Dear Sirs,

I was glad to find your site and articles. This was after I had already read "The Intelligent Investor" 1973 Hardcover edition by Graham (TII), and "Value Investing for Dummies" 2002 edition by Sander and Haley (VIFD).

Now, please bear with me while I build up to my question. What I couldn't reconcile between the two books was the intrinsic value formula. In "TII" on page 158 given as:

Value = Current (Normal) Earnings x (8.5 plus twice the expected annual growth rate),
and there is a footnote that qualifies the equation as not giving the "true value" of a growth stock, but only approximates the results of more elaborate calculations.

Whereas in "VIFD" on page 37 and 210 a similar formula is presented (attributed to Graham):

Intrinsic value = Earnings x [(2 x growth rate) + 8.5] x [4.4 / bond yield]

No attempt was made to explain the 4.4 factor.

Now, when reading the article on your site "Finding Undervalued Stocks 3 - Using Intrinsic Value"
the same formula is found and the 4.4 factor is explained as follows:

"Graham's formula takes no account of prevailing interest rates; at the time he last updated the chapter, around 1971, the yield on AAA Corporate Bonds
was around 4.4%. We can adjust the formula by normalizing it for current bond yields by multiplying by a factor of 4.40/{AAA Corporate Bond Yield}."

This is all well and good in principle, normalizing to current interest rate conditions. It is not clear who came up with the correction factor as "VIFD" doesn't credit your site, and there is no by line in your article. What matters is that the 4.4% rate may not be correct, as I will shortly explain, and it would be good for the original author to consider the following:

On page 48 of "TII" it states that "In early 1972 those of highest quality yielded 7.19% for a 25-year maturity, as reflected in the published yield of Moody's Aaa corporate bond index."

This clearly contradicts the above quote from your site's article. It would seem that the 4.4 factor needs to be revised to 7.2, in which case all previously calculated intrinsic values would increase.

I would sincerely appreciate any comments that could be made in regards to this difference. Thank you.

You're right. The article is not correct, it should be "around 1962" not "around 1971". Check out the following links:

http://research.stlouisfed.org/fred2/data/AAA.txt

http://en.wikipedia.org/wiki/Benjamin_Graham_formula

Interestingly an article posted by the Motley Fool has a different interpretation:

http://www.fool.com/portfolios/rulemaker/2001/rulemaker011031.htm

"4.4
This was Graham's benchmark for a required rate of return to invest, period. He surmised that at a minimum, an investor needed to be compensated for the effects of inflation and a small risk premium above that. You might be tempted to "play around" with the 4.4, but I keep it constant."

I am new to the stock market and find myself leaning towards value investing. Based on my style and personality, it just makes sense to me and for me.

I like your blog because it is centered around Graham's principles of investing. I am blogging my stock market journey: http://www.ourstockmarketjourney.blogspot.com/ and I hope to continue implement the principles of Graham, Buffett, and other successful investors.

Thank you and keep up the good work!

Be well.

Thanks for a great blog!

"The time has come the walrus said, to talk of many things": Of corrections--portfolios--- and window dressing--- of market cycles--- wizards--- and reality.

Quarterly portfolio window dressing is one of many immortal Jaberwock-like creatures that roam the granite canyons of the Manhattan triangle, sending inappropriate signals to unwary investors and media spokespersons. Many of you, like the unsuspecting young oysters in the Lewis Carroll classic, are responding to the daily news nonsense with fear instead of embracing the new opportunities that are surely right there, cloaked, just beyond your short-term vision field.

Older and wiser mollusks who have experienced the cyclical realities of the markets tend to stick with proven strategies that are based on a solid foundation of QDI (quality, diversification, and income production). They know that corrections lead to rallies, and that rallies always give way to corrections. If only the corrections could elicit patience instead of fear; if only rallies didn't produce greed and excess. There's a lot of confusion in a world that considers commodities safer instruments than corporate bonds.

Long lasting investment portfolios are consciously asset allocated between high quality income and equity securities. Each class of securities is then diversified properly to mitigate the risk that the failure of a single security issuer will bring down the entire enterprise. Simply put, a portfolio with 100% invested in the absolute, hands-down, best company on the planet is a high-risk portfolio. There is no cure for cyclical changes in security market values--- diversified portfolios thrive on it, in the long run.

