Graham's Formula -- Still Applicable, Right?

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3funder
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Graham's Formula -- Still Applicable, Right?

Post by 3funder » Sun May 06, 2018 7:46 am

20 minus inflation multiplied by trailing twelve months earnings.

20-2=18.

18x110.98=1,997.64

The S&P 500 is approximately 25% overvalued.

What do you think?

AlohaJoe
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Re: Graham's Formula -- Still Applicable, Right?

Post by AlohaJoe » Sun May 06, 2018 7:52 am

You mean the formula of which Graham himself said:
Let the reader not be mislead into thinking that such projections have any high degree of reliability, or, conversely, that future prices can be counted on to behave accordingly as the prophecies are realized, surpassed, or disappointed

3funder
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Re: Graham's Formula -- Still Applicable, Right?

Post by 3funder » Sun May 06, 2018 7:57 am

AlohaJoe wrote:
Sun May 06, 2018 7:52 am
You mean the formula of which Graham himself said:
Let the reader not be mislead into thinking that such projections have any high degree of reliability, or, conversely, that future prices can be counted on to behave accordingly as the prophecies are realized, surpassed, or disappointed
I should have clarified. Is this a reasonable way to try and get a general gauge on valuations?

david1082b
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Re: Graham's Formula -- Still Applicable, Right?

Post by david1082b » Sun May 06, 2018 8:03 am

Spring 2009 saw trailing earnings of around ten apparently http://www.multpl.com/s-p-500-earnings/table?f=m

This would have made S&P 500 massively overvalued right at the bottom of the market. Of course extreme things were going on - finance stocks had to book huge one-off losses due to declines in the value of their assets. A more normalized earnings number might make Graham look more relevant.

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JoMoney
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Re: Graham's Formula -- Still Applicable, Right?

Post by JoMoney » Sun May 06, 2018 8:05 am

The valuations are what they are, what are you try to gauge about them? What are you comparing them to?
Valuations are higher than they were in the past, there are easier ways to see that.
Whether or not that they're "overvalued" is a bit subjective. You can create some formula to gauge what for you is too high or low, but what is the basis for that formula? What do you expect that it's telling you? Can you validate that it's predictive of anything?
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

3funder
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Re: Graham's Formula -- Still Applicable, Right?

Post by 3funder » Sun May 06, 2018 8:09 am

JoMoney wrote:
Sun May 06, 2018 8:05 am
The valuations are what they are, what are you try to gauge about them? What are you comparing them to?
Valuations are higher than they were in the past, there are easier ways to see that.
Whether or not that they're "overvalued" is a bit subjective. You can create some formula to gauge what for you is too high or low, but what is the basis for that formula? What do you expect that it's telling you? Can you validate that it's predictive of anything?
I'm not necessarily making moves based on them. I'm simply asking if you think this is as decent a guidepost as any. That's all. Nothing more; nothing less.

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corn18
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Re: Graham's Formula -- Still Applicable, Right?

Post by corn18 » Sun May 06, 2018 8:10 am

I'd like the P/E to be below 20 and since it's around 24, I think it's over valued by 17%. CAPE 10 is 31 and should be below 20, so I think that's over valued by 35%. So your 25% looks to be as good a WAG as any.

So I am going to keep my AA at 60/40 with 25% international, same as it was before I read this thread. Same as it will be until I retire in 3 years (hopefully).

Rudder amidships, steady as she goes.

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JoMoney
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Re: Graham's Formula -- Still Applicable, Right?

Post by JoMoney » Sun May 06, 2018 8:17 am

3funder wrote:
Sun May 06, 2018 8:09 am
JoMoney wrote:
Sun May 06, 2018 8:05 am
The valuations are what they are, what are you try to gauge about them? What are you comparing them to?
Valuations are higher than they were in the past, there are easier ways to see that.
Whether or not that they're "overvalued" is a bit subjective. You can create some formula to gauge what for you is too high or low, but what is the basis for that formula? What do you expect that it's telling you? Can you validate that it's predictive of anything?
I'm not necessarily making moves based on them. I'm simply asking if you think this is as decent a guidepost as any. That's all. Nothing more; nothing less.
A "guidepost" to guide you for what? I mean you can pick any valuation point, or formulaic one, that you like and measure against it and say yeah it's higher or lower than that... As I said though, there are easier ways to look at it and say "yeah" valuations are higher (or lower) than they were at some point(s) in the past.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

3funder
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Re: Graham's Formula -- Still Applicable, Right?

