[2025–2026] Week 6: Benjamin Graham’s Security Analysis, Part 6
Reading assignment and questions for week 6 of the Value Investing Seminar
(Note: If you are just joining the seminar, please start by reading the Introduction)
Many of you have been curious about how to use AI for investing purposes, so I want to highlight an article that I just published, How AI Helps Me Combat Confirmation Bias (And Research Faster), where I do a deep dive into how I have integrated AI into my investing process and share all of the prompts that I use.
Shifting topics to Part 5 of Security Analysis, when thinking about the income statement, it is very important to remember that it is just an estimate. In the accrual system of accounting, we try to match the timing of revenues with the timing of the benefits received by customers and of the timing of costs with revenues. As a result, there is necessarily leeway for management to influence what we see as investors.
That’s not necessarily a bad thing – after all the goal is to present the investor with a close approximation of economic reality. However, it can be misleading either due to management’s intent to mislead or simply due to the natural ebb and flow of business.
When we bring the Balance Sheet and the Cash Flow statements into our analysis, we get a much more complete picture of how the business is doing. For example, consider a company with Net Income of $100 last year. How sustainable is it?
Well, in isolation, that’s a hard question to answer. Now consider two scenarios:
That company has Book Equity of $1,000
That company has Book Equity of $500
Now we can see that Company #1 has a Return On Equity (ROE) of 10% and Company #2 a ROE of 20%. The typical public company has a ROE of around 10%, close to its cost of equity. The 20% ROE might be a sign that Company #2 is enjoying a temporary boom in profits that is not sustainable. Or it could be a superior business that has earned those returns. At the very least it gives you, as the analyst, something material to investigate.
The point is that bringing the Balance Sheet into our analysis is akin to looking at the world in 3D rather than 2D – you are going to notice much more depth.
I can’t do the topic of analyzing financial statements justice in these pages, so if you want to dive into this deeper, I highly recommend Howard Schilit’s Financial Shenanigans. You will be amazed at how creative management can get with financial manipulation.
Regarding Question 1 Alan wrote: “Graham highlights several issues with relying solely on earnings for assessing a business. The first is that changes in earnings are more volatile than changes in the balance sheet and so without caution can lead to exaggeration in the companies performance. His second point is that earnings are easier to manipulate than the balance sheet. Thirdly he highlights that an important piece of information is the level of earnings that the assets generate.
The less capital a business requires the less important the balance sheet is. However the implication of Grahams framework is that capital light businesses are more likely to have manipulated earnings and/or unstable earnings and so you should be less certain of the earnings. The introduction of cashflow statements since 1939 can help to reduce this issue. At the opposite end of the spectrum are banks which have big balance sheets, in these cases the balances sheets should be more of a focus”
Regarding Question 2 Navin wrote: “Benjamin Graham, in Security Analysis, warned that income statements can be misleading due to non-recurring items, subsidiary and affiliate accounting, and manipulation of reserves and surplus.
Analysts to adjust for these distortions via
• Adjust earnings to exclude one-time or exceptional items for a clearer view of recurring profitability.
• Analyze subsidiary contributions separately to assess core operational performance.
• Monitor changes in reserves over time to identify potential earnings management.
• Validate reported profits by reconciling them with cash flow statements and balance sheet data.”
Regarding Question 4 James wrote: “Graham says “Quantitative data are useful only to the extent that they are supported by a qualitative survey of the enterprise” and he italicises it for emphasis. He says that normally a long record of consistent earnings is enough, but there are plenty of exceptions, such as mining companies running out of good quality ore in its mines, or an exceptionally good or bad period of trading for the economy as a whole. The analyst must not work blindly on the figures alone. A historical average fails to take into account a trend, and it can be manipulated by picking the right starting and end points.”
Regarding Question 5 Peter wrote: “Graham’s rule to not pay more than 20x average earnings was more about discipline than drawing a line in the sand. Valuation is not prediction, but protection. Exact P/E threshold may change with the times and interest rates, but the underlying intent remains the same. Anchor valuation to proven earning power and demand a margin of safety.”
Week 6 assignment is to read Part 6 of Security Analysis and answer the following questions:
Question 1: What are the useful features of using book value as a valuation metric? What are its limitations?
Question 2: When does Graham believe book value to be of practical use to the security analyst? What do you think about that in the modern context?
Question 3: Describe how Graham approaches calculating a company’s liquidation value.
Question 4: Perform Graham’s liquidation analysis for two stocks trading below tangible book value and show all work/assumptions.
Question 5: What are some ways in which you can lose money by investing in a stock below its liquidation value?
Question 6: What is the importance of management when considering stocks that are selling below their liquidation value?
Question 7: Can you find a company that is currently trading at a sufficiently large discount to its liquidation value that if Graham were looking at it today, he would find it an attractive investment? If you can, show your work for why it’s attractive and justify your assumptions.
Question 8: Can you think of a useful AI prompt based on the material in part 6?
