Wednesday, December 20, 2006

Graham's Fair Value of sensex

What could be the fair value of sensex according to Graham's valuation methods. I recently analysed all the stocks in India using the criteria laid down in Graham-Rao Method. The article is awaiting publication. The following scrips satisfied all the criteria with the price of 15-12-2006 as the basis.

1. Cheviot co. Ltd.
2. Ucal Fuel Systems Ltd.
3. Kothari Products Ltd.
4. South Indian Bank Ltd.
5. Shipping Corporation of India Ltd.
6. Micro Inks Ltd.
7. Oriental Bank of Commerce Ltd.
8. Sutlej Industries Ltd.
9. City Union Bank Ltd.
10. India Nippon Electricals Ltd.

I also calculated the earnings based valuation of all scrips in the sensex, using 15 as multiplier for shorter period average EPS for some companies which do not have 7-year EPS data. The market capitalization came to Rs. 3,64,454 crore. The market capitalization for 19-12-2006 reported in ET of 20-12-2006 is Rs. 8,58,332 crores. The index reported is 13382.01. Hence the fair value of index will turnout to be 5682.09.

Thus the index has a huge speculative component.

In this context, it will be interesting to read the statement by Marc Faber reported in Economic Times dated 19th December in page 23. He said sustaining returns would be difficult considering the huge rise in asset prices since 2003. He also said, "you can have an expanding economy, but the market may not go anywhere."

20th December 2006
2.00 p.m.

Sunday, November 26, 2006

Business Standard Article On Graham-Rao Method

The Smart Investor of 27 November 2006 has the article "The merit of value investing" in pages 6 and 7. The article can be accessed from address This article has the description of the method of analysis developed by me. The analysis was applied to BSE "A" group stocks in January 2003 and 38 stocks were identified as value stocks on the basis of earnings valuation criteria.

The portfolio of these value stocks was reviewed in August 2006 and November 2006. In both these months, the value portfolio outperformed the BSE Sensex. The performance up to November 2006 is described in the article. I came across the book by Graham and Dodd in 1984 or 85. It took almost 20 years for me to come out with a successful application of the ideas from the book. I am very happy to share the results of my research effort with all investors and potential investors.

Narayana Rao
NITIE, Mumbai
27 November 2006
11.05 a.m.

Friday, October 13, 2006

Productivity in Agriculture

Today (13th October 2006), Lakshya 2006, was inaugurated at NITIE, Mumbai. Shri Jayant Patil, Finance Minister of Maharashtra, was the chief guest. He mentioned his experience with high speed trains in Germany and wished that in India also such facilities will be installed. He is a right person to talk of infrastructure development as he is basically a civil engineer with a successful record in the area of finance. He can finance the ventures and then guide them in operational issues.

Shri Y.C. Deveshwar, Shri Keshub Mahindra and Shri Azim Premji were felicitated as Business Visionaries. Shri Y.C. Deveshwar brought to the fore the issue of productivity in agriculture and pointed out that NITIE, the institute who area of focus is improving productivity has to play its expected role. I hope his call will energise some of the students and faculty members to focus on this area. The institute can take up study of agricultural activities as a one week project for all the students of IE course, may be before they start the summer project.

I take this opportunity to publish the definition suggested by me for industrial engineering once again in my blog as it specifically mentions agriculture.

Industrial Engineering is Human Effort Engineering. It is an engineering discipline that deals with the design of human effort in all occupations: agricultural, manufacturing and service. The objectives of Industrial Engineering are optimization of productivity of work-systems and occupational comfort, health, safety and income of persons involved.”

Wednesday, October 11, 2006

NRao on Buffett's Investment Methods - I

These days I am spending my time going through the various investment texts and my posts reflect it.

I have to give a presentation on Warren Buffett's integration of Graham's ideas and Phil Fisher's ideas. In this connection I am going through the books, Buffetology Work Book and Permanent Value.

The last time I read the book Permanent Value, I did not appreciate the content. But in this reading, I appreciate the contribution made by the author in explaining Buffett's investment methodology and practice.

This remark on Freddie Mac in page 457, brings out clearly the power of relative value analysis.

"If you were to take Freddie Mac and look at the simple numbers-it's selling at 12 times earnings versus 18 to 20 times earnings for the S&P. It probably has a double-digit earnings growth rate versus an average growth rate over nine years of7% or even less for the S&P. Its return on equity is 20% or better against an average return of 12.5% to 13% for the S&P. So by any simple statistical measure, it's very attractive stock."

Buffett used exactly the investment operations in running his partnerships that Graham employed in his investment practice

Page 81

1. "Generals" - Undervalued stocks generally to be held for a long time.
2. "Workouts"- Securities with a timetable, arbitrage situations arising form sell-outs, mergers, reorganizations and the like.
3. "Control"- owning such a sizeable block that the partnership gains control of the business.

The similarity with Phil Fisher is Buffett also has quality criteria which are different from the quantitative numbers. Important among them is that Buffett liked consumer monopoly companies. In this respect Buffett is following the principle of selection among the companies that satisfy the quantitative criteria. Graham used to buy or recommend buying of all the companies that satisfy the criteria.

Saturday, October 07, 2006

NRao on Intelligent Investor - Chapter 1

Chapter 1 Investment versus Speculation: Results to be Expected by the Intelligent Investor

The aim of this chapter is developing appropriate portfolio policy for the individual, nonprofessional investor. It is not meant for the professionals in securities like brokers and dealers.

What do we mean by “investor”?

To explain the term investor, Graham reiterates the definition from the textbook, Security Analysis. “An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”

Graham wants a clear distinction between investment and speculation in common stocks. He advises Wall Street as an institution to reinstate this distinction and to emphasize it in all its dealings with the public. But as Jason Zweig (He wrote a commentary on Intelligent Investor) commented Wall Street wants trades and it encourages speculation under various names and pretexts.

The reader of this book will gain a reasonably clear idea of the risks that are inherent in common-stock commitments-risks which are inseparable from the opportunities of profit that they offer, and both of which must be allowed for in the investor’s calculations. Graham wants every investor to be aware the risks associated with the stocks.

He states that there is no longer such a thing as a simon-pure investment policy comprising representative common-stocks-in the sense that one can always wait to buy them at a price that involves no risk of a market or “quotational” loss large enough to be disquieting. In most periods the investor must recognize the existence of a speculative factor in his common-stock holding. The speculative factor could be the stock in speculators’ hands. Any time he may run away from it selling at any price. It is investor’s task to keep this component within minor limits, and to be prepared financially and psychologically for adverse results that may be of short or long duration.

A rare advice by Graham on speculation:

Graham’s books are not meant for speculators. In this instance, he says speculation is necessary and unavoidable, for in many common-stock situations there are substantial possibilities of both profit and loss, and the risks therein must be assumed by someone. But there is intelligent speculation as there is intelligent investing. But there are many ways in which speculation may be unintelligent.

Of these the foremost are:

(1) speculating when you think you are investing;
(2) speculating seriously instead of as a pastime, when you lack proper knowledge and skill for it; and
(3) risking more money in speculation than you can afford to lose.

Jason Zweig is more concrete and recommends ten percent of your portfolio as a limit for speculative component.

Graham says strongly “Never mingle your speculative and investment operations in the same account, nor in part of your thinking.”

Results to be Expected by the Defensive Investor

The future of security prices is never predictable.

Sometimes, the expectations may be less favorable for stocks against bonds. But, we cannot be certain that bonds will work out better than stocks from those levels.

There is always the possibility …of accelerating inflation, which in one way or another would have to make stock equities preferable to bonds payable in a fixed amount of dollars. There is the alternative possibility that business will become so profitable, without stepped up inflation, as to justify a large increase in common-stock values in the next few years. Finally, there is the more familiar possibility that one may witness another great speculative rise in the stock market without a real justification in the underlying values. Any of these reasons, and perhaps others which were not mentioned, might cause the investor to regret a 100% concentration on bonds even at their more favorable yield levels.

Hence, the basic compromise policy for defensive investors is that at all times they should have a significant part of their funds in bond-type holdings and a significant part also in equities. It is still true that they may choose between maintaining a simple 50-50 division between the two components or a ratio, dependent on their judgment, varying between a minimum of 25% and a maximum of 75% of either.

It should be remembered that between 1949 and 1969 the price of the DJIA had advanced more than fivefold while its earnings and dividends had about doubled. Hence the greater part of the impressive market record for that period was based on a change in investors’ and speculators’ attitudes rather than in underlying corporate values.

Graham is very skeptical of the ability of defensive investors generally to get better than average results and he extends this skepticism to the management of large funds by experts.
He repeats his warning that the investor cannot hope for better than average results by buying new offerings, or “hot” issues of any sort, meaning thereby those recommended for a quick profit.

The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condition. (An analyst worth his salt could make up such a list.)

The defensive investor can try these alternatives:

The first is the purchase of the shares of well-established investment funds as an alternative to creating his own common-stock portfolio.

He might also utilize one the “common trust funds,” or “commingled funds,” operated by trust companies and banks in many states; or if his funds are substantial, use the services of recognized investment-counsel firm. This will give him professional administration of his investment program along standard lines.

