The merit of value investing
THE MERIT OF VALUE INVESTING:-A portfolio of stocks designed on the basis of Benjamin Graham's principles has beaten the market over the past three years.
Benjamin Graham, the author of Security Analysis, is hailed as the dean of Wall Street. In another book titled Intelligent Investor, Graham outlined an analytical method for defensive investors who want to use only simple methods of analysis as they cannot spare much time for active investment effort.
To make Graham's method growth-oriented and more explicit, this author provided specific numerical estimates and the modified Graham-Rao method was described in A Nine-step Route to Picking Value Stocks published in the The Smart Investor dated August 25, 2003.
The key criteria The analytical criteria of the Graham-Rao method contain quality criteria and valuation criteria. The quality criteria are:
The company must have an adequate size (Sales of Rs 100 crore may be taken as adequate size for Indian companies)
Current assets should be at least twice that of current liabilities and the total debt-equity ratio should not be greater than 1:1
The company should have paid dividends and earned profits for the last 10 years
There should be a growth in earnings per share (EPS) of 10 per cent per annum over the last seven years
The two valuation criteria are:
1.The current share price should not exceed 20 times the average EPS in the last seven years for companies with a seven-year growth (GAGR) higher than 20 per cent. For companies with past growth rate between 10 and 20 per cent per annum, the multiplier has to be the growth rate itself. In other words fair value is the average EPS of the last seven years multiplied by the P/E ratio specified as above
2.The current price should also not be more than 1.5 times the latest book value.
The method requires 10-year data to analyse stocks. But the method is unambiguous and uses a limited number of ratios.
Investors may complain about the 10-year data requirement; but they have to keep in mind that their hard-earned money has to be protected by committing it to companies with a good past record. Graham actually recommended dividend payment for 20 years.
Even though Graham's method has been known to the investment community since 1960, descriptions of its successful application were not available in published literature in both scholarly as well as popular versions and hence the method did not get the attention that it deserved.
The method is value-oriented and hence is more suitable to use during periods when the share prices are stable or falling. During periods when share prices are appreciating at a fast pace like in the past few times, value methods fail to identify potential buys and momentum methods take centrestage.
As a person interested in this method from a scientific as well as practical perspective, I applied this method of analysis on BSE's 'A' group shares in December 2002 and January 2003. I found 38 shares to be potential buys under the main valuation criteria of using past seven-year growth rate in earnings per share (EPS) and past seven-year average EPS.
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Benjamin Graham, the author of Security Analysis, is hailed as the dean of Wall Street. In another book titled Intelligent Investor, Graham outlined an analytical method for defensive investors who want to use only simple methods of analysis as they cannot spare much time for active investment effort.
To make Graham's method growth-oriented and more explicit, this author provided specific numerical estimates and the modified Graham-Rao method was described in A Nine-step Route to Picking Value Stocks published in the The Smart Investor dated August 25, 2003.
The key criteria The analytical criteria of the Graham-Rao method contain quality criteria and valuation criteria. The quality criteria are:
The company must have an adequate size (Sales of Rs 100 crore may be taken as adequate size for Indian companies)
Current assets should be at least twice that of current liabilities and the total debt-equity ratio should not be greater than 1:1
The company should have paid dividends and earned profits for the last 10 years
There should be a growth in earnings per share (EPS) of 10 per cent per annum over the last seven years
The two valuation criteria are:
1.The current share price should not exceed 20 times the average EPS in the last seven years for companies with a seven-year growth (GAGR) higher than 20 per cent. For companies with past growth rate between 10 and 20 per cent per annum, the multiplier has to be the growth rate itself. In other words fair value is the average EPS of the last seven years multiplied by the P/E ratio specified as above
2.The current price should also not be more than 1.5 times the latest book value.
The method requires 10-year data to analyse stocks. But the method is unambiguous and uses a limited number of ratios.
Investors may complain about the 10-year data requirement; but they have to keep in mind that their hard-earned money has to be protected by committing it to companies with a good past record. Graham actually recommended dividend payment for 20 years.
Even though Graham's method has been known to the investment community since 1960, descriptions of its successful application were not available in published literature in both scholarly as well as popular versions and hence the method did not get the attention that it deserved.
The method is value-oriented and hence is more suitable to use during periods when the share prices are stable or falling. During periods when share prices are appreciating at a fast pace like in the past few times, value methods fail to identify potential buys and momentum methods take centrestage.
As a person interested in this method from a scientific as well as practical perspective, I applied this method of analysis on BSE's 'A' group shares in December 2002 and January 2003. I found 38 shares to be potential buys under the main valuation criteria of using past seven-year growth rate in earnings per share (EPS) and past seven-year average EPS.
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posted by kalpana at 9:24 PM
1 Comments:
Good words.
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