Fifty percent was not an arbitrary number, but the logical result of Graham’s value discipline when buying stocks. For example, if a company’s tangible book value was $9/share, Graham would consider buying shares at $6, or 2/3 of the book value. Not only would $6/share provide a sufficient margin of safety between price and value, but a 50% increase in price from $6 would bring the stock price to the $9 tangible book value. Selling the shares at $9 would not only be logical (obtaining fair value for what was purchased at a discount, i.e. tangible assets), but enforces a value discipline, as the margin of safety that once existed in the stock price has disappeared.

(2) Regarding your second question, I’m not sure Graham answered that question specifically, but his many writings, lectures, interviews, etc. provide helpful clues. First, a value investing strategy should be pursued at all times except when the broad market valuation is “dangerously high” (Graham’s term). During those periods, intelligent investors should be content with a cash position until the overvaluation is corrected.

Second, Graham would have likely approved an investor committing funds over an extended period of time, perhaps several quarters. (Joel Greenblatt, a noted value investor, endorses this strategy in his “magic formula” concept.) This way, various groups of stocks “mature” at different points in the market cycle. Of course, the 50% selling discipline forces an investor out of stocks in a rising market, and the margin of safety concept doesn’t allow reinvestment of funds until values are available.

(Note: in a taxable account, selling into a bear market can create “assets” for the investor in the form of tax-losses that can be used to offset capital gains taxes for both current-year and future gains, and new investment opportunities should be readily available.)

In the end, regardless of bull or bear market, taxable or qualified account, the 2-year selling discipline should still be enforced, because if a catalyst for a higher stock price hasn’t materialized within two years, it is reasonable to assume better opportunities exist for the intelligent investor.

Recall, however, Graham ALWAYS sought a margin of safety. Problems can arise when screening for low P/E stocks, as current earnings (i.e. trailing four quarters) can be distorted by recent events (e.g. spiking commodity prices, introduction of a “hot” new product, one-time asset sales, etc.).

Graham suggested investors use a moving average of earnings (i.e. 5-, 7-, or even 10-years) under the current price to smooth out the cyclical earnings volatility experienced by many businesses. James Montier (formerly of SocGen, now at GMO) has written about this metric, referring to it as the “Graham and Dodd P/E.” It is also the same technique Robert Shiller of Yale uses to value the S&P 500, after adjusting for inflation.

Any answers would be great. thanks.

I think that 50% appreciation is not for the price and price does not represent the true value. That 50% appreciation of the price is regarding the tangible book value of the stock, as Graham believed that after some point the stock will follow/match its book value (efficient markets concept). With price at 67% of the book value, the appreciation potential is 50% from there to reach the book value assuming there is no degradation in the book value of the stock.

Manish

The data series may be found at http://research.stlouisfed.org/fred2/series/AAA

Thanks a lot!
Kyle Laracey

The Yahoo! Finance site conveniently provides a current snapshot (from the EDGAR database) of any company’s tangible book value or “net tangible assets” within the Financials/Balance Sheet link.