What Is the Benjamin Method?
The Benjamin Method is a term used to describe the investment philosophy of Benjamin Graham (1894-1976), who is credited with inventing the strategy of value investing using fundamental analysis, whereby investors analyze stock data to find assets that have been systematically undervalued.
- The Benjamin Method refers to the original value investing philosophy created by Benjamin Graham in the 1930s.
- Graham focused on long-term investment in companies based on fundamental analysis of financial ratios and rejected short-term speculation.
- Legendary value investor Warren Buffett has credited the Benjamin Method with his success.
Understanding the Benjamin Method
The Benjamin Method of investing is the brainchild of Benjamin Graham, a British-American investor, economist, and author. He came to prominence in 1934, with the publication of his textbook Security Analysis, which he co-wrote with David Dodd. Security Analysis is a foundational book for the investment industry today, and the teachings of Benjamin Graham heavily influenced famous investors like Warren Buffett. Benjamin Graham taught Warren Buffett while Buffett was studying at Columbia University, and Buffett has written that Graham’s books and teachings “became the bedrock upon which all of my investment and business decisions have been built.” His famous book, The Intelligent Investor, has gained recognition as the foundational work in value investing.
Benjamin Graham’s method of value investing stresses that there are two types of investors: long-term and short-term investors. Short term investors are speculators who bet on fluctuations in the price of an asset, while long-term, value investors should think of themselves as the owner of a company. If you are the owner of a company, you shouldn’t care what the market thinks about its worth, as long as you have solid evidence that the business is or will be sufficiently profitable.
Using the Benjamin Method
The original Benjamin Method for finding the intrinsic value of a stock was:
V = EPS × (8.5 + 2g)where:V = intrinsic valueEPS = trailing 12-mth EPS of the company8.5 = P/E ratio of a zero-growth stock
In 1974, the formula was revised to include both a risk-free rate of 4.4%, which was the average yield of high-grade corporate bonds in 1962 and the current yield on AAA corporate bonds represented by the letter Y:
V=YEPS × (8.5 + 2g) × 4.4
Example Using the Benjamin Method
Let’s say you are an investor who is considering purchasing shares in the hypothetical Philadelphia Widget Company. The company is well known and is the leading purveyor of widgets in America. Its stock is trading at $100 per share, while it earns $10 per year in profits. A competitor to the Philadelphia Widget Company is the Cleveland Widget Company, a younger upstart that is not well known but has gained market share in recent years. It earns far less money, just $2 per year, but the stock is also a lot cheaper at $15 per share.
An investor following the Benjamin Method of investing would use these figures and other data to perform a fundamental analysis of the company. For instance, we can see that the Cleveland Widget Company is cheaper for every dollar of earnings to buy than the Philadelphia Widget Company. The price-to-earnings (P/E) ratio of the Philadelphia Widget Company is 10, whereas it is 7.5 for the Cleveland Widget Company. A follower of the Benjamin Method of investing would conclude that the Philadelphia company is overpriced simply because it is well known. This investor would choose the Cleveland company instead.