Adjusting Benjamin Graham's Price Calculations Today

A defensive investor today could consider stocks with P/E ratios of 32 — and more — based on current bond yields.

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 framework 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.

NCAV grade 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.

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 free Classic Graham Screener is limited to an Intrinsic Value(%) of 70%. However, the Advanced Graham Screener and the free Graham Analysis Search have no such restrictions.

Value Investing 101 provides a list of standard preloads that can be quickly applied to Serenity's Graham screeners.

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?

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.

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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