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 F.A.S.T. Graphs™ below represents earnings multiplied by Ben Graham's formula. As you review each F.A.S.T. Graphs™ 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. (NYSE:BA), there is more deviation between price and intrinsic value, which is due to the cyclical nature of this aerospace industrial. Yet even with Boeing Co. (NYSE: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. (NYSE:BA)
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.
About the author:
Prior to forming his own investment firm, he was a partner in a 30-year-old established registered investment advisory in Tampa, Florida. Chuck holds a Bachelor of Science in economics and finance from the University of Tampa. He is a sought-after public speaker who is very passionate about spreading the critical message of prudence in money management. Chuck is a veteran of the Vietnam War and was awarded both the Bronze Star and the Vietnam Honor Medal.