BENJAMIN GRAHAM gave a formula that i reproduce below for the analysis of everyone and their views.
BENJAMIN GRAHAM'S FORMULA : Intrinsic Value = Earnings x (8.5 + 2 x Expected Growth)Summary : I - WHAT IS GRAHAM's FORMULA ?A - A FEW IMPLICATIONS OF GRAHAM'S FORMULA1 - Price Earning Ratio (P/E) as a function of future growth (G)2 - Implicit Growth derived from price and earnings.B - HOW TO ESTIMATE LONG TERM GROWTH ?C - COMPARING GRAHAM's FORMULA WITH DISCOUNTED CASH FLOW METHODE - GRAHAM'S FORMULA LIMITATIONSD - BACK TESTING GRAHAM'S FORMULA II - HOW IS GRAHAM's FORMULA APPLIED ON INVESTINVALUE.COM ?I - WHAT IS GRAHAM'S FORMULA ?Benjamin Graham describes a formula he used to value stocks in the 11th chapter of the “Intelligent Investor”.(whole text here) :"Most of the writing of security analysts on formal appraisals relates to the valuation of growth stocks. Our study of the various methods has led us to suggest a foreshortened and quite simple formula for the valuation of growth stocks, which is intended to produce figures fairly close to those resulting from the more refined mathematical calculations. Our formula is : Intrinsic Value = Current Earnings x (8.5 + 2 x Expected Annual Growth Rate)The growth figure should be that expected over the next seven to ten years."Example n°1 : A stock is trading at 120$. Its current earnings are 8$ per share. The annual growth rate over the next 7 to 10 years should be around 7%. The Intrinsic Value is = 8 *( 8.5 + 2 * 7) = 180 $. The Margin of Safety is : (180 - 120) / 180 = 33%.Example n°2 : the same stock is still trading at 120$, but its earnings are revised to 9$ per share and the annual long term growth rate should now be around 8%. The Intrinsic Value becomes = 9 *( 8.5 + 2 * 8) = 220.5. The Margin of Safety is : (220.5 - 120) / 220.5 = 56%.Example n°3 : the same stock is trading at 120$, its earnings are 5.5$ per share, the annual growth rate around 6.5%. The Intrinsic Value is = 5.5 *( 8.5 + 2 * 6.5) = 118. The Margin of Safety is : (118 - 120) / 118 = -1%.A - A FEW IMPLICATIONS OF GRAHAM'S FORMULA1 - Price Earning Ratio (P/E) as a function of future growth (G)If we assume that Intrinsic Value = Price, then Graham's Formula is equivalent to : Price / Earnings = 8.5 + 2 x G.In other words, the P/E for a no-growth company (G = 0) should be around 8.5.2 - Implicit Growth derived from price and earnings.From the fomula above, a P/E can be linked to G this way : G = (P/E - 8.5) / 2.P/E 5 8.5 10 15 20 25 30
Long term annual GROWTH (in %) -1.75 0 0.75 3.25 5.75 8.25 10.75
or graphically : Example : If a stock is trading at 100$ and has earnings of 5$, then we have : G = ( P/E - 8.5 ) / 2 = (100/5 - 8.5) / 2 = (20-8.5)/2 = 11.5 / 2 = 5.75%.B - HOW TO ESTIMATE LONG TERM GROWTH ?Estimating long term growth over the next seven to ten years as required by Benjamin Graham is a key point. Unfortunately, what is certain about future growth is that it is unpredictable. Yet, a few techniques are available :- dividing earnings current earnings by earnings ten years ago and assuming that past growth will reflect future.- dividing average earnings on last three years by average 3 years earnings ten years ago- estimating future growth by fundamentals from the balance sheet- linear regression or log-linear regressions : this is the one chosen on Investinvalue.com.- you can also try this one : hereA good study of the different ways of estimating growth (... and much more...) is available on Pr. Aswath Damodaran website : hereC - COMPARING GRAHAM's FORMULA WITH DISCOUNTED CASH FLOW METHOD ?A good website to compare valuation methods is MoneyChimp : hereGRAHAM'S FORMULA / DCF SIMULATOR : With this simulator (click HERE) you can compare the fair value given by a two-stage discounted cash flows model with the fair value of Graham's Formula.D - GRAHAM'S FORMULA LIMITATIONSConcerning Future Growth Rate :Investinvalue.com utilizes a linear regression of past 10 years earnings to determine growth rates : the last ten years may or may not reflect the future growth rate. Competitive landscapes change, capital structures change, and hence earnings growth rates will be affected.Concerning the level of Current E.P.S. :- earnings may be bloated or understated depending on accounting choices.- cyclical businesses in the late stages of an economy will have a very high earnings base that is used as the basis of the valuation.- Balance sheet leverage is also not considered in the valuation.- Businesses that are currently loss-making are worth zero in this analysis.What follows is taken from an excellent blog : http://valuediscipline.blogspot.com/" This raises another important reminder. Valuation is an incredibly imprecise art. In some ways, the development of the spreadsheet was one of the most dangerous inventions of the twentieth century. Extrapolating data into the hereafter without consideration of its reasonableness, without consideration of competitive advantage periods, and without considering something other than linear growth has often provided ridiculous results.Though elegant spreadsheet models may create an illusion of precision, their complexities do not necessarily suggest greater accuracy than the Graham model. I do prefer free cash flow based valuation models but like every model, the valuation is entirely dependent on the input assumptions. Man have I gotten a lot of those wrong over time, but the spreadsheet sure looked impressive.I think the website is definitely worth a look and a spin. You may or may not agree with the valuation it accords your stock, but at least it should make you think about the reasonableness of your assumptions. If it achieves that, it's a great site."E - BACK TESTING GRAHAM'S FORMULAGRAHAM's formula has been applied to S&P500 index since 1940. The datas come from Professor Robert J. Shiller (Yale University).
