Comparing four companies
Graham's side-by-side method: profitability, stability, growth, finances, dividends and price, on his 1970 four.
FinanceGraham ch. 13About 4 min: 2 reading, 2 practiceUpdated
General education, not financial advice.
- Calculate the main ratios Graham uses to compare companies
- Read a comparison table for profitability, stability, growth, finances and dividends
- Explain why Graham thought high price/earnings ratios carry high risk
The Intelligent Investor: Benjamin Graham's ideas: lesson 14 of 24
- Graham ch. 1
- Investment versus speculation 4 min
- Graham ch. 2
- Inflation and the investor 4 min
- Graham ch. 3
- A century of market history 5 min
- Graham ch. 4
- The defensive investor's portfolio 4 min
- Graham ch. 5
- Defensive investors and stocks 4 min
- Graham ch. 6
- What the enterprising investor avoids 4 min
- Graham ch. 7
- What the enterprising investor does 5 min
- Graham ch. 8
- Mr. Market 5 min
- Living with fluctuations 5 min
- Graham ch. 9
- Investing in funds 5 min
- Graham ch. 10
- The investor and his advisers 4 min
- Graham ch. 11
- Security analysis for the lay investor 4 min
- Graham ch. 12
- Per-share earnings and their traps 4 min
- Graham ch. 13
- Comparing four companies 4 min
- Graham ch. 14
- The defensive investor's screen 4 min
- Graham ch. 15
- The enterprising investor's screen 7 min
- Graham ch. 16
- Convertibles and warrants 6 min
- Graham ch. 17
- Four extreme case histories 7 min
- Graham ch. 18
- Eight pairs of companies 7 min
- Graham ch. 19
- Shareholders, managements and dividends 5 min
- Graham ch. 20
- Margin of safety (1): the idea 5 min
- Margin of safety (2): in practice 7 min
- Graham appendix 1
- The superinvestors of Graham-and-Doddsville 6 min
- Graham postscript
- Graham today 7 min
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Pairs with Graham, The Intelligent Investor, revised edition with commentary by Jason Zweig (HarperBusiness, 2003), chapter 13, "A Comparison of Four Listed Companies"
What it is
In chapter 13 Graham compares four companies that happened to sit next to each other on the New York Stock Exchange list at the end of 1970: ELTRA, Emerson Electric, Emery Air Freight and Emhart. (They're a historical case study: of the four, only Emerson still existed in the same form in 2003, Zweig notes.)
He reviews each on six points:
- Profitability: earnings as a % of book value; profit per unit of sales.
- Stability: the biggest fall in earnings in any of the last ten years.
- Growth: recent average earnings against earlier averages.
- Financial position: current assets ÷ current liabilities (he wants at least 2), and low debt.
- Dividends: above all, an unbroken record.
- Price history.
His key observation: the four companies' price/earnings ratios varied much more than their business results.
| Company | P/E | Price ÷ book | Yield |
|---|---|---|---|
| ELTRA | 9.7 | 1.0 | 4.5% |
| Emerson | 33 | 6.4 | 1.8% |
| Emery | 45 | 14.3 | 1.8% |
| Emhart | 11.7 | 1.2 | 3.7% |
(P/E on average earnings for 1968–70; prices at the end of 1970.)
Quick check
Tap an answer to check it.
A company's current assets are 300 and current liabilities 100. What is its current ratio, and does it meet Graham's standard?
- Divide current assets by current liabilities, not the other way
Show answer
3, which beats his minimum of 2. 300 ÷ 100 = 3 ≥ 2.
Why it matters
Graham accepted that the two expensive companies had grown faster. His question was whether that justified paying three to four times as much per unit of earnings. High valuations entail high risks, he wrote. He recalled another company that had once been valued just as richly, then saw its profits halve and its price fall by about three-quarters.
Worked example
An imaginary pair:
| A | B | |
|---|---|---|
| Share price | 30 | 90 |
| Earnings per share | 3 | 2 |
| Book value per share | 25 | 12 |
| Dividend per share | 1.20 | 0.40 |
- P/E: A = 30 ÷ 3 = 10; B = 90 ÷ 2 = 45.
- Price ÷ book: A = 30 ÷ 25 = 1.2; B = 90 ÷ 12 = 7.5.
- Return on book value: A = 3 ÷ 25 = 12%; B = 2 ÷ 12 ≈ 16.7%.
- Dividend yield: A = 1.20 ÷ 30 = 4%; B = 0.40 ÷ 90 ≈ 0.44%.
B is the more profitable business, but you pay four and a half times as much for each unit of its earnings. Graham's method makes that trade-off visible.
Common mistake
Choosing the company with the more exciting share price. Graham notes that many analysts preferred the two dear companies mainly for their "market action" (rising prices), which he calls something for speculators, not a valid reason for a conservative investor.
Key terms
- book value
- a company's net assets per share, from its balance sheet
- return on book value
- earnings ÷ book value
- current ratio
- current assets ÷ current liabilities
- dividend yield
- dividend per share ÷ share price
- price/book ratio
- share price ÷ book value per share
Practise the key terms
Tap a card to turn it over. 5 cards.
| Front | Back |
|---|---|
| book value | a company's net assets per share, from its balance sheet |
| return on book value | earnings ÷ book value |
| current ratio | current assets ÷ current liabilities |
| dividend yield | dividend per share ÷ share price |
| price/book ratio | share price ÷ book value per share |
Practice
Work it through
Company C: price 48, earnings per share 4, book value per share 40, dividend 1.92, current assets 500, current liabilities 200.
- 48 ÷ 4
- 48 ÷ 40
- 1.92 ÷ 48 × 100
- 500 ÷ 200
Quick quiz
Tap an answer to check it.
What did Graham find most striking about his four companies?
- He found their records surprisingly good
Show answer
Their P/E ratios varied much more than their business results. The market priced the "glamour" pair far higher.
Why did Graham reject "market action" as a reason to choose a stock?
- It's easy to see; that's not his objection
Show answer
It's something for speculators, not a reason for a conservative investor. Rising prices are not an analysis of the business.
In short
- Compare companies on profitability, stability, growth, financial position, dividends and price history.
- Graham's 1970 four: P/E ratios varied far more than business results.
- High valuations entail high risks.
- Rising prices ("market action") aren't a reason for a conservative investor to buy.
Mastery check
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How does Graham measure earnings stability?
Show answer
By the biggest fall in earnings per share in any of the last ten years, against the average of the three years before it.
A share at 60 earns 4 and has a book value of 30. What are its P/E and price-to-book?
Show answer
P/E 15; price-to-book 2.
What current ratio did Graham look for?
Show answer
At least 2 (2 of current assets for each 1 of current liabilities).
Further reading
- Benjamin Graham, The Intelligent Investor, revised edition with commentary by Jason Zweig (HarperBusiness, 2003), chapter 13.
- On this site: Security analysis for the lay investor.
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