The differences between a correction in either a market (equity or debt) or a market sector (financials, drugs, transportation, etc.), and a fall from grace in a specific company are important to appreciate. Corrections are broad downward movements that affect nearly all securities in a specific market. This particular one has impacted prices in both investment markets, while creating rallies in more speculative arenas. Ten years ago, the dot-com bubble began under very similar circumstances. Ten years earlier, it was interest rates--- and on, and on. When all prices are down, opportunity is at hand.

There are approximately 450 Investment Grade Value Stocks, and at least half are down significantly from their 52-week highs; fewer than ten per cent were in this condition just over a year ago. But very few companies have thrown in the towel, or even cut their dividends. Closed end income fund prices are still well below the levels they commanded when interest rates were much higher, yet they provide the same cash flow as before the financial crises. The economy and the markets have been through much worse.

Why aren't the wizards of Wall Street assuaging our nerves by explaining the cyclical nature of the markets and pointing out that similar crises have always preceded the attainment of new all time highs? Right, because the unhappy investor is Wall Street's best friend. Why can't politicians address economic problems with capitalist-economic solutions? Fear, and the panic it evokes, creates an easy market for walruses, oyster knives in hand.

Wall Street plays to the operative emotion of the day--- greed in the commodities markets and fear in the others. Once per quarter, they trim their holdings in unpopular sectors and add to their positions in areas that have strengthened. Under current conditions in the traditional investment arena, don't be surprised by larger than usual cash holdings (certainly not "Smart Cash"). Window dressing pushes the prices of your holdings lower, in spite of their continued income production and sustained quality ratings.

How have the wizards managed to re-define the long-term investment process as a quarterly horse race against indices and averages that have no relationship to investor goals, objectives, or portfolio content? Why do these proponents of long-term investment planning and thinking religiously conspire to make short-term decisions that prey upon the emotional weaknesses of their clients? The "art of looking smart" window-dressing exercise accomplishes several things in correcting markets:

The things you own are artificially manipulated lower in price to make you even more uncomfortable with them, while the things you don't have positions in stabilize or move higher. The glossies from the new fund family your advisor is talking about show no holdings in any of the current areas of weakness. It's easy to make fearful investors change positions and/or strategies. Sic 'em boys. Brilliant!

Value investors (those who invest in IGVSI stocks, and income securities with an unbroken cash flow track record) may lapse into fearful thinking as well, and this is where the Working Capital Model comes to the rescue. By focusing on the purpose of the securities you own, their enhanced attractiveness at lower prices becomes obvious. Higher yields at lower market valuations and more shares at lower prices equal faster realized profits as the numbers move higher during the next upward movement of the cycle. That's just the way it is. A reality you can count on.

Surprisingly few investors have the courage to take advantage of market corrections. Even more surprising is how reluctant the most respected institutional walruses are to suggest buying when prices are low. The instant gratification expectation of investors combined with the infallibility expected of professionals, by both the media and their employers, is the cause. Gurus are expected to know what, when, and how much. Consequently, they prefer to manipulate their portfolios to create an illusion of past brilliance, rather than taking the chance that they may actually be in the right position a few quarters down the road. There is no know in investing.

The stock market yard sale is in full swing--- add to your retirement accounts, buy more of IGVSI stocks at bargain prices, increase your dependable income and increase current yields at the same time. Apply patience, and vote for economic solutions to economic problems.

Perge'

Steve Selengut
http://www.sancoservices.com
http://www.kiawahgolfinvestmentseminars.com
Professional Portfolio Management since 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"

Does anybody know where exactly I can find the quote: "In the short-run it's a voting machine, but in the long-run it is a weighing machine" by Benjamin Graham.

Thanks,

please mail to: andres.reibel"at"gmail.com

There has never been a correction that has not proven to be an investment opportunity. While everything is down in price, there is actually less to worry about than when prices are historically high. More money has been lost by people who bought into last year's markets than by those who will buy into this one, at this stage of the correction. When the going gets tough, the tough go shopping.

Every correction is different, the result of various economic and/or political circumstances that create the need for adjustments in the financial markets. This correction is worse than most that I've experienced, but the doom and gloom scenarios many have been pushing are unlikely to come to fruition. Once the media elects a new president, they'll just have to start reporting better news: 96% of all mortgages are current sounds a whole lot better than 20% of all sub-prime mortgages are in trouble.

