value
Cap the price multiple
The rule
Even a great company is a bad buy if you pay too