Benjamin Graham's Simple Valuation Formula for Growth Stocks

Value = Current (Normal) Earnings × (8.5 + 2 × Expected Growth Rate)

The growth rate here refers to the long-term annual average growth rate over the next 7 to 10 years.

It's a rule-of-thumb formula for quickly estimating a stock's reasonable price, not a precise calculation; it's more like an empirical rule.

Core Logic:

- 8.5: Represents the reasonable price-to-earnings (P/E) ratio for a company with no growth (growth rate = 0).

- 2 × Growth Rate: The premium for growth; faster growth leads to a higher valuation.

So, essentially, the formula calculates:

Reasonable P/E Ratio = 8.5 + 2g

Reasonable Value = Earnings Per Share × Reasonable P/E Ratio

2. How to understand the numbers?

Take the simplest example:

Scenario A: Company with zero growth (g=0%)

Reasonable P/E Ratio = 8.5 + 0 = 8.5x P/E

Scenario B: Company growing 5% annually

Reasonable P/E Ratio = 8.5 + 2×5 = 18.5x P/E

Scenario C: Company growing 10% annually

Reasonable P/E Ratio = 8.5 + 2×10 = 28.5x P/E

Scenario D: Growing 15%

8.5 + 30 = 38.5x P/E

For every additional 1% of growth, the valuation gets an extra 2x P/E. That's the meaning of the formula.

3. Why use the 7-10 year growth rate?

Because Graham believed:

- Short-term growth (1-2 years) is unreliable and often just a cyclical upturn.

- Only long-term, sustainable growth deserves a high valuation.

Therefore, the formula requires you to use the average annual compound growth rate over the next 7-10 years, not this year's sudden surge.

4. Why did Graham say "I have never used it myself"?

This statement is crucial and reflects his true attitude:

1. It's only a rough reference, not a basis for investment.

2. He personally placed greater emphasis on margin of safety, asset value, liabilities, and cash flow, rather than such growth formulas.

3. The growth rate itself is a forecast, and forecasts are easily wrong, making the formula naturally inaccurate.

4. He feared people would blindly believe in the formula, so he specifically emphasized "I don't use it myself."

In short:

The formula can be used to quickly ballpark a reasonable range, but it shouldn't be used to make real investment bets.

5. How to understand it more practically in the real world?

- A mature company with no growth: reasonable valuation is roughly 8-10x P/E.

- Growth of 5%: reasonable valuation 15-20x P/E.

- Growth of 10%: reasonable valuation 25-30x P/E.

- Growth of 15%: reasonable valuation 35-40x P/E.

If it's above this range, it's likely expensive; if below, it might be cheap.

For a company with stable growth, the reasonable P/E ratio is approximately equal to 8.5 plus twice the long-term growth rate.

But this is only a rough guideline; don't take it too seriously, and definitely don't use it to make major investment decisions.