There are several documents written by Ben Graham that are currently stored at the New York Research Library, and amongst them is a microfilm document titled “The Renaissance of Value”, written in 1974 by Ben Graham and which I have just obtained for our readers.
The document discusses several questions posed by Graham, one being the following: to what degree should the valuation techniques presented in Graham & Dodd’s Security Analysis be modified to account for recent developments?
According to Graham, the midpoint of the value range has typically been found by applying an appropriate multiplier to estimated future earnings, which is not the best technique to use (This technique is still used today). Instead, the earnings figure taken should be what Graham calls “normal current earnings” and all the future prospects – favorable or unfavorable, specific or general – should enter into the multiplier. This procedural change obviates the necessity of establishing a future value, and then discounting the same to its present worth.
In this document, Graham also corrects some of the formulas he proposed in Security Analysis. For example, Graham had previously suggested that the intrinsic value could be approximated by a formula that employs a single variable G, representing the expected growth rate over the next seven to ten years. The formula read:
Value = “current normal earnings” x (8.5+2G)
However, Graham states that this formula had the great defect of failing to allow for changes in the basic rate of interest. To account for this, Graham re-states his intrinsic value formula as:
Value = “current normal earnings” x (37.5+8.8G)/AAA rate
With the AAA rate at 5.39% today and a historical GNP growth rate of 4%, Graham’s equation indicates that the current multiplier for the market should be 13.5. With operating earnings at $49 for the S&P500, Graham’s formula seems to indicate a fair value of 661 for the S&P500 benchmark relative to its current value of 831. At ValueHuntr, we do not believe in a single formula for valuation estimates, but it is an interesting exercise.
Additionally, it is clear that Graham saw no systematic way of reducing multipliers to allow for investments in companies with a below par debt position. His advice to analysts is to rather avoid attempting a formal valuation of such companies. In other words, analysts should limit their appraisals to enterprises of investment quality.
In general, “Renaissance of Value”, as Graham noted in 1974, involved the reappearance of sub-working capital opportunities. It seems that 2008 was a year which Graham would hail as the “Re-Renaissance of Value”.
A scan of the microfilm document has been posted in our resources section. Click here to read.