Benjamin Graham's Misquoted Intrinsic Value Formula

The Equation quoted above was first presented by Graham in the 4th 1962 Edition of Security Analysis, Principles and Technique in what has been termed the Lost Chapter of Security Analysis, on pages 537-538.

This chapter is reproduced in its entity in
'Benjamin Graham and the Power of Growth Stocks: Lost Growth Stock Strategies from the Father of Value Investing' by Frederick K. Martin, Nick Hansen, Scott Link, and Rob Nicoski.

Martin writes,
'A ... flaw has to do with the potential competition from high interest rates. Should the P/E ratio of stocks be immune to high interest rates? Of course not. Graham himself addressed this issue when he suggested that P/E ratios should be adjusted downward if long-term interest rates on corporate bonds exceeded 4.4 percent. Graham picked 4.4 percent because the AAA
corporate rate averaged 4.4 percent in 1964. He introduced his revised formula at a seminar sponsored jointly by the Institute of Chartered Financial Analysts and the Financial Analysts Research Foundation, held on September 18, 1974, in New York City.'

The 4th 1962 Edition of Security Analysis, Principles and Technique had been greatly revised in the light of the BUBBLE MARKET up to 1961, with revisions throughout the Common Stock Analysis Section, culminating in the ‘Lost Chapter’, Chapter 39 on valuing Growth Stocks.

The Preface of the 4th. Edition states,

“The three previous editions of Security Analysis were published in 1934, 1940, and 1951. Like this (the 4th.) volume, they dealt with three main topics: (1) the orderly, comprehensive, and critical analysis of a company's income account and balance sheet; (2) the formulation of appropriate criteria for the selection of well-protected bonds and preferred stocks, and (3) approaches to the selection of common stocks for investment purposes. It does not seem to us that the first two divisions present any new difficulties of great magnitude, or require significant changes in our handling of them. But we cannot say the same about common-stock investment.

[truncated]

Our title page notes the advent of the new principal author, Sydney Cottle, who has taken a major part of the work of revision from the shoulders of its original authors. We are happy to retain the collaboration of Charles Tatham, who is responsible for the chapters on public utility analysis and his rendered other aid. We acknowledge with deep thanks for physical help and kind indulgence accorded by Stamford Research Institute, which has granted Dr. Cottle leave from his institute duties. Others, who helped with former additions, are remembered with gratitude.
The preface to the 1951 edition closed with the following paragraph:

"Our final word is addressed to the student – reader who may be planning to make security analysis his calling, and to whom we have ventured to dedicate this third edition. Security analysis is on the verge of attaining some measure of formal recognition as a professional discipline. It will demand better training and more rigorous thinking from its members than it has done in the past. We think it offers rewards fully commensurate with its demands and responsibilities. The "average" analyst will probably fare about the same as the average member of any other profession. But for the outstanding man - Who combines native ability, a flair for the subject, and courageous, independent spirit – the sky is the limit."

Since 1951 a profession has made great strides in numbers, capabilities, and influence. We wish it even greater success in the years ahead.

Benjamin Graham
David L Dodd
Sidney Cottle
Charles Tatham

Footnote: We ask the reader to bear in mind that our manuscript was virtually completed and this preface drafted toward the end of 1961, when prevailing sentiment was in strong disagreement with our conservative position.”

Note: The 6th. 2009 and 7th. 2024 Editions are reproductions of the 2nd. 1940 Edition, which as stated in the prefaces of the 3rd. 1951 and 4th. 1962 Editions was completely obsolete.