How to Value Stocks

Stock Valuation Formula From Benjamin Graham Benjamin Graham and the Power of Growth Stocks, Part 2 in a Series   “The intrinsic value of a company lies entirely in its future.” –          Warren Buffett Wall Street has relied on many formulas for determining whether the current price of a stock is high, low or right on target. But there are few, if any, strategies that are more effective than a little-known methodology espoused by the late Benjamin Graham in 1962, according to author Frederick Martin of Disciplined Growth Investors. In the 1962 edition of his book “Securities Analysis,” Graham introduced a simple-yet-brilliant strategy for investing in growth stocks in Chapter 39. However, in subsequent editions of “Securities Analysis,” that chapter was inextricably omitted, so readers have been denied the opportunity to learn Graham’s growth stock strategy for the past half century. Fortunately, that strategy was revived in 2011, when Martin reintroduced it in his book, “Benjamin Graham and the Power of Growth Stocks” (McGraw-Hill). Martin, the president and chief investment officer of Disciplined Growth Investors in Minneapolis, had read the 1962 edition of Graham’s book and has used the methodology with great success as the basis of his portfolio management methodology for nearly 40 years. What makes the formula so effective? One of the great difficulties of effectively valuing stocks is that you must account for so many variables—earnings, revenue, growth rate, competitive environment, and long-term prospects, among others.  Graham’s formula helps solve that issue, according to Martin, by limiting the variables. “Benjamin Graham provided all stock market investors (both growth and value) with a critically important tool that freezes one of the key variables of the investment process to simplify the purchase decision,” explained Martin. Here’s the formula: Intrinsic Value = 8.5 + (2 x Earnings Growth) x Earnings per Share For example, the value of a company with an earnings growth rate of 3% and earnings per share of $2 would be calculated like this: 8.5 + (2 x 3) = 14.5 x 2 = $28 intrinsic value That stock would have a price-earnings ratio of 14.5. A faster growing company—with a 10 percent growth rate and $2 of earnings per share—would look like this: 8.5 + (2 x 10) = $28.5 x 2 = $57 That stock would have a price-earnings ratio of 28.5. If that seems a little rich for your tastes, there’s a twist to the methodology that analysts sometimes overlook. According to Martin, “in order to calculate today’s intrinsic value using Graham’s formula, one must estimate the company’s normalized current earnings per share and forecast the company’s earnings growth rate into the future.” An earnings growth rate based only on the past four quarters represents too small of a sample size to accurately calculate a company’s true value. “One must adjust for where we are in the overall economic cycle and the company’s industry cycle, and where the company is in its investment cycle,” Martin explained. Graham, in fact, had suggested that his formula was designed to be used based on “the average annual growth rate expected over the next seven to ten years.” So if you expect a company’s growth rate to slow down in the years ahead—which is typical of most growth stocks—you need to insert a lower, more realistic long-term growth rate into the formula. For instance, that company with a 10 percent current growth rate might see its average slip to 7 percent over the next 7 to 10 years. In that case, the valuation formula should look like this: 8.5 + (2 x 7) = 22.5 x 2(EPS)...

