# Ben Graham Instrinsic  Value Calculation



## darien44 (27 July 2021)

Looking for some insights guys in understanding how you go about calculating the IV for a stock. 

The modified Graham IV for a growth stock is the following:
IV= [EPS x (8.5+2g) x 4.4]/Y

Where g is the growth rate and Y the risk free rate. In the formula Graham uses 8.5 for a no growth stock. 4.4 was the yield on a triple A corporate bond when Graham was active.

Running this formula on a couple of stocks I hold I'm getting some implausibly high IVs.

Doing a bit more digging  I see some investors think the formula is too aggressive for the stock market today. They use 1g instead of 2g and replace the 8.5 to 7.

I guess what I really want to understand is the underlying logic of the formula. Firstly, why is a p/e of 8.5 the number for a hypothetical stock that does not grow? Secondly, how is the growth rate multiplied by 2 telling you anything meaningful?

Lastly I see many people keep the 4.4 in the formula today as a required rate of return when the risk free rate today is lower than when Graham was operating.
Thanks


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## divs4ever (27 July 2021)

well you can't rely of forecast earnings in the current climate  , nor should you assume benchmark interest rates  stay abnormally low  for a reasonable period  ( so what do you use for a risk-free rate .. 8% and hope you are close , perhaps  ?? )

 i have nothing against Ben Graham's formula  , but do ask if this is an appropriate time to apply it 


darien44 said:


> Running this formula on a couple of stocks I hold I'm getting some implausibly high IVs.




 that MIGHT be because they are implausibly over-valued  , i have DOZENS of stocks like that , some are lucky to have a CURRENT div. yield ( as opposed based on MY buying price ) of 1%  and yet folks are still buying them HOPING for growth in the mid-term 

 now IF your EPS  is based on historic results ( July 2020 to June 2021 ) that is going to spit out some wild figures as well 

 cheers


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## Value Collector (27 July 2021)

darien44 said:


> Looking for some insights guys in understanding how you go about calculating the IV for a stock.
> 
> The modified Graham IV for a growth stock is the following:
> IV= [EPS x (8.5+2g) x 4.4]/Y
> ...



I don’t think you can break this type of thing down into a formula.

Its been a while since I read security analysis, but I can’t remember Ben Graham using any complicated formula, his were pretty basic calculations from memory.

Before you even try to apply a valuation formula to a company you need to have a good understanding of the business.


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## darien44 (27 July 2021)

Value Collector said:


> I don’t think you can break this type of thing down into a formula.
> 
> Its been a while since I read security analysis, but I can’t remember Ben Graham using any complicated formula, his were pretty basic calculations from memory.
> 
> Before you even try to apply a valuation formula to a company you need to have a good understanding of the business.



I get the need to understand the business, but once that hurdle is overcome, how do you  go about calculating a range of fair value for which it makes sense to make an investment?


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## Value Collector (27 July 2021)

darien44 said:


> I get the need to understand the business, but once that hurdle is overcome, how do you  go about calculating a range of fair value for which it makes sense to make an investment?



The fair value range will be based on three main things.

1, what your personal required return is.
2, what your estimate is for the required return the market will want from this style of business.
3, what margin of safety you will attach to the business to protect you in the event your understanding of the economics is off.

Let me give you a simplified example, if there was a magic black box that produced a $100 note on the 1st of January every year, and it 100% guaranteed to  produce a $100 every year.

how much is that black box worth to you?

1, if your required return is 10%,  the black box is worth $1000 + you might be willing to pay an extra $90 if it’s close to the 1st of Jan and due to produce a $100 note soon, or it might only be worth $500 to you if you require a 20%, that’s 

2, if the market generally values these boxes based on a 5% return, then it should be worth $2000 to them. So if you believe the market will eventually offer $2000 for it, you might be willing to pay a little more eg $1500 knowing your cash return is less than your required 10%, but your return will probably be pushed above 10% by the $500 capital gain you believe will happen over the next couple of years once the market wakes up to this black box.

