A Modern Approach to Graham and Dodd Investing
Updates Graham and Dodd's valuation method for modern financial statements
Summary
Au, a portfolio manager, updates the Graham and Dodd framework for markets in which most companies have few tangible assets and where the original net current asset screens produce almost no candidates.
His approach retains the Graham foundations of intrinsic value, margin of safety and treating market price as separate from value, and adds methods for handling growth companies and intangible-heavy businesses. He works through dividend discount and earnings power valuation, the use of sustainable growth rates derived from return on equity and retention ratios, and a set of adjustments intended to make balance sheet analysis useful for companies whose assets are not physical. He also covers economic cycle positioning, arguing that Graham and Dodd's criteria should be applied differently at different points in a cycle, and includes material on international and emerging market application.
The reference has not verified the specific screens, thresholds and case examples in this book. It is a practitioner's adaptation rather than a work with an established following, and it should be read alongside rather than instead of the original Security Analysis or of Greenwald's Value Investing, which addresses the same problem of adapting Graham's framework to modern balance sheets with more rigour and a clearer method. Au's contribution is the attempt to make the classical criteria operational for a market Graham would not recognise.
Key takeaways 7
- Graham's net current asset screens produce almost no candidates in modern markets, which requires adapting the criteria rather than abandoning the framework.
- Intrinsic value, margin of safety and separating price from value remain applicable regardless of how a company's assets are composed.
- Sustainable growth derived from return on equity and the retention ratio constrains what growth assumption a valuation can defensibly use.
- Balance sheet analysis requires adjustment for companies whose principal assets are intangible and therefore not recorded.
- Valuation criteria should be applied differently at different points in the economic cycle, since the same multiple means different things at different stages.
- An investor should be able to state the specific assumption on which their valuation depends and what would refute it.
- The reference has not verified the specific screens and thresholds this book proposes.
Who should read it
Value investors interested in adapting Graham's criteria to intangible-heavy businesses, read alongside Greenwald's more rigorous treatment of the same problem.
Where it sits in the reference 2
Who recommended it 1
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