Some fundamentals in many excellent companies have eroded significantly (due in part to accounting rules that are being changed), but for the most part, interest payments are being made and few dividends have been cut. Bargain prices abound in both the equity and fixed income markets and interest rates are historically low.

A cocktail of credit market laxatives is working its way into a constipated world economy. Relief is on the way. Today's prices may well be looked at as the lowest of the next ten years! Here's a list of things to think about or to do while Investment Grade value Stock prices are at ten-year lows:

Don't beat yourself up by looking at your account market value. You should expect it to be down significantly because all security prices have fallen. Look for ways to add to your portfolios---that's what the smart guys are doing.

Keep in mind that someone is buying the individual shares that the others are selling. The buyers will hold on until they can turn a profit, and the cash on the sidelines will eventually find its way back into the markets as prices rise.

There are no crystal balls, and no place for hindsight in an investment strategy. Buying too soon, in the right portfolio percentage, is nearly as important to long-term investment success as selling too soon is during rallies.

Take a look at the future. Nope, you can't tell when the rally will come or how long it will last. If you are buying quality securities now, as you certainly should be, you will be able to love the rally even more than you did the last time--- as you take yet another round of profits.

As, or if, the correction continues, buy more slowly as opposed to more quickly, and establish new positions incompletely so that you can add to them safely later. There's more to "Shop at The Gap" than meets the eye, and you may run out of cash well before the new rally begins.

Cash flow is king, so take smaller profits sooner than usual as long as there are abundant buying opportunities. Today, nearly eighty percent of all Investment Grade Value Stocks are down more than 15% from their 52-week highs.

In looking at your income securities, cash flow is the primary concern; as long as it continues unabated, the change in market value is merely a perceptual/emotional issue. A loosening of the credit markets should move CEF prices back into normal ranges.

Note that Working Capital keeps growing in spite of falling prices. Examine your holdings for opportunities to average down on cost per share or to increase your yield on fixed income securities.

Identify new buying opportunities using a consistent set of rules, rally or correction. That way you will always know which of the two you are dealing with in spite of what the Wall Street propaganda mill spits out. Focus on Investment Grade Value Stocks; it's easier, generally less risky, and better for your peace of mind.

Stop examining your portfolio's performance in market value terms--- it leads to fearful, often frantic, decision-making. Keep your asset allocation and investment objectives clearly in focus and try to think in terms of market and economic cycles as opposed to calendar quarters and years. The Working Capital Model provides a calmer way of dealing with portfolio dislocations during severe corrections.

So long as everything is down, there is really less to worry about. This is the result of panic selling by ETF and open-end mutual fund owners and the beginnings of year-end window dressing by fund managers.

Corrections, regardless of cause, will vary in depth and duration, but both characteristics are only clearly visible in rear view mirrors. The short and deep ones are most lovable; the long and slow ones are more difficult to deal with. If you over-think the environment or over-cook the research, you'll miss the after-party.

Unlike many things in life, Stock Market realities need to be dealt with quickly, decisively, and with zero hindsight. Because amid all the uncertainty, there is one indisputable fact that reads equally well in either market direction: there has never been a correction/rally that has not succumbed to the next rally/correction.

Get out there and buy low for a change.


Steve Selengut
http://www.kiawahgolfinvestmentseminars.com/
http://www.valuestockindex.com
Professional Portfolio Management since 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"

Every fall, especially in opportunity rich markets like this, I encourage investors to think about some year-end strategies that make the final calendar quarter a special time in all markets. Several forces are at work, all of which have links to conventional Wall Street wisdom; none of which promote good long-term investment decision-making.

This year, we have the added excitement of anticipating a new, perhaps economically too liberal, administration taking over with an already implanted, and demonstatably inept, congress. The markets are in a truly unprecedented state of "uncertainty overload". What's an investor to do--- or not to do?

Typically, the November syndrome has features that impact in both directions. It causes weak prices to fall even further and strong prices to climb higher. This year, the strong category requires a microscope for candidate viewing, while the weak seem to have inherited the listings. Money Market funds and Treasury securities are the low yielding, lower-risk, depositories of choice.

