Monday, November 24, 2008

How to Value Equities Using Benjamin Grahams Simple Formula! - Example SATS Singapore

We just finished reading "The Intelligent Investor" by Benjamin Graham and we will distill the important points for our dear readers. Actually, we didn't really agree on some of Benjamin's methodology because some of it was purely rule of thumb. BUT....given that he has "reproduced" some pretty fine students, see below table and compare their performance with our Dear Aberdeen Fund Managers and Dear Fidelity Fund Managers from Fundsupermart Singapore, we have becomed believers. Shameful.....still taking management fees somemore!
Read here on what Warren Buffet say about such people.

Benjamin Graham came up with a simple rule of thumb formula to find the intrinsic value of a stock. (Seriously, don't ask us how its derived...its baffling! )

Intrinsic Value per share= Current ( Normal) Earnings per share X (8.5 + twice the expected annual growth rate of earnings per share)

Take note that (Normal ) means one-off , extraordinary items that inflate or deflate the earning for that year are excluded. These extraordinary items refers to, for example, currency gains, sale of property ( non-property company), or anything that is earned/loss from activities not in the normal course of a company's business. The expected annual growth rate of earnings is the growth expected over the next 7 to 10 years.

Let's use it on Singapore Airport Terminal Services shall we!

We pulled the data out from Reuters ( let's assume reuters is correct) You can get the reuters data from ( thats if you believe in their data!) Look at Diluted EPS Excluding ExtraOrd Items. Note that we use Diluted EPS instead of Basic EPS as the former is a more accurate reflection on the ownership of a company. Read here for a better explanation.
This data has already excluded extra-ordinary items therefore it is "normal".

Expected Annual Growth rate of SATS earnings per share = 0! ( based on the above. It might be negative too.. but let's be good shall we! This is up to your assumptions. Garbage in Garbage out!)

Current (Normal) Earnings per share = 0.179

Intrinsic Value per share = 0.179 X ( 8.5 + 0) = $1.512

Current value now as of 24 Nov 2008 = $1.37

Wow...let's go chiong and buy! Wait. Benjamin Graham also mentioned about the Margin of Safety! So is $1.512 - $1.37 = $0.142 a good discount and sufficient as a Margin of Safety?? Use your own judgement!.

As Graham once wrote: " You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right."

(Updated 25 Nov 2008, on a commenter's comments on using the weighted average of earnings per share for 3 years instead of just the most recent year's earnings per share, we thought about it, and we think it actually makes sense to use a weighted average, as some industries are highly cyclical. A weighted average will smooth earnings out through the years. Hmm maybe a simple average will suffice to keep it simple.... )

Important: The objective of the articles in this blog is to set you thinking about the company before you invest your hard-earned money. Do not invest solely based on this article. Unlike House or Instituitional Analysts who have to maintain relations with corporations due to investment banking relations, generating commissions,e.t.c, SGDividends say things as it is, factually. Unlike Analyst who have to be "uptight" and "cheem", we make it simplified and cheapskate. -The Vigilante Investor, SGDividends Team


  1. I dont agree with the first comparison table you made.

    While I am also against the enlistment of fund managers to take care of one's investment, I must point out that the timeframe of comparison varied greatly.

    In addition, the years ranges from 10 years to 28 years in your examples, which makes the returns looks astronomical compared to the funds.

    Also, some of Graham's less famous students will probably never be featured even though they followed his rule, simply because the stocks they picked didn't work out as planned.

    All these should be taken into account.

  2. Hi Tak,

    Yes Graham's students is shown with more than 10 years of time horizon while Aberdeen and Fidelity is 10 years.

    However, we feel 10 years is a long enough time horizon for a fund manager to at least prove himself or herself. This is their full time job and they are paid (richly) for it through management fees.

    Just imagine an investor just putting money in the DOW and let it go passively with no human intervention and it still beats these fund managers.