The third is the device of “dollar-cost averaging,” which means simply that practitioner invests in common stocks the same number of dollars each month or each quarter. In this way he buys more shares when the market is low than when it is high, and he is likely to end up with a satisfactory overall price for all his holdings.

Results to be Expected by the Aggressive Investor

It is no difficult task to bring a great deal of energy, study, and native ability into Wall Street and to end up with losses instead of profits. These virtues, if channeled in the wrong directions, become indistinguishable from handicaps.

The ways in which investors and speculators generally endeavor to attain better than average results include:

1. Trading on the market. This usually means buying stocks when the market has been advancing and selling them after it ahs turned downward. .. A small number of professionals frequently engage in short selling.

2. Short term selectivity. This means buying stocks of companies which are reporting or expected to report increased earnings, or for which some other favorable development is anticipated.

3. Long-Term Selectivity. Here the usual emphasis in on an excellent record of past growth, which is considered likely to continue in the future. In some cases also the “investor” may choose companies which have not yet shown impressive results, but are expected to establish a high earning power later.

Graham expressed a negative view about the investor’s overall chances of success in the above three methods.

According to him, to enjoy a reasonable chance for continued better than average results, the investor must follow policies which are (1) inherently sound and promising, and (2) are not popular in Wall Street.

In theory, it is possible to find some approaches to get better than average results, and there are broad reasons to think that it can be achieved in practice as well. Everyone knows that speculative stock movements are carried too far in both directions, frequently in the general market and at all times in at last some of the individual issues. Furthermore, a common stock may be undervalued because of lack of interest or unjustified popular prejudice.

Hence it seems that any intelligent person, with a good head for figures, should have a veritable picnic in Wall Street, battening off other people’s foolishness. But somehow it doesn’t work out that simply. Buying a neglected and therefore undervalued issue for profit generally proves a protracted and patience-trying experience. And selling short a too popular and therefore overvalued issue is apt to be a test not only of one’s courage and stamina but also of the depth of one’s pocketbook. Graham concludes: “The principle is sound, its successful application is not impossible, but it is distinctly not an easy art to master.”

There is also a fairly wide group of “special situation,” which may bring an annual return of 20%, with a minimum of overall risk to those who knew their way around in this field. They include inter security arbitrages, payouts or workouts in liquidations, protected hedges of certain kinds. The typical case is a projected merger of acquisition which offers substantially higher value for certain share than their price on the date of the announcement. But with the multiplication of merger announcements came a multiplication of obstacles to mergers and of deals that didn’t go through, and some operations are resulting in losses in these once-reliable operations. Perhaps, there is more competition now.

A third and final example of these opportunities (though not recently available) is the purchase of bargain issues easily identified as such by the fact that they were selling at less than their share in the net current assets (working capital) alone, not counting the plant account and other assets, and after deducting all liabilities ahead of the stocks. In 1975 a list was published showing nearly 200 issues of this type available in the market. In various ways practically all these bargain issues turned out to be profitable, and the average annual result proved much more remunerative than most other investments. But this opportunity virtually disappeared from the stock market in the next decade.

However, at the low prices of 1970 there again appeared a considerable number of such “sub-working-capital” issues and despite the strong recovery of the market, enough of them remained at the end of the year to make up a full sized portfolio.

Graham has warned initially that enterprising investment is possible in theory and but very difficult in practice. But he concludes the chapter on an optimistic note saying the enterprising investor under today’s conditions still has various possibilities of achieving better than average results. The huge list of marketable securities must include a fair number that can be identified as undervalued by logical and reasonably dependable standards. These should yield more satisfactory results on the average than will the DJIA or any similarly representative list.

He says, “ In our view the search for these would not be worth the investor’s effort unless he could hope to add, say, 5% before taxes to the average annual return from the stock portion of his portfolio.”

The chapter end with the sentence, “We shall try to develop one or more such approaches to stock selection for use by the active investor.”
Saturday, 7 Oct 2006

Sunday, October 01, 2006


Benjamin Graham, acknowledged as the Dean of Wall Street authored “Intelligent Investor.’ It was first published in 1949. The fourth revised edition was published in 1973 by Harper Row, Publishers Inc. New York. A recent print of the book contains commentary by Jason Zweig. Interesting ideas (according to me) from the 1973 edition are being posted by me in parts as I am studying the book once again as a preparation to my presentations on value investing principles of Benjamin Graham. While I posted the actual sentences from the book in my posts on Graham and Dodd, I am posting summarized versions along with my comments in these posts.

From Preface

Graham acknowledged the contribution of Warren Buffett in writing this edition and commented that his counsel and practical aid had proved invaluable.

The purpose of the book is to supply, in a form suitable for laymen, guidance in the adoption and execution of an investment (portfolio) policy. The technique of analyzing securities is not the aim. But very useful things about security analysis are given in this book.

The famous warning of Santayana: “Those who do not remember the past are condemned to repeat it,” is truly applicable to Wall Street. Hence in the book historical patterns of financial markets are described by Graham. He says one should be forearmed with an adequate knowledge of how the various types of bonds and stocks have actually behaved under varying conditions-some of which, at least, one is likely to meet again in one’s own experience.

Graham emphasized that this is not a “how to make a million” book. There are no sure and easy paths to riches in Wall Street or anywhere else.

Defensive (Passive) and Enterprising Investors – A Distinction

The defensive (or passive investor) will place his chief emphasis on the avoidance of serious mistakes or losses. His second aim will be freedom from effort, annoyance, and the need for making frequent decisions. According to Graham, majority of the population falls into this category. It is logical also. Most of people in this world are consumers of many products. But a very small minority does business in any product. Securities are similar to the products that we consume. Any body with savings can acquire them. Only few with adequate knowledge, training and flair for the business complexities involved can do business in them.

The determining trait of the enterprising (or active, or aggressive) investor is his willingness to devote time and care to the selection of securities that are both sound and more attractive than the average. Over many decades an enterprising investor of this sort could expect a worthwhile reward for his extra skill and effort, in the form of a better average return than that realized by the passive investor. But the opportunities for this type of investment may not be present on all the days. The investor has to scan the market and the fundamentals periodically to find out suitable investment opportunities and has to acquire such securities in competition with investors/analysts who are also awaiting such opportunities. Hence in theory, enterprising investment is possible, but in practice it is a difficult endeavor. Graham says so very strongly.

Investing based on future physical growth opportunities is not an easy activity.
1. Obvious prospects for physical growth in a business do not translate into obvious profits for investors.
2. The experts do not have dependable ways of selecting and concentrating on the most promising companies in the most promising industries.

Graham says that he did not follow growth-prospects approach in his financial career as fund manager, and cannot offer either specific counsel or much encouragement to those who may wish to try it.

While earnings valuation is the mainstay of Graham’s approach, he suggests as one of the chief requirements that readers limit themselves to issues selling not far above their tangible-asset value. Otherwise, the investment is at the mercy of the speculative elements of the stock market.

The art of investment has one particular characteristic that is not generally appreciated. A creditable, if unspectacular, result can be achieved by the lay investor with a minimum of effort and capability; but to improve upon this easily attainable standard requires much application and more than a trace of wisdom.

Since anyone-by just buying and holding a representative list-can equal the performance of the market averages, it would seem a comparatively simple matter to “beat the averages”; but as a matter of fact the proportion of smart people who try this and fail is surprisingly large. Even a majority of the investment funds, with all their experienced personnel, have not performed so well over the years as has the general market. This is one more warning to persons who want to try enterprising investment approach.

According to Graham, the record of the published stock-market predictions of the brokerage houses is below average, for there is strong evidence that their calculated forecasts have been somewhat less reliable than the simple tossing of a coin. Benjamin Graham wants the broking firms to change their research methods. We have to remember that Graham is the developer of the subject with the title “Security Analysis” and hence he has all the credentials to recommend changes to the practices of broking firms.

A strong-minded (enterprising) approach to investment, firmly based on the margin-of-safety principle, can yield handsome rewards. But a decision to try for these emoluments rather than for the assured fruits of defensive investment should not be made without much self-examination. It is interesting to notice that Graham used the word emoluments to the return in enterprising investment. This actually refers to the excess return over the return available to defensive investors. Hence the enterprising investor is earning his emoluments for the extra labour that he is putting in. But the warning is clear. It is a high-risk activity. Many who tried have not got the anticipated emoluments.
The chapter wise points will be covered in the future posts.

Saturday, September 30, 2006


An interview with Gary Hamel was published in the Corporate Dossier of September 15 2006. I liked the following statement of Gary Hamel regarding democratization of creativity.

"Now, technology is democratising creativity. It's emancipating human imagination,.... I would argue that Apple, Adobe with photoshop and a blogger which makes the blogging software, these companies have done more to spur human creativity than most organisations."

I agree with the above statement as the facilities of internet and related applications like blogger have made a difference in my intellectual pursuits in both inward and outward communication. The facility for outward communication makes you motivated to do more. The facility for inward communication facilitates your learning and stimulates the brain to add on to the others ideas and output.


Monday, September 25, 2006

Ideas of Graham and Dodd - Part VII (Last Part)




Page 684

Since we have emphasized that analysis will lead to a positive conclusion only in the exceptional case, it follows that many securities must be examined before one is found that has real possibilities for the analyst. By what practical means does he proceed to make his discoveries?

