Benjamin Graham's Growth Valuation - APOLLO (6432)

Hi GenghisHoe, I don't have a FB.

I do setup a blog - http://intelligentinvestor8.blogspot.com

2014-08-07 09:47

II, I'm currently using Jae Jun's revised formula with no growth P/E of 7 and G multiplier of 1.5. Of so many evaluation methods for calculating intrinsic value, which one works best for you?

2014-08-07 10:25

HI shinado, it is depend on the company quality and the MOS.

You can use a lower number if you want to have higher MOS or company quality is not good.

2014-08-07 10:41

So which valuation methods do you find that is personally working best for you? (DCF, EPV, etc etc...)

2014-08-07 11:21

You can refer to my post - http://intelligentinvestor8.blogspot.com/2014/08/when-should-we-click-buy-button.html

2014-08-07 11:49

Hi Intelligent Investor, are you using US corporate bond rate to calculate Apollo's value?

2014-08-07 12:59

Hi Cheongcy,

Yes. I am not sure how to locate the local bond rate.

2014-08-07 13:31

Hi Intelligent Investor, this site may help:

http://www.bnm.gov.my/index.php?tpl=govtsecuritiesyield

2014-08-07 13:35

Hi Cheongcy,

This is MGS but not Corporate Bond.

2014-08-07 13:56

Dear Intelligent Investor, seems like it is not easy to search for Malaysia Corporate AAA bond rate. In this case do you think it is appropriate to use US bond rate to calculate Malaysia stocks? Also, what rate you would recommend other than US one or MGS?

2014-08-07 14:40

Hi cheongcy,

To make it simple, I just use the US bond rate. I'd rather be approximately right than precisely wrong.

Valuing a business is part art and part science; and there is no right or wrong.

If worst case happen, margin of safety will help if I perform any mistake in my calculations.

2014-08-07 14:59

Dear Intelligent Investor, let's assume a situation where US corporate AAA bond rate has dropped to 3% or 2%(jz assume), while MGS stay more or less 4%. Will you still use US Corporate bond to calculate?

2014-08-07 16:22

I tend to play safe and use the higher option.

2014-08-07 16:50

I did read from somewhere that Malaysia Corporate AAA bond was 4.35%. Unfortunately I can't remember where I read that!

2014-08-07 17:16

Dear Intelligent Investor, seems like you are selectively pick a higher rate to do the calculation. If this is the case, assume another situation where Europe AAA Corporate Bond has a rate of 6%, will will pick Europe AAA Bond to do the calculation? Or you will stick with US AAA bond rate?

2014-08-07 17:56

I will compare to the local Risk Free Rate.

It is our own judgement, how much risk premium you are willing to be paid for a 20yr Grade A Corporate Bond?

In today context, I won't go for 6%. It is too high if compare to the risk free rate.

2014-08-07 18:04

Look at the company quality - http://intelligentinvestor8.blogspot.com/2014/06/financial-statement-analysis-apollo.html

And think what will be the interest rate if a company with strong balance sheet raising money from debt market?

2014-08-07 18:06

Dear Intelligent Investor,

I have no doubt at all on Apollo's quality and you have done a very good write up. My core question remain the same, why did you choose US Corporate Bond as benchmark to evaluate a Malaysian stock instead of MGS? Is MGS not considered as risk free?

If one day Malaysia long term interest rate or MGS drop to 3% or 2%, and US AAA Bond has a rate of 6%, what will you pick?

2014-08-07 19:32

Hi Cheong,

It wont praticle to use that if the spread is huge.

We divide the 4.4% with the bond rate in order to adjust the 4.4% in graham time to the present. So, we need to use a rate that make sense in current context.

Do use the MY's corporate bond rate if you able to get it.

2014-08-07 22:35

I would just use the FD rate as that is the risk free investment for me. Bonds are not exactly accessible to retail investors as they require a large capital. Nothing is risk free. If Malaysian govt bankrupt, your MGS will be worthless. Divide the 4.4% with the bond rate is to normalize the risk free returns from Graham's time to present day.

2014-08-07 22:44

Hi Intelligent Investor, correct me if I am wrong. The 'constant' 4.4% in the formula is the average yield of high grade corporate bonds in US in 1962. Again the figure 4.4% is an average figure derived from US.

I am not sure if this model is suitable to apply in Malaysia without any further adjustment. Most important of all, I do not know how Benjamin derived the formula.

My question remain why did you choose US Bond Rate to calculate Malaysia's stock? Is US Bond rate a better benchmark to reflect Malaysia economic conditions as compared to Malaysia MGS or FD or any rate that is almost risk free and easy accessible to retail investors in Malaysia?

2014-08-07 23:21

I think I have reply you earlier. I am not sure how to locate the local bond rate.

2014-08-07 23:25

Hi Noby,

I think the bond rate is higher than the FD rate. If we use the FD rate, then the intrinsic value will be slighty higher.

2014-08-07 23:26

kcchongnz

Very thorough analysis. The data and assumptions are also well articulated. Good to see that there are people who invest based on facts and figures, rather than rumours, hypes and fads. Well done Intelligent Investors.

Very good feedback for this post too. I agree with cheongcy that theoretically you should use the long-term risk-free rate of MGS. We are investing in Bursa, not the US market.

I also like Noby's very practical comment to use the bank fixed deposit rate as a proxy to the local risk-free rate as the reason of hard to buy long-term MGS for a retail investor. Maybe there is the reason why Jae Jun use the long-term AAA corporate bond. However the present FD rate may be a little low compared to the long term FD rate in the past. It appears that there is higher probability that the long term interest will rise.

However bear in mind that the bigger market players are not be the retail investors, but the institutional investors and fund manager who can invest in long-term corporate or government bonds.

2014-08-08 06:47

http://www.tradingeconomics.com/malaysia/government-bond-yield

MGS yields are about 3.89 pct. It may move in tandem with interest rates

2014-08-08 08:31

Hi Noby,

The bank negara website from cheong's comment - http://www.bnm.gov.my/index.php?tpl=govtsecuritiesyield should be better source to locate MGS

2014-08-08 10:02

Hi. Mr. Chong,

In my opinion, we should use the Malaysia Coporate Bond Rate instead of MGS. It is because the objective of the "Y" in graham formula is to adjust the 4.4% bond rate in graham time to the present. So, we need to use apple to adjust the apple.

But, I am not sure how to locate the local bond rate.

Do you know how can I get this?

2014-08-08 10:04

II, my understanding is that the 4.4% was the risk free rate in Graham time. We divide it by Y to normalize that rate to today's risk free rate. Just because Jae Jun used AAA corporate rate doesnt mean we have to. Is MGS considered a risk free ? I think it is pretty much the best we have locally next to FD. So it is technically still apple to apple in my opinion. How much higher you think the AAA corporate bond rate going to be for Malaysia ? I think the valuation wont go so far. This is just a rough number.

2014-08-08 10:43

Found it! The link: http://www.bpam.com.my/op/O1002.asp

2014-08-08 10:45

Hi Shinando, thanks.

Hi Noby, thanks for reminder. The 4.4% should be RFR instead of bond rate.

2014-08-08 11:02

Hi Noby,

Graham mentioned this "It seems logical to me that the earnings/price ratio of stocks generally should bear a relationship to bond interest rates. Viewing the matter from another angle, I should want the Dow or Standard & Poor's to return an earnings yield of at least four-thirds that on AAA bonds to give them competitive attractiveness with bond investments."

I give a second thought, and I am not sure what is the RFR mentioned by graham. Is it the FD rate or AAA bonds rate?

Do you have any idea?

2014-08-08 11:10

Dear Intelligent Investor, seems like the Malaysia 30year AAA Corporate Bond rate is 5.6% something. Will you adjust your calculation fir Apollo in this case?

2014-08-08 11:15

For graham, if growth is 0, the intrtinsic value for a stock is, V = EPS x (8.5 + 2 x 0) = EPS x 8.5. And, the EY is 1/8.5 = 11.76%

Does graham consider EY of 11.76% is four-thirds on AAA bonds EY?

2014-08-08 11:16

Hi Cheong,

I think I need to understand what is the Risk Free Rate tha mentioned by Graham. Is the RFR is the corporate bond rate or the FD rate?

Says, the 4.4% is the Bond Rate, then we can use the bond rate in MY to adjust the 4.4%.

2014-08-08 11:18

A good read about the formula, why 4.4% was chosen, and alternative to it:
http://www.buffettsecrets.com/intrinsic-value-graham-formula.htm#Finding_the_input_values

2014-08-08 11:49

serenitystocks

Intrinsic Value = Earnings x (8.5 + 2 x growth)

If these valuations are based on the above formula as the article says, Graham actually warned against this formula and only used it to show why such oversimplified growth formulas are unreliable. This formula is popular only due to a printing omission in recent editions of The Intelligent Investor.

Article 1: http://seekingalpha.com/article/1709112 discusses the issue in detail.

Benjamin Graham actually recommended three different categories of stocks - Defensive, Enterprising and NCAV - with 17 different qualitative and quantitative criteria for finding them.

Article 2: http://seekingalpha.com/article/2260803 discusses Graham's actual 17 stock selection criteria and shows how to apply them to 5000 NYSE & NASDAQ stocks today.

2014-08-08 13:02

Hi shinado and serenitystocks,

Thanks for your link. It is useful.

2014-08-08 14:03

@ II, I try to keep it simple. From my opinion, 4.4 is probably the highest risk free rate that Graham could achieve during his time (whether its corporate AAA or govt bonds etc doesnt matter). We just need to normalize that to the highest risk free rate we can find in Malaysia. If you insist to use AAA corporate bond rates in Malaysia, you could do that too, obviously the higher the risk free rate today, the more conservative the IV will be.

2014-08-08 14:19

Hi Serenity, from the writeup on your post, I believe you are very familiar with graham's methodology and investment principle.

I would like to seek your comment on graham statement: "It seems logical to me that the earnings/price ratio of stocks generally should bear a relationship to bond interest rates. Viewing the matter from another angle, I should want the Dow or Standard & Poor's to return an earnings yield of at least four-thirds that on AAA bonds to give them competitive attractiveness with bond investments."

I am trying to dissect the graham formula, Intrinsic Value = Earnings x (8.5 + 2 x growth) and try to understand why graham use 8.5 as a no growth P/E.

If growth is 0, the intrtinsic value for a stock is, V = EPS x (8.5 + 2 x 0) = EPS x 8.5. And, the EY is 1/8.5 = 11.76%

Does graham consider EY of 11.76% is four-thirds on AAA bonds EY?

2014-08-08 14:31

Hi Noby, thanks for your feedback.

After I read serenity's post. I think this formula might not be a good tools to help us to calculate the intrinsic value.

And, I think I will stick to the toolset as mentioned in my earlier post - http://intelligentinvestor8.blogspot.com/2014/08/when-should-we-click-buy-button.html

What's your opinion?

2014-08-08 14:35

Actually Jae Jun did compile a list of valuation methods which have been researched, backtested and tested on a paper portfolio. Link: http://www.oldschoolvalue.com/stock-screener.php

And Graham formula actually does produce a decent return in the long run. Not the best valuation out there, but definitely a viable option.

2014-08-08 15:20

Hi shinado,

Thanks. I believe this is from US market.

2014-08-08 17:26

II, honestly I never use Graham formula. But I think it only serve as spot check to see if a company is overvalued.

One thing I notice about the Graham number, it shares some similarity with Katsenelson's absolute PE method. The similarity is that both methods will start from baseline PE and adjust this PE based on other factors. While Graham emphasizes on the growth factor in the (8.5+2G) part, Katselson's method is more detail, adding points for dividend yield, business durability etc. Graham's formula is less subjective and more straight forward.

But the main problem with this method still lies in the drawbacks of the PE ratio and EPS as what KC has explained before.

2014-08-08 18:10