When I say understand the business, I mean really understand it, eg be able to estimate it’s earnings, what it’s likely dividends will be, how much profit it should be retaining, how much earning power these retained earnings should produce etc.

as I said the black box is a simplified example, in reality there is multiple levels, that need to be understood and estimated, it’s not suited to a one size fits all formula.

because let’s say that instead of paying out the $100 each year the black box retained it, and it earned 20% on the $100 notes it retained.

if you only required a 10% return you could pay a lot more for the box than $1000 knowing that the box was going to compound the retained money at 20%.


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## Value Collector (27 July 2021)

Check out post number 3006 in the FMG thread, you will see how I break things down and make my estimates





__





						FMG - Fortescue Metals
					

Latest recommendation report  Valuation: $7.70    Last updated: 24/08/20   Fortescue Rides Iron Ore Price to Strong Fiscal 2020, but Record Profits Unlikely to Last Investment rating Fortescue's accelerated development plans and unprecedented volume growth, fuelled predominantly by debt, saw the...




					www.aussiestockforums.com


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## divs4ever (27 July 2021)

Value Collector said:


> The fair value range will be based on three main things.
> 
> 1, what your personal required return is.
> 2, what your estimate is for the required return the market will want from this style of business.
> ...



but don't points 2 and 3  mean you really have to understand the business ( at least from one angle )

 take a real life angle  , i spent a while as a specialist cleaner ( needed security vetting ) now sometimes i am working  when there are no staff around  and sometimes staff are working  , so i can see work floor layouts , is the place a hodge-podge of add-ons , is it orderly and efficient , do they staff look content ( without appearing lazy  )

 meanwhile a different former boss had been in the past a forensic auditor  and  he at glance could see perks given ( rightfully or not ) etc etc etc  before his fingers touched the first set of books  , he had a good idea whether he was looking for a rogue (s ) or entrenched nepotism  before he sat down to crunch the figures

 so it is possible to have different perspectives of the same business


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## Value Collector (27 July 2021)

divs4ever said:


> but don't points 2 and 3  mean you really have to understand the business ( at least from one angle )
> 
> take a real life angle  , i spent a while as a specialist cleaner ( needed security vetting ) now sometimes i am working  when there are no staff around  and sometimes staff are working  , so i can see work floor layouts , is the place a hodge-podge of add-ons , is it orderly and efficient , do they staff look content ( without appearing lazy  )
> 
> ...




Thats my point, you have to understand the business and not just base your valuation on a 1 size fits all type formula.

After all Ben Graham himself said “Investment is most intelligent when it is most business like”.

You have to think like a businessman / businesswoman.

You should be asking the same questions when you buy a share as you would if you were buying part ownership in your local pizza shop of some other business.


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## darien44 (27 July 2021)

Value Collector said:


> The fair value range will be based on three main things.
> 
> 1, what your personal required return is.
> 2, what your estimate is for the required return the market will want from this style of business.
> ...



Thanks, I guess the message is that there are no shortcuts! I had the idea that all I would need to do is identify a wonderful business and then plug some numbers into a formula.
I will have a good read of the thread you referenced.


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## Value Collector (27 July 2021)

darien44 said:


> Thanks, I guess the message is that there are no shortcuts! I had the idea that all I would need to do is identify a wonderful business and then plug some numbers into a formula.
> I will have a good read of the thread you referenced.



The more companies you look at, and more experience you get, the faster you will get at identifying businesses that you can understand, and from there the process speeds up.

but yeah there is no shortcuts.

have listen to these four filters, the last one is the one that most of what I have said here relates to.


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## divs4ever (27 July 2021)

Value Collector said:


> You should be asking the same questions when you buy a share as you would if you were buying part ownership in your local pizza shop of some other business.



 i do , i look at the business ( business model as well  if available ) the sector  and geo-political risk  ( and have a black book of directors i try to avoid )

 the concept of refreshing management is something  i try to avoid , there is no guarantee the 'new broom' will sweep in the right corners


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