A Comparison of Eight Pairs of Companies
This is the eighteenth discussion of the ModernGraham Book Club’s reading of The Intelligent Investor by Benjamin Graham (affiliate link). In last week’s discussion, we discussed the seventeenth chapter, in which Graham provided four examples of implementing his theories in practice. This week we will discuss the eighteenth chapter, which is titled “A Comparison of Eight Pairs of Companies.” I encourage you to purchase the book (preferably by clicking the link to Amazon, because a purchase through that link will help support the club) and join in with us as we read through a chapter each week; however, even if you don’t have the book I think you will find our discussions to be very useful in your own understanding of value investing, and you can still bring a lot to the discussion from your own experiences as an investor. Whether this is the first day you’ve ever been interested in investing, or you have decades of experience with the stock market, we’d love to hear your thoughts in the comments below!
Please feel free to leave a comment on this post with your own responses to the questions, along with any other thoughts you have, and return throughout the next couple of days to see what others have said. If you find something that has been said by another commentator interesting, feel free to respond to them with another comment. We’ve had some great discussions throughout the book club, so keep it up!
ModernGraham’s Comments
Ben
This chapter, and Zweig’s commentary that comes along with it in the newer editions, should be read directly by all book club members in order to gain the most value out of the work. Graham provides some insight into comparing different companies in order to make points as to what traits an intelligent investor should seek out. It’s most important to remember that the investor must maintain the understanding that value is independent of price, and just because a price rises does not mean the company has increased in intrinsic value.
Zweig provided a similar thought when he said, “The market scoffs at Graham’s principles in the short run, but they are always revalidated in the end. If you buy a stock purely because its price has been going up – instead of asking whether the underlying company’s value is increasing – then sooner or later you will be extremely sorry. That’s not a likelihood. It is a certainty.”
Discussion Questions
Please leave a comment below and feel free to answer any of these questions, or just give your general thoughts.
- What quote from this chapter do you think best summarizes the point Graham is making?
- Pick two companies and do a comparison like Graham did here – i.e. look at the financials at some point in the past, and compare what happened to the companies since then. Do you find anything interesting to share with the group?
- Pick two companies and make a prediction – i.e. look at the financials and predict where each will be in 5 years.
- What did you think of the chapter overall?
Next Week’s Discussion: Chapter Nineteen
Chapter Title – Shareholders and Managements: Dividend Policy
When reading the next chapter, try to think about how the concepts Graham presents in the chapter could apply to your own investments, whether you consider yourself a Defensive Investor or an Enterprising Investor.
What are some other ways to participate?
If you are a blogger, you can give your thoughts in a post on your own site, link to the discussion here on ModernGraham, and I will be sure to let our readers know that the conversation is going on over at your site as well.
In addition, you can use the hashtag #MGBookClub in social media to talk about the book on Twitter or Facebook!
1. What quote from this chapter do you think best summarizes the point Graham is making? “For the most part the companies with better growth records and higher profitability have sold at higher multipliers of current earnings – which is logical enough in general. … The trouble is, rather, that their price contained too much “promise” and not enough actual performance.”
2. Pick two companies and do a comparison like Graham did here – i.e. look at the financials at some point in the past, and compare what happened to the companies since then. Do you find anything interesting to share with the group? Just sold Stryker (SYK) this week for a handsome profit because its valuation became excessive: P/E 41.85 P/B 3.53 Av 3yr earnings of 3.16 gives a P/E3 = 83.97/3.16 = 26.57.
Computing the Graham #: P/E3 x P/B = 26.57 x 3.53 = 93.79
93.79/22.5 = 417% over valued
using DCF 12.5% growth next 4yrs., 6% growth for another 30yrs., 12% discount rate, FY13 EPS 2.63 and 3yr Av EPS 3.53 gives a value range of 48.87 to 65.59 showing the overvaluation between 172% to 78%
Lastly, a PEG of 13.1 also indicates excessive over-valuation.
Purchased Chevron (CVX) with the proceeds: P/E = 12.75, P/B = 1.65, P/E3 = 130.36 /12.62 = 10.33
computing Graham #: P/E3 x P/B = 10.33 x 1.65 = 17.04
17.04/22.5 = 0.75% of intrinsic value
using DCF 3.6% growth rate for 40yrs., 12% discount rate, FY13 EPS 11.09, and 3yr Av EPS 12.62 gives a value range of 133.01 to 151.36 showing a discount of intrinsic value between 2% – 14% basicly fairly valued in an overbought market. But it has sound financials, steady growth, and a good dividend.
