The Intelligent Investor — How should we invest?
Introduction
As part of my retrospective of 2017, I put together my notes on the brilliant book The Intelligent Investor to share with you what I’ve learned throughout reading the book. This is a, without any doubt, fantastic book for beginners in value investing. Personally, I found this book particularly inspiring because I could actually resonate a lot with the advises and philosophy behind. If you haven’t yet read this book, I highly recommend it. You won’t regret it.
Two Kinds of Intelligent Investor
- Active or enterprising investor: by continually researching, selecting, and monitoring a dynamic mix of stocks, bonds, or mutual funds.
- Passive or defensive investor: by creating a permanent portfolio that runs on autopilot and requires no further effort (but generates very little excitement)
There is no room in this philosophy for a middle ground, or a series of gradations, between the passive and aggressive status. Many, perhaps most, investors seek to place themselves in such an intermediate category; in authors’ opinion that is a compromise that is more likely to produce disappointment than achievement.
The Single Best Advice
Investing in a Total Stock-Market Index Fund for a Long Time.
The single best choice for this lifelong holding is a total stock-market index fund. An index fund — which owns all the stocks in the market, all the time, without any pretense of being able to select the “best” and avid the “worst” — will beat most funds over the long run. For most investors, selecting individual stocks is unnecessary — if not inadvisable.
Hold an index fund for 20 years or more, adding mew money every month, and you are all but certain to outperform the vast majority of professional and individual investors alike. Late in his life, Graham praised index funds as the best choice for individual investors, as does Warren Buffett.
A serious investor is not likely to believe that the day-to-day or even month-to-month fluctuations of the stock market make him richer or poorer. The long-time investor is the only kind of investor there is.
Graham urges you to invest only if you would be comfortable owning a stock even if you had no way of knowing its daily share price. If, after you set up such an online autopilot portfolio, you find yourself trading more than twice a year — or spending more than an hour or two per month, total, on your investments — then something has gone badly wrong.
A low-cost index fund is the BEST tool ever created for low-maintenance stock investing — and any effort to improve on it takes more work (and incurs more risk and higher costs) than a truly defensive investor can justify.
Efficient Markets Hypothesis
Efficient Markets Hypothesis (EMH), an academic theory claiming that the price of each stock incorporates all publicly available information about the company.
What EMH Means for Investors
Proponents of the EMH conclude that, because of the randomness of the market, investors could do better by investing in a low-cost, passive portfolio. Data compiled by Morningstar Inc. through its June 2015 Active/Passive Barometer study supports the conclusion. Morningstar compared active managers’ returns in all categories against a composite made of related index funds and exchange-traded funds (ETFs). The study found that year-over-year, only two groups of active managers successfully outperformed passive funds more than 50% of the time. These were U.S. small growth funds and diversified emerging markets funds.
In all of the other categories, including U.S. large blend, U.S. large value and U.S. large growth, among others, investors would have fared better by investing in low-cost index funds or ETFs. While a percentage of active managers do outperform passive funds at some point, the challenge for investors is being able to identify which ones will do so.
Less than 25% of the top-performing active managers are able to consistently outperform their passive manager counterparts.
Read more: Efficient Market Hypothesis (EMH) https://www.investopedia.com/terms/e/efficientmarkethypothesis.asp#ixzz54rk9YwHm
The take away here is almost like this: you will likely end up better financially with passive investment on total stock market index than hiring a financial advisor.
Investor and Speculator
The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices.
Intelligent investor doesn’t pay much attention to market fluctuations.
In any case, for anyone who will be investing for years to come, failing stock prices are good news, not bad, since they enable you to buy more for less money.
The intelligent investor should be perfectly comfortable owning a stock or mutual fund even if the stock market stopped supplying daily prices for the next 10 years.
On the whole it may be better for the investor to do his stock buying whenever he has money to put in stocks, except when the general market level is much higher than can be justified by well-established standards of value.
The investors who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. The primary cause of failure is that they pay too much attention to what the stock market is doing currently.
Investing isn’t about beating others at their game. It’s about controlling yourself at your own game.
Don’t Blindly Believe in So-called Experts
The experts do not have dependable ways of selecting and concentrating on the most promising companies in the most promising industries.
Gordon Equation
The stock market’s future return is the sum of the current dividend yield plus expected earnings growth.