read more

Growth Stocks

Growth Versus Value? Go for the Growth Benjamin Graham and the Power of Growth Stocks, Part 1 in a Series   All intelligent investing is value investing – acquiring more than you are paying for. You must value the business in order to value the stock. —  Charlie Munger   In the eyes of most stock market investors, value stocks are typically perceived as a safer bet than growth stocks. After all, the very term “value” insinuates that the stocks are selling at a price that represents a value or a bargain for the investor—that you are buying these stocks at an advantageous price that tends to minimize the downside risk.             But in his book, Benjamin Graham and the Power of Growth Stocks, Frederick Martin makes the case that over the long term, the potential advantages of investing in growth stocks far outweigh the few benefits of value stock investing.             What’s the difference between value stocks and growth stocks? Martin defines a value stock as “a mature company that is growing more slowly than the average company” and a growth stock as “a company that grows faster than the average company over the long term and earns a satisfactory return on its investors’ capital.”             The late Benjamin Graham, who is widely considered to be the “Father of Security Analysis” defined a growth stock as “one which has done better than average over a number of years in the past and is expected to do so in the future” in his book, The Intelligent Investor. In the 1962 edition of his book, Security Analysis, he further explained that “the term ‘growth stock’ is applied to one which has increased its per share earnings in the past at well above the rate for common stocks generally and is expected to continue to do so in the future.”             By definition, Graham seems to make the case for growth stocks as the preferable choice for long-term investors. Yet most of the stocks Graham purchased during his career would be considered value stocks—slow moving stocks he could buy at a discount to their fair market value and sell when their price increased. The fact is, by nature Graham was not a long-term investor, but rather a short-term trader who scoured the market for bargains that he could turn over quickly for a small profit.             Ironically, his most successful investment was a growth company, GEICO, that he bought for $27 per share and watched grow to the equivalent of $54,000 per share. That single purchase, which accounted for about a quarter of his assets at the time, ultimately yielded more profit than all his other investments combined. So while he is widely associated with value investing—and has been dubbed the “Father of Value Investing,”—he enjoyed immense success as a long-term growth investor. Advantages of Growth over Value Martin has spent his career focusing exclusively on growth stocks as the managing director of Disciplined Growth Investors, a Minneapolis money management firm. In his book, he makes the case for growth stock investing, offering several important draw-backs to value investing: ·         Constant trading. Value investors must spend their life researching and buying stocks at a price they believe is lower than the company’s intrinsic value and selling them at a price that is equal to or higher than their intrinsic value. By contrast, growth stock investors can hold for the long-term and benefit from the growth of the company. Growth stock investors can succeed with far fewer trades over the course of their lifetime. ·         Time works against you. Let’s say your...

read more

Volatility

Volatility: The Gift that Keeps on Giving Benjamin Graham and the Power of Growth Stocks, Part 6 in a Series I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful. –          Warren Buffett   Volatility is one of the most intimidating characteristics of the stock market, but it also presents the most potent opportunity for advantageous investing for those who understand it and have the patience and fortitude to take advantage of it, according to author Frederick Martin of Disciplined Growth Investors. Volatility gives shrewd investors the opportunity to take advantage of price swings to buy when prices fall well below the value of the company and sell when they climb well above the company’s intrinsic value. “One of the enduring characteristics of the stock market has been its short-term volatility,” Martin writes in his book, “Benjamin Graham and the Power of Growth Stocks” (McGraw-Hill). “We do not choose to waste our analytical efforts to understand why the stock market or individual stocks are priced at the current levels. We do care that this phenomenon repeats itself. This is crucial for those who want to earn returns well above 10 percent.” Short-term volatility will always be part of the market, but to take full advantage of that volatility, it is important to understand that over time, the market always returns to its appropriate level. “In the short run, the market is a voting machine but in the long run it is a weighing machine,” said the late Benjamin Graham, who was known as “The Father of Securities Analysis.”   Understanding and recognizing the causes of volatility can help you take advantage of these inevitable market swings, as long as you don’t allow your emotions to dictate your investment decisions. As investment manager David Dreman put it, “investors repeatedly jump ship on a good strategy just because it hasn’t worked so well lately, and, almost invariably, abandon it at precisely the wrong time.”   CAUSES OF VOLATILITY There are many forces that contribute to stock market volatility, but the most lethal is probably human emotion. “The key ingredient to short-term volatility is human nature and physiology,” writes Martin.  “We are all imperfect. We all suffer from biases related to our own experiences. We are subject to fear and greed.” Martin maintains that when our portfolio is doing well, a substance known as dopamine is triggered in the brain, creating a euphoric feeling similar to a cocaine high. When our portfolio is slumping, the brain tells us we are in mortal danger. “Consider then that most investors fluctuate between a cocaine-like high and mortal fear!” That swing in emotions can cause investors to accelerate their buying or selling activity, creating further volatility in the market. But there are also many outside factors that influence the movement of the market: Transaction-driven brokers. The brokerage industry is largely made up of retail and institutional brokers who make their living through commissions they earn by convincing investors to buy and sell their stocks. Their buy and sell recommendations are driven by analysts’ reports purportedly designed to guide the decision of investors through ‘buy’ and ‘sell’ target levels. “The framework used by the ‘analysts’ who work for the retail brokerage industry is designed to create transactions,” says Martin. “Investors should understand that there are at least two major flaws in the average report. First, the report is applying a one-year time horizon to a long-lived asset. This makes little or no sense. Second, the reports base their recommendations on a data point...