II - HOW IS GRAHAM's FORMULA APPLIED ON INVESTINVALUE.COM ?
1 - Estimating Earnings Long term Growth : the "G" parameterOur estimation of earnings long term growth rate is based on a linear regression of the past ten years earnings per share. For example, consider Citigroup's Historical earnings on this chart.
The linear regression on the past ten years earnings (orange bars) looks like this (red line) :
The prospective linear regression for the next year is the red line.Long term growth is estimated by dividing next years earnings (estimated by regression) by current year earnings ; here, long term growth rate estimation is 4.79 / 4.48 - 1 = 6.91%
2 - Applying GRAHAM's FORMULAIn the example above :Current Earnings Per Share = EPS = 4.48Long Term Growth Rate = G = 6.91Intrinsic Value = V = EPS * (8.5 + 2 * G ) = 4.48 * (8.5 + 2 * 6.91) = 100 dollars.
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Sunday, December 12, 2010
Friday, December 10, 2010
Why Silver ???
Silver, the poor cousin of gold has been on a roll. Since the beginning of this year, the metal has given a whopping 61% returns. Gold in the same period has given a return of around 15%.
Also, silver prices have been on all time high levels, and currently quote at `44,130 per kg. Despite these all-time high levels, buying silver seems to be catching on in India.
Take the case of 58-year old Usha Joshi, who always wanted to buy silver. However, the idea of holding silver physically seemed problematic to her. While she could buy gold through exchange traded funds (ETFs), she could not do the same in case of silver, as no silver ETFs are available in India.
However, now she has a solution to her problem. She buys both e-gold and e-silver through the National Spot Exchange, where it is possible to buy silver in lots of 100 grams and gold in lots of 1 gram.
At the opportune time, Ms Joshi, plans to gift these precious metals to her grandchildren. “It’s easier than going to a jewellery shop. All I do is instruct my broker to buy it,” says Joshi.
Several people like Joshi are buying silver nowadays. “In the last couple of months, we have received a lot of enquires from retail investors who want to buy silver and are opening accounts,” says Sushil Sinha, business head, Karvy Commtrade. “We are adding 3,000-4,000 client accounts every month,” says Anjani Sinha, MD and CEO, National Spot Exchange.
So, What’s The Silver Story?: Silver, unlike gold, has a lot of industrial uses. “Silver is the best conductor of electricity, the best heat transfer agent, the best reflector of light, a marvellous lubricant and a versatile catalyst and alloy,” says Theodore Butler, silver analyst, Butler Research, and one of the most respected silver analysts in the world. Other than these properties silver, after gold, is also the most ductile and malleable.
“Silver has industrial value and finds use in dentistry, photography and motherboards. The demand for these industrial products is on the rise,” explains Vijay Bhambwani, chairman, Bhambwani Securities. Besides that, the global recession has taught people to go beyond paper assets and invest in precious metals. Hence the recent interest in gold and silver.
Bhambwani recommends investors to buy silver for the long term, and has a target of `60,000 per kilo with a three-year timeframe. What is also not too well known is that there is less silver on earth than gold. As Butler says, “There is less silver bullion in the world than gold bullion inventory.
The shocking thing is how few people are aware that silver is rarer than gold.” He estimates that global silver inventories have fallen to around 1 billion ounces (one troy ounce equals 31.1 grams). In comparison there are 5 billion ounces of gold available around the world. Of course, Butler is very optimistic on the price of silver. “I’ll be amazed if we haven’t climbed past $100 per ounce in that period, in the next three to five years.” Currently, silver quotes at around $28.4 per ounce.