At the individual investor level, the mad dash to lose money on equity securities has begun. The idea that this is somehow a good thing is an anomaly created by a counter productive tax code and an industry that has a vested interest in perpetuating the absurdities it (the IRC) creates.

Assuming that we are dealing with investment grade securities, lower prices should most logically be seen as an opportunity to add to positions cheaply--- not as an opportunity to reduce one's tax liability on investment earnings. There is, and never will be, a good loss or a bad ---.

Naturally, both you and your CPA feel better with lower tax bills, but why sell a perfectly good security at a loss to produce pennies on the dollar in tax relief? Speculations, sure, valueless securities, why not? But when nearly all IGVSI stocks are at their lowest levels in decades, selling for losses should be the last thing on your mind.

Most IGVS companies remain profitable. Less profitable, for sure, but few have cut dividends and nearly all will survive and prosper when the economy recovers. Would your CPA accept just half his fee to save on his own taxes? Would you barge into your boss' office and demand a pay cut?

In the old days, when markets moved slowly and buy-and-hold was the investment strategy of choice, the 30-day, buy-it-back, tactic was an effective way of having your tax break cake and maintaining your portfolio as well. But with 1,000-point weekly swings, there are no guarantees that the markets will tread water for your personal tax convenience.

In fact, more often than not, major corrections such as this one produce either a Santa Clause rally or "January Affect" that is far more profitable for November-low buyers than for tax-motivated sellers.

Similarly, "letting your profits run" to push the dreaded taxes into next year is foolishness. Talk to the geniuses that didn't take profits in 1999, or in the '87 or '07 summers. The objective of the equity investing exercise is to take profits--- the more quickly and more frequently, the better. This year's volatility has produced hundreds of profit taking opportunities.

Another popular year-end shell game is the "bond swap", which preys on the fear most income investors experience when their somewhat guaranteed, income securities, fall in market value. This is the same absurdity that allowed "mark-to-market" accounting rules to crack the foundations of financial institutions around the world.

A contract (from a quality borrower) to pay a fixed rate of interest, and full principal at maturity will vary in price throughout its existence. It's nothing to be particularly anxious about. Junk bonds are for speculators, not for those of us with gray-templed children.

Bond swaps allow an advisor to pick your pocket by exchanging them at a "nice tax loss" for another bond with "about the same yield". He gets a double dip (invisible) commission and you get a bond of longer duration or lower quality.

On the same page, the idea of exchanging a steady, much-higher-than-normal-yield, closed-end-fund (CEF) cash flow for an overpriced T-Bill yielding less than 1% is above Emperor's New Clothes absurdity levels.

But there are even more year-end games going on to take advantage of your confusion. Wall Street gangs up on you with a self-serving strategy blithely referred to by the media as "Institutional Year End Window Dressing"--- a euphemism for consumer fraud.

In this annual ritual, mutual fund and other institutional money managers unload stocks (and CEFs) that have been weak and (usually) load up on those that are at their highest prices of the year. This year, they'll be holding cash and Treasuries.

Always keep in mind that (a) Wall Street has no respect for your intelligence and (b) the media "talking heads" are entertainers, not investors. Institutions must paint a picture of brilliance in their annual glossies. This year, a panic-stricken Main Street is helping them with their annual "sell low" hypocrisy.

It would be an understatement to say that these year-end tax and face saving activities are misguided and unnecessary. But this year's "November Syndrome" is an unprecedented investment opportunity that most people are too confused to appreciate.

Simply put, get out there and buy the (high quality) November lows, both equity and fixed income. Establish new positions for diversity, and add to old ones without surpassing "working capital model" diversification limits. Keep appendages crossed for a therapeutic dose of "January Affect" elixir, as you reaffirm your understanding of long-term investment strategy.

The media will talk about this New Year phenomenon with wide-eyed amazement. Most of those terrible losers (you just sold?) begin to rise from the ashes, as the professional window dressers repurchase the solid companies they just sold for losses--- interesting place Wall Street.

One last thought; if you have taxable profits that you can't bear the thought of holding on to, just send the profit portion to me. I'll pay the terrible taxes.

Steve Selengut
http://www.sancoservices.com/
http://www.kiawahgolfinvestmentseminars.com
Professional Investment Management from 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"