I am reading The Intelligent Investor, and the follow quote doesn't make total sense to me:

An industrial company’s finances are not conservative unless the common stock (at book value) represents at least half of the total capitalization, including all bank debt. For a railroad or public utility the figure should be at least 30%

First, I don't get what "common stock (at book value)" means. I know what common stock is, and I know what book value is. But what does the phrase "common stock at book value" mean?

Second, he talks about 'total capitalization'. I wasn't sure exactly what that was, and looked it up. Is this article the correct definition in context with this excerpt?

Market Capitalization

Another aspect of capitalization refers to the company's capital structure. Capitalization can refer to the book value of capital, which is the sum of a company's long-term debt, stock, and retained earnings.

The alternative to the book value is the market value. The market value of capital depends on the price of the company's stock. It is calculated by multiplying the price of the company’s shares by the number of shares outstanding in the market. If the total number of shares outstanding is 1 billion and the stock is currently priced at $10, the market capitalization is $10 billion. Companies with a high market capitalization are referred to as large caps; companies with medium market capitalization are referred to as mid caps; and companies with small capitalization are referred to as small caps.

It is possible to be overcapitalized or undercapitalized. Overcapitalization occurs when earnings are not enough to cover the cost of capital such as interest payments to bondholders, or dividend payments to shareholders. Undercapitalization occurs when there's no need for outside capital because profits are high and earnings were underestimated.

Source: Capitalization on Investopedia

If you want to see the full context of the section, it is page 122 of this version of The Intelligent Investor: https://www.e-reading.club/bookreader.php/133361/The_Intelligent_Investor.pdf

Thanks in advanced for any input!

  • Your reference to Capitalization on Investopedia mentions two uses of the term; I've included a quote from the one that's applicable to your question (plus reproduced their links to two of the terms it uses). Please edit if this has changed your original intention. – TripeHound Jul 18 '19 at 8:34

When people use non-standard terms to refer to pretty standard concepts, they are likely looking to appear as the sole authority on the topic, rather than one of many sources you could be learning from.. Using standardized terms reduces the above to the following:

"An industrial company should have a debt:equity ratio of 1:1 or less."

ie: They should be funded by, at most, 50% debt, with the remaining financing having come from equity (shares).

It seems this book in particular is 70+ years old, meaning the wording choice may have been standard at the time. This just raises the issue that using rules of thumb at all can be misguided, but using them from nearly a century ago, is likely even worse (e.g. considering Railroads a noteworthy category of 'industry').

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  • okay, so when you say "They should be funded by, at most, 50% debt", is that of book value? So if a company has a book value of $1 million, then by Graham's rules, they shouldn't have more than $500 thousand in debt to be considered conservative. Am I getting this right? – Addison Jul 18 '19 at 11:18
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    @Addison Correct. If no one clarifies, the general assumption on these ratios is that you would use the accounting (aka 'book') values present on the financial statements. – Grade 'Eh' Bacon Jul 18 '19 at 12:40
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    I don't like the first sentence in your answer.... Couldn't it just be that between the author writing the book (1949), and the OP asking the question (70 years later) the commonality of the terms significantly changed ? (Also as a side note, there weren't too many other sources at the time) – xyious Jul 18 '19 at 15:54
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    @xyious Okay if that's written 70 years ago, that definately makes sense. Also creates a problem of trying to use 'rules of thumb' from 3 generations ago, but I'll edit my answer to discuss. – Grade 'Eh' Bacon Jul 18 '19 at 21:06
  • Not just railroads. Debt was king. After all, a bond pays regular income (as long as the company remains liquid), while common stock isn't required to pay dividends, although good companies (meaning public utilities) pay high dividends regularly. Common stock that doesn't pay dividends is useless. Nevertheless, it's a good read, and quite useful; the techniques for analyzing the ongoing value of a company are clearly explained, and still applicable. – Pete Becker Jul 19 '19 at 12:48

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