Post by 3funder » Sun May 06, 2018 8:22 am

JoMoney wrote:
Sun May 06, 2018 8:17 am
3funder wrote:
Sun May 06, 2018 8:09 am
JoMoney wrote:
Sun May 06, 2018 8:05 am
The valuations are what they are, what are you try to gauge about them? What are you comparing them to?
Valuations are higher than they were in the past, there are easier ways to see that.
Whether or not that they're "overvalued" is a bit subjective. You can create some formula to gauge what for you is too high or low, but what is the basis for that formula? What do you expect that it's telling you? Can you validate that it's predictive of anything?
I'm not necessarily making moves based on them. I'm simply asking if you think this is as decent a guidepost as any. That's all. Nothing more; nothing less.
A "guidepost" to guide you for what? I mean you can pick any valuation point, or formulaic one, that you like and measure against it and say yeah it's higher or lower than that... As I said though, there are easier ways to look at it and say "yeah" valuations are higher (or lower) than they were at some point(s) in the past.
Ok, I'll give you a real-life example. My wife and I have a somewhat modest amount of extra money to invest in a taxable account. Given that the taxable account has an undetermined time horizon (we already have retirement covered via maxing 403(b)s and Roth IRAs), I've chosen to invest the money (roughly $5K) in VGTSX, as valuations (P/E, P/B) are much lower than VTSMX. I'm not questioning the wisdom of my decision; VGTSX is a low-fee, highly diversified mutual fund. I'm merely curious as to how Bogleheads try and gauge US market valuations for themselves. Additionally, when I say I'm not making moves based on valuations, I mean that I'm not making drastic moves (i.e. what's the big deal about having $5K extra invested in international stocks?).

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corn18
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Re: Graham's Formula -- Still Applicable, Right?

Post by corn18 » Sun May 06, 2018 8:36 am

Nothing wrong with a little international value tilt. Just don't let that $5k turn into $50k unless your ISP says so.

mrpotatoheadsays
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Re: Graham's Formula -- Still Applicable, Right?

Post by mrpotatoheadsays » Sun May 06, 2018 8:40 am

That aint Graham's formula.

anil686
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Re: Graham's Formula -- Still Applicable, Right?

Post by anil686 » Sun May 06, 2018 8:41 am

3funder wrote:
Sun May 06, 2018 8:22 am
JoMoney wrote:
Sun May 06, 2018 8:17 am
3funder wrote:
Sun May 06, 2018 8:09 am
JoMoney wrote:
Sun May 06, 2018 8:05 am
The valuations are what they are, what are you try to gauge about them? What are you comparing them to?
Valuations are higher than they were in the past, there are easier ways to see that.
Whether or not that they're "overvalued" is a bit subjective. You can create some formula to gauge what for you is too high or low, but what is the basis for that formula? What do you expect that it's telling you? Can you validate that it's predictive of anything?
I'm not necessarily making moves based on them. I'm simply asking if you think this is as decent a guidepost as any. That's all. Nothing more; nothing less.
A "guidepost" to guide you for what? I mean you can pick any valuation point, or formulaic one, that you like and measure against it and say yeah it's higher or lower than that... As I said though, there are easier ways to look at it and say "yeah" valuations are higher (or lower) than they were at some point(s) in the past.
Ok, I'll give you a real-life example. My wife and I have a somewhat modest amount of extra money to invest in a taxable account. Given that the taxable account has an undetermined time horizon (we already have retirement covered via maxing 403(b)s and Roth IRAs), I've chosen to invest the money (roughly $5K) in VGTSX, as valuations (P/E, P/B) are much lower than VTSMX. I'm not questioning the wisdom of my decision; VGTSX is a low-fee, highly diversified mutual fund. I'm merely curious as to how Bogleheads try and gauge US market valuations for themselves. Additionally, when I say I'm not making moves based on valuations, I mean that I'm not making drastic moves (i.e. what's the big deal about having $5K extra invested in international stocks?).
I keep an eye on valuations via PE ratios and PB as well. A lot of it is probably noise, though, because the predictive probabilities were determined many years ago when market participants were different than today (more individual less institutional 50 years ago) and with different accounting standards. With a long enough horizon (meaning 10-15 years) and the fact I DCA and not lump sum - due to just investing when I have the money - I feel it will balance itself out. I remember Malkiel saying in multiple books that the US market was overvalued in his opinion in 1994 and then it went up dramatically until 1999 - if one stayed out of the market all that time, they would have missed a compounded return of some insane amount of 30% per year or something like that. Sure, the dot com crash came later but still you were further ahead if you were investing in the market through the whole period instead of staying out from 1994 to 2002. I know you are not staying out - but my point is market valuations can stay high or low for extended periods of time (years and years) making it hard to gauge relative dollars in investing to one asset class versus another IMO...

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stemikger
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Re: Graham's Formula -- Still Applicable, Right?

