NJ Value Factor

Value Factor

Paying too much for your stocks? Consider the Value Factor.

The name Benjamin Graham is synonymous with value investing. Mr. Graham and co-author David Dodd released the influential book “Security Analysis” in 1934. (Graham & Dodd, 2008). This book provided a formula to calculate a company's intrinsic value based on its long-term growth potential and Earnings Per Share (EPS). And while this formula was improved upon in his follow-up book, "The Intelligent Investor" (Graham, 2013), which was published in 1974, its fundamental principles have remained the same for almost a century.

Value Investing

Value investing's fundamental tenet still revolves around buying stocks whose intrinsic value is higher than their current market price. However, its effective application depends on also being able to predict a company’s growth rate accurately and as a result, the exact formula isn’t commonly used in factor investing. Instead, factor investing focuses on Price to Book Value (P/B), Price to Sales (P/S), Price to Earnings (P/E), and Dividend Yield to measure value.

Value Factor Investing

Value investing is synonymous with Benjamin Graham. In 1934, Mr Graham along with co-author David Dodd, published a seminal

book called Security Analysis (Graham & Dodd, 2008). This book prescribed a formula to measure the intrinsic value of a company that was based on its Earnings Per Share (EPS), and its long term growth potential. And while this formula was further enhanced in his subsequent book “The Intelligent Investor” (Graham, 2013) published in 1974, its core has remained unchanged for close to a century now.

The basic premise of investing in stocks that have an intrinsic value higher than their prevailing market price continues to be the essence of value investing. However, since the formula requires an estimated future long term growth rate to function, it relies on the ability to forecast this growth rate accurately for successful implementation. For this reason, it cannot be used in factor investing directly.

To overcome this, researchers and practitioners focused on the part of the formula that can be populated mathematically like the EPS of a company as a starting point and, over the years, developed various mathematical derivations of the “discount to intrinsic value” concept that rely on ratios like Price-to-Earnings (P/E), Price-to-Book (P/B), Price-to-Sales (P/S), Price-to-cash flow (P/CF), Enterprise Value to Earnings Before Interest, taxes, Depreciation and Amortised Expenses (EV/EBITDA), and Dividend Yield among others with varying degrees of success. These have emerged as the predominant way of measuring value across the world.

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