Be Wary of New Issues
Investor cannot hope for better than average results by buying new offerings, or “hot” issues of any sort, meaning thereby those recommended for a quick profit. Our one recommendation is that all investors should be wary of new issues — which means, simply, that these should be subjected to careful examination and unusually severe tests before they are purchased. There are two reasons for this double caveat. The first is that new issues have special salesmanship behind them, which calls therefore for a special degree of sales resistance. The second is that most new issues are sold under “Favorable market conditions” — which means favorable for the seller and consequently less favorable for the buyer.
Dollar-Cost Averaging
Practitioner invests in common stocks the same number of dollars each month or each quarter, which is an application of a broader approach known as “formula investing”.
Bargain Issues
Bargain issues were selling at less than their share in the net current assets (working capital) alone, not counting the plant account and other assets, and after deducting all liabilities ahead of the stock.
Three Elements of Investing
- you must thoroughly analyze a company, and the soundness of its underlying businesses, before you buy its stock;
- you must deliberately protect yourself against serious losses; (margin of safety)
- you must aspire to “adequate”, not extraordinary, performance. (investment instead of speculation)
Investing in Bonds
Correct Expectations on Returns on Index Fund
You will never be able to boast that you beat the market, because the job of an index fund is to match the market’s return, not to exceed it. But a fund can offer excellent value even it it doesn’t beat the market — by providing an economical way to diversify your holdings and by freeing up your time for all the other things you would rather be doing than picking your own stocks.
Past Cannot Imply Future
The heart of Graham’s argument is that the intelligent investor must never forecast the future exclusively by extrapolating the past.
Three Factors the Stock Market’s Performance Depends On
- real growth (the rise of companies’ earnings and dividends)
- inflationary growth (the general rise of prices throughout the economy)
- speculative growth — or decline (any increase or decrease in the investing public’s appetite for stocks)
Everyone should keep a minimum of 25% in bonds.
We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequent inverse range of between 75% and 25% in bonds.
There is an implication here that the standard division should be an equal one, or 50–50, between the two major investment mediums. According to tradition the sound reason for increasing the percentage in common stocks would be the appearance of the “bargain price” levels created in a protracted bear market. Conversely, sound procedure would call for reducing the common-stock component below 50% when in the judgment of the investor the market level has become dangerously high.
Notes: Are these ratings trustworthy?
Inflation is one of your worst enemies.
Bonds and interest rates teeter on opposite ends of a seesaw: If interest rates rise, bond prices fall — although a short-term bond falls far less than a long-term bond. On the other hand, if interest rates fall, bond prices rise — and a long-term bond will outperform shorter ones.
Invest in bond funds instead of individual bonds. For most investors, bond funds beat individual bonds hands down.
Investing in Stocks
Prediction and Protection, Two Research Approaches
Every competent analyst looks forward to the work will prove good or bad depending on what will happen and not on what has happened. Nevertheless, the future itself can be approached in two different ways. which may be called the way of prediction (or projection, or qualitative approach) and the way of protection (quantitative or statistical approach). Those who emphasize prediction will endeavor to anticipate fairly accurately just what the company will accomplish in future years — in particular whether earnings will show pronounced and persistent growth. By contrast, those who emphasize protection are always especially concerned with the price of the issue at the time of study. Their main effort is to assure themselves of a substantial margin of indicated present value above the market price — which margin could absorb unfavorable developments in the future. Generally speaking, the company’s long-run prospects as it is to be reasonably confident that the enterprise will get along.
Dividends are the Greatest Force in Stock Investing
For patient investors who reinvested their income, stock returns were positive over this otherwise dismal period, simply because dividend yields averaged more than 5.6% per year. Far from being an afterthought, dividends are the greatest force in stock investing.
Notes:
Financial sector offers the highest dividend yield (as of today):
Four Rules for the Common-Stock Portfolio Selection
- There should be adequate though not excessive diversification. This might mean a minimum of ten different issues and a maximum of about thirty.
- Each company selected should be large, prominent, and conservatively financed.
- Each company should have a long record of continuous dividend payments.
- The investor should impose some limit on the price he will pay for an issue in relation to its average earnings over, say, the past seven years. We suggest that this limit be set at 25 times such average earnings, and not more than 20 times those of the last twelve-month period.
Notes: Are these numbers still valid?
Growth Stock
Growth stock 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.