Post by stemikger » Sun May 06, 2018 8:42 am

I follow the formula of Graham's most famous student. The average person should simply invest a like sum every month into the S&P 500 Index. Keep investing through thick and thin, especially thin.

The results will be far better than most of the complicated strategies and endowments.

However, so-called sophisticated and wealthy people just can't take this advice (even after I walk them through the numbers) and admit that they are doing what the average investor with modest means can do.
Choose Simplicity ~ Stay the Course!! ~ Press on Regardless!!!

magneto
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Re: Graham's Formula -- Still Applicable, Right?

Post by magneto » Sun May 06, 2018 10:27 am

Too rigid historic benchmarks do not allow for the tendency of the valuation median anchors to drag this way and that from decade to decade.
Take another look at :-
http://www.multpl.com/
How do things seem casting an eye back over the most recent 10 to 20 years?
Somewhat high maybe? - But need the cautious investor take overly drastic action?

Whether the Shiller is more significant is open to debate.
http://www.multpl.com/shiller-pe/
Last edited by magneto on Sun May 06, 2018 10:30 am, edited 1 time in total.
'There is a tide in the affairs of men ...', Brutus (Market Timer)

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willthrill81
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Re: Graham's Formula -- Still Applicable, Right?

Post by willthrill81 » Sun May 06, 2018 10:29 am

The market is worth what market participants collectively say it's worth.

Market valuations are not reliably mean-reverting.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

dodonnell
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Re: Graham's Formula -- Still Applicable, Right?

Post by dodonnell » Sun May 06, 2018 11:42 am

3funder wrote:
Sun May 06, 2018 7:46 am
20 minus inflation multiplied by trailing twelve months earnings.

20-2=18.

18x110.98=1,997.64

The S&P 500 is approximately 25% overvalued.

What do you think?
I wonder how much higher today's earnings would be, if GAAP/IFRS accounting standards used to report earnings were frozen back to the time of Graham? ... 110.98 would be how much larger?

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oldzey
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Re: Graham's Formula -- Still Applicable, Right?

Post by oldzey » Sun May 06, 2018 12:25 pm

stemikger wrote:
Sun May 06, 2018 8:42 am
I follow the formula of Graham's most famous student. The average person should simply invest a like sum every month into the S&P 500 Index. Keep investing through thick and thin, especially thin.

The results will be far better than most of the complicated strategies and endowments.

However, so-called sophisticated and wealthy people just can't take this advice (even after I walk them through the numbers) and admit that they are doing what the average investor with modest means can do.
+1

Simplicity...
"The broker said the stock was 'poised to move.' Silly me, I thought he meant up." ― Randy Thurman

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JoMoney
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Re: Graham's Formula -- Still Applicable, Right?

Post by JoMoney » Sun May 06, 2018 12:30 pm

dodonnell wrote:
Sun May 06, 2018 11:42 am
3funder wrote:
Sun May 06, 2018 7:46 am
20 minus inflation multiplied by trailing twelve months earnings.

20-2=18.

18x110.98=1,997.64

The S&P 500 is approximately 25% overvalued.

What do you think?
I wonder how much higher today's earnings would be, if GAAP/IFRS accounting standards used to report earnings were frozen back to the time of Graham? ... 110.98 would be how much larger?
I wonder how it would change if there were a lot of companies selling software, intellectual property, electronic media, and other IT like companies that can grow and scale at incredibly fast rates with very little need for additional investment in tangible property and equipment.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

JBTX
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Re: Graham's Formula -- Still Applicable, Right?

Post by JBTX » Mon May 07, 2018 2:09 am

3funder wrote:
Sun May 06, 2018 7:46 am
20 minus inflation multiplied by trailing twelve months earnings.

20-2=18.

18x110.98=1,997.64

The S&P 500 is approximately 25% overvalued.

What do you think?
What is the magic of 20? Seems like that assumes interest rates are 5%. If long term rates are 3%, should the multiple be 33?

The market feels over valued, but it is hard to quantify considering the position of interest rates. One would expect higher multiples with lower long term rates.

3funder
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Re: Graham's Formula -- Still Applicable, Right?

Post by 3funder » Mon May 07, 2018 10:44 am

JBTX wrote:
Mon May 07, 2018 2:09 am
3funder wrote:
Sun May 06, 2018 7:46 am
20 minus inflation multiplied by trailing twelve months earnings.

20-2=18.

18x110.98=1,997.64

The S&P 500 is approximately 25% overvalued.

What do you think?
What is the magic of 20? Seems like that assumes interest rates are 5%. If long term rates are 3%, should the multiple be 33?

The market feels over valued, but it is hard to quantify considering the position of interest rates. One would expect higher multiples with lower long term rates.
I have no idea why 20 is the multiple.

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