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I'm reading the Intelligent Investor and I came across a passage where Graham calculates the 'times earnings' of the DJIA. But is it wrong, or am I misreading it?

Since the market value of these issues is well above their book value—say, 900 market vs. 560 book in mid-1971—the earnings on current market price work out only at some 6 1⁄4%. (This relation- ship is generally expressed in the reverse, or “times earnings,” manner—e.g., that the DJIA price of 900 equals 18 times the actual earnings for the 12 months ended June 1971.)

This must be very simple for you guys, but isn't 'times earnings' supposed to be 900/560 = 1.6? I'm wondering where that 18 came from

(Please let me know if this question belongs in money.stackexchange.com)

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  • $\begingroup$ You are mixing two different valuation measures. M/B or market to book is indeed 900/560 = 1.6, but Graham is referring to E/P or earnings yield. You don't mention what 12 months of earnings (E) is, but presumably 900 / E $\approx$ 18 and E / 900 $\approx$ 0.0625 , so E must have been about 50 or 56 approx. See if you can find the exact figure for E in the text. $\endgroup$
    – nbbo2
    Dec 17, 2021 at 16:34
  • $\begingroup$ @noob2 I see... I don't think it does mention the earnings, then. Thank you!! $\endgroup$
    – user5646514
    Dec 19, 2021 at 12:12

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Index = 900 (ie market price of equity) Book Value = 560 (ie accountant's estimate of the equity capital invested in the company)

The 16x PE multiple (the reciprocal of the 6.25% "earnings yields") implies an EPS of 56.25.

Which does indeed imply a "price/book value" of 1.6x as you say. It also implies a "return on equity" of 56.2/560 = 10.0%. This is an accounting ratio estimating the productivity of these assets.

Intuitively, you should be prepared to pay more for a more productive asset than you would for a less productive asset. Hence Graham is the Bible for value investors, ie low P/E is good because it implies a good trade-off between P/B and ROE (equals E/B)

Needless to say, reality has long been more nuanced than this. And the accounting "book" has become an ever less concrete measure of capital invested in a business, as businesses have become less physical-capital-intensive.

The Graham approach struggles to differentiate between two identical businesses, one of whose brands is strong while the other's are weak. And it never ever pretended to know which of the Facebook versus Google models for attracting eyeballs to adverts were superior to the other. It never even pretended to know how to value either in the first place, neither being dependent on physical plant and equipment that declined in value through use, wear and tear...

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  • $\begingroup$ Thank you for making it clear and going the extra mile to put it in today's reality! $\endgroup$
    – user5646514
    Dec 19, 2021 at 12:11
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560 is the book value, not earnings. For earnings you'd have to find the earnings per share of each constituent and take the proper weighted total.

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