Calculation of the Past Growth Rate
We suggest that the growth rate (compounded) itself be calculated by comparing the average of the last three years with corresponding figures ten years earlier.
One fairly dependable sign of the approaching end of a bull swing is the fact that new common stocks of small and nondescript companies are offered at prices some what higher than the current level for many medium-sized companies with a long market history.
To obtain better than average investment results over a long pull requires a policy of selection or operation possessing a twofold merit: (1) It must meet objective or rational tests of underlying soundness; and (2) it must be different from the policy followed by most investors or speculators. If he is the right kind of investor he will take added satisfaction from the thought that his operations are exactly opposite from those of the crowd.
Bargain Issue
The key requirement here is that the enterprising investor concentrate on the larger companies that are going through a period of unpopularity. The large companies thus have a double advantage over the others. First, they have the resources in capital and brain power to carry them through adversity and back to a satisfactory earnings base. Second, there market is likely to respond with reasonable speed to any improvement shown.
We define a bargain issue as one which, on the basis of facts established by analysis, appears to be worth considerably more than it is selling for. To be as concrete as possible, let us suggest that an issue is not a true “bargain” unless the indicated value is at least 50% more than the price. The first is by the method of appraisal. This relies largely on estimating future earnings and then multiplying these by a factor appropriate to the particular issue. If the resultant value is sufficiently above the market price — and if the investor has confidence in the technique employed — he can tag the stock as a bargain. The second test is the value of the business to a private owner. This value also is often determined chiefly by expected future earnings — in which case the result may be identical with the first. But in the second test more attention is likely to be paid to the realizable value of the assets, with particular emphasis on the net current assets or working capital.
Two major sources of undervaluation: (1) currently disappointing results and (2) protracted neglect or unpopularity.
(When considering to buy a “bargain issue”) The investor should require an indication of at least reasonable stability of earnings over the past decade or more — i.e., no year of earnings deficit — plus sufficient size and financial strength to meet possible setbacks in the future. The ideal combination here is thus that of a large and prominent company selling both well below its past average price and its past average price/earnings multiplier.
Primary and Secondary Companies
Companies that ave substantial size combined with a leading position in the industry are often referred to as primary companies; all the other common stocks are then called secondary. Although the distinction between primary and secondary issues ned not be made too precise.
Substantial profits from the purchase of secondary companies at bargain prices arise in a variety of ways. First, the dividend return is relatively high. Second, the reinvested earnings are substantial in relation to the price paid and will ultimately affect the price. Third, a bull market is ordinarily most generous to low-priced issues; thus it tends to raise the typical bargain issue to at least a reasonable level. Fourth, even during relatively featureless market periods a continuous process of price adjustment goes on, under which secondary issues that were undervalued may rise at least to the normal level for their type of security. Fifth, the specific factors that in many cases made for a disappointing record of earnings may be corrected by the advent of new conditions, or the adoption of new policies, or by a change in management.
An important new factor in recent years has been the acquisition of smaller companies by larger ones, usually as part of a diversification program. In these cases the consideration paid has almost always been relatively generous, and much in excess of the bargain levels existing not long before.
Foreign Stocks
Investing in foreign stocks may not be mandatory for the intelligent investor, but it is definitely advisable. Putting up to a third of your stock money in mutual funds that hold foreign stocks (including those in emerging markets) helps insure against the risk that our own backyard may not always be the best place in the world to invest.
The better a company’s record and prospects, the less relationship the price of its shares will have to their book value. But the greater the premium above book value, the less certain the basis of determining its intrinsic value — i.e. the more this “value” will depend on the changing moods and measurements of the stock market. Thus we reach the final paradox, that the more successful the company, the greater are likely to be the fluctuations in the price of its shares. This really means that, in a very real sense, the better the quality of a common stock, the more speculative it is likely to be — at least as compared with the unspectacular middle-grade issues.
Buying funds based purely on their past performance is one of the stupidest things an investor can do.
- The average fund does not pick stocks well enough to overcome its costs of researching and trading them;
- The higher a fund’s expense, the lower its returns; (Decades of research have proven that funds with higher fees earn lower returns over time. Higher returns are temporary, while high fees are nearly as permanent as granite. Since a fund’s expenses are far more predictable than its future risk or return, you should make them your first filter.)