Page 685

A quick glance at a hundred of such reports may reveal between five and ten that look interesting enough from the earnings or current-asset standpoint to warrant more intensive study.

Page 691

Yet judging from observations made over a number of years, it would seem that investment in apparently undervalued common stocks can be carried on with a very fair degree of over-all success, provided average alertness and good judgment are used in passing on the future-prospect question- and provided also that commitments are avoided at times when the general market is statistically much too high.

Page 692

Market Behavior of Standard and Nonstandard Issues

Standard or leading issues almost always respond rapidly to changes in their reported profits-so much so that they tend regularly to exaggerate marketwise the significance of year-to-year fluctuations in earnings.

The action of less familiar issues depends largely upon what attitude is taken towards them by professional market operators. If interest is lacking, the price may lag far behind the statistical showing. If interest is attracted to the issue, either manipulatively or more legitimately, the opposite result can readily be attained, and the price will respond in extreme fashion to changes in the company’s exhibit.

Page 694

Market exaggerations Due to Factors Other than Changes in Earnings

The inveterate tendency of the stock market to exaggerate extends to factors other than changes in earnings. Overemphasis is laid upon such matters as dividend changes, stock split-ups, mergers and segregations.

An increase in the cash dividend is a favorable development, but it is absurd to add $20 to the price of a stock just because the dividend rate is advanced from $5 to $6 annually.

The excited responses often made to stock dividends are even more illogical, since they are in essence nothing more than pieces of paper. The same is true of split-ups, which create more share but give the stockholder nothing he did not have before-except the minor advantage of a possibly broader market due to the lower price level.

Page 695

Wall Street becomes easily enthusiastic over mergers and just as ebullient over segregations, which are the exact opposite.

The exaggerated response made by the stock market to developments that seem relatively unimportant in themselves is readily explained in terms of the psychology of the speculator. He want “action,” first of all; and he is willing to contribute to this action ie he can be given any pretext for bullish excitement.

The tendency of Wall Street to go to extremes is illustrated in the opposite direction by its tremendous dislike of litigation.

Page 707

…the analyst should not urge a security exchange unless either (1) the issue to be bought is attractive, regarded by itself, or (2) there is a definite contractual relationship between the two issues in question.

Page 713

Market Analysis and Security Analysis

Forecasting security prices is not properly a part of security analysis.

However, the two activities are generally thought to be closely allied, and they are frequently carried on by the same individuals and organizations.

Endeavors to predict the course of prices have a variety of objectives and a still greater variety of techniques.

If as many believe, one can dependably foretell the movements of stock prices without any reference to the underlying values, then it would be sensible to confine security analysis to the selection of fixed-value investments only.

Many other people believe that the best results can be obtained by an analysis of the market position of a stock in conjunction with an analysis of its intrinsic value. If this is so, the securities analyst who ventures outside the fixed-value field must qualify as a market analyst as well and be prepared to view each situation from both standpoints at the same time.

Page 714

(Graham and Dodd recognized the existing practice of market analysis in a separate chapter and offered their views on various methods of market analysis in use at that time [around 1940]).

Two Kinds of Market Analysis

A distinction may be made between two kinds of market analysis. The first finds the materials for its predictions exclusively in the past action of the stock market. The second considers all sorts of economic factors, e.g., business conditions, general and specific; money rates; the political outlook.

Those who devote themselves primarily to a study of these price movements are know as “chartists,” and their procedure is often called “chart reading.”

Page 715

It must be realized that the vogue of such “technical study” has increased immensely during the past fifteen years.

Such consideration, we believe should lead to the following conclusions:

1. Chart reading cannot possible be science.
2. It has not proved itself in the past to be a dependable method of making profits in the stock market.
3. Its theoretical basis rests upon faulty logic or else upon mere assertion.
4. Its vogue is due to certain advantages it possesses over haphazard speculation, but these advantages tend to diminish as the number of chart students increases.

Page 716

The past earnings of a company supply a useful indication of its future earnings-useful, but not infallible. Security analysis and market analysis are alike, therefore, in the fact that they deal with data that are not conclusive as to the future. The difference, as we shall point out, is that the security analyst can protect himself by a margin of safety that is denied to the market analyst.

Page 718

The Second type of Mechanical Forecasting

As far as the general market is concerned, the usual procedure is to construct indices representing various economic factors, e.g., money rates, car loadings, steel production, and to deduce impending changes in the market from an observation of a recent change in these indices.

Page 719

Broadly speaking, therefore, the endeavor to forecast security-price changes by reference to mechanical indices is open to the same objections as the methods of the chart readers. They are not truly scientific, because there is no convincing reasoning to support them and because, furthermore, really scientific i.e., entirely dependable) forecasting in the economic field is logical impossibility.

Page 721

Prophesies based on Near-term Prospects

A good part of the analysis and advice supplied in the financial district rests upon the ner-term business prospects of the company considered. It is assumed that, if the outlook favors increased earnings, the issue should be bought in the expectation of a higher price when the larger profits are actually reported. In this reasoning, security analysis and market analysis are made to coincide.

If markets generally reflected only this year’s earnings, then a good estimate of next year’s results would be of inestimable value. But the premise is not correct.

(over the period 1902-1927), it is difficult to establish any definite correlation between fluctuations in earnings and fluctuations in market quotations (of United States Steel Corporation common).

Page 722
We are skeptical of the ability of the analyst to forecast with a fair degree of success the market behavior of individual issues over the near-term future-whether he base his predictions upon the technical position of the market or upon the general outlook for business or upon the specific outlook for the individual companies.

More satisfactory results are to be obtained, in our opinion, by confining the positive conclusions of the analyst to the following fields of endeavor (in case of equity shares):

The discovery of common stocks, or speculative senior issues, that appear to be selling at far less than their intrinsic value.
The determination of definite price discrepancies existing between related securities, which situations may justify making exchanges or initiating hedging or arbitrage operations.

Comments by KVSSNRAO

The second edition of Graham and Dodd published in 1940 is a 851 page book. The important ideas related to equity investment are presented in seven parts by me. I hope the readers of these seven parts will take up reading the full book of Graham and Dodd to understand the methodology of analysis advocated by them for investors and analysts. They made a brief comment that their analytical method can be used by small investors also but they advised the investor to consult a professional analyst for approval of his analysis. But as they repeated mentioned (it was there in one of the parts), an investor has to study a number of securities to find the one that satisfies their conditions. It is difficult for the investors to do analysis themselves. It will be more practical, if investors are given the responsibility to study the equity research report prepared by the analysts and agree with its analysis based investor’s knowledge of the analytical method. The simplicity of Graham and Dodd’s security analysis would be of immense help in this regard. Graham-Rao method is one of the attempts in this context.

Sunday, September 24, 2006

Ideas of Graham and Dodd Part VI (Current Asset and Cash Asset Values)


Page 537

Allowances for Changes in Capitalization

In dealing with the past record of earnings, when given on a per-share basis, it is elementary that the figures must be adjusted to reflect any important changes in the capitalization which have taken place during the period. In the simplest case these will involve a change only in the number of shares of common stock due to stock dividends, split-ups, etc. All that is necessary then is to restate the capitalization throughout the period on the basis of the current number of shares.

Page 540

The intrinsic value of a common stock preceded by convertible securities, or subject to dilution through the exercise of stock options or through participating privileges enjoyed by other security holders, cannot reasonably be appraised at a higher figure than would be justified if all such privileges were exercised in full.

Page 543

Principle of Optimum Capitalization Structure

The optimum capitalization structure for any enterprise includes senior securities to the extent that they may safely be issued and bought for investment.

Part VI of the Book


Page 567

By way of introduction to this section of our work, let us list five types of information and guidance that the investor may derive from a study of the balance sheet:

It shows how much capital is invested in the business.
It reveals the ease or stringency of the company’s financial condition, i.e., the working-capital position.
It contains the details of the capitalization structure.
It provides an important check upon the validity of the reported earnings.
It supplies the basis for analyzing the sources of income.

The book value per share of a common stock is found by adding up all the tangible assets, subtracting all liabilities and stock issues ahead of the common and then dividing by the number of shares.

In addition to the well-known concept of book value, we wish to suggest two others of similar character, viz., current-asset value and cash-asset value.

The current-asset value of a stock consists of the current assets alone, minus all liabilities and claims ahead of the issue. It excludes not only the intangible assets but the fixed and miscellaneous assets as well.

The cash-asset value of a stock consists of the cash assets alone, minus all liabilities and claims ahead of the issue.

Page 576

In any particular case the message that the book value conveys may well prove to be inconsequential and unworthy of attention. But this testimony should be examined before it is rejected. Let the stock buyer, if he lays any claim to intelligence , at least be able to tell himself, first, what value he is actually setting on the business and, second, what he is actually getting for his money in terms of tangible resources.

There are indeed certain presumptions in favor of purchases made far below asset value and against those made at a high premium above it.

A business that sells at a premium does so because it earns a large return upon its capital; this large return attracts competition, and, generally speaking, it is not likely to continue indefinitely.

