The True way to use Benjamin graham formula 22.5
It is very important to know about Benjamin graham formula 22.5 as when buying big companies or blue chip stocks or index stocks like NASDAQ or DOW Jones index stocks.Here Benjamin graham defined a simple rule of thumb that PE * (price to book value) < 22.5.This formula can be used for growing companies only .It should not be used for non-growth companies.
Benjamin graham methods are a lot of attention because of its simplicity i.e
1) it is very easy to understand
2) it is very easy to use.
3) it is very easy to adjust to different scenarios.
Now i am going to discuss the similar formulae other than that is :
Here Y = total number of years.Here instead of using 1.5 use 1.I tested with hundreds of companies and 1 is the formula that fits.
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benjamin graham formula |
The 7 Filters to Use the benjamin graham formula 22.5
1. Seek Safety with Large Predictable companies.
Look for stocks with at least $100m in sales (back in the year 1970’s). Adjusted after inflation, that number should be around $465 million.
2. Strong Financial Condition to Prevent the company from Bankruptcy
Current ratio > 2
Long term debt < working capital of the company
3. Earnings Stability should be there
No losses over the past 10 years of record. Companies that can maintain positive earnings are more stable to buy.
4. Consistent Dividends
The company should have the history of paying the dividends without problems for the past 20 years of record. Check the payout ratio here.
5. Earnings Growth
Net income per share should be or have increased by at least a 1/3 in the past 10 years.
6. Price to Earnings Ratio below 15 say the company is not overvalued
7. Price to Book below 1.5 say the company is not overvalued
You can see that the points in this criteria number 6 and 7 make up the Graham number.
Combine criteria 1 through 5 and you will got the full
Graham number methodology.
But there are limitations you have to know.
Only works for the companies with the positive earnings and positive the tangible book value.
The Graham Number doesn’t include any of the growth assumptions. Won’t work well for growing companies like coco-cola.Cyclical stocks or businesses with one time lower earnings are punished with this method. A better adjustment is to use the normalized figures over the past 3 to 5 years.
Underestimates stocks with very little tangible assets. Industries like software, service and information won’t make in this list.