In the revised edition of the Intelligent Investor the reader is advised that the text of Graham’s original footnotes can be found in the Endnotes section beginning on page 579.
Some time ago I finished reading chapter 11 in the Intelligent Investor, Security Analysis for the Lay Investor: General Approach, in which the formula for valuation of growth stocks is discussed. The formula is:
By going through the Endnotes section one can see that there is a footnote of interst – see picture below. The footnote, now an endnote, warns the reader about taking the formula value as the “true value” of a growth stock. Graham goes on an warns that “…The valuations of expected high-growth stocks are necessarily on the low side, if we were to assume these growth rates will actually be realized.”
So, beware when it comes to expectations about future growth. Seems like Graham introduced some kind of a margin of safety about this section of valuing growth stocks by stating the following: “Warning: This material is supplied for illustrative purposes only, and because of the inescapable necessity in security analysis to project the future growth rate for most companies studied. Let the reader not be misled into thinking that such projections have any high degree of reliability or, conversely, that future prices can be counted on to behave accordingly as the prophecies are realized, surpassed, or disappointed.”
If we invert, and instead look at the stock price we can derive the market’s expected growth rate. And maybe, it is by using the formula in this way, i.e. solving for growth, that an intelligent investor gets the greatest benefit out of it.
Inspired by Grahams own table – Annual Earnings Multipliers Based on Expected Growth Rates, Based on a Simplified Formula – I made my own that includes earnings multipliers for growth rates between zero and twenty percent.
Calculations shown in the table above were based on the formula:
- Earnings Multiplier = 8.5 + 2G
- G = the expected annual growth rate which according to Graham should be “The growth figure […] expected over the next seven to ten years.