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Warren Buffets Professor Benjamin Graham at Columbia Business School co-authored the book titled Security Analysis. This book happens to be Warren’s favorite. It is the foundation of value investing.
Security Analysis teaches the reader how to value a security whether it be a bond, preferred stock, common stock, etc. The authors include countless examples embedded throughout the book so the reader can perform the calculations themselves to gain a full understanding.
The book covers both qualitative and quantitative analysis of businesses including the Income Accounts, Balance Sheets, Earnings, Dividends, etc. In their analysis of the income account the authors go over the suggested average earnings multiplier. Graham and Dodd suggest that 20 times average earnings (Price/Average Earnings = 20) is the maximum price one should pay for an investment in a common stock. Any higher in price and this is deemed speculation.
How do you use this to your advantage? If you employ this as a rule in your investments/trading it will protect you from over-inflated stock prices that the market/hype creates. This can protect you from big losing stocks and preserve your wealth. To find the average earnings multiplier of a stock you need to find the yearly earnings of the stock then average them. Next you take the current stock price and divide that by the average earnings you calculated (P/AvgE). If it is over 20 then this is not an investment but more speculation because the stock price is much higher than what the company is actually earning.
YP Investors hopes you use these fundamental analysis tips to your advantage and continue to grow your wealth. Check out our Buffett Fundamentals Tool to help analyze a stock’s value and earnings!
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