Page 577
It may be pointed out that under modern conditions the so-called ‘intangibles,” e.g., good-will or even a highly efficient organization, are every whit as real from a dollars-and-cents standpoint as are buildings and machinery. Earnings based on these intangibles may be even less vulnerable to competition than those which require only a cash investment in productive facilities.

We do not think, therefore, that any rules may reasonably be laid down on the subject of book value in relation to market price, except the strong recommendation already made that the purchase know what he is doing on this score and be satisfied in his own mind that he is acting sensibly.

Page 578

The current-asset value is generally a rough index of the liquidating value.

Page 581

Our computations indicate that over 40% of all the industrial companies listed on the New York Stock Exchange were quoted at some time in 1932 at less than their net current assets. A considerable number actually sold for less than their cash-asset value.

In the recession of 1937-38 this situation was repeated on a smaller scale. Available data indicate that 20.5% of the industrial companies listed on the New York Stock Exchange sold in early 1938 at less than their net-current-asset value. (At the close of 1938, when the general price level was by no means abnormally low, a total of 54 companies out of 648 industrials studied sold for less than their net current assets.)

Page 583

Stocks selling below liquidation value are in many cases too cheap and so offer an attractive medium for purchase. We have thus a profitable field here for the technique of security analysis. But in many cases also the fact that an issue sells below liquidating value is a signal that mistaken policies are being followed and that therefore the management should take corrective action-if not voluntarily, then under pressure from the stockholders.

Page 587

There is scarcely any doubt that that common stocks selling well below liquidating value represent on the whole a class of undervalued securities. They have declined in price more severely than the actual conditions justify. This must mean that on the whole these stocks afford profitable opportunities for purchase. Nevertheless, the securities analyst should exercise as much discrimination as possible in the choice of issues falling within this category. He will lean toward those for which he sees a fairly imminent prospect of some one of the favorable developments listed above (Page 583). Or else he will be partial to such as reveal other attractive statistical features besides their liquid-asset position, e.g., satisfactory current earnings and dividends or a high average earning power in the past. The analyst will avoid issues that have been losing their current assets at a rapid rate and show no definite signs of ceasing to do so.

Page 583

The objection to buying these issues (*issues selling below current asset value - liquidating value) lies in the probability, or at least the possibility, that earnings will decline or losses continue and that the resources will be dissipated and the intrinsic value ultimately become less than the price paid. It may not be denied that this does actually happen in individual cases. On the other hand, there is a much wider range of potential developments which may result in establishing a higher market price. These include the following:

The creation of an earning power commensurate with the company’s assets. This may result from:
1. General improvement in the industry.
2. Favorable change in the company’s operating policies, with or without a change in management. These changes include more efficient methods, new products, abandonment of unprofitable lines, etc.
3. A sale or merger, because some other concern is able to utilize the resources to better advantage and hence can pay at least liquidating value for the assets.
4. Complete or partial liquidation.

Page 589

Common stocks that (1) are selling below their liquid-asset value, (2) are apparently in no danger of dissipating these assets, and (3) have formerly shown a large earning power on the market price, may be said truthfully to constitute a class of investment bargains. They are indubitably worth considerably more than they are selling for, and there is reasonably good chance that this greater worth will sooner or later reflect itself in the market price. At heir low price these bargain stocks actually enjoy a high degree of safety, meaning by safety a relatively small risk of loss of principal.

Saturday, September 23, 2006

Important Points form Graham and Dodd - Part V


Page 516

Intuition Not a Part of the Analyst’s Stock in Trade.-In the absence of indications to the contrary we accept the past record as a basis for judging the future. But analyst must be on the lookout for any such indications to the contrary.

The ability to see what is coming is of inestimable value, but it cannot be expected to be part of the analyst’s stock in trade.

He can be asked to show only that moderate degree of foresight which springs from logic and form experience intelligently pondered.

Analysis of the Future Should be Penetrating Rather than Prophetic.-Analytical reasoning with regard to the future is of a somewhat different character, being penetrating rather than prophetic.

Page 530

In previous chapters various references have been made to Wall Street’s ideas on the relation of earnings to values. A given common stock is generally considered to be worth a certain number of times its current earnings. This number of times, or multiplier, depends part on the prevailing psychology and partly on the nature and record of the enterprise.

Page 531

Exact Appraisal Impossible.-Security analysis cannot presume to lay down general rules as to the “proper value” of any given common stock. Parctically speaking, there is no such thing. The bases of value are too shifting to admit of any formulation that could claim to be even reasonably accurate.

But the stock market itself has no time for such scientific scruples. It must make its value first and find its reasons afterwards.

Hence the prices of common stocks are not carefully thought out computations but the resultants of a welter of human reactions. The stock market is a voting machine rather than a weighing machine. It responds to factual data not directly but only as they affect the decisions of buyers and sellers.

Limited Functions of the Analyst in Field of Appraisal of Stock Prices.-Confronted by this mixture of changing facts and fluctuating human fancies, the securities analyst is clearly incapable of passing judgment on common-stock prices generally.

There are, however, some concrete, if limited, functions that he may carry on in this field, of which the following are representative:

He may set up a basis for conservative or investment valuation of common stocks, as distinguished from speculative valuations.
He may point out the significance of: (a) the capitalization structure; and (b) the source of income, as bearing upon the valuation of a given stock issue.
He may find unusual elements in the balance sheet which affect the implications of the earnings picture.

Page 531

A Suggested Basis of Maximum Appraisal for Investment.- …the profits of the most recent year, taken singly, might be accepted as the gage of future earnings, if (1) general business conditions in that year were not exceptionally good, (2) the company has shown an upward trend earnings for some years past and (3) the investor’s study of the industry gives him confidence in its continued growth.

In very exceptional case, the investor may be justified in counting on higher earnings in the future than at any time in the past. This might follow from developments involving a patent or the discovery of new ore in a mine or some similar specific and significant occurrence.

But in most instances he will derive the investment value of a common stock from the average earnings of a period between five and ten years.

This does not mean that all common stocks with the same average earnings should have the same value. The common-stock investor (i.e., the conservative buyer) will properly accord a more liberal valuation to those issues which have current earnings above the average or which may reasonably be considered to possess better than average prospects or an inherently stable earning power.

But it is the essence of our viewpoint that some moderate upper limit in every case be placed on the multiplier in order to stay within the bounds of conservative valuation. We would suggest that about 20 times average earnings is as high a price as can be paid in an investment purchase of a common stock.

Page 533

We must emphasize also that a reasonable ratio market price to average earnings is not the only requisite for a common-stock investment. It is a necessary but not a sufficient condition. The company must be satisfactory also in its financial set-up and management, and not unsatisfactory in its prospects.

Thursday, September 21, 2006

Important Points from Graham and Dodd - Part IV


Page 368

Selection based on Margin-of-Safety principle – If the analyst is convinced that a stock is worth more than he pays for it, and he is reasonably optimistic as to the company’s future, he would regard the issue as a suitable component of a group investment in common stocks.

Page 372

A natural classification of the elements entering into the valuation of a common stock would be under the three headings:

The dividend rate and record
Income account factors (earning power)
Balance sheet factors (asset value)

Page 402

…the Wall-Street method of appraising common stocks has been simplified to the following standard formula:

Find out what the stock is earning. (This usually means the earnings pre share as shown in the last report.)
Multiply these per-share earnings by some sutable ‘coefficient of quality” which will reflect:

the dividend rate and record
the standing of the company-its size, reputation, financial position, and prospects.
The type of business 9e.g., a cigarette manufacturer will sell ast a higher multiple of earnings than a cigar company).
The timer of the general market. (Bull-market multipliers are larger than those used in bear markets.)

The foregoing may be summarized in the following formula:
Price = current earnings per share * quality coefficient1
(Foot note 1 on page 403 Where there are no earnings or where the amount is recognized as being far below “normal,” Wall Street is reluctantly compelled to apply what is at bottom a more rational method of valuation, i.e., one ascribing greater weight to average earning power, working capital, etc. But this is the exceptional procedure.)

The result of this procedure is that in most cases the “earnings per share” have attained a weight in determining value that is equivalent to the weight of all the factors taken together. The truth of this is evident if it be remembered that the quality coefficient is itself largely determined by the earnings trend, which in turn is taken from the stated earnings over a period.


The past exhibit remains a sufficiently dependable guide, in a sufficient proportion of cases, to warrant its continued use as the chief point of departure in the valuation and selection of securities.

The concept of earning power has a definite and important place in investment theory. It combines a statement of actual earnings, shown over a period of years, with a reasonable expectation that these will be approximated in the future, unless extraordinary conditions supervene. The record must cover a number of years, first because a continued or repeated performance is always more impressive than a single occurrence and secondly because the average of a fairly long period will tend to absorb and equalize the distorting influences of the business cycle.

A distinction must be drawn, however, between an average that is the mere arithmetical resultant of an assortment of disconnected figures and an average that is “normal” or “modal,” in the sense that the annual results show a definite tendency to approximate the average.

Page 508

In studying earnings records an important principle of security analysis must be borne in mind:

Quantitative data are useful only to the extent that they are supported by a qualitative survey of the enterprise.

In order for a company’s business to be regarded as reasonably stable, it does not suffice that the past record should show stability. The nature of the undertaking, considered apart from any figures, must be such as ot indicate an inherent permanence of earning power.

