions that are worth noting:

1. A more complete integration of the use of the food service industry and McDonald's Corporation throughout the text.

2. New material on arbitrage pricing theory and stock index futures.

3. The latest developments in taxation and accounting which are relevant to securities analysis and investing.

4. Expanded material on international diversification to include international fixed-income securities.

5. Integrating cases placed throughout the text. These can be assigned to help students deal with real-world situations.

The authors are both pleased and honored that this text has been chosen to be a centerpiece in the education and certification activities of the Security Analysts Association of Japan (SAAJ). Mr. Gentaro Yura, Executive Managing Director of SAAJ, has provided strong support for the translation of this book into Japanese. The Japanese translation and publication of this text were made possible through the diligent efforts of an outstanding translation team headed by Professor Hidefumi Tsumura of Senshu University. The authors also owe a special debt to Mr. Hitoshi Shibuya, whose considerable energy and endearing enthusiasm served to launch the project and move it forward.

In the preparation of this Fourth Edition, the authors benefited from the counsel of several people. We are especially grateful to Richard McEnally, of the University of North Carolina, for his valuable advice and encouragement. A number of practitioners have provided especially useful information and suggestions: David Marks,

CIGNA Corp.; David Dunford, Travelers Investment Management Company; Kenneth Lynch, Travelers Corp.; John L. Maginn, Mutual of Omaha; Thomas Hylinski, Peoples Bank; and Michael Porreca, Aetna Life and Casualty Co. We are grateful to the Institute of Chartered Financial Analysts, especially Alfred C. Morley, President, and Darwin M. Bayston, Vice-President, for permission to use certain questions and problems appearing on the annual examinations for the designation of Chartered Financial Analyst (CFA). We would also like to thank the following reviewers for their help: Dr. Carl F. Luft, DePaul University; Dr. Chantee Lewis, Bryant College; Paul G. Fellows, University of Utah; and William P. Dukes, Texas Tech University.

Donald E. Fischer Stamford, Connecticut

Ronald J. Jordan West Hartford, Connecticut