The Technical Reason: “Silver moved in a band of $10 to $21 per ounce, for a long period from 2007 to 2010. It broke that band after a long time, which makes me bullish on the metal,” says Bajrang Banthia, MD & CEO, Ashika Commodities.
He feels that within two to three years, globally silver could reach $50 per ounce against the current price of $28.4 per ounce, while in India, it could reach `55,000 per kilo from current levels of around `44,000 per kilo. The rationale for a lower rise in silver in terms of Indian rupees is due to the fact that Banthia expects the rupee to strengthen and go up to `42 per dollar, limiting the gains in rupee terms.
Gold Versus Silver: The investment argument of silver is pretty simple. The various industrial uses of silver are growing and there isn’t enough silver going around to satisfy that demand.
Adrian Douglas, the proprietor of Market Force Analysis, and also a director of GATA (the Gold Anti-Trust Action Committee), said in a recent interview that the world will run out of silver in 2020, and thus silver will become the first element from the periodic table to become extinct.
Given this analysts, expect silver prices to appreciate faster than gold. “As global uncertainty fades and industrial activity picks, I expect higher demand for silver, so it could move faster than gold,” says Anand James, chief analyst, Geojit Commtrade.
“In the short term, silver prices could see a correction,” adds Banthia.
However, for retail investors it is very difficult to time the market and it is best that they accumulate it over a long term. “Retail investors should systematically buy gold and silver every month. This could constitute up to 10% of your total investment portfolio,” says Partha Iyengar, founder and CEO, Accretus Solutions.
How To Buy Silver: Of course, the traditional way to buy silver is buying it from your jeweller. Traditionally, individuals are used to buying coins or silver bars. Some even buy ornaments, while some families also buy silver utensils. However, there are a couple of problems in buying coins and bars.
The first is that of purity and the second is of storing it. Silver is bulkier than gold and needs more storage space. So, storing bars can be a problem. As Devendra Nevgi, managing partner and founder, Delta Global Partners explains, “Physical silver is typically more bulky and investors sometimes face this storage problem for larger quantities.
This increases the cost of storage and may be the cost of insurance too. Though smaller investors can easily manage the storage as a typical 1 kg silver bar would be 99 x 49 x 22 mm in size,” says Nevgi.
Vijay Chabbria, a certified financial analyst who runs Prudent Investment Advisors, says, “It is not practical to buy 20 kg as an investment — firstly to store it is cumbersome and secondly, purity may be an issue in some cases. Also, normally I need to sell it back to the same merchants so that they recognise the purity. More than that, there is that wealth tax that has to be paid on physical silver.”
While there are a lot of gold ETFs, silver ETFs have not been allowed as yet. So, how does one buy it for investment? The most practical solution is to buy e silver.
E silver has been launched recently by National Spot Exchange. According to brokers, about `30 to `40 crore of silver is traded on a daily basis, thus giving enough liquidity for retail investors.
This is the same way as you buy shares and they are held in dematerialised form. In case you want physical silver, you can do the necessary paperwork with the depository participant and collect it. However, currently there are limited centres which could be a barrier for investors.
For example, if you stay in Hyderabad, it may not be feasible to take possession of physical silver as the delivery centres of National Spot Exchange are located in Mumbai, Delhi and Ahemdabad. So, go ahead and buy e silver to ride the white metal boom, keep it as a hedge against inflation or pass it on to your next generation.
Also, silver prices have been on all time high levels, and currently quote at `44,130 per kg. Despite these all-time high levels, buying silver seems to be catching on in India.
Take the case of 58-year old Usha Joshi, who always wanted to buy silver. However, the idea of holding silver physically seemed problematic to her. While she could buy gold through exchange traded funds (ETFs), she could not do the same in case of silver, as no silver ETFs are available in India.
However, now she has a solution to her problem. She buys both e-gold and e-silver through the National Spot Exchange, where it is possible to buy silver in lots of 100 grams and gold in lots of 1 gram.
At the opportune time, Ms Joshi, plans to gift these precious metals to her grandchildren. “It’s easier than going to a jewellery shop. All I do is instruct my broker to buy it,” says Joshi.
Several people like Joshi are buying silver nowadays. “In the last couple of months, we have received a lot of enquires from retail investors who want to buy silver and are opening accounts,” says Sushil Sinha, business head, Karvy Commtrade. “We are adding 3,000-4,000 client accounts every month,” says Anjani Sinha, MD and CEO, National Spot Exchange.
