Research Articles

Ben Graham's Stock Valuing Formula: It Really Works

Julie C - Wednesday, February 09, 2011

Ben Graham’s famed formula for valuing a stock works in the real world!

V* = EPS x (8.5 + 2g)

Ten Real World examples of companies growing between zero and 5%

These ten examples are based on our article: "A primer on valuation: Testing the Wisdom of Ben Graham's Formula" (part one) published on 2/08/2011. These represent just a few examples of many we could provide. Ben’s formula works because it is sound.

The orange line on each logarithmic below represents earnings multiplied by Ben Graham's formula. As you review each note how the black price line tracks and correlates to Ben Graham's calculation of intrinsic value. In some cases, the correlation is almost perfect. In other examples, such as Boeing Co. (BA), there is more deviation between price and intrinsic value, which is due to the cyclical nature of this aerospace industrial. Yet even with (BA), the stock price inevitably moves to Ben's valuation. However, in all cases, the validity of Ben Graham's formula is verified.

When reviewing the performance calculations for each example, notice how the closing annualized rate of return (the capital appreciation component) closely correlates with earnings growth. Any difference between earnings growth in the closing annualized rate of return can be explained by valuation anomalies. But essentially, long-term shareholder returns are functionally related to the earnings growth the company achieves. Anomalies can be explained by valuation anomalies, for example, if starting valuation is low and ending valuation is high then the closing annualized rate of return will be higher than growth rate and vice versa.

Boeing Co. (BA)

Click to Enlarge

Briggs & Stratton (BGG)

Click to Enlarge

Convergys Corp. (CVG)

Click to Enlarge

Ennis Inc. (EBF)

Click to Enlarge

FMC Corp. (FMC)

Click to Enlarge

Nisource Inc. (NI)

Click to Enlarge

Northrop Grumman Corp. (NOC)

Click to Enlarge

Newell Rubbermaid Inc. (NWL)

Click to Enlarge

Scana Corp. (SCG)

Click to Enlarge

Integrys Energy Group Inc. (TEG)

Click to Enlarge

Conclusions

Ben Graham's formula works for low growth companies (earnings growth between zero and 5%) because it is based on sound principles of business and economics. As a general statement, when you purchase a company when the price is in line with its intrinsic value, your earnings yield rewards you for the risk you take. When you overpay for a company, your earnings yield is inadequate, and therefore, your risk is too high and your future returns less. If you underpay, the opposite is true; your risk is lower because you now enjoy a margin of safety, and your long-term returns will be enhanced. Lower risk and higher returns is ultimately what Ben Graham was all about.

Disclosure: I am long SCG.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

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“About Chuck's F.A.S.T. Graphs™: They are invaluable to me in making decisions about the stocks I own (in addition to what you are saying about doing other research) and the ones I hope to own in the future.”


"Chuck -- Your proprietary F.A.S.T. Graphs™ are a VERY impressive tool!"


“If there were an Investor Hall of Fame for people who have helped others with their investing, and sharing valuable information, you and your F.A.S.T. Graphs™ would get one of my selections.”


“I love Chuck's F.A.S.T. Graphs™! Well worth the price of admission for what he gives you.”


"Chuck - Thank you for your well thought out articles. I tend to be a visual type of person so I really appreciate the F.A.S.T. Graphs™ approach."


"Great article, as always! I always look forward to your articles, and am especially eagerly awaiting your next in this series. I find the F.A.S.T. Graphs™ extremely helpful."


“Your F.A.S.T. Graphs™ put all of this in a single artful picture and the accompanying spreadsheets hammer home the point.”


“I use the F.A.S.T. Graphs™ method to evaluate all of my ideas. I recommend it for individual investors, since it helps them focus on data and get past the many emotional arguments.”


“I recently subscribed to the F.A.S.T. Graphs™, and these articles are helping me learn how to better use them. They really do give you a good quick look at the valuations picture. A much needed tool!”


“I also always appreciate the clear-cut information provided through your F.A.S.T. Graphs™ and articles.”


“Thanks, Chuck, for your F.A.S.T. Graphs™. Each of these graphs is worth 1,000 words in describing a company's growth, consistency and valuation. Thanks for sharing your graphs.”


“Thanks, Chuck. Love the F.A.S.T. Graphs™! It makes investing so much more clear.”


“Chuck's F.A.S.T. Graphs™: They are invaluable to me in making decisions about the stocks I own (in addition to what you are saying about doing other research) and the ones I hope to own in the future.”


”I am amazed at the usefulness of your F.A.S.T. Graphs™ and I plan on using them for a long time to come.”


“Chuck's F.A.S.T. Graphs™ will give you a tool to find those well chosen stocks...”


“Thanks for the F.A.S.T. Graphs™, Chuck. They are the best tool I've used.”