Revisiting Margin of Safety Formula by Benjamin Graham For Value Investors

Many of you may never heard about Benjamin Graham. The above photograph is of Benjamin Graham whose book, The Intelligent Investor is most popular among the value investors from all around the world. In fact, Warren Buffet, the legendary investor follows the investment principles given in his book.

The Intelligent investor book has completed the 50 full years and still today its value investing principles are world famous. This is my most favourite book on the stock investing. Warren Buffet once upon a time was a student of Benjamin Graham. The Margin of Safety formula by Benjamin graham is the most popular formula in the world. Let me tell you that What is Margin of Safety Formula and why is it so much important in the world of investments?

The formula as described by Graham in the 1962 edition of Security Analysis, is as follows:

V* = EPS X (8.5 + 2g)

V = Intrinsic Value

EPS = Trailing Twelve Months Earnings Per Share

8.5 = P/E base for a no-growth company

g = reasonably expected 7 to 10 year growth rate

Where the expected annual growth rate “should be that expected over the next seven to ten years.” Graham’s formula took no account of prevailing interest rates.

The above is that margin of safety formula which has passed through all the tests and in all the market conditions. Many finance gurus and investors have challenged this formula but still the formula is un beaten eve today.

In 1974, Graham has revised the formula. Whish is as below.

Graham suggested a straight forward practical tool for evaluating a stock’s intrinsic value. His model represents a down-to-earth valuation approach that focuses on the key market-related and company-specific variables.

The Graham formula proposes to calculate a company’s intrinsic value V* as:

V* = EPS X (8.5 + 2g) X 4.4 / Y

V: Intrinsic Value

EPS: the company’s last 12-month earnings per share

8.5: the constant represents the appropriate P-E ratio for a no-growth company as proposed by Graham

g: the company’s long-term (five years) earnings growth estimate

4.4: the average yield of high-grade corporate bonds in 1962, when this model was introduced

Y: the current yield on AAA corporate bonds

To apply this approach to a buy-sell decision, each company’s relative Graham value (RGV) can be determined by dividing the stock’s intrinsic value V* by its current price P:

RGV = V* / P

An RGV of less than one indicates an overvalued stock and should not be bought, while an RGV of greater than one indicates an undervalued stock and should be bought.

If you want more explanation about this formula than buy the Book Intelligent Investor by Benjamin Graham and read it’s Chapter 20. It’s Chapter 20 has all the details about margin of safety formula.

Watch the above video. it’s the Warren Buffet’s tribute to Benjamin Graham. According to Buffet, Chapter 8 and Chapter 20 of the book The Intelligent Investor will set a basic mindset of investing in your brain. And after that you will just have to prevent your emotions to erode this mindset.

In 1949, when Warren Buffet was just 19 years old, he picked up the book The Intelligent Investor and that single book has changed his entire life according to him. This is because the investment principles in that book are still effective for making profits in the stock market.

Benjamin Graham was a professor of Warren Buffet in his second semester.

So in my opinion, rather than following the hot stock tips and investing blindly in the companies about which you know little to nothing, it is advisable to learn the margin of safety formula from the book intelligent investor.

If you really want to become a successful investor in your life than Chapter 8 and 20 of this book are extremely important for you. Invest in your own Knowledge first and that will give you the highest dividends in the long run.

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