Page 510

The market level of common stocks is governed more by their current earnings than by their long-term average. This fact accounts n good part for the wide fluctuations in common-stock prices, which largely (though by no means invariably) parallel the changes in their earnings between good years and bad.

(The above statement supports my contention in my classes that Security Analysis has at least four different categories of analysis: Analysis of Value; Analysis of Market Price, Analysis of Trend, and Analysis of Market Excess. Graham and Dodd’s book focuses on Analysis of Value either by absolute number or by a judgment that states the current value of the security is far above the current market price.)

Page 511

The analyst* cannot follow the stock market in its indiscriminate tendency to value issues on the basis of current earnings. He may on occasion attach predominant weight to the recent figures rather than to the average, but only when persuasive evidence is at hand pointing to the continuance of these current results.

* (Graham and Dodd mean analyst of value)

Page 512

…it must be remembered that the automatic or normal economic forces militate gainst the indefinite continuance of a given trend. Competition, regulation, the law of diminishing returns, etc., are powerful foes to unlimited expansion, and in smaller degree opposite elements may operate to check a continued decline. Hence instead of taking the maintenance of a favorable trend for granted-as the stock market is wont to do-the analyst must approach the matter with caution, seeking to determine the causes of the superior showing and to weigh the specific elements of strength in the company’s position against the general obstacle in the way of continued growth.

If such a qualitative study leads to a favorable verdict-as frequently it should-the analyst’s philosophy must still impel him to base his investment valuation on an assumed earning power no large than the company has already achieved in a period of normal business. This is suggested because, in our opinion, investment values can be related only to demonstrated performance; so that neither expected increases nor even past results under conditions of abnormal business activity may be taken as a basis.

(According to Graham and Dodd, an average for seven to ten years is the preferred way of calculating the earning power. But as they state in the above paragraph, the analyst make take an average of a shorter period, or a the current earnings figure or earnings figure of a more representative year provided he has strong reasons to demonstrate that the trend will continue)

…this assumed earning power may properly be capitalized more liberally when the prospects appear excellent than in the ordinary case, but we shall also suggest that the maximum multiplier be held to a conservative figure (say, 20, under the conditions of 1940) if the valuation reached is to be kept within strictly investment limits.

(The above condition was incorporated in the Graham-Rao Method of Analyzing Shares for Buy and Hold Investment.)

The divergence in method between the stock market and the analyst-as we define his viewpoint-would mean in general that the price levels ruling for the so-called “good stocks” under normal market conditions are likely to appear overgenerous to the conservative student. This does not mean that the analyst is convinced that the market valuation is wrong but rather that he is not convinced that is valuation is right. He would call a substantial part of the price a “speculative component,” in the sense that it is paid not for demonstrated but for expected results.

Attitude of Analyst Where Trend is Downward.- … Here again a qualitative study of the company’s situation and prospects is essential to forming an opinion whether at some price, relatively low, of course, the issue may not be a bargain, despite its declining earnings trend.

6.45 a.m.

Tuesday, September 19, 2006

Graham and Dodd 2nd Ed. Part III

The following ideas were converted by Graham into analytical method for defensive investors in his book 'Intelligent Investor.' I modified some of the criteria by introducing explicit growth criterion and integrating a current analytical idea of accepting PEG ratio of one as attactive for investment. That's how Graham-Rao method of Analysis for Buy and Hold Investment took shape.

Page 348

… the prewar relationship between analysis and investment on the one hand and price changes and speculation on the other may be set forth as follows: Investment in common stocks was confined to those showing stable dividends and fairly stable earnings; and such issues in turn were expected to maintain a fairly stable market level.

Page 349

The function of analysis was primarily to search for elements of weakness in the picture. If the earnings were not properly stated; if the balance sheet revealed a poor current position, or the funded debt was growing too rapidly; if the physical plant was not properly maintained; if dangerous new competition was threatening, of it the company was losing ground in the industry; if the management was deteriorating or was likely to change for the worse; if there was reason to fear for the future of the industry as a whole-any of these defects or some other one might be sufficient to condemn the issue form the standpoint of the cautious investor.

On the positive side, analysis was concerned with finding those issues which met all the requirements of investment and in addition offered the best chance of future enhancement.

To a lesser extent, the analyst sought to look into the future and to select the industries or the individual companies that were likely to show the most rapid growth.

Narayana Rao

Monday, September 18, 2006

Ideas, Opinions and Thoughts from Graham and Dodd - part II

From Graham and Dodd, Second Edition

Page 57

Investment or investing, … is “a word of many meanings.” Of these three will concern us. The first meaning, or set of meanings, relates to putting or having money in business. …
It accepts rather than rejects element of risk – the ordinary business investment is said to be made “at the risk of business.”
The second set of uses applies the term in a similar manner to the field of finance. In this sense all securities are “investments.” We have investment dealers or brokers, investment companies or trusts, investment lists. Here, again, no real distinction is made between investment and other types of financial operations such as speculation. It is a convenient omnibus word, with perhaps an admixture of euphemism - i.e., a desire to lend a certain respectability to financial dealing of miscellaneous character.

Alongside of these two indiscriminate uses of the term “investment” has always been a third and more limited connotation-that of investment as opposed to speculation.

Page 62 & 63

A Proposed Definition of Investment

An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculation.

The phrases thorough analysis, promises safety and satisfactory return are all chargeable with indefiniteness, but the important point is that their meaning is clear enough to prevent serious misunderstanding.

By thorough analysis we mean, of course, the study of the facts in the light of established standards of safety and value.

The safety sought in investment is not absolute or complete; the word means, rather protection against loss under all normal or reasonably expected conditions or variations. A safe bond for example, is one which could suffer default only under exceptional and highly improbable circumstances. Similarly, a safe stock is one which holds every prospect of being worth the price paid except under quite unlikely contingencies. Where study and experience indicate that an appreciable chance of loss must be recognized and allowed for, we have a speculative situation.

Page 64

“Satisfactory” is a subjective term; it covers any rate or amount of return, however low, which the investor is willing to accept, provided he acts with reasonable intelligence.

It may be helpful to elaborate our definition from a somewhat different angle, which will stress the fact that investment must always consider the price as well as the quality of the security.

…in our opinion the great majority of common stocks of strong companies must be considered speculative during most of the time, simply because their price is too high to warrant safety of principal in any intelligible sense of the phrase.

… we shall embody our principle in the following additional criterion of investment:

An investment operation is one that can be justified on both qualitative and quantitative grounds.

Page 66

Both investment and speculation must meet the test of the future; they are subject to its vicissitudes and are judged by its verdict.

For investment, the future is essentially something to be guarded against rather than to be profited from. If the future brings improvement, so much the better; but investment as such cannot be founded in any important degree upon expectation of improvement. Speculation, on the other hand, may always properly-and often soundly-derive its basis and its justification form prospective developments that differ from past performance.

Types of investments

It might be useful if some descriptive adjective were regularly employed, when care is needed, to designate the particular meaning intended. Let us tentatively suggest the following:

1 Business investment – Referring to money put or held in a business
2 Financial investment or investment generally – Referring to securities generally
3 Sheltered investment – Referring to securities regarded as subject to small risk by reason of their prior claim on earnings or because they rest upon an adequate taxing power.
4 Analyst’s investment – Referring to operations that, upon thorough study, promise safety of principal and an adequate return.

Unless we specify otherwise, we shall employ the word “investment,” and its relatives, in the sense of “analyst’s investment,” as developed in this chapter.

Page 68

It is important to recognize that such value (intrinsic value) is by no means limited to “value for investment”- i.e., to the investment component of total value-but may properly include a substantial component of speculative value, provided that such speculative value is intelligently arrived at. Hence the market price maybe said to exceed intrinsic value only when the market price is clearly the reflection of unintelligent speculation.

Generally speaking, it is the function of the stock market, and not of the analyst, to appraise the speculative factors in a given common-stock picture. To this important extent the market, not the analyst, determines intrinsic value. The range of such appraisal may be very wide, as illustrated by our former suggestion that the intrinsic value of J.I. Case common in 1933 might conceivably have been as high as 130 or as low as 30. At any point between these broad limits it would have been necessary to accept the market’s verdict-changeable as it was from day to day-as representing the best available determination of the intrinsic value of this volatile issue.

Sunday, September 17, 2006

Interesting opinions, thoughts and Ideas of Graham and Dodd

I have an invitation to present the ideas and methods of Benjamin Graham to associates of two broking companies in Mumbai. To do this in a better manner, I started study of the 2nd edition of Security Analysis by Graham and Dodd. I thought it would be a good idea to post the ideas that I feel are important in this round of my study in this blog. I request the readers/viewers to present their reactions to these ideas.

From Security Analysis, Graham and Dodd, Second Edition, McGraw-Hill Book Company

Page 13

The numerous issues selling below net current asset value, even in normal markets, are a powerful indication that Wall Street’s favoritism has been overdone.

Page 15

Traditionally the investor has been the man with patience and the courage of his convictions who would buy when the harried or disheartened speculator was selling. If the investor is now to hold back until the market itself encourages him, how will be distinguish himself from the speculator, and wherein will he deserve any better than the ordinary speculator’s fate?

