Likewise, the Benjamin Graham intrinsic value formula doesn’t quite catch risks that require wise human judgment. You’d be foolish to think that John’s business was a bargain even if it were offered at a 40% discount to Jane’s business. Same profits, yet Jane has 3x as much cash earnings, or “owner earnings”. Even though both earn a taxable profit of $1,000,000 per year, Jane has $900,000 in cash that can be spent, reinvested, or given to charity.

John owns a construction equipment company that requires him to reinvest $700,000 of his earnings to grow, all of which sits in his lot rusting until it is sold. Jane owns an advertising agency and only has to reinvest $100,000 in capital expenditures to maintain her business, upgrading phone lines, putting in new computers, installing new furniture, and raising employee salaries. Imagine that Jane and John each own a business that earns $1,000,000 per year in profit.

An illustration may help you understand why I’m adamant about that belief. What are the shortfalls? It doesn’t account for capital intensity, for one. There are several flaws in the model but for the average person who wants to try and put together a diversified portfolio of high quality blue chip stocks that will grow over time without major wipeout risk, it does have utility. The Benjamin Graham Intrinsic Value Formula Is Incomplete But Still Usefulīenjamin Graham’s intrinsic value formula isn’t perfect. Market, and the value investing strategies he used at his hedge fund, Graham Newman Corporation. Those who follow finance know that Graham is perhaps most famous for his margin of safety concept, his allegory of Mr. He encouraged investors to only buy shares that passed the test and, if the market fell substantially as it is prone to do from time to time, to sit back, collect the dividends from their share of the profits, and ignore the stock price, instead acting just as you would if you owned a neighborhood pharmacy or a local hotel. Image © Stockbyte/Thinkstockīenjamin Graham, the rich investor, professor, and mentor to Warren Buffett, once proposed a quick back-of-the-envelope intrinsic value formula for investors to determine if their stocks were at least somewhat rationally priced. This is probably the single most famous allegory in the history of finance. Market who is manic depressive and wants to either buy your interest or sell you his every day at wildly different prices. Benjamin Graham, the father of value investing, recommended that intelligent investors imagine they have a business partner named Mr.

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