The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [125]
Our own observation, however, leads us to minimize somewhat the practical value of most of the industry studies that are made available to investors. The material developed is ordinarily of a kind with which the public is already fairly familiar and that has already exerted considerable influence on market quotations. Rarely does one find a brokerage-house study that points out, with a convincing array of facts, that a popular industry is heading for a fall or that an unpopular one is due to prosper. Wall Street’s view of the longer future is notoriously fallible, and this necessarily applies to that important part of its investigations which is directed toward the forecasting of the course of profits in various industries.
We must recognize, however, that the rapid and pervasive growth of technology in recent years is not without major effect on the attitude and the labors of the security analyst. More so than in the past, the progress or retrogression of the typical company in the coming decade may depend on its relation to new products and new processes, which the analyst may have a chance to study and evaluate in advance. Thus there is doubtless a promising area for effective work by the analyst, based on field trips, interviews with research men, and on intensive technological investigation on his own. There are hazards connected with investment conclusions derived chiefly from such glimpses into the future, and not supported by presently demonstrable value. Yet there are perhaps equal hazards in sticking closely to the limits of value set by sober calculations resting on actual results. The investor cannot have it both ways. He can be imaginative and play for the big profits that are the reward for vision proved sound by the event; but then he must run a substantial risk of major or minor miscalculation. Or he can be conservative, and refuse to pay more than a minor premium for possibilities as yet unproved; but in that case he must be prepared for the later contemplation of golden opportunities foregone.
A Two-Part Appraisal Process
Let us return for a moment to the idea of valuation or appraisal of a common stock, which we began to discuss above on p. 288. A great deal of reflection on the subject has led us to conclude that this better be done quite differently than is now the established practice. We suggest that analysts work out first what we call the “past-performance value,” which is based solely on the past record. This would indicate what the stock would be worth—absolutely, or as a percentage of the DJIA or of the S & P composite—if it is assumed that its relative past performance will continue unchanged in the future. (This includes the assumption that its relative growth rate, as shown in the last seven years, will also continue unchanged over the next seven years.) This process could be carried out mechanically by applying a formula that gives individual weights to past figures for profitability, stability, and growth, and also for current financial condition. The second part of the analysis should consider to what extent the value based solely on past performance should be modified because of new conditions expected in the future.
Such a procedure would divide the work between senior and junior analysts as follows: (1) The senior analyst would set up the formula to apply to all companies generally for determining past-performance value. (2) The junior analysts would work up such factors for the designated companies—pretty much in mechanical fashion. (3) The senior analyst would then determine to what extent a company’s performance—absolute or relative—is