- The more frequently a fund trades its stocks, the less it tends to earn;
- Highly volatile funds, which bounce up and down more than average, are likely to stay volatile;
- Funds with high past returns are unlikely to remain winners for long. (But also yesterday’s losers almost never become tomorrow’s winners. So avoid funds with consistently poor past returns — especially if they have above-average annual expenses.)
To succeed, the individual investor must either avoid shopping from the same list of favorite stocks that have already been picked over by the giant institutions, or own them far more patiently.
If you’re not prepared to stick with a fund through at least three lean years, you shouldn’t buy it in the first place. Patience is the fund investor’s single most powerful ally.
Common Stock Valuation
Obvious prospects for physical growth in a business do not translate into obvious profits for investors.
A great company is not a great investment if you pay too much for the stock.
Do not buy more stocks because the stock market has gone up; do not sell them because it has gone down. The very hear of Graham’s approach is to replace guesswork with discipline. Also, never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop.
Wall Street’s analysts have always tended to call a stock a “strong buy” when its price is high, and to label it a “sell” after its price has fallen — the exact opposite of what Graham (and simply common sense) would dictate. As he does throughout the book, Graham is distinguishing speculation — or buying on the hope that a stock’s price will keep going up — from investing, or buying on the basis of what the underlying business is worth.
A Two-Part Appraisal Process
We suggest that analysts work out first what we call the “past-performance value”, which is based solely on the past record. The second part of the analysis should consider to what extent the value based solely on past performance should be modified because of new conditions expected in the future.
These industry groups, ideally, would not be overly dependent on such unforeseeable factors as fluctuating interest rates or the future direction of prices for raw materials like oil or metals. Possibilities might be industries like gaming, cosmetics, alcoholic beverages, nursing homes, or waste management.
Good or Bad Stock
There is no such thing as a good or bad stock; there are only cheap stocks and expensive stocks. Even the best company becomes a “sell” when its stock price goes too high, while the worst company is worth buying if its stock goes low enough.
Margin-of-Safety Principle
The margin of safety is the difference between the percentage rate of the earnings on the stock at the price you pay for it and the rate of interest on bonds, and that margin of safety is the difference which would absorb unsatisfactory developments.
If the average market level of most growth stocks is too high to provide an adequate margin of safety for the buyer, then a simple technique of diversified buying in this field may not work out satisfactorily.
Five Decisive Elements in Picking Stocks
- Company’s “general long-term prospects”
- Quality of its management
- Financial strength and capital structure
- Dividend record
- Current dividend rate
Negative Indicators for Company
- An average of more than two or three acquisitions a year
- Getting cash from financial activities: borrowing debt or selling stock to raise boatloads of Other People’s Money (A.K.A OPM companies). To determine whether a company is an OPM addict, read the “Statement of Cash Flows” in the financial statements. This page breaks down the company’s cash inflows and outflows into “operating activities”, “investing activities”, and “financial activities”. If cash from operating activities is consistently negative, which cash from financing activities is consistently positive, the company has a habit of craving more cash than its own businesses can produce- and you should not join the “enablers” of that habitual abuse.
- The company is a Johnny-One-Note, relying on one customer (or a handful) for most of its revenues.
- CEO gets unjustified overpaid.
- Company reprices (or “reissues” or “exchanges”) its stock options for insiders
- The newly issued options will dilute your holdings. Factor in the potential flood of new shares from stock options whenever you estimate a company’s future value.
- Senior executives and directors repeatedly sale their stocks. (This is a bright red flag)
- The company’s accounting practices are designed to make its financial results opaque.
- Company repurchases its stock when it’s overpriced.
Positive Indicators for Company
- The company has a wide “moat”, or competitive advantage. Several forces can widen a company’s moat: a strong brand identity; a monopoly or near-monopoly on the market; economies of scale, or the ability to supply huge amounts of goods or services cheaply; a unique intangible asset; a resistance to substitution.
- The company is a marathoner, not a sprinter. The fastest-growing companies tend to overheat and flame out. A growth rate at 15% (pre-tax) or a sudden burst of growth in one or two years — is all but certain to fade, just like an inexperienced marathoner who tries to run the whole race as if it were a 100-meter dash.
- The company sows and reaps. Company has an adequate budget for research and development. Spending nothing on R&D is at least as vulnerable as one that spends too much.
Go Retrospective
Read the past annual reports to see what forecasts the managers made and if they fulfilled them or fell short.