Page 16

Our search for definite investment standards for the common-stock buyer has been more productive of warnings than of concrete suggestions. We have been led to the old principle that the investor should wait for periods of depressed business and market levels to buy representative common stocks, since he is unlikely to be able to acquire them at other times except at prices that he future may cause him to regret. On the other hand, the thousands of so-called secondary companies should offer at least a moderate number of true investment opportunities under all conditions, except perhaps in the heyday of a bull market. This wide but quite unpopular field may present the more logical challenge to the interest of the bona fide investor and to the talents of the securities analyst.

Page 20

We must recognize, however that intrinsic value is an elusive concept. In general terms it is understood to be that value which is justified by the facts, e.g., the assets, earnings dividends, definite prospects, as distinct, let us say, from market quotations established by artificial manipulation or distorted by psychological excesses.

Page 21

Sometime ago intrinsic value (in the case of common stocks) was thought to be about the same thing as “book value,” i.e., it was equal to the net assets of the business, fairly priced. This view of intrinsic value was quite definite, but it proved almost worthless as a practical matter because neither the average earnings nor the average market price evinced any tendency to be governed by the book value.

Hence this idea was superseded by a newer view, viz., that the intrinsic value of a business was determined by its earning power.

This means that the concept of “earning power,” expressed as a definite figure, and the derived concept of intrinsic value, as something equally definite and ascertainable, cannot be safely accepted as a general premise of security analysis.

Page 22

Let us try to formulate a statement of the role of intrinsic value in the work of the analyst
which will reconcile the rather conflicting implications of our examples. The essential point is that security analysis does not seek to determine exactly what is the intrinsic value of a given security. It needs only to establish either that the value is adequate-e.g., to protect a bond or to justify a stock purchase-or else that the value is considerably higher or considerably lower than the market price. For such purposes an indefinite and approximate measure of the intrinsic value may be sufficient. To use a homely simile, it is quite possible to decide by inspection that a woman is old enough to vote without knowing her age or that a man is heavier than he should be without knowing his exact weight.

Page 29
In anticipation of amore detailed inquiry in a later chapter, we have assumed throughout this chapter that investment implies expected safety and speculation connotes acknowledged risk.

Page 37

The analyst must pay respectful attention to the judgment of the market place and to the enterprises which it strongly favors, but he must retain an independent and critical viewpoint. Nor he should he hesitate to condemn the popular and espouse the unpopular when reasons sufficiently weighty and convincing are at hand.

Page 43

It follows that the qualitative factor in which the analyst should properly be most interested is that of inherent stability.

But in our opinion stability is really a qualitative trait, because it derives in the first instance from the character of the business and not from its statistical record.

Page 44

To sum up this discussion of qualitative and quantitative factors, we may express the dictum that the analyst’s conclusions must always rest upon the figures and upon established tests and standards. These figures alone are not sufficient; they may be completely vitiated by qualitative considerations of an opposite import. A security may make a satisfactory statistical showing, but doubt as to he future or distrust of the management may properly impel its rejection. Again, the analyst is likely to attach prime importance to the qualitative element of stability, because its presence means that conclusions based on past results are not so likely to be upset by unexpected developments. It is also true that he will be far more confident in his selection of an issue if he can buttress an adequate quantitative exhibit with unusually favorable qualitative factors.

But whenever the commitment depends to a substantial degree upon these qualitative factors-whenever, that is, the price is considerably higher than the figures alone would justify-then the analytical basis of approval is lacking. In the mathematical phrase, a satisfactory statistical exhibit is a necessary though by no means a sufficient condition for a favorable decision by the analyst.
Narayana Rao
Sunday, 17 Sep 2006, 3.45 p.m.

Monday, September 11, 2006


Graham-Rao Method

The analytical criteria of Graham-Rao Method contain quality criteria and valuation criteria.

The quality criteria are:

1. The company must have an adequate size (Rs. 100 crore sales may be taken as adequate size for Indian companies).
2. The current assets should be at least twice that of current liabilities.
3. The total debt-equity ratio should not be greater than 1:1.
4. The company should have paid dividends for the last 10 years.
5. The company must have earned profits for the last 10 years.
6. There should be a growth in earnings per share (EPS) of 10 per cent per annum over the last seven years.

The two valuation criteria are:
1. The current price should not exceed 20 times the average EPS in the last seven years for companies with past seven-year growth higher than 20 per cent. For companies with past growth rate between 10 and 20 percent per annum, the multiplier has to be the growth rate itself. In other words fair value is the average EPS of the last seven years multiplied by the P/E ratio specified as above.
2. The current price should also not be more than 1.5 times the book value last reported.

The method requires 10-year data to analyse stocks. But the method is unambiguous and uses a limited number of ratios. Investors may complain about the 10-year data requirement; but they have to keep in mind that their hard-earned money has to be protected by committing it to companies with a good past record. Graham actually recommended dividend payment for 20 years.

Narayana Rao
12th September 2006

MY Photo Five years Back

Wednesday, September 06, 2006

Application of Graham Rao Analysis in January 2003 to "A" Group Stocks of BSE

S.No. Company, 7 year Avg. EPS, 7 year growth rate, fair value, Price on 29/1/03
1 ABBOTT(I) 25.36 29.5 507.26 303.25
2 ADANIEXPO 31.92 18 574.56 135.55
3 AUROPHARMA 21.77 50 435.32 240.8
4 BEL 11.23 50 224.68 188.15
5 BHEL 19.96 11 219.60 188.6
6 BPCL 20.67 15.5 320.43 194.4
7 CONCOR 22.69 35 453.80 233.8
8 EMERCK 14.54 20 290.80 241.6
9 GAIL 10.58 18 190.48 69.9
10 GMDC 19.53 15 292.95 86.1
11 GSK CONSUMER 17.11 25.2 342.20 269
12 GTL 31.88 20 637.68 76.3
13 HCL-INSYS 12.24 39 244.80 90.8
14 HIND ZINC 1.82 19.5 35.49 17.9
15 HINDALC0 72.92 10 729.20 599.35
16 IBP 25.92 27.8 518.40 225.2
17 ICI 13.68 15 205.20 119.95
18 IOC 26.41 16 422.56 244.3
19 JB CHEMICALS 16.13 13.8 222.53 178.35
20 KOCHI REF. 11.94 12.9 154.03 45.5
21 LICHSGFIN 12.77 20 255.40 65
22 MOSERBAER 16.95 36 339.00 194.55
23 MRF 146.15 24 2923.00 874.1
24 MTNL 18.12 13 235.56 107.45
25 NEYVELI LIGNITE 2.70 18.8 50.80 25
26 NIIT 25.27 24.5 505.40 133.15
27 NOVARTIS 16.02 19 304.42 267.55
28 ONGC 24.06 18.5 445.11 376.75
29 P&G 24.45 22.9 489.00 394
30 PENTAMEDIA GR. 24.03 13.9 334.02 16.35
31 PIDILITE 13.75 25 274.92 241.55
32 PUNJABTRAC 13.36 36 267.16 144.65
33 ROLTA 8.66 34.5 173.20 70
34 SBI 30.17 17.5 527.94 283.45
35 SONATSOFTW 1.46 38.5 29.22 15.95
36 SSI 18.24 41.5 364.76 84.5
37 TATATEA 16.72 18.5 309.32 160.45
38 VSNL 34.77 23 695.40 90

The above shares were identified as potential buys using Graham-Rao analysis in Januarry 2003. Each row contains 7 year averate EPS, 7 year growth rate in EPS, calculated fair value and market price on 29/1/03. In August 2006, it was found that this portfolio outperformed the BSE sensex. I prepared a working paper on the performance of this portfolio.

Narayana Rao

Thursday, August 31, 2006


September 1, 2006

Benjamin Graham is hailed as the Dean of Wall Street. He is credited with systematising Security Analysis. It so happened that his book on Security Analysis was the first text book that I studied, when I began studying books on this subject. In his other book titled 'Intelligent Investor', he gave two methods one for conservative investors and the other for aggressive investors.

As I began teaching his ideas to employees of broking companies and students, the question of actual application and its utility came up. I developed a method of application in 2003 and applied it to A group shares at that time and came with a list of companies recommended by the method.

I explained the method in my article published in Business Standard in 2003. Readers can access this paper from my website

I compared the performance of the stocks recommended by the method over the period Jan 2003 to August 2006 and found that it outperformed the sensex. I am in the processing of preparing an article on this performance and publish it.

Narayana Rao

Sunday, August 27, 2006

Investor Meet

This is the photo of the investor meet that I have done with students at ICFAI Business School, Mumbai. I am there at the left most position.

Narayana Rao

Marathon Running: A Hobby of Global CEOs

I prepared the article and it was published in the July 2006 issue of Global CEO. I was motivated by the participation of Anil Ambani and Ms.Sulajja Firodia in Mumbai Marathon 2006 to do some review of articles on this topic and comeup with this article. Please send an email to me for the soft copy of the article.

Narayana Rao

Sunday, August 13, 2006

Spectator for Thane Varsha Half Marathon 2006

On July 23 2006, Thane Varsha Half Marathon was held. I was a spectator for this run, and watched the race at around 9 km point. Saw the lead runners and walked along with the participants 4 kms on the route. Today I searched for blogs on this marathon by participants and found two blogs one by Mr.Mihir a resident of Thane and one by Mr.Girish Mallya.

