Thomas P. Au
1 Questionable
At its core, this book attempts to find a more modern version of Ben Graham's well-known shorthand formula for valuing stocks. The formula suggested in this book is: intrinsic value of a stock = book value plus 10 times dividends. No scientific explanation is provided, nor is the reader told how the author arrived at this formula.
The formula is questionable. By using the formula, two identical businesses - both earning 15% return on equity - will be awarded radically different values if one business pays out all its earnings as static dividends while the other reinvests all dividends and lets its book value and future earnings compound at 15% per year. The dividend paying business will be valued more than twice as high as the non-dividend paying business. Logic tells us that both businesses should be valued equally if the investor's required rate of return is 15%. The non-dividend paying business may even be more valuable. Warren Buffett, for one, prefers compounding to static dividends.
Backtesting the formula does identify undervalued stocks. However, the success of the formula can probably be ascribed to the formula's inherent conservative nature rather than its scientific correctness. Any formula that forces an investor to use conservative valuation measures is likely to yield good results, even if the formula itself is incorrect.
I enjoyed this book despite disagreeing with the author's methodology. The main strength of the book is that it encourages a conservative approach to investing. It offers interesting insights into stocks versus other investments, including bonds, direct real estate investments and REITS. It also offers some interesting views on Warren Buffet's success, e.g. that Buffett's success is a result of his ability to identify businesses with reliable growth as opposed to high growth.
This book is recommended for experienced value investors interested in reading about a fellow value investor's novel approach to investing. Readers who are looking for a scientific approach to value investing may be disappointed.
2 Highly Recommended !
Benjamin Graham and David Dodd literally wrote the book (the classic Security Analysis, 1940) on value investing. Warren Buffett followed their advice, which helped make him a household name. But Graham and Dodd devised their investing approach in the 1930s and, obviously, the markets have changed. Investors face different accounting requirements, international investments and non-equity alternatives to traditional corporate stocks. Author Thomas P. Au has undertaken to update the vintage Graham and Dodd approach and, by using numerous examples and explanations, to make it relevant to today's markets. The basic emphasis on value remains, but he has adapted it to suit a faster, more complex investment world than the old masters ever imagined. We think that they would have approved of Au's clear, lucid, well-organized book, which is highly recommended for investors.
