Financial markets are far different today than the markets were in 1949 when Benjamin Graham wrote The Intelligent Investor.
Here are his 11 rules for investors and analysts:
Rules for Appraising Stocks
1. As a preliminary to calculating value, estimate the company’s earning ability, multiply appropriately and adjust for the value of assets.
2. Earning power is an estimate of the company’s earnings over a five-year horizon.
3. Estimate a company’s average earnings over this five-year horizon by averaging good and bad prior years, then projecting revenues and margins into the future.
4. Adjust prior years’ figures to reflect any capitalization changes in the company.
5. Use a minimum multiplier of eight and a maximum of 20. The multiplier allows for earnings changes over the long term.
6. If the value calculated on the basis of earning power is greater than the value of tangible assets, deduct from the earnings value appraisal. “Our suggested factor is as follows: Deduct one-quarter of the amount by which the earning-power value exceeds twice the asset value. (This permits a 100% premium over tangible assets without penalty.)”
7. If the valuation based on earnings power is less than the value of net current assets, add 50% of the difference to the value calculated on earning power.
8. In unusual circumstances, such as those related to war, rentals or short-lived royalties, adjust the appraised value accordingly.
9. Allocate value among stockholders and bondholders or preferred stockholders. Before taking this step, calculate the enterprise value as if its capital structure consisted only of common stock. 10. The more aggressive the capital structure is (that is, the more debt and preferred stock in proportion to common stock), the less reliable the appraised value will be.
11. When a stock’s appraisal is a third higher or lower than its current market value, that can be the basis for a decision to buy or sell. When the differential is less, the appraisal is merely another fact to consider in the analysis.