Adjusting Benjamin Graham's Price Calculations Today

Benjamin Graham — Warren Buffett's mentor and founder of Value Investing — recommended a P/E ratio no higher than 13.3 based on an AA bond yield of 7.5%.

Our basic recommendation is that 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. This would mean a P/E ratio no higher than 13.3 against an AA bond yield of 7.5%.
Chapter 14: Stock Selection for the Defensive Investor, The Intelligent Investor.

Based on the same principle, a defensive investor today could consider stocks with P/E ratios up to 32, since 10-year AA corporate bond yields are now close to 3.09% [Feb 2017].

Adjusting Graham's criteria to screen Defensive grade stocks with P/E ratios of 32 instead of 15 (all else being equal) would involve the following:

32÷15 = 2.13
√2.13 = 1.46

We would need to multiply the Graham Number of a stock by 1.46, to adjust it to a P/E of 32.

Note: Since the Graham Number is designed to balance Earnings and Assets, stocks with P/E values higher than 32 could clear Graham's rules too if they have lower P/B values.

Serenity's Advanced Graham Screener has a filter specifically for Intrinsic Value(%).

The filter values for finding Defensive grade stocks with the adjusted Graham Number would be:

Graham Grade: Defensive
Intrinsic Value(%): > 70%

70% is used for the Intrinsic Value(%) because the reciprocal of 1.46 is 0.6849, or 68.49%; and Intrinsic Value = Graham Number for Defensive grade stocks.

Prices for Enterprising grade stocks can be adjusted similarly as well.

Considering today's bond yields, Defensive and Enterprising grade stocks would need an Intrinsic Value(%) of 70% or higher to be classified as true Graham stocks.

Serenity's Classic Graham Screener is limited to an Intrinsic Value(%) of 70%. The Advanced Graham Screener has no such restrictions.

Note: NCAV stocks require Intrinsic Values of 100% or higher since NCAV Intrinsic Values are calculated based on asset values alone, which — unlike earnings yields — are not dependent on bond rates.

Comments

Based on this and how the advanced screener calculates GN, should we be looking at 1.46*GN versus previous close when considering margin of safety from a dollars perspective?

serenity's picture

That's correct, LearningGraham!

The way to do that on Serenity's screeners is to screen for Defensive and Enterprising grade stocks with Intrinsic Value(%) greater than 70%.
Also, for Defensive grade stocks, Intrinsic Value = Graham Number.

I believe Buffet said once that a good way to see the value of a stock is by comparing its earning yield vs 10 years treasury yield. If earning yield is at least 2x the current 10 years treasury yield it is a good buy. For example, 10 years treasury yield right now is 2.3%, which means if we buy a stock with P/E of 21.74 (4.6% earning yield), that's a good buy.
It is tough to find bargain nowadays. Dow hit all time high. S&P 500 index P/E ratio is 26.16.

serenity's picture

Thank you for your informative comment, Will!

Serenity's database lists 100+ stocks that completely clear Graham's requirements as of today. Value Investing 101 provides a list of the standard preloads required for Serenity's stock screeners to display them.

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