Monday, July 17, 2006

Cannot access blogs

Today I came to know from papers that Indian Government has directed internet service providers to stop access to blog sites including I tried to access my blog but could not. I am trying to post. I have to see whether I can post to my blog.

18th July 2006

Thursday, July 06, 2006

Definition of Industrial Engineering Proposed by Me

“Industrial Engineering is Human Effort Engineering. It is an engineering discipline that deals with the design of human effort in all occupations: agricultural, manufacturing and service. The objectives of Industrial Engineering are optimization of productivity of work-systems and occupational comfort, health, safety and income of persons involved.” - Narayana Rao

According to me Industrial Engineering as profession will survive as long as human beings are on earth or in the universe provided even self employed persons believe in the skills of industrial engineers and invite them to study their work and redesign their work procedure.

I prepared a full paper on the back ground to this proposed definition and persons interested in having the paper can send a mail to me at nrkvss@


Wednesday, June 28, 2006


28 June 2006

I joined National Institute of Industrial Engineering (NITIE), Mumbai as professor on 14th June 2006.

Tuesday, May 09, 2006

Runners Knee

The symptoms of runners knee include pain near the knee cap usually at the medial (inner) portion and below it. Pain is usually also felt after sitting for a long period of time with the knees bent. Running downhill and sometimes even walking down stairs can be followed by pain. This has been called the "movie theatre sign".

Runners Knee is also called Patellofemoral pain syndrome. It is often caused by the kneecap not tracking smoothly in its femoral groove. The symptoms are aggravated when the knee is bent since (with increased vectors of force) increased pressure exists between the joint surface of the knee cap and the articular surface of the femur (thigh bone). This increase in force over-stresses the injured area and leads to pain.

Some of the mechanical conditions that may contribute to this include:

Wide Hips (female runners)
Knock Knees (Genu Valgum)
Subluxating Patella
Patella Alta (high patella)
Small medial pole of patella or corresponding portion of femur
Weak Vastus Medialis
Weak Quadriceps Muscles
Tight Hamstrings or calf muscles
Pronation of the feet

Treatment of Runners Knee

At an early stage running should be decreased to lessen stress to this area and allow healing to begin. It is important to avoid downhill running which stresses the patello-femoral complex.

Exercises performed with the knee bent should be avoided. When the knee is bent the forces under the knee cap are increased.

Vastus Medialis is the muscle that helps stabilize the knee cap medially and prevents it from shifting laterally and tracking improperly at the patello-femoral joint. The Vastus Medialis Oblique (VMO) and Vastus Medialis Longus (VML) have been shown to be considerably weaker than the Vastus Lateralis (VL) in patients with Patellofemoral Pain Syndrome compared to normals (Makhsous et. al. 2004).

Straight leg lifts strengthen the vastus medialis muscles and do not significantly stress the undersurface of the knee cap. They should be done in sets of 10 times on each side. Start with 5 sets of 10 and work your way up to 10 sets of 10. Straight leg lifts are best performed lying on a cushioned but firm surface, with the exercising leg held straight and the non-exercising leg somewhat bent to take pressure off of the back. Lying on a carpet or mat on the floor is a perfect place to perform this exercise.

Tight posterior muscles should be stretched. In many cases tight calf muscles or hamstrings lead to a "functional equinous" and make the foot pronate while running or walking. This pronation is accompanied by an internal rotation of the leg which increases the Q angle and contributes to the lateral subluxation of the knee cap. On occasion a tight iliotibial band may contribute to PFPS.

“...Straight leg lifts strengthen the vastus medialis and do not significantly stress the undersurface of the knee cap.”

If you over-pronate make sure you use shoes that offer more anti-pronation features. Move up a ranking in the amount of stability and pronation control that your shoes offer. If further control of pronation is needed orthotics should be considered. The late George Sheehan, M.D., sports medicine physician and philosopher, was the first to popularize the notion that it was important to look at the foot when runner's knee occurs. It is also important to rule out other knee problems when knee pain occurs in runners and not just lump every pain as "runner's knee".

Some authors have suggested that core muscle strength may play a role in this problem. Suggestions for improving core body strength including gluteal muscles have been made. There is nothing wrong with this suggestion and it may help. Be sure to perform the above exercises first, since they are more specific to the problem being addressed.

Treatment Summary:

Rest or Relative Rest: Run Less
Avoid exercises or activities that require your knees to be bent
Avoid running or walking downhill, downstairs or down inclines
Do posterior muscle stretches (hamstrings and calf muscles)
Do Straight Leg Lifts (Start with 3 sets of 10, work up to 10 sets of 10)
Check Your Feet and Shoes, overpronation often contributes to this problem
Consider More Stable Shoes (with better anti-pronation features)
Orthotics If Needed (OTC or Custom)


KVSSNRAO, 10th May 2006

Stretching to Avoid Injuries in Running

Magic Six, Plus Two

George Sheehan recommended his "magic six" stretches in several of his columns and in his book "Running To Win", Rodale Press,1991. Dr. Pribut recommends a slightly modified version of Dr. Sheehan's Magic Six for runners:

Magic Six, Plus Two
Wall Push-Up: This is basically the calf stretch. My version stretches one leg at a time. Stand with the rear foot approximately two to three feet from the wall. The rear leg should be straight, the front leg is bent and your hands touch the wall. Feet point straight ahead, heels are on the ground. Hold for 10 seconds, switch legs, repeat 10 times.

Hamstring Stretch: Straighten one leg, place it, with the knee locked, on a foot stool. Bend your body and bring your head towards the leg. Hold this position for 10 seconds. Switch sides, repeat 10 times.

Knee Clasp: Lie on a firm surface. A carpeted floor or grass is best. Bring both knees to your chest. Hold for 10 seconds. Repeat 5 times. This stretches the hamstrings and lower back.

Chest Push-Up: Lie on the floor with your abdoman pressed flat on to the floor. Place your hands flat on the floor, beneath your shoulders. Push your chest up with your arms and hold for 10 seconds. Repeat 5 times.

Backward Stretch: While standing straight, place the palms of your hands against the small of your back. Tighten your buttocks and bend backwards. Hold for 10 seconds, relax, repeat 5 times.

Shin Splinter: This is performed to strenthen the shins. Sit on a table with your legs dangling over the side. Place a 3 to 5 pound weight over your toes. Flex your foot at the ankle (bend it up). Hold for 6 seconds, repeat 5 times.

Straight Leg Lifts: This is performed to strengthen the quadriceps. Lying on the floor. Flex one knee to approximately a right angle. Lift the other leg rapidly to between 30 and 60 degrees. Lower and repeat 10 times. Switch legs, repeat 5 times and work up to 10 sets of 10 repetitions.

Bent Leg Sit-Up: This strenthens the abdominals. Dr. Sheehan recommended that the sit up be a gradual one rather than a rapid thrust forward. It should feel as if you are moving forward one vertebrae at a time. Lie on the floor with your knees bend. Come forward to a postion 30 degrees from the floor. Lie back and then repeat 20 times.

Since almost no runner will perform 8 exercises, even if disguised as 6 + 2, I have selected 4 of the above exercises that really should be done and 1 more to do if you have "runner's knee". I call these these:

Hopeful 4, Plus One:

Wall Push-Up: This stretches the achilles and calf muscles one leg at a time. Stand with the rear foot approximately two to three feet from the wall. The rear leg should be straight, the front leg is bent and your hands touch the wall. Feet point straight ahead, heels are on the ground. Hold for 10 seconds, switch legs, repeat 10 times.

Hamstring Stretch: Straighten one leg, place it, with the knee locked, on a foot stool. Bend your body and bring your head towards the leg. Hold this position for 10 seconds. Switch sides, repeat 10 times.

Knee Clasp: Lie on a firm surface. A carpeted floor or grass is best. Bring both knees to your chest. Hold for 10 seconds. Repeat 5 times. This stretches the hamstrings and lower back.

Bent Leg Sit-Up: This strenthens the abdominals. Dr. Sheehan recommended that the sit up be a gradual one rather than a rapid thrust forward. It should feel as if you are moving forward one vertebrae at a time. Lie on the floor with your knees bend. Come forward to a postion 30 degrees from the floor. Lie back and then repeat 20 times.

Straight Leg Lifts: This is performed to strengthen the quadriceps. Lying on the floor. Flex one knee to approximately a right angle. Lift the other leg rapidly to between 30 and 60 degrees. Lower and repeat 10 times. Switch legs, repeat 5 times and work up to 10 sets of 10 repetitions. This is best performed while watching the evening news or "sports extra."


KVSSNRAO, 10th May 2006

Thursday, May 04, 2006

Break in Training

I decided to take a break from runnning and restart from August 2006. In the mean time, I shall focus on strength training.

Thursday, 4th May 2006

Monday, May 01, 2006

Full Marathon Training - Sunday - April 30

I did 8 miles at a pace of 13 minutes per mile. Throught out the day I felt mild discomfort. Even though it was not painful, still it was annoying. On Tuesday I did 6X400 repeats.


