Article 1: The Concept of Intrinsic Value
The market is NOT a weighing machine
The market is a voting machine in the short term: prices are partly the product of reason and partly of emotion. Only in the long run does it function as a weighing machine. Market price is frequently out of line with real value, and there is an inherent tendency for these disparities to correct themselves.
Intrinsic value is expressed as a RANGE
Analysis does not seek to determine EXACTLY the intrinsic value. It only needs to establish that:
(a) the value is adequate to justify a purchase, OR
(b) the value is considerably higher or lower than the market price.
When uncertainty is low → narrow range. When high → wide range. A conclusion is valid only when the price falls WELL outside the range.
V = EPS × (8.5 + 2g) × 4.4 / Y
EPS = Earnings per share (average or TTM)
g = Expected growth rate (conservative)
8.5 = Base P/E for zero-growth company
4.4 = AAA yield in Graham's era
Y = Current yield on AAA corporate bonds
Ejemplo: EPS $3.18, g=5%, Y=5.0%
V = $3.18 × (8.5 + 10) × (4.4/5.0) = $3.18 × 18.5 × 0.88 = $51.79
Article 2: Investment vs. Speculation
The "New Era" Fallacy
In every bubble the same argument is repeated: "This time is different, value standards have changed." Graham saw it in 1929, it repeated in 2000, 2008, 2021.
DANGER SIGNAL: If a stock sells at 35x its MAXIMUM earnings instead of 10x its AVERAGE earnings, the conclusion is that it is TOO EXPENSIVE — not that value standards have changed.
Numerical example: Buying at $100 a company earning $2.50 per share has no logical basis. The same reasoning would "justify" buying at $200, $1,000, or any price — which demonstrates the absurdity.
Insufficient periods to establish trends
Growing earnings for only 3-5 years were considered a "guarantee" of uninterrupted future growth. This is INSUFFICIENT evidence. Normal economic forces militate AGAINST the indefinite continuation of a trend. Competition, regulation, and the law of diminishing returns are powerful enemies of unlimited expansion.
Article 3: Earning Power — The Capacity to Earn
Earning Power = Average + Reasonable Expectation
Earning power combines:
1. A statement of REAL earnings shown over a period of years, WITH
2. A REASONABLE expectation that they will be approximated in the future
Critical distinction between two averages:
• S.H. Kress: average $4.50/share with each year near the norm → YES it's earning power ✅
• Hudson Motors: average $4.75 but range from -$3.54 to +$13.39 → NOT earning power ❌
An average that is merely the arithmetic result of disconnected figures has NO predictive value.
Current Earnings Are NOT the Basis of Valuation
The market is IRRATIONAL in varying its valuation proportionally with temporary changes in reported earnings. A private business owner would NEVER mark up or down the value of their company just because one year was better or worse.
The classic formula for beating the market: Buy stocks at low prices caused by TEMPORARILY reduced earnings. Sell at inflated levels created by abnormal prosperity. Requires: strength of character + patience to wait.
Article 4: P/E Ratios & Stock Valuation
20x avg earnings = MAXIMUM investment price
12.5x avg earnings = TYPICAL fair price (neutral prospects)
<5x avg earnings = possible BARGAIN (if quality confirmed)
Period to calculate: 5-10 years of average earnings
Minimum earnings yield: 5% (= max P/E of 20)
Paying >20x = SPECULATION, not investment
Empirical Evidence: Investment vs. Speculation Group
Group A (speculative due to high price):
• General Electric: earnings yield 2.9% sobre precio. Max yield 5.1%
• Johns-Manville: earnings yield 2.7%. Max 4.5%
Blue chips, but the PRICE made them speculative.
Group C (investment quality):
• Adams-Millis: earnings yield 15.7% sobre precio
• American Safety Razor: 13.7%
• J.J. Newberry: 10.7%
Investment-quality companies had earnings yield 2.5x GREATER than the MAXIMUM earnings of the speculative ones.
Article 5: Margin of Safety — The Central Concept
Procedure for Exploiting Market Cycles
1. Select a diversified list of leading stocks
2. Determine "normal" value = average earnings 7-10 years × appropriate multiplier
3. BUY when the price is at 2/3 of normal value (33% discount) or on a descending scale from 80% of value
4. SELL when the price exceeds normal value by 33-50%
⚠️ The direct owner MUST expect to buy too early and sell too early. But the margin operator who waits for exact timing typically ends in disaster.
Article 6: Balance Sheet — What It Reveals About Value
The Question Wall Street Never Asks
"How much is the ENTIRE business selling for?"
