Understanding Benjamin Graham’s Intrinsic Value

Benjamin Graham

Let’s get into the fascinating world of intrinsic value and explore Benjamin Graham’s principles.

What is Intrinsic Value?

Intrinsic value, championed by Benjamin Graham, represents a security’s true worth based on its fundamental attributes rather than market sentiment. Graham’s insight illuminated the irrationality of short-term market fluctuations, emphasizing the importance of a rational valuation approach.

Benjamin Graham’s Intrinsic Value Formula

At the heart of Graham’s contributions lies the Intrinsic Value Formula, an enduring pillar of value investing. This formula equips investors with a systematic methodology to estimate a stock’s intrinsic value. Let’s break it down:

  • Earnings per Share (EPS): As the formula’s cornerstone, EPS reflects a company’s profitability per outstanding share after deducting expenses and taxes.
  • Expected Annual Growth Rate: This vital element incorporates a conservative estimate of a company’s future annual earnings growth over 7 to 10 years.

The equation, simplified, is:

Intrinsic Value=EPS×(8.5+2×Expected Annual Growth Rate)

Graham’s Approach to Value Investing

Graham’s approach focuses on the concept of an intrinsic value justified by a firm’s assets, earnings, dividends, and financial strength. By calculating intrinsic value, investors can identify stocks trading at a discount to their true worth. Here are some key takeaways:

  • Contrarian Thinking: Value investing requires contrarian thinking. While others follow market trends, value investors seek out undervalued stocks that the rest of the market might be underestimating.
  • Long-Term Commitment: It’s a long-term strategy that may take several years before generating profits, as stocks need time to reach their intrinsic value.
  • Fundamental Analysis: Investors perform fundamental analysis to assess a company’s intrinsic value. This involves examining financials, business models, and other qualitative criteria.

Methods to Identify Undervalued Stocks

Apart from Graham’s formula, there are other methods to identify undervalued stocks:

  • Graham Number: A calculation combining book value per share and earnings per share.
  • Enterprising Price Calculation: A more aggressive approach that considers a company’s net current asset value.
  • Net Current Asset Value (NCAV): Focuses on a company’s liquidation value.

Remember, value investing is about patience, research, and rational decision-making. By understanding intrinsic value, you’ll be better equipped to navigate the unpredictable market landscape and make informed investment choices.