Financial Strength and Capital Structure
The most basic possible definition of a good business is this: it generates more cash than it consumes. Start by reading the statement of cash flows in the company’s annual report, and see whether cash from operations has grown steadily throughout the past 10 years. In addition, owner earnings can be a better measure than reported net income. Owner earnings = Net income + amortization and depreciation — normal capital expenditures.
If owner earnings per share have grown at a steady average of at least 6% or 7% over the past 10 years, the company is a stable generator of cash, and its prospects fro growth are good.
Next, look at the company’s capital structure. Turn to the balance sheet to see how much debt (including preferred stock) the company has; in general, long-term debt should be under 50% of total capital. In the footnotes to the financial statements, determine whether the long-term debt is fixed-rate (with constant interest payments) or variable (with payments that fluctuate, which could become costly if interest rates rise).
Look in the annual report for the exhibit or statement showing the “ratio of earnings to fixed charges.”
The decision of whether to own stocks today has nothing to do with how much money you might have lost by owning them a few years ago. When stocks are priced reasonably enough to give you future growth, then you should own them, regardless of the losses they may have cost you in the recent past.
High multipliers have been maintained only if the company has maintained better than average profitability.
The intelligent investor must always be on guard for “nonrecurring” costs that just keep on going.
Tips for Researching Company’s Financial Reports
- Read backwards, because anything that the company doesn’t want you to find is buried in the back.
- Read the notes. Never buy a stock without reading the footnotes to the financial statements in the annual report.
- Be sure to compare the footnotes with those in the financial statements of at least one firm that’s a close competitor, to see how aggressive your company’s accountants are.
- Three solid books full of timely and specific examples are Martin Fridson and Fernando Alvarez’s Financial Statement Analysis, Charles Mulford and Eugene Comiskey’s The Financial Numbers Game, and Howard Schilit’s Financial Shenanigans.
Overall Earnings to Price Ratio
The stock portfolio, when acquired, should have an overall earnings / price ratio — the reverse of the P/E ratio — at least as high as the current high-grade bond rate. (Graham also suggests that the “average” stock be priced about 20% below the “maximum” ratio)
Note: As of Jan 20, 2018, the 10-Year High Quality Market (HQM) Corporate Bond Spot Rate is 3.42. The corresponding earnings / price ratio is 26. The average stock price (at 80%) is 21.
Notes: evaluate the current popular funds and their expense ratio.
The enterprising investor may confine this choice to industries and companies about which he holds an optimistic view, but we counsel strongly against paying a high price for a stock (in relation to earnings and assets) because of such enthusiasm. If he followed our philosophy in this field he would more likely be the buyer of important cyclical enterprises — such as steel shares perhaps — when the current situation is unfavorable, the near-term prospects are poor, and the low price fully reflects the current pessimism.
Avoid Second-Quality Issues
Avoid second-quality issues in making up a portfolio, unless — for the enterprising investor — they are demonstrable bargains.
If you enjoyed the experiment and earned sufficiently good returns, gradually assemble a basket of stocks — but limit it to a maximum of 10% of your overall portfolio (keep the rest in an index fund).
From EPS to ROIC
To see how much a company is truly earning on the capital it deploys in its businesses, look beyond EPS to ROIC, or return on invested capital. ROIC is the percentage amount that a company is making for every percentage point over the [Cost of Capital|Weighted Average Cost of Capital (WACC). More specifically the return on investment capital is the percentage return that a company makes over its invested capital. However, the invested capital is measured by the monetary value needed, instead of the assets that were bought. Therefore invested capital is the amount of long-term debt plus the amount of common and preferred shares.
An ROIC of at least 10% is attractive; even 6% or 7% can be tempting if the company has good brand names, focused management, or is under a temporary cloud.
See which leading professional money managers own the same stocks you do. If one or two names keep turning up, go to the websites of those fund companies and download tier most recent reports. By seeing which other stocks these investors own, you can learn more about what qualities they have in common: by reading the manager’s commentary, you may get ideas on how to improve your own approach.
Successful investing professionals have two things in common: First, they are disciplined and consistent, refusing to change their approach even when it is unfashionable. Second, they think a great deal about what they do and how to do it, but they pay very little attention to what the market is doing.
Gambler’s Fallacy
Investors believe that an overvalued stock must drop in price purely because it is overvalued. just as a coin does not become more likely to turn up heads after landing on tails for nine times in a row, so an overvalued stock (or stock market!) can stay overvalued for a surprisingly long time. That makes short-selling, or betting that stocks will drop, too risky for mere mortals.