read more

Book Publishing

Publishing a Book Can Have Many Benefits But Be Prepared for a Colossal Commitment of Time By Gene Walden While there’s no question publishing a book can have many benefits for professional service providers and other business owners, do you really have time to write one? Writing a quality book is a major undertaking. Even with the help of a ghostwriter, you can plan on spending most of your spare time for the next six to 18 months getting your book written and published—and that’s just the beginning. But if a book burns within you, writing and publishing it can certainly give you a competitive advantage in your field.   Being an author elevates your status as a professional in your field, as a speaker, as a writer, and as a media source. In other words, it’s a great way to get yourself and your business in front of a lot of people.   A book can also serve as the perfect gift—personally autographed—to give to every client and prospect.   The cold reality, however, is that as difficult and time-draining as a book may be to write, getting it publish is just the beginning. Getting the maximum marketing bang for your business from your book requires a long, aggressive promotional campaign that takes both time and money. Not that that should be of any concern to you right now. First step, get something down on paper—an outline, a title, a concept—for this book you hope to write. Figuring out how to promote it is likely years away. (Excerpt from 16 Ways to Land More Clients READ FULL ARTICLE) About Gene Walden: Gene Walden is the best-selling author of more than a dozen books on business and personal finance and a ghostwriter of books for investment and professional services executives. He is the founder and Editorial Director of InvestmentWritingServices.com.  ...

read more

Book Publishing

Book Publishing: As self-publishing Explodes, Author Offers 4 Tips for Authors Don’t Sell Your Back Cover Short! She Says The number of self-published books has exploded, growing 287 percent since 2006, according to research by Bowker, the official ISBN agency for the United States. “In 2012, more than 235,000 print and e-books were self-published in the United States, up from 148,424 in 2011,” says award-winning marketing strategist Catherine Foster, executive publisher/CEO of BlueSky Publishing Partner. “This is an exciting time to be an author because the playing field is finally leveled – you can get your book published! You don’t have to beg an agent to take you on and you don’t have to deal with those heartbreaking rejection letters. There’s no longer a stigma associated with self-publishing — in fact, many of my authors say it’s the very best option.” CreateSpace was the No. 1 print self-publisher in 2011 with 39 percent of the market, and Smashwords was No. 1 for e-books, with 47 percent, according to Bowker’s most recent information. However, while most readers no longer pay attention to where a book was published, authors should know they do pay attention to what it looks like, Foster says. “The most important overlooked element is not the front cover but the back cover,” she says. “That’s where potential readers will spend the most time deciding if they want to buy your book.” Browsers spend 10 to 15 seconds reading the back cover. If you want to keep their interest, Foster says follow these four basic rules of book marketing.” • Know your audience: You have to consider their point of view when you decide what to say on the back cover, and you need to know who they are in order to figure that out. This is your 10-second commercial, so be sure you give your audience what they’re looking for! • Keep it simple: Many authors try to cram too much information on the back cover in the hopes that something will pique the reader’s interest. But too much information overwhelms browsers and their brain becomes sluggish. Rather than read everything, they read nothing and walk away. Treat the text on your back cover like poetry and keep the message condensed and poignant. • Choose the right fonts: Certain font styles appeal to different audience demographics. Whether your audience is mostly teens or college students, middle-aged adults or seniors, they’ll respond differently to the looks of different type faces. Choosing small red fonts on your cover is the worst thing you can do if your market is the reader older than 55 because red is one of the hardest colors to read when aging affects vision. Also, your fonts shouldn’t blend in with the colors on your back cover, or the words lose value to the reader. • Typos will kill your book sale: If your back cover has a typo, even a small one such as a redundant word or two words with no space between them, it will doom your book. Authors are indeed “judged like a book by its cover” and readers will assume that your book wasn’t edited and that it will be full of errors. One of the most frustrating things for readers is finding typos in a book. It dilutes the meaning of the content, distracts them from reading, and most importantly, makes the author look amateurish. Even if the only typo in your book is the one on your back cover, readers will make critical assumptions based on that one fatal flaw.   Foster recommends having your book professionally edited, cover to cover. If...

read more