Security Analysis Learnings - Bond Selection in Indian Context

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In this post, I'll try to summarise my learnings from the Security Analysis book by Benjamin Graham and David L. Dodd. In addition to the learnings, I'll try to fit the examples of the Indian bonds related to the content.

So the book gives us five principles to guide our investments in bonds. But before that, it is important to understand what is a bond and how you can buy them. I've posted few useful links below for the same. People generally prefer bonds because they give more interest income than savings accounts interest and FDs of any bank but they do get a little riskier going up the yield. I know HDFC bank gives around 3.4% annual interest rate on savings account and FD gives around 5-6% (currently). But, on the other hand, bonds can give you interest up to 13% annually.

(Picture was taken from GoldenPi. These are current bonds listed there with the highest yield)


But to bring you to the other side of the picture as well, high yield bonds are also notorious for defaults. -The Indian corporate bond market: From the IL&FS default to the pandemic



1. All things kept equal, a Bond is an investment of limited return i.e. you get coupon payments for the money you paid to the issuer for the bond. Hence, the book says, that we should look for investments in those bonds where we have a low risk of default rather than better returns. Chief emphasis should be on avoidance of loss. So, Good enterprise paying decent return>> bad enterprise high return

ICICI Bonds >> Dewan Housing Finance Bonds

  • Lien is no Guarantee against the shrinkage of values- If you have first lien bond in a bad company then it wouldn't make a difference because when the company will default bondholders generally get nothing. So, here, it wouldn't matter if you have a first lien or subordinate bondholder of the same company. Both of them are bad investments
  • Another point here is that, suppose you have the first lien and that is covered by a secured asset then if the company goes bankrupt then the value of that asset, as seen from experience, also goes down and you won't be able to get the full value of your invested capital if the asset is liquidated
  • If let's say, the value of the asset does not fall down in the case of bankruptcy then there are so many delays that are there to liquidate the covered asset that you will not be compensated enough for the money you invested. 
  • If the asset itself is valuable and covers the debt amount appropriately then the company itself wouldn't let go of that asset so easily, it will lead to long-run cases with the company and in the end, the asset value will go down.
  • So the best situation is to completely ignore the bad company (or the trouble)
  • If you do want to invest in high yielding bonds then it makes sense to buy subordinate lien in a good company (which covers the interest to be paid sufficiently) only if they offer a substantial advantage to the first lien.



2. Bonds should be bought after checking the performance and interest coverage of a company in a depression/recession. 

  • No industry is depression/recession-proof so it is advisable to look for companies that are stable by inherent nature. (That would be chemical companies, Government institutions, etc.) 
  • Performance of the bond or the company during the depression should be taken as the litmus test
  • Some of the various causes of the bond collapse listed by the book are
    • An excessive funded debt of companies - If companies have taken a huge amount of debt then stay away
    • Stability of earnings should not be taken for granted - Some of the companies in the past looked very good in the prosperous times and they offered low yielded bonds as their earnings were presumed to be stable (as seen from the light of prosperous years). But only one bad earnings decreased the value of those bonds significantly. I think all of us are aware of the IL&FS fiasco. It was said that the company is very stable as it is funded by the government but ultimately it defaulted on coupon payments (Link).
  • You should not invest at all if you don't see any bonds of good companies, rather than selecting the best out of the available lot.
3. It is not rational to ignore the safety of principle for high yield.
  • This point does not mean that high yielding bonds are not safe. Opportunities may arise for an investor to get a safe bond with a good yield. The prices of the security are not only dependent on the risk involved but also on the popularity of the issues. Popular issues are traded at a premium and it is possible to get unpopular issues with the same level of safety at a discount. 
  • Always prefer the bond where the initial investment is less give the yield is the same. For e.g., if you have two options, one bond trading at discount with a low coupon rate but the yield of 10% and the other with a high coupon rate trading at a premium and having the same yield of 10%, then always prefer the bond where your capital investment is low i.e. the first one.
  • Some may argue that high coupons will somehow cover up the loss of principle (if it happens) if the bond defaults. But then the argument shifts to when will the default happen. If you get enough coupons to get the assurance of the safety of initial investment then you may get profit overall but the thing is we don't know if it will the case every time and the idea of due diligence is to remove the factor of luck from your rational investments


(The two pictures above show that the yields of both the bonds are nearly the same but one is trading at a discount and the other at a premium. Assuming both the bonds ensure the safety of the principle then, as per the author, we should select the bond trading at a discount i.e. 1st pic)

4. Investor should come up with definite standards to ensure the safety of the investment
  • The author specifies general criteria as a checklist for investment as listed below
    • The nature and location of the business - Whether the business is cyclical/steady, the cash flows can be predicted with greater confidence, etc. The author mentions that there are some industries/sectors that are not popular and that is where you can get the best opportunity to invest. So look for industries not preferred by the general public and pick the bond that ensures safety and gives the best yield
    • The size of the enterprise - The author specifies the minimum requirement of the size for some industries which are not applicable now and in the Indian context but the main point highlighted here is that the investor should exclude small enterprises as their earning power can not be estimated with a good degree of confidence.
    • The terms of the issue
    • The historical record of any solvency of the company or defaults. (If you check the list of bonds available you'll see India Bulls housing finance bonds being traded on the exchange. The author warns investors to invest in such issues where the company previously has defaulted on its payments)
    • How much more the company is earning w.r.t the interest payments requirements
    • The value of the property pledged (in some cases discussed later)
    • Stock Capitalization of the company related to the issue size

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