    If you look at work done or value added during these past 10 years. Then these fund managers must have really wasted their time analysing companies, having meetings, interviewing companies cos effectively, no value has been added to those investors who invested the money. Negative value in the end.

    Agree than Graham's less famous students may even be losing money. We have not come across but will definitely put it up as a post if we do come across.

    Actually our site is not about advocating any thing is better..its just to bring everything into the open.. the good and the bad...

    If you do find any, pls do let us know :)

  3. Hi,

    1) Benjamin Graham's method involves not just one year of earnings but a weighted average of three years.

    2) He also advocates looking at companies which have had positive earnings for at least ten years

    3) There is a growth rate for earnings also (atleast 3-4.5% p.a.) for the stock

    Would you want to consider those ?


  4. Hi Anonymous,

    What you say is true. In fact he had additional criterias such as:

    Eliminate all firms with debt to total asset ratios greater than 0.60 (i.e., firms with total debt greater than 60% of total assets).

    Eliminate all firms with negative earnings (losses).

    Eliminate all firms with share prices above net working capital per share.

    Eliminate all firms with E/P (earnings divided by price) that are less than twice the AAA bond yield.

    And a new formula he revised
    P = ProjEPS * (8.5 + (2*G)) * (4.4/AAA yield)

    We did not include this in the article as we really want to make things as simplified as possible .

    Thanks for your opinion ! :)

  5. Hi,

    I don't think that Graham actually advocated using the formula above to measure intrinsic value of a company. As I recall, the formula was used for growth stocks, and furthermore, was used to approximate analysts' valuations in his time. I believe he noted that it was not necessarily a reflection of the true value of a company.


  6. Hi Anonymous,

    You have a point there. The price is definitely not necessarily a reflection of the true value of a company.

    The price calculated is just a guage. Investing is more of an art. Everything is based on a best guess. In fact, seriously, we don't even know how he derived this formula.

    But what is interesting is that if you look at the prices we calculated in the spreadsheet on the link in the right column, a majority of the values are actually quite reasonable.

    For example, ST Eng , price calculated in $1.2, Keppel is $3.8. Yes, STEng is now around $2 but calculated as $1.2. Its quite far but not unreasonably fair. Keppel price is not around $3-4 and the value calculated is around $3.8 which is actually quite spot on .

    You can look further the list and the prices are very conservative but not totally unreasonable. (Wilmar of cos is quite weird but maybe its really not worth investing....)

    Anyway, in our opinion, it has been very useful when SGDividends pick stocks. Not that we depend on the exact numerical value, but rather, it helps us to anchor and discard the euphoria of last years prices and to seriously reconsider a purchase as now, there is a figure to center around. Of cos, as we mentioned, other analysis have to be made

  7. For example, ST Eng , price calculated in $1.2, Keppel is $3.8. Yes, STEng is now around $2 but calculated as $1.2. Its quite far but not unreasonably far off. Keppel price is now around $3-4 and the value calculated is around $3.8 which is actually quite spot on .

    Corrected somethings

  8. I believe the best method of determining if a stock is really undervalued is comparing the size of a company to its market cap say a company has a market cap of just 100 million dollars but does 1 billion in annual sales than the value the market is putting on the company is only 10% of what it does in sales on an annual basis. This metric is so very important in being successful when purchasing a undervalued stock simple because their is no other metric of value that will give you as enormous a price advantage as this metric.

    1. It is better to be roughly right than precisely wrong.February 8, 2013 at 2:09 PM

      Hello QSU4D, I doubt if Ben Graham will rise from his grave to challenge you. If he did, I'm sure he'd wonder why you ignore profit (Gross, net, EBITDA, or earnings.) You must have an interesting portfolio. Have a look at its dividend return. That might be all you'll make for the next 10 years of this sideways market. Me, I'd like a measure of value that includes a weighted average of past earnings, growth and forecast future interest rates. BG's rule of thumb formula is just fine for a rough guide of price below/above value - to steer my buy/sell decisions.


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