If a businessman receives an offer of 5% return on a business at $10,000, he multiplies by 20 and establishes a proposed value of $200,000 for the entire company. The rest of the calculation revolves around whether the business is a "good buy" at $200,000.
Wall Street never makes this basic calculation. General Electric in 1930: price $95, total market value $2,740M, book value $396M. Buyers were paying a $2,000M PREMIUM over the money actually invested. That is not valuation — it's sleight of hand.
Three Levels of Balance Sheet Value
1. Book Value: Activos tangibles totales − obligaciones − acciones senior ÷ shares
2. Current Asset Value: Solo activos corrientes − todas las obligaciones ÷ shares (excluye planta/equipo)
3. Cash Asset Value: Solo cash + securities − todas las obligaciones ÷ shares
If the price is below Current Asset Value, you're literally buying the fixed assets, plant, equipment, and brand for FREE.
Caso: Great Atlantic & Pacific Tea Co. (1938)
One of the largest retail companies in America, with an uninterrupted record of earnings and dividends for many years, was selling for LESS than its net current assets alone. Total market price: $126M vs net current assets: $134M. Market's reasons: threat of chain store taxes + recent decline in earnings. The market expresses fears, not exact valuations.
Article 7: Discrepancies Between Price and Value — Where the Bargains Are
Graham's Group A Opportunities
Stocks that meet BOTH criteria simultaneously:
✅ Selling at less than 7x last year's earnings
✅ Selling at less than net current asset value
When you find this, you have a company where the market is giving away fixed assets, plant, equipment, and brand for zero.
Graham's Group B Opportunities
Stocks that meet BOTH criteria:
✅ Price ≤ 2/3 of net current asset value
✅ P/E ≤ 12x last year's or average earnings
Graham found 10-20 of these at any given moment in the market. The hard part is NOT finding them — it's determining whether qualitative factors justify the purchase.
Graham's Recommended Strategy
Graham favors investing in a DIVERSIFIED group of "bargain issues" with only ordinary prospects, INSTEAD of trying to locate the next big winner by buying at high prices based on future possibilities.
Investment in undervalued stocks can be conducted with general success, provided:
• Good judgment is used in evaluating future prospects
• Commitments are avoided when the general market is statistically too high
• Broad diversification is used (10-30 positions)
Article 8: When and How to Buy Stocks
Low-Price Stocks — Genuine vs. Fraudulent
Genuinely low-priced: The market value of the ENTIRE issue is SMALL relative to the company's assets, sales, and earnings.
Ejemplo: Barker Brothers a $5/acción — market cap $743K vs ventas $8.1M y activos netos $7.2M ✅
PSEUDO-low price (TRAP): Low price achieved by creating an ENORMOUS number of shares. Total market cap is excessive vs. the business.
Ejemplo: Wright-Hargreaves a $7 — pero 5.5M acciones = market cap $38.5M vs ventas máximas $3.9M ❌
⚠️ The public buys the wrong ones because those are the ones ACTIVELY PROMOTED (insiders want to unload).
Signs of TRANSITORY Earnings (Don't Buy)
• Company depends on a single "gadget" product → success is typically short-lived
• Company depends on brand popularity in a field of variable tastes → peak followed by decline
• New industry flooded with capital → overcapacity and acute competition are predictable
Case: Coty Inc. — cosmetics rose to 30x maximum earnings ($82/share). In a field where women's tastes destroy earnings as easily as they build them, it fell from $82 to $1.50 in 3 years.
Case: Intertype Corp — The Correct Reasoning
Price $8. Net current assets: $20/share (2.5x the price). Avg earnings $0.87. In 6 of the last 10 years it traded 2-4x higher. Questions: Will it remain in business? Will it participate as before in good times? If yes → shares can be bought with very little probability of final loss and every indication they will double under favorable conditions.
Article 9: The Defensive Investor's Scorecard
The Defensive Investor's 7 Criteria
For a stock to qualify as INVESTMENT, it must pass ALL:
✅ Adequate size: Revenue > $400M (eliminates small/fragile companies)
✅ Financial strength: Current Ratio ≥ 2.0 (can pay short-term obligations)
✅ Earnings stability: Positive for the last 10 consecutive years
✅ Dividend record: Paid continuously for 20+ years
✅ Earnings growth: EPS grew ≥33% in the last 10 years
✅ Moderate P/E: ≤ 15x average earnings of last 3 years
✅ Moderate P/B: ≤ 1.5x book value (or P/E × P/B ≤ 22.5)