Benjamin Graham transformed the idea of security analysis over his career, and many of the techniques he put forward are still in use today.
One of these is the so-called Graham formula, (Value = Current [Normal[ Earnings x [8.5 plus twice the expected annual growth rate]) which is still quoted as a method for computing a company's intrinsic value today even though it was only briefly mentioned in Graham's book, "The Intelligent Investor."
The dean of value investing re-visited the formula in 1975. In an article titled "The Decade 1965-1974: Its Significance for Financial Analysts," Graham published an updated version to take account of the "phenomenal advance in interest rates" during the previous decade.
The updated formula is as follows:
V = {EPS x (8.5 + 2g) x 4.4} / Y
where:
Y: the current yield on 20 year AAA corporate bonds
In this article, Graham also went on to detail his thoughts on debt, especially his views on debt in relation to securities prices. This is particularly important today, at a time when, after a decade of near-zero interest rates, overall corporate debt is at record levels.
Here's what Graham had to say on the topic:
"A multiplier based on expected growth and interest rates alone would imply that a company's financial structure and debt position do not enter into the valuation process. This might be the case if the formula were applied--as originally intended-only to high-growth companies, whose prospects are considered so good that they are assumed to face no financial problems. But if we seek to generalize our formula to apply to average-growth companies, we must recognize many of these may be in unsatisfactory financial condition, caused in part by inflation pressures and in good part also by the over-expasion of corporate debt in the past decade. (I consider the total figures for corporate debt since 1968, published in the June 1974 issue is the Survey of Current Business, to be most disquieting. They she is an overall increase of 74% in only five years, with more to come in 1974.)
I see no satisfactory way of reducing the multiplier to allow for a below-par debt position. My advice to analysts would be rather to avoid attempting a formal valuation of such companies. In other words, limit your appraisals to enterprises of investment quality, excluding from that category such as do not meet specific criteria of financial strength. This statement brings me back to our old position that speculative companies cannot be dealt with at all by the analyst with satisfactory overall results. By my own rather strict quantitative criteria, Firestone would pass the financial-strength test by a modest margin. Such tests might well exclude up to half of the NYSE list today from investment consideration, but there would remain enough qualifying issues to give the analysts and the investor an ample selection. It should be clear that I have faith in the valuation process as a guide to investment choices, but that I would limit this technique rather strictly to companies that meet criteria of financial soundness. Also, I should require that the buy-decisions based on this approach involve a margin-of-safety factor. This might well be a purchase price not over two-thirds of the central appraised value."
We know from most of his writing that Graham didn't like companies with debt. His criteria for investing in common stocks sought to exclude any companies that might be at risk from financial difficulty.
This quote goes one step further, advocating the exclusion of all companies that do not "meet criteria of financial soundness" from investors' investment universe.
Graham even refused to put forward a debt-adjustment factor for analysts who want to appraise these companies. As corporate debt has surged over the past decade, this advice is now more relevant than ever for investors.
Disclosure: The author owns no share mentioned.
