Benjamin Graham was an economist and professional investor, who taught Warren Buffett, Irving Kahn, Walter J. Schloss and other famous investors at Columbia Business School.
Buffett describes Graham as the second most influential person in his life after his own father and even named his son after Graham. In the preface to Graham's book The Intelligent Investor, Buffett calls it "by far the best book about investing ever written." Graham recommended three different grades of stocks for investment, with 16 specific calculations for identifying them. Today, we will do a complete Graham analysis for LinkedIn (NYSE:LNKD) and see what grade and price Graham would have recommended for it.
LinkedIn is a social networking website mainly used for professional networking. As of June 2012, LinkedIn reports more than 175 million registered users in more than 200 countries and territories. LinkedIn is also unique in that, of the 4000 NYSE and Nasdaq stocks analyzed on Serenity, LinkedIn displays one of the largest disparities with Graham's calculations.
With an EPS of $0.13 for 2011 and a current price of $98.77, LinkedIn sells at a P/E of 760, a P/B of 12.6, and at 20 times its Graham Number.
1. A Defensive Analysis:
The first grade of stocks recommended by Graham are called Defensive stocks. The criteria that Graham specified for identifying Defensive stocks are as follows:
Summarized from CHAPTER 14 of The Intelligent Investor - Stock Selection for the Defensive Investor:
1. Not less than $100 million of annual sales.The publicly available financial figures for LinkedIn are as follows (see the automated analysis for the list of sources):
[Note: This works out to $500 million today based on the difference in CPI/Inflation from 1973]
2-A. Current assets should be at least twice current liabilities.
2-B. Long-term debt should not exceed the net current assets.
3. Some earnings for the common stock in each of the past 10 years.
4. Uninterrupted [dividend] payments for at least the past 20 years.
5. A minimum increase of at least one-third in per-share earnings in the past 10 years.
6. Current price should not be more than 15 times average earnings.
7. Current price should not be more than one and a half times the book value.
As a rule of thumb we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5.
|Annual sales||$668.69 Million|
|Current assets||$885.10 Million|
|Current liabilities||$338.78 Million|
|Long term debt||$60.79 Million|
|Shares outstanding||107.13 Million|
Based on the figures above, we get the following results for each of Graham's Defensive criteria for LinkedIn:
Graham's recommended price for Defensive stocks can be calculated from criteria 6 and 7 as the square root of (22.5 x EPS x BVPS). This price is popularly known as the Graham number and works out to $4.79 for LinkedIn. But this is not Graham's recommended price since LinkedIn doesn't meet the other Defensive requirements.
Let's now take a look at the other grade calculations given by Graham and see if LinkedIn meets them.
2. An Enterprising Analysis:
If a stock failed to meet the criteria for Defensive investment, Graham recommended the following criteria for Enterprising investment.
This second set of criteria gives us a maximum price for a stock meeting Enterprising conditions, as the lower of 120% net tangible assets (book value), or 10 times current earnings. Again, LinkedIn does not meet criteria 2, 3 and 4. Even if it had, the recommended price would have only worked out to $1.30 per share.
Summarized from CHAPTER 15 of The Intelligent Investor - Stock Selection for the Enterprising Investor:
[Note: For issues selling at P/E multipliers under 10]
1-A. Current assets at least 11⁄2 times current liabilities.
1-B. Debt not more than 110% of net current assets.
2. Earnings stability: No deficit in the last five years covered in the Stock Guide.
3. Dividend record: Some current dividend.
4. Earnings growth: Last year's earnings more than those of 1966.
[Note: This corresponds approximately to the earnings of 2007 today]
5. Price: Less than 120% net tangible assets.
Finally, let's look at the criteria that Graham recommended for NCAV, Net-Net, or Bargain stocks; and see if LinkedIn meets them.
3. An NCAV or Net-Net Analysis:
If a stock met neither Defensive nor Enterprising requirements, Graham recommended these final set of criteria.
Summarized from CHAPTER 15 of The Intelligent Investor - Stock Selection for the Enterprising Investor:These criteria give us what are called NCAV stocks - stocks selling for less than the value of their cash worth alone, and with positive earnings in the last one year.
"Bargain Issues, or Net-Current-Asset Stocks"
"price less than the applicable net current assets alone - after deducting all prior claims, and counting as zero the fixed and other assets."
"eliminated those which had reported net losses in the last 12-month period."
These stocks are also the most famous of Graham's stocks, and the source of the general misconception that Graham recommended stocks only because they were cheap. These were, in fact, the last grade of stocks that Graham recommended.
LinkedIn's NCAV price works out to $4.53 and since the company has not reported net losses for the last 12 months, and since it did not meet any of the other sets of criteria, $4.53 is also Graham's recommended price for LinkedIn.
LinkedIn's IPO price of $45 works out to a P/E of 1,125 times its then earnings of $0.04, and a P/B of 10.72 times its then book value. Graham's general recommendation on IPOs was to be unusually wary of them because he felt that:
1. IPOs have more salesmanship behind them, thus requiring more resistance and caution from investors.
2. Most IPOs are sold under market conditions favorable to the seller, and thus less favorable for the buyer.
LinkedIn's current price of $98.77 works out to a P/E of 760 and a P/B of 12.60. This could be compared against the S&P 500 which has a P/E of 65.57, a P/B of 2.12 and a Graham Number of to 544.94 as against its current value of 1,353.33.This could be compared against the general market using the S&P 500, which has a P/E of 15.15, a P/B of 2.12 (see the data and sources used) and a Graham Number of 1133.55 as against its current value of 1,353.33.
Since LinkedIn does not meet Graham's Defensive or Enterprising criteria but has not reported a net loss in the last one year, Graham's recommended price for LinkedIn is the NCAV price, which works out to $4.53. LinkedIn is also unique in that due to its low earnings number, its Graham Number is almost the same as its NCAV price.
However, do note that this analysis should not be considered a recommendation to short sell LinkedIn. Graham never tried to predict a stock's future price. As far as Graham's principles are concerned, LinkedIn may remain at its current or even higher levels indefinitely. Graham simply recommended the prices at which stocks should be bought to avoid losses, and to consistently make profits.
Graham's elaborate financial calculations, when applied conscientiously to the financial data of companies, highlight any discrepancies between stock prices and the underlying numbers. Having such information helps in making objective investment decisions, minimizing losses, and identifying unique investment opportunities.
Disclaimer: The results were arrived at by automated quantitative analysis and were not verified manually. Verify the validity of the data and sources used before making an investment decision.