Graham Rating - Earnings Growth

For defensive stocks, the Value Investing framework of Benjamin Graham — Warren Buffett's mentor — required a 33% increase in earnings over the past decade.

Definition

The Earnings Growth rating on GrahamValue is based on the following Graham rule:

5. A minimum increase of at least one-third in per-share earnings in the past ten years using three-year averages at the beginning and end.

Chapter 14: Stock Selection for the Defensive Investor, The Intelligent Investor.

Interpretation

The Earnings Growth rating is therefore to be interpreted as follows:

A value of 100% indicates 33% growth, or Earnings 1.33 times that of 10 years ago. A value of 200% indicates 66% growth or Earnings now 1.66 times, and so on.

The Earnings Growth rating is expressed as a percentage of Graham's requirement — rather than the percentage of growth itself — for the sake of uniformity. A stock is considered fully Defensive when all its Graham Ratings are 100%.

The years used for calculating the averages are the fiscal years 1, 2, 3 and 10, 11, 12 previous.

Note: Since the upper limit of any earnings growth calculation is theoretically infinite, this rating is capped at 1,000,000.00%.

50% For U.S. Stocks

It may be worth noting that the inflation rate in the U.S. in the 10-year period that Graham wrote the above rule for was about 33%.

Considering that the inflation rate in the U.S. during the past ten years has been closer to 16%, an earnings growth of 16% may be sufficient for a stock to qualify as Defensive today. This would correspond to a Earnings Growth rating of 50% on GrahamValue.

Note: Non-U.S. economies such as the U.K. may continue to require an Earnings Growth rating of 100%.

Example

Given below is a sample Earnings Growth rating calculation, using three years of EPS values each at the beginning and end of the period:

$4.06 +
$5.25 +
$4.66
Sum $13.97

$3.70 +
$1.13 +
$0.31
Sum $5.14

($13.97 - $5.14) ÷ $5.14 = 1.72 (172% growth)
Rating = 1.72 ÷ 0.33 = 5.2058 = 520.58% (of the growth Graham required)

Buffett: Growth Part Of Value

At the 2000 Berkshire Hathaway Annual Shareholders Meeting, Buffett says that there is no distinction between Growth and Value stocks.

"But there is no distinction in our minds between growth and value. Every business we look at as being a value proposition. The potential for growth and the likelihood of good economics being attached to that growth are part of the equation in evaluation.

Warren Buffett, Berkshire Hathaway Annual Shareholders Meeting (2000).