Now it’s your turn:
Submit your answers in the comments below this article with all your answers in a single comment. I will engage with some of the answers each week and highlight some of the ones I find most insightful in next week’s seminar assignment article.
Engage with the answers of some of your fellow seminar members in the comments below. Remember – the goal is to learn together. Be kind, be respectful and try to add to our learning as a community.
Feel free to ask any questions about the reading in your comment.
Until next week,
Gary
About the author
Gary Mishuris, CFA is the Managing Partner and Chief Investment Officer of Silver Ring Value Partners, an investment firm that seeks to apply its intrinsic value approach to safely compound capital over the long-term. He also teaches the Value Investing Seminar at the F.W. Olin Graduate School of Business.
Question 1:
The only recommendation Graham makes with regards to using book value as a valuation metric is that the purchaser ensures that they understand if they are satisfied with any discount/premium they are paying. He arrives at this conclusion by considering two contradictory models for how book value affects price, he sees both models as equally valid, so he cannot make any more concrete recommendations. The first model is that if a company is trading a significant multiple to it’s book value then this implies high returns from cash invested which attracts competition lowering future returns. The other model is that the premium is justified by an intangible that isn’t recognised in the book value and cannot simply be bought for cash by a competitor.
Question 2:
Graham describe several derivatives of book value (Current Asset Value, Cash Asset Value and Liquidation Value) that are useful approximations of what a business could be sold for if it stopped trading, the assets were sold and liabilities cleared. If a company is trading at a price below book value then it can be purchased and either liquidated, sold to a trade buyer, held until trading improves (knowing there is a floor to the realisable value) or some combination of all three. There are risks associated with this approach which are highlighted in the answer to question 5&6. These opportunities don’t exist to the same extent as when the book was written. I believe this is because there is a greater awareness of this strategy and the strategies that can be used to correct the valuation.
I believe this was down to early private equity that bought companies in this position and took them private so they could the actions highlighted and return them to the market at a higher price. Activist shareholders also contribute to this by buying stakes in companies and exerting their ownership rights to effect change.
Question 3:
Graham applies two general principles for calculating liquidation value. The first principle is that liabilities are valued at book value and assets at less than book value. Secondly the reduction in asset values is related to the type of asset with cash being the only asset valued at book value. Grahams suggested liquidation values as a percentage of reported values are:
Cash - 100%
Receivables - 75-90%
Inventories - 50-75%
Fixed Assets - 1-50%
Graham provides a range of percentages, which is an important reminder that these values are not guaranteed and that the judgement of the analyst is an important factor.
Question 4:
Stock 1 - TST.L Touchstar PLC
At June 2025
Total Liabilities - £3.5M
Cash - £2M
Receivables - £1.7M
Inventories - £0.9M
Fixed Assets - £0.1M
Right of Use Assets - £0.6M
Liquidation value (Low) = 2+1.7*0.75+0.9*0.5+0.6-3.5 = £0.8M
Liquidation value (High) = 2+1.7*0.9+0.9*0.75+0.6-3.5 = £1.3M
Market Cap £6M
I have included the Right of Use Assets at full value as these have an approximately matching liability, the company could negotiate a break in the lease.
I’ve run out of time to analyse a second company
Question 5:
In order for an investment of this type to be profitable either the earnings prospects must improve and/or assets be sold off above liquidation value. Therefore if a company continues to make substantial losses and does not liquidate/sell assets then the value of the company would continue to decline. Even if the company takes the correct actions, if it does do so quickly enough the investor can still lose money as the book value will have declined further.
Question 6:
Management is critical to the successful investment of a stock trading below liquidation value. With the exception of an industry declining for exogenous reason everything else depends on the quick actions of management. Management is responsible for liquidating assets, identify assets that can be sold and turning around failing operations.
Question 7:
I used a stock screener to filter for LSE listed stocks with a Price/Tangible Book Value between 0 and 1. This returned 48 stocks out of the 1746 listed on the exchange, less than 3% of stocks. Filtering out stocks with a market cap of less than £10,000,000 and those linked to countries that are un-investable, for example Russia, the number of stocks reduce to 34. Removing stock for jurisdictions that I would need to research further before deciding it to invest or not reduces the number to 25. Of the 25 I put them in groups that require different techniques for analysis:
- Asset Managers - 11
- Banks - 5 -
- Real Estate - 2
- Operating Company - 7
Banks, Asset Managers and Real Estate all hold bonds, cash, equities, properties and so the soundness of these assets would need assessing. If the assets are not liquid their value and salability would need to be determined independently. Operating companies would be assessed as outlined by Graham. Digging further into these companies 2 operate in uninvestible countries and 1 is a closed end fund. The remaining companies all appear to be due to a calculation issues in the source I’m using.
Question 8:
LLM will not reliably calculate data for you, however there is a work around….
These instruction use Gemini 2.5 Pro with Canvas selected.
Create a csv file with the following contents:
Company Name,Total Liabilities,Cash,Receivables,Inventories,Fixed Assets,Right of Use Assets
Touchstar PLC,3500000,2000000,1700000,900000,100000,600000
Attach the csv you just created to the query and type the following:
‘Attached is a csv of company financial data, each row represents one company. Row one is a list of column names. I need to calculate a liquidation value for each company. The Liquidation value = Cash + Receivables*0.75 + Inventories *0.5 + Fixed Assets * 0.01 + Right of Use Assets - Total Liabilities. I would like you to output the liquidation value for each company.’
Once the query has run hit ‘Export To Colab’, which will open another window. In the new window click Connect, open Files and Upload the csv created above. Finally hit ‘Run All’ and a file with the calculated values will appear in the file viewer.
Question 1:
Book value can still be useful because it gives you a rough idea of what the company has built up on its balance sheet over time. It is simple, audited, and doesn’t swing around like earnings. It also helps you notice when the market price looks unusually low compared to the company’s net assets. The problem is that book value can be misleading. Some assets may not be worth what they’re carried for, and in many modern businesses the real value is not on the balance sheet at all. Book value works better for companies with real, tangible assets and less well for asset-light companies.
Question 2:
Graham thought book value is practical mainly when you are dealing with companies where the assets are actually tangible and could be sold at some reasonable fraction of their value. He used it most when the stock was trading far below that number, giving a margin of safety. Today, that still holds in industries like shipping, real estate, and some industrial companies. For software or brand-driven companies, book value tells you very little. So the principle still applies, but the number of places where it works is much more limited now.
Question 3:
Graham’s liquidation process is basically a very conservative mark-to-reality exercise. He takes the balance sheet and applies heavy haircuts to most asset categories. Cash stays at full value. Receivables get discounted. Inventory is marked down a lot. Other current assets get cut in half. Fixed assets are marked way down because they usually don’t sell anywhere close to book value in a forced situation. Intangibles are left out. Then he subtracts all liabilities. The goal is simply to make sure the investor is protected even if things go badly.
Question 4: Liquidation Analysis for Two Stocks Below Tangible Book Value
Below are the updated calculations using QuickFS TTM numbers.
ZIM
Inputs
Cash 1314.7
Short-term investments 800.4
Receivables 908.5
Inventories 212.2
Other current assets 25.1
Net PPE 6844
Other long-term assets 68.5
Total liabilities 7346.8
Haircuts applied
Cash 1314.7
Short-term investments 800.4
Receivables at 80 percent 726.8
Inventories at 66 percent 140.1
Other current assets at 50 percent 12.6
PPE at 15 percent 1026.6
Other long-term assets at 10 percent 6.9
Total adjusted assets
4028.1 million
Subtract liabilities
4028.1 minus 7346.8 = about negative 3319 million
Conclusion
Even though ZIM trades below tangible book, it fails the Graham liquidation test. The main reason is that vessels do not hold their book value in a forced sale.
GSL
Inputs
Cash 141.375
Short-term investments 26.15
Receivables 12.843
Inventories 18.905
Other current assets 101.969
Net PPE 1903.274
Other long-term assets 168.729
Total liabilities 909.764
Haircuts applied
Cash 141.38
Short-term investments 26.15
Receivables at 80 percent 10.27
Inventories at 66 percent 12.48
Other current assets at 50 percent 50.98
PPE at 15 percent 285.49
Other long-term assets at 10 percent 16.87
Total adjusted assets
543.62 million
Subtract liabilities
543.62 minus 909.764 = about negative 366 million
Conclusion
Like ZIM, GSL also fails the liquidation test. The discounted value of the fleet is well below the liabilities.
Question 5:
You can lose money buying below liquidation value in a few ways. The assets might not sell for the amounts you assumed. The company might burn cash while you wait. Management might make decisions that reduce asset value. Or the catalyst you are counting on may never show up. Liquidation value is only helpful if the gap eventually closes.
Question 6:
Management matters a lot here. If the business is trading below liquidation value, you need people in charge who will act in a shareholder-friendly way, not ignore the discount. Poor management can waste the margin of safety or drag things out so long that the assets deteriorate. Good management can help the value surface.
Question 7:
For the two companies I looked at, ZIM and GSL, both initially seemed interesting because they were trading below tangible book. That is the type of situation that usually gets attention in a Graham screen. But once I pulled the full QuickFS data and applied the haircut method, both ended up with negative liquidation values. Almost all their book value sits in vessels, and in an actual forced sale those would not come close to book value. So under Graham’s strict liquidation rules, they are not attractive. They might still make sense on earnings power or replacement cost, but not on liquidation value alone.
Question 8:
A helpful AI prompt based on Part 6 would be something like:
“Using the company’s most recent balance sheet, apply conservative Graham-style haircuts to each asset category, remove intangibles, subtract all liabilities, and calculate liquidation value per share. Then explain whether any margin of safety exists. reasoning_effort = high.”