So, What’s The Silver Story?: Silver, unlike gold, has a lot of industrial uses. “Silver is the best conductor of electricity, the best heat transfer agent, the best reflector of light, a marvellous lubricant and a versatile catalyst and alloy,” says Theodore Butler, silver analyst, Butler Research, and one of the most respected silver analysts in the world. Other than these properties silver, after gold, is also the most ductile and malleable.
“Silver has industrial value and finds use in dentistry, photography and motherboards. The demand for these industrial products is on the rise,” explains Vijay Bhambwani, chairman, Bhambwani Securities. Besides that, the global recession has taught people to go beyond paper assets and invest in precious metals. Hence the recent interest in gold and silver.
Bhambwani recommends investors to buy silver for the long term, and has a target of `60,000 per kilo with a three-year timeframe. What is also not too well known is that there is less silver on earth than gold. As Butler says, “There is less silver bullion in the world than gold bullion inventory.
The shocking thing is how few people are aware that silver is rarer than gold.” He estimates that global silver inventories have fallen to around 1 billion ounces (one troy ounce equals 31.1 grams). In comparison there are 5 billion ounces of gold available around the world. Of course, Butler is very optimistic on the price of silver. “I’ll be amazed if we haven’t climbed past $100 per ounce in that period, in the next three to five years.” Currently, silver quotes at around $28.4 per ounce.
The Technical Reason: “Silver moved in a band of $10 to $21 per ounce, for a long period from 2007 to 2010. It broke that band after a long time, which makes me bullish on the metal,” says Bajrang Banthia, MD & CEO, Ashika Commodities.
He feels that within two to three years, globally silver could reach $50 per ounce against the current price of $28.4 per ounce, while in India, it could reach `55,000 per kilo from current levels of around `44,000 per kilo. The rationale for a lower rise in silver in terms of Indian rupees is due to the fact that Banthia expects the rupee to strengthen and go up to `42 per dollar, limiting the gains in rupee terms.
Gold Versus Silver: The investment argument of silver is pretty simple. The various industrial uses of silver are growing and there isn’t enough silver going around to satisfy that demand.
Adrian Douglas, the proprietor of Market Force Analysis, and also a director of GATA (the Gold Anti-Trust Action Committee), said in a recent interview that the world will run out of silver in 2020, and thus silver will become the first element from the periodic table to become extinct.
Given this analysts, expect silver prices to appreciate faster than gold. “As global uncertainty fades and industrial activity picks, I expect higher demand for silver, so it could move faster than gold,” says Anand James, chief analyst, Geojit Commtrade.
“In the short term, silver prices could see a correction,” adds Banthia.
However, for retail investors it is very difficult to time the market and it is best that they accumulate it over a long term. “Retail investors should systematically buy gold and silver every month. This could constitute up to 10% of your total investment portfolio,” says Partha Iyengar, founder and CEO, Accretus Solutions.
How To Buy Silver: Of course, the traditional way to buy silver is buying it from your jeweller. Traditionally, individuals are used to buying coins or silver bars. Some even buy ornaments, while some families also buy silver utensils. However, there are a couple of problems in buying coins and bars.
The first is that of purity and the second is of storing it. Silver is bulkier than gold and needs more storage space. So, storing bars can be a problem. As Devendra Nevgi, managing partner and founder, Delta Global Partners explains, “Physical silver is typically more bulky and investors sometimes face this storage problem for larger quantities.
This increases the cost of storage and may be the cost of insurance too. Though smaller investors can easily manage the storage as a typical 1 kg silver bar would be 99 x 49 x 22 mm in size,” says Nevgi.
Vijay Chabbria, a certified financial analyst who runs Prudent Investment Advisors, says, “It is not practical to buy 20 kg as an investment — firstly to store it is cumbersome and secondly, purity may be an issue in some cases. Also, normally I need to sell it back to the same merchants so that they recognise the purity. More than that, there is that wealth tax that has to be paid on physical silver.”
While there are a lot of gold ETFs, silver ETFs have not been allowed as yet. So, how does one buy it for investment? The most practical solution is to buy e silver.
E silver has been launched recently by National Spot Exchange. According to brokers, about `30 to `40 crore of silver is traded on a daily basis, thus giving enough liquidity for retail investors.
This is the same way as you buy shares and they are held in dematerialised form. In case you want physical silver, you can do the necessary paperwork with the depository participant and collect it. However, currently there are limited centres which could be a barrier for investors.
For example, if you stay in Hyderabad, it may not be feasible to take possession of physical silver as the delivery centres of National Spot Exchange are located in Mumbai, Delhi and Ahemdabad. So, go ahead and buy e silver to ride the white metal boom, keep it as a hedge against inflation or pass it on to your next generation.
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