We were recently able to obtain copies of some of Ben Graham’s original lectures (dated 1932 to 1947) while he was teaching at Columbia University, and we thought we would share some common themes among them.
According to Graham, analysts who value companies based upon the capitalization of its earning power must make certain adjustments for the asset picture. However, asset valuation is more reliable than earnings-based valuation because the assets tend to move slower than earnings.
In general, Graham points out that if the earning power value exceeds the asset value, the value of the business should be marked upwards, but that some reduction should be made based on its assets. He suggests that to value these cases conservatively, analysts should take off a quarter of the difference between earning power value and asset value. The other case is that the asset value exceeds the earnings power value. For this case, companies should not be valued upwards because the assets have no earnings-generating potential, with the exception of cases where working capital exceeds earnings power. From experience, Graham points out that when this exception is validated, the analyst should add half the difference between earnings power value and working capital to correct for the eventual impact of this excess working capital on the business once it is put to work.
Additionally, Graham explains the two fundamental approaches that analysts may use to pursue the valuation of securities. These are:
1) The conventional – that is based primarily on quality and prospects.
2) The penetrating one – that is based on value.
Lastly, Graham insists that analysts should stay away from the game of expectations – the idea that because the prospects of a company are good then the company should be bought. He is most skeptical of this frequent Wall St. activity because “it tends to be the most popular form of passing the time for security analysts”. Graham stresses throghout the lectures that this behavior is naïve, at best.
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