It’s well established that people often assign a mental value to stocks based largely on the emotional imagery that companies evoke. But the intelligent investor always digs deeper.
A company with good public image isn’t necessarily a good investment. A company that used to be a good investment might not be as good in the future. And stock investment is always about the future.
No company as big as Cisco had ever been able to grow fast enough to justify a price/earnings ratio above 60 — let along a P/E ratio over 200.
The market’s appraisal of cash-dividend policy appears to be developing in the following direction: Where prime emphasis is not placed on growth the stock is rated as an “income issue”, and the dividend rate retains its long-held importance as the price determinant of market price. At the other extreme, stocks clearly recognized to be in the rapid-growth category are valued primarily in terms o the expected growth rate over, say, the next decade, and the cash-dividend rate is more or less left out of the reckoning.
Notes: Netflix v.s. Intel
Unconventional investments are those that are suitable only for enterprising investor. The broadest category is that of undervalued common stocks of secondary companies, which we recommend for purchase when they can be bought at two-thirds or less of their indicated value.
Simply by keeping your holdings permanently diversified, and refusing to fling money at Mr. Market’s latest, craziest fashions, you can ensure that the consequences or your mistakes will never be catastrophic.
Investment Strategies for Defensive Investor
The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condition.
Defensive investor, might be guided in his selection by the rating given to each issue by Moody’s or Standard & Poor’s. One of three highest ratings by both services — Aaa (AAA), Aa (AA), or A — should constitute a sufficient indication of adequate safety.
Seven Statistical Requirements for Inclusion in a Defensive Investor’s Portfolio
- Adequate size
- A sufficiently strong financial condition
- For industrial companies current assets should be at least twice current liabilities — a so-called 2-to-1 ratio
- For public utilities the debt should not exceed twice the stock equity (at book value)
- Continued dividends for at least the past 20 years
- No earnings deficit in the past ten years
- Ten-year growth of at least one-third in per-share earnings (using three-year averages at the beginning and end)
- Price of stock no more than 1.5 times net asset value
- Price no more than 15 times average earnings of the past three years
- The product of the multiplier times the ratio of price to book value should not exceed 22.5
Investment Strategies for Enterprising Investor
Enterprising investors may buy other types of common stocks, buy they should be on a definitely attractive basis as established by intelligent analysis.
Criteria to Pick Common Stock for Enterprising Investors
- The purchase of low-multiplier stocks of important companies (such as DJIA list)
- The choice of a diversified group of stocks selling under their net-current-asset value (or working-capital value, which equals the current assets per share, minus the current liabilities per share, divided by the number of shares outstanding)
- Low price to earnings ratio
1. A low price in dollars per share (Less than 120% net tangible assets)
2. A low price in relation to the previous high price
- A very large enterprise, as measured by number of outstanding shares
- Asset values of at least two-thirds the market price
- A high quality-ranking by Standard & Poor’s
- Financial condition
3. Current assets at least 1.5 times current liabilities
4. Debt not more than 110% of net current assets (for industrial companies)
- Earnings stability
5. No deficit in the last five years covered in the Stock Guide
- Dividend record
6. A high dividend return
7. A very long dividend record
- Earnings growth
8. Last year’s earnings more than those of 1966
Value = Current (Normal) Earnings * (8.5 + 2 * Expected annual growth rate)
This growth figure should be that expected over the next 7 to 10 years.
The valuations of expected high-growth stocks are necessarily on the low side, if we were to assume these growth rates will actually be realized. What the valuer actually does in these cases is to introduce a margin of safety into his calculations. On this basis the purchases would realize his assigned objective even if the growth rate actually rallied proved substantially less than that projected in the formula. Of course, then, if that rate were actually realized the investor would be sure to enjoy a handsome additional return. There is really no way of valuing a high-growth company (with an expected rate above, say, 8% annually), in which the analyst can make realistic assumptions of both the proper multiplier for the current earnings and the expectable multiplier for the future earnings.
A given schedule of expected earnings, or dividends, would have a smaller present value if we assume a higher than if we assume a lower interest structure, since the alternative of investing in bonds has become relatively more attractive.
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This is part of my review of 2017. To see other highlights of my 2017, Click here.
I have also published several other reading journals:
