Ben Graham's strategy to pick a stock (Part 2)

Glitter of the stock market can often make people complacent. Naturally people will feel more comfortable if you follow the joint opinion. Unfortunately the stock market, togetherness can sometimes plunges us into the deepest abyss. Euphoria dot.com stocks in the United States in the late '90s was the result of collective mistranslation caused havoc for most participants. Something similar happened during the great depression hit the world in 1929. Market participants have been

'forgotten' that stock prices can not rise forever, especially if not backed by strong fundamentals. This is where stock valuations we will be footing to be able to be rational in the midst of the hustle and bustle of the stock market.

To my surprise, the valuation method used is very simple, especially if we compare it with the screening process is done to look for study fundamental of stocks . Benjamin Graham argues that he is trying to use a magic formula and aim to get results close to the results of calculations with more complex methods.

One very important thing is the new valuations can be carried out if a stock has escaped from the screening as I described in previous articles.

Benjamin Graham formula used is as follows (Security Analysis, 1962):

V = EPS x (8.5 + 2G)

Where:

V = the intrinsic value of shares (fair value of shares)

EPS = Earnings per Share

8.5 = P / E is not reasonable for the company to grow earnings

G = the long-term earnings growth rate (7 -10 years)

This formula will produce a very aggressive valuations for corporate earnings growth rate of 15% will have a fair value of 38.5 x EPS. Although Benjamin Graham stressed the need for a margin of safety (the difference between market price and fair price), this formula still feels very aggressive. Benjamin Graham recommends the margin of safety by 50% which means that companies like the above example worthy to be bought if the price was 19:25 x EPS (in other words the P / E ratio, it is 19:25). It would be very easy to look for stocks with P / E ratio and somewhat doubtful if the stock with a P / E ratio as high as it is called a value stock.

Benjamin Graham seemed to realize the weakness of this formula and in 1974 he revised it to be:

V = EPS x (8.5 + 2G) x (4.4/AAA)

The modification adds 4.4 which represents the risk-free rate and AAA representing the coupon (interest) of high quality corporate bonds.

Return to the company on the foregoing discussion. If high-quality coupon bonds is about 10%, then the fair price to be (8.5 + 2 × 15) x (4.4.10) x 16.94 x EPS = EPS. With a margin of safety by 50% then it is worth buying the shares at a price 8:47 x EPS. Seen that the revised formula that gives more valid results than ever before.

My comment:

4.4 → 4.4 value that represents the risk-free rate should be adjusted to be applicable in Indonesia. Risk free-rate instruments that can be used is BI rate currently is 6.5%.

G → We must be extremely cautious in predicting long-term earnings growth of a company. It is very difficult to maintain long-term earnings growth of 15% consistently (although it does not mean none).

Quote of my Benjamin Graham's valuation formula for modifications to Indonesia are as follows:

V = EPS x (8.5 + 2G) x (6.5/AAA)

Case 1: The shares of PT. Unilever (UNVR).

EPS = 399,769

G = 17:53 (I get this value from reuters) in the long term growth rate. Because the value is too high I'm down to 15 only.

AAA = 11 625% (Bond Bank Export Indonesia IV of 2009 Series B)

With the existing data is the fair price of the shares of Unilever were as follows:

V = 399 769 x (8.5 + 2 × 15) x (6.5/11.625) = 8.893

With a margin of safety of 50%, a level safe to buy stocks UNVR is 4.446.

This value is well below the current share price UNVR, which is 15.800 which represents the P / E ratio of 39.52. Very high, even for a stake in Indonesia.

Case 2: PT. Multi Adira Finance (ADMF).

EPS = 399,769

G = 32.10 (I'm a bit uncomfortable with this value and do the 'downgrade' to 15)

AAA = 11 625% (Bond Bank Export Indonesia IV of 2009 Series B)

With the existing data is the fair price of the stock ADMF are as follows:

V = 1,212.4 x (8.5 + 2 × 15) x (6.5/11.625) = 26.099

With a margin of safety of 50%, a level safe to buy stocks ADMF is 13.050. ADMF current stock price is 9.150.

It is apparent that the stock ADMF interesting enough to buy at current price levels.

So that can be delivered on Benjamin Graham's valuation method. Of course, the valuation method has been greatly developed at this time. However, the concept of valuation is its simplicity may prevent us from buying stocks whose prices are too expensive.