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|Subject: Ben Graham's Equation||Date: 10/31/2001 3:16 PM|
|Author: hsifyllej||Number: 16493 of 18386|
Today's Rule Maker column is about Graham's equation: http://www.fool.com/portfolios/rulemaker/2001/rulemaker011031.htm I quoute:
In The Intelligent Investor, Graham laid out an equation that was designed to help people value a growth company. The equation goes like this:
P = ProjEPS * (8.5 + (2*G)) * (4.4/AAA yield)
I would strongly recommend against using this equation which is little more useful than the PEG ratio. Like the PEG=1 rule it's ad hoc and doesn't account for risk and book value, two key components of valuation. Graham is from a time when the world looked a lot different than today. In the context of valuation you might say that in Graham's time the earth was thought to be flat. There's been a revolution in the field of valuation since which brings us to another quote from today's Rule Maker article:
I started today with Graham's equation, but we can't stop there. Discounted cash flow analysis is out there, along with other concepts such as "real options" that we need to consider.
You can start and stop with discounted cash flow analysis, or any other variant of the dividend-discount model, which is the correct way to value stocks. Real options are often abused here and elsewhere as a residual value generator, i.e. if a company is overvalued relative to formal valuation analysis but we are in love with the company it must have real option value making up for the difference and more.
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