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Strategies & Market Trends : Value Investing
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To: E_K_S who wrote (55397)6/3/2015 2:12:50 PM
From: Graham Osborn1 Recommendation

Recommended By
E_K_S

  Read Replies (2) of 78673
 
Yeah, so basically the Graham Number is the geometric mean of the maximum multiples of earnings and book you are willing to pay. The defaults are P/B 1.5 and P/E 15. Honestly don't know where those numbers came from - I think in SA Graham gives 11 for the P/E. But anyway:

P/B = 1.5
P/E = 15
(P/B)*(P/E) = 22.5
P^2/(B*E) = 22.5
P = sqrt(22.5*B*E)

So really there ain't much magic here except the GN pulls us out of the clouds - we're comparing to Graham's absolute multiples rather than comparable companies. The shortcomings are the same as of the individual P/B and P/E ratios and how you calculate them. One thing you can do is look at historic multiples for the company and the industry, i.e. not just the current ones. I'd go back at least 50 years. I've seen people claim higher multiples are more appropriate nowadays (maybe since the Bernanke Doctrine is protecting us).

Obviously if you are going to use this for a Buffett type company then you are going to need to adjust the multiples for growth. So the default Graham's Number is going to be over conservative for a true Buffett company. And obviously you wouldn't want to average earnings here. But if its an insurer with earnings that fluctuate without much direction then a 5 or 10 year average would be OK if liquidity is sufficient during the troughs.

For BV I think you just have to choose a conservative multiple based on historic norms for that subindustry.

I'm not an expert on conservative multiples for reinsurers and assessing the risk profile of their policies so I'll let someone else answer to that. I'll have a look though and try and educate myself. I do know a good reinsurer is worth more to Buffett than retail investors.
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