Modified Benjamin Graham Formula

BenG
The key variables in the Ben Graham formula are the base PE ratio and the multiplier to the EPS growth rate. Let’s take a look at what happens when we calculate the intrinsic value of a stock with a growth rate of 5%. We selected BBBY for this (their projected growth rate is much higher, but this is just for illustration) and plugged in 5% for the projected growth rate over the next 5 years. By the way, BBBY has insignificant debt, so that will not complicate this investigation.

The intrinsic value calculation results give us the following:
graham

The Graham formula gives us an intrinsic value about 50% above the value given by just using the growth in EPS calculation ( $36.07 vs. $23.84). Since debt is not a factor in these calculations, it appears that the Graham formula evaluates the intrinsic value of a stock at a higher value that the traditional method.

A detailed investigation of the Graham variables shows us that for a stock that has projected growth of 0% over the next 5 years, we expect to have a P/E ratio of 8.5 (this is the base P/E ratio). For every additional percent of expected growth, the P/E ratio would be increased by a factor of 2.

In other words, a company with a 5 percent projected growth rate would be expected to have a P/E of 18.5 (8.5 plus 2 X growth rate of 5).

ZenValue software allows you to modify the variables that go into the Benjamin Graham formula in order to make more accurate estimates of intrinsic value. For example, if we adjusted the values so BPE would be 6.5 (P/E of 6.5 for a company with no growth prospects) and a multiplier of 1.5 (we’ll pay an additional 1.5 times for every additional percent of growth), we would get the following in our BBBY example:

Graham 2

graham 3
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