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Graham's Approach to Valuation/Stock Selection


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I was re-reading the Intelligent Investor and Graham suggested an approach to finding values that I wonder if anyone follows.  He suggests doing valuation based upon the past data first then have a senior analyst make adjustments to this base value for things like growth and other factors and record the results.  And thus he was hoping to develop a sort of "practice guide" similar to medicine.  He had developed three techniques described in the Intelligent Investor in this way.  It sounds like an interesting idea but I have never heard of anyone do this explicitly. 

 

 

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I was re-reading the Intelligent Investor and Graham suggested an approach to finding values that I wonder if anyone follows.  He suggests doing valuation based upon the past data first then have a senior analyst make adjustments to this base value for things like growth and other factors and record the results.  And thus he was hoping to develop a sort of "practice guide" similar to medicine.  He had developed three techniques described in the Intelligent Investor in this way.  It sounds like an interesting idea but I have never heard of anyone do this explicitly.  

 

 

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This is what we do when we make long term investments.  However, sometimes we make a small investment in a company before fully understanding the history of its competitive advantage.  For example, we made an investment in USG several years ago after it went into Cpt XI.  I knew it was a good company, although cyclical, when we made our initial investment, but I wanted to find out why it was so good that WEB had bought 15% of their stock despite their asbestos liability (which turned out to be confined to only one of their subsidiaries ).  

 

The answer to the riddle of how they had maintained significant advantage in relation to their competitors was found in a privately published history of the company.  Reading their 100 year history, helped me understand in a profound way why WEB liked the company so much.  Gaining a deep understanding of all aspects of the company and their situation, gave confidence to load up on the stock near the low of their market price and hold most of the position as USG added a billion dollars of retained earnings to their balance sheet, enabling them with WEB's help to pay off the accumulated interest on their debt and their asbestos liability.

 

Had we lacked understanding of their historical profit potential in an expansion of construction in the economy, we might have made a small profit, but not had the fortitude to hold most of the position for a ten bagger.  :)

 

The same attention to relevant history is integral to making other large investments such as our large holding of Lancashire.  This process is merely an extension of Graham's reasoning underlying the P/E 10 concept to as much of the historical record as is available.

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