Wednesday, April 26, 2006

A Search of Blogs using my surname "Kambhampati"

Today I made a search of blogs using my surname "Kambhampati". The search returned 19 results of which only two blogs are by persons with the same surname.

1. Hi Everybody, my name is Kambampati Anirudh Durga ...
3 Feb 2006 by Anirudh Kambhampati
Hi Everybody, my name is Kambampati Anirudh Durga Sarma. This is my first blog, my daddy created this for me to keep in touch with all of you. Whenever I feel talking to you, I will update this blog. Also I will share my photos & ideas ...

myfirst -

2. Photo Album: Animals
11 Aug 2005
Animals. No photos.

Bharathi -

I have to add that the surname of Vallabhacharya is "Kambhampati."

kvssnrao, Thurday, 27th April 2006

Monday, April 24, 2006

Full Marathon Training - 16 Miles - 23rd April 2006

I completed the training run of 16 miles on sunday 23rd April 2006. I wanted to run at a pace of 14 minutes per mile. But it took much longer time. I started actual running at 6.45 a.m.. I stopped at 11.30 a.m.. Till 9th mile I could run cleanly with 2 walk breaks per mile. From 10th to 13 miles I did 50% running and 50% walking. From 14th mile it was walking only. One can take comfort from Jeff Galloway's comment that stamina improves irrespective of speed. I did some stairs climbing during the run as this time I went to my house after every two miles to have some gatorade. Surprisingly, I did not have any significant pain in the legs at the end of the run. Of course I took leave on Monday and stayed at home for the full day. Galloway says that by slowing down, one can recover faster and avoid injuries during training for long runs.

Today, tuesday, 25th April 2006, I did stairs climbing. I did 12 rounds of 7 stairs alternating between regular climbing and two step climbing. Now I look forward to the next long run. I plan to do 20 miles on 14th May.

Tuesday, April 04, 2006


My training for full marathon is going on fairly smoothly. On Sunday 2nd April, I ran the half marathon distance. I ran the Mumbai half marathon 2006 at a pace of 12 minutes per mile. But during this training run I took 14 minutes per mile. But what is good is I did clean running this time. Running for 900 metres and walking for a minute following Galloway's method. I did not feel the pain that I normally feel for a full day after the long run. I recovered pretty fast the next day after a two kilometre walk. I am now looking forward to 16 mile run on 23rd April and a 10*800 runs on 9th and 16th April.

I came to know during this week that President George Bush ran a marathon during 1990s.

Yesterday (4/3/06), I went around the Parel area looking for shoes. The salesmen do not know anything about suggesting appropriate running shoes. They do not even ask what is the distance you want to run and whether you are a beginner or a seasoned runner. The situation needs a lot of improvement.


Sunday, March 26, 2006


On 25th March 2006, I had the opportunity to chair the session on Finance in the National Research Conference organised by St. Francis Institute of Management & Research (SFIMAR, Borivili, Mumbai during 24-26 March 2006. I made the following observations on Research projects, research papers and support for post-Ph.D. research in academic institutions.

A comprehensive research project starts with a practical problem that is being faced by a large number of entitites. The aim is to find a general solution that is applicable across all the entities. After selecting the problem on which he wants to use his research expertise, the researcher spends time and effort on observing the entity and collecting relevant data. The researcher has to creatively arrive at a solution that uses his existing knowledge of various sciences that have applicability to the problem at hand to identify the independent variables and dependent variables and explain their relation in a way that provides a solution to the problem. The solution so arrived at has to be checked first for logical correctness. This effort may have taken even 100 years and more for certain problems. Research is a risky activity. Answers to the problems may not be found for hundreds and thousands of years even though the wisest of people of the day spend their time and effort on them.

After finding a logically correct solution to a problem, the researcher has to test the solution in a sample, the size of which is determined as per the principles of Statistics. If he gets a satisfactory resolution of the practical problem in the sample, the researcher has found a useful solution to the problem and he can declare it to the society at large for use. If the solution does not deliver the result, the researcher is back in his research effort. First he has to find out the lacunae in his logical solution and then try once again to find a new solution. The cycle continues till some researcher finds a practically successful solution to the problem being faced by the society.

Every Ph.D research project and every research paper presented or published by a researcher will not be a comprehensive research project. Researchers need to do many projects involving some component of the comprehensive research project to make research results useful to the society.

For instance, just because one researcher declares that he discovered a solution will not lead to its immediate implementation commercially. Other researchers have to do similar investigation and confirm that the solution is delivering the result. As more and more researchers confirm the result, the commercial entities will start implementing the solution. Hence we see a need for research projects that focus on testing the solution only. Many of the Ph.D thesis are of this nature. The solution proposed needs to be tested in different geographical locations, different cultures, differnt demographic segments etc. Thus there is a need and scope for a large number of research projects whenever a new solution is found for a practical problem.

There are certain researchers who specialise in refining the logical solution put forward by other researchers. These researchers, called theoretical researchers, do not select practical problems and do the observation and data collection themselves. But once some researcher does the primary observation and comes out with a theoretical conjecture, they spend their knowledge on refining the theory and provide a more logically correct and more refined solution.

Researchers sometimes identify the problems and bring it to the notice of fellow researchers for doing furthe research.

One author commented that just because a research paper was published in a journal may not mean that the society will get benefit immediately. The publication may mean that the author of the paper and one or two referees may have read the paper. There is no guarantee that a published article gets converted into a benefit for the society. Hence papers that do literature reviews and discuss various papers that pertain to a topic become useful to disseminate research carried out so far to a larger audience.

The initial successful commercial implementations of a solution proposed by a researcher is worthy of being described by researchers and published in journals and conference proceedings.

Thus we see a variety of papers being presented in the research conferences. People should discriminate between comprehensive research papers and partial research papers. An aspiring Ph.D candidate should not feel that doing a literature review will get him the degree. The review is only a beginning for starting his creative work on the gap in the literature on the topic. The reviews can be research papers but they cannot be dissertations. They are essential part of a thesis, but the real contribution comes from a new theoretical conjencture and a new test of an old theoretical conjecture.

Regarding promoting post-Ph.D Research

Most of the times, Ph.D degree holders acquire 50-80% of the expertise in the research process. Rest of the required inputs come from the guide, other faculty members, and other researchers. Hence unless, some more elaborate research projects are carried out, Ph.D degree holders may not acquire the full expertise. Academic institutes have to motivate, facilitate. monitor and provide incentives to the fresh Ph.D holders to take up further research. In my post-Ph.D experience in four institutions, I find such opportunities are scarce. Routine academic work itself takes up the full time of a new recruit. I appealed to all the persons present in the conference to think of providing such opportunities to fresh Ph.D's.

Wednesday, March 22, 2006


I was asked to coordinate the activities of IIMT, Mumbai. First class postgraduates who want to become faculty members in management schools are given a three year education in management teaching and research. Third year of the program is under a foreign professor. After three years, they are absorbed as senior lecturers in ICFAI Business Schools. In the first year of the program, the candidates get a stipend equal to the salary of a lecturer, Rs.18,000/- p.m. The last date for applications for the batch starting in August 2006 is 25th March 2006. Details can be seen from

Tuesday, March 21, 2006


I noted this quotation long back may be in 1992. I had no interest in running or walking at that time. Now that I developed interest in running and trying to do some regular training every week with three days of running and three days of cross training, this quotation seems to be more relevant to remember. I thought it is relevent for many long-distance running enthusiasts, who want to break at least their personal recods.

Herb Elliott, the unbeaten Australian one miler said it: "Any one can train when he feels like it. But you have to keep training when you don't feel like it. You have to keep going at it all the time. Even when you're tired. That's what makes a champion. And that's what proves you're a man."

Active Portfolio Management-EEP

The program went on well. Eight participants were there. We had discussions on basics of Sharpe Model and Treynor Black's use of the model to pronounce an active trading strategy. This program gives me the confidence to think of one more program in the near future.

Wednesday, February 15, 2006

Added a site metre

Added a site metre

Active Portfolio Management for Exceeding Benchmark Performance

I am offering an executive education program on the above topic during 17-18 March 2006. Interested persons are requested to send an email to my id nrkvss@ for the brochure.


Faculty Positions - ICFAI Business School, Mumbai

Faculty Positions in ICFAI Business School, Mumbai

ICFAI Business School, Mumbai is looking for persons with excellent academic background and professional experience for faculty positions in all areas of management. Interested persons can send their cv to my email


Sunday, February 12, 2006

My Comments on Mumbai Marathon on


My comments on Mumbai Marathon appeared on


Subject: I ran the Mumbai Marathon

I ran the half marathon in 2 hours and 36 minutes. The certificate says 25 in my age class. I am just short of 50 years. The organisers must have published the full list of persons who completed the full marathon and half marathon. For the recent Singapore Marathon, the full lists are available on the net.

For a marathon event, the number of persons who complete the marathon, and the number of persons who completed marathon for the first time are important information. More and more marathons are organized to create more and more marathon runners. But unfortunately all the media coverage is being given to the top three or four athletes forgetting the new entrants into the marathon club. I hope this neglect is recognised by the organisers and the media.

Narayana Rao

Posted by K.V.S.S. Narayana Rao on 03-FEB-06