Setting a multiplier when value investing (Graham/Dodd)

[adventurer]

Hello,

 

can somebody explain to me the idea behind setting a multiplier when valuing a business as well as to which factors determine the multiplier? I have read about it in the Intelligent Investor and in Security Analysis but I did not get it fully. For instance why doesn`t the price-earnings ratio or any other of those numbers (P/B-Ratio, P/S-Ratio, P/CF-Ratio etc.) suffice instead?

 

Perhaps somebody has a link to similar topics on here?

 

Thank you.

[gfp]

3 hours ago, adventurer said:

Hello,

 

can somebody explain to me the idea behind setting a multiplier when valuing a business as well as to which factors determine the multiplier? I have read about it in the Intelligent Investor and in Security Analysis but I did not get it fully. For instance why doesn`t the price-earnings ratio or any other of those numbers (P/B-Ratio, P/S-Ratio, P/CF-Ratio etc.) suffice instead?

 

Perhaps somebody has a link to similar topics on here?

 

Thank you.

 

I think in Graham's time the price to book value or book value in general was more important than it is today.  In some industries, book value is still useful and important but for many modern firms the book value is almost meaningless.  Berkshire's book value is useful.  Fairfax's book value is useful.  Apple's book value is headed towards zero and of basically no use.  

 

Graham liked to use his multiplier concept to allow higher price to book stocks to make it past his filters if they traded sufficiently cheap relative to their earnings.  He didn't want people paying over 20x earnings or 1.5x book but he was willing to bend his price to book guidelines for a company where the value could be justified by the earnings (and vice versa if something was very cheap on liquidation value but wasn't currently showing a lot of earnings).

 

No standard ratio is going to tell you how to value a company.  Every company is unique and the art of this thing is trying to determine the earning power over time, what the management is likely to do with those earnings, and what you are interested in paying for that combination.  

 

You might think a cyclical stock at 4x earnings is a slam dunk only to realize you were buying the peak.  Same with PE 1000 stocks or no PE stocks that could end up being fantastic investments.  Focusing too much on the popular ratios (especially in the age of websites publishing wildly inaccurate ratios based on garbage data in the first place) is a mistake.

[Saluki]

All those ratios and measurements are just tools, and you have to decide what is the best tool for the job.  If you have enough of those measures, P/E, P/B, EV/Sales, etc, you will eventually find one that makes it look cheap.  But you probably need to do a deep dive on the industry for a stock that you are interested in to know what is the measure that is most important.  In Banking it's usually price to book, in Insurance it's usually that and the combined ratio. If it's a retail company, same store sales growth is probably the most important metric etc. 

 

Graham's theories came out of the great depression, so he put more emphasis on assets (book value) than earnings because he saw how the depression (or now COVID) can make income unreliable, but the assets don't fluctuate so much.  But every sword is double edged and the asset thing is hard today because most tech companies have very little assets compared to older industries.  So price to book is meaningless.  Also, book value reflects what you paid for it, and if you screen for it you will pick up a lot of stuff that is selling for a lot less than replacement costs, but which nobody wants.  When oil was cheap, offshore drillers were selling dirt cheap.  But those things are expensive to build and don't have a lot of scrap value as the cost is in the technology which is worth less the longer it's not being used and maintained.