Monday, November 27, 2006

Grahams value investing principles in a nutshell

Benjamin Grahams Value investing

The analytical criteria of the Graham-Rao method contain quality criteria and valuation criteria. The quality criteria are:

# The company must have an adequate size (Sales of Rs 100 crore may be taken as adequate size for Indian companies)

# Current assets should be at least twice that of current liabilities and the total debt-equity ratio should not be greater than 1:1

# The company should have paid dividends and earned profits for the last 10 years

# There should be a growth in earnings per share (EPS) of 10 per cent per annum over the last seven years The two valuation criteria are:

1.The current share price should not exceed 20 times the average EPS in the last seven years for companies with a seven-year growth (GAGR) higher than 20 per cent. For companies with past growth rate between 10 and 20 per cent per annum, the multiplier has to be the growth rate itself. In other words fair value is the average EPS of the last seven years multiplied by the P/E ratio specified as above

2.The current price should also not be more than 1.5 times the latest book value.