Lastly, a PEG of .90 indicates undervalued.
3. Pick two companies and make a prediction – i.e. look at the financials and predict where each will be in 5 years. No predictions but the risk of SYK undergoing P/E compression is significantly higher than the risk of CVX under performing in the long run. I bought Stryker around 2009 when it was significantly undervalued, it is a great company and I would buy it again if or when it comes back down to earth.
4. What did you think of the chapter overall? Informative but a little dull. The common thread seems to be ROE, debt levels and P/E.
1) What quote from this chapter do you think best summarizes the point Graham is making?
“Most security analysts try to select the issues that will give the best account of themselves in the future, in terms chiefly of market action but considering also the development of earnings. We are frankly skeptical as to whether this can be done with satisfactory results. Our preference for the analyst’s work would be rather that he seek the exceptional or minority cases in which he can form a reasonably confident judgment that the price is well below value. He should be able to do this work with sufficient expertness to produce satisfactory average results over the years.”
This is a great quote, and it speaks volumes to the idea that nobody knows what the market will do. You can only bet and buy when objective measures say the security is on sale and sell when the measures say it is at a premium. This is simple logic. Snow ball describes Buffet and he quest for financial knowledge, and every other method did not pass his or Grahams test; only this straight forward value method.
2) Pick two companies and do a comparison like Graham did here – i.e. look at the financials at some point in the past, and compare what happened to the companies since then. Do you find anything interesting to share with the group?
I will compare Ford (07/08/14 price $17.32)and Toyota (07/08/14 price $121.16). My data comes from Value Line for EPS and Yahoo finance, and I come to different conclusions about Ford as did Ben Clark in his calculations because the data input is different. These two companies are clear leaders in the auto industry. They both stand for quality and value. However, I would bet that Toyota has built a stronger moat, but you must account for the ADR status since Toyota is a Japanese company.
[EPS]
Ford: EPS 2014 = $1.30; 2013 = $1.62; 2012 = $1.40; 2011 = $1.93; 2010 = $1.91; 2009 = $0.00; 2008 = -$3.13; 2007 = -$0.19; 2006 = -$1.5; 2005 = $1.25 [[[[[EPSmg=1.53; Value based on MG estimated growth = 0; Value based on 3% growth = 22.00; Value based on no growth 13.00]]]]]
Toyota: EPS 2014 = $11.6; 2013 = $11.77; 2012 = $7.24; 2011 = $2.20; 2011 = $1.89; 2010 = $1.44; 2009 = $-2.84; 2008 = $12.93; 2007 = $8.68 [[[[[EPSmg=8.87; Value based on MG estimated growth = $341.60; Value based on 3% growth = 128.65; Value based on no growth $75.41]]]]]
Both companies have adequate size of enterprise.
Current Ratio: Ford above 2; Toyota at 1
Stability of Earnings over the last 10 years: Ford faired much worse during the recession than did Toyota as the EPS numbers above show.
Dividend Record: Ford (div yield 3%) started to pay a dividend again in 2012 while Toyota (div yield 2%) has paid a consistent dividend with no interruption.
Moderate PE ratio less than 20: Both pass this test. Ford 17.32/1.30= 13.3; Toyota 121.16/11.6=10.4
Moderate Price to Assets PB less than 2.5: Ford 2013 (17.32 / BV per share 6.69= 2.6) Toyota 2013 (121.16 / BV per share 95.45=1.27) Toyota passes this test and Ford just missed it.
I find that both of these companies have had a tough time in during the recession because the auto industry was vastly impacted. However, Toyota did a much better job, but their share price has been hit by negative press and the recession making Toyota a great buy compared to Ford. Both companies have a Beta around 1, so they show a strong correlation with the market, and they have done well in the current bull market. Both companies had a very small annual interest expense in relation to cash they carried end of year. Both companies also have senior leaders that have been with their companies for many years, but Toyota leaders have clearly staked their entire careers with Toyota.
3) Pick two companies and make a prediction – i.e. look at the financials and predict where each will be in 5 years.
I would not venture to say which company will do better in the next 5 years, but I will say that Toyota is currently priced at a solid discount and worth further consideration for the value investor, and Toyota is a much better buy than Ford. One must take into account that it is a Japanese company, but they have diversified well into the US and other countries. I expect the economic recovery to continue, and the vehicle age is relatively large, so people will be replacing their cars.
4) What did you think of the chapter overall?
This is a great chapter because Graham gives you clear examples of the nuts and bolts logic.