Tuesday, June 5, 2012

Value Indicators: Preamble and Ben Graham's P/E Ratio

I've been woefully lax on posting  for the last little while.  Let's jump right in and look at the value indicators for this sector (oil & gas, integrated).

The value indicators I use are:
1) The Ben Graham P/E ratio,
2) Growth in Cash Flow from Operations,
3) Accounting changes, Extra-ordinary earnings, special items,
4) Capital Structure,
5) Owners' Earnings,
6) Theoretical Price.

Those of you familiar with Ben Graham's work will no doubt recognize these indicators.  For the majority, I've taken his work verbatim (or at least intended too).  A couple of times I've tempered the measure a bit to make it fit the information I have access to and one, as you'll see, is most definitely NOT something that the eminent Mr. Graham bestowed upon us.  It is, however, a nifty calculation.  And even thought it uses beta, I still think it speaks to the spirit of the measure, if not the law.

Mr. Benjamin Graham.  Definitely one of the good guys.  Thank you for sharing your great mind.


Ben Graham's P/E Ratio

You know, for the "simplest" and most often cited financial ratio the P/E ratio has a lot of different ways it can be calculated.  I find that disturbing, or at the very least, a pet peeve.  It is like driving down a road that suddenly, for no apparent reason, changes name, or the analog of that, a road that continues in name, even though it ended somewhere else.  The point is, it is confusing.  And you can get lost.

Which is why Verdant Analysis is just so good, so useful.  You know exactly what financial ratios you are getting because you've built them yourself.  And we're going to develop more and more great stuff beyond the ability to do ratios that will be simple to use, yet powerful in scope.

Ben Graham P/E ratio takes the average of the last three earnings figures as its denominator and Mr. Graham's rule of thumb is to limit yourself to securities trading at 15 times earnings or less.

It is a simple and easy to do calculation.  
1) Build an analysis template in Verdant by requesting the diluted, normalized EPS for Y, Y-1 and Y-2.  This is found on the income statement.
2) Export to Google or excel
3) Calculate the PE ratio with the following formula: C2/(average(F2:H2)).  C2 is the security's price. F2, G2 and H2 are the three earnings.

The next step is to rate the results.  I used three "if" calculations in order give a rating of 1 to PEs greater than 0 and less than 15, -1 for PEs less than zero and greater than 25 and 0 for PEs between 15 and 25.  

You can see the spread sheet here

Thanks for reading and I'll be back with the second indicator in a couple of days! 

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