COMMON STOCKS AND uSAFETY OF PRINCIPAL"

WRITERS ON INVESTMENT theory and practice seem to be almost universally agreed on the fact that one of the crucial general tests of investment quality is "safety of principal." For instance, in their outstanding work on investment analysis, Graham and Dodd make "safety of principal" an essential element in their definition of an investment commitment; the proposition is advanced that unless a commitment to securities promises such safety it is not an investment but must be relegated to the rather dubious category of a "speculation.?' In view of the importance thus attached to "safety of principal," it might be expected that something very precise and distinct would be implied by this incontestably desirable attribute. However, one finds that the usual discussion of the safety concept does not lead to sharply defined conclusions that may be applied to specific investment decisions. This is true to some extent in the treatment of fixed income securities, but there is an especial lack of distinct implications in the field of common stocks. In this article it is intended that attention will be concentrated on three major questions involved in the appraisal of common stocks relative to their safety elements. First, should a distinction be drawn between "safety of principal" and "recoverability of principal"? If there is such a distinction, what is the relationship between volatility of market price and safety? Second, is it always necessary to diversify commitments to common stocks in order to obtain even a modicum of safety? If so, why is it that a commitment to a single common stock does not have the "safety" essential to classify it as an investment? Third, should "safety of principal" be interpreted mainly in the light of dollar values or should greater specific emphasis be placed on so-called ureal" values when this concept is discussed as a measure of investment quality? Some of these questions have been discussed by investment authorities under various topical headings, but to my knowledge they have never been specifically considered as a whole when the focus of attenton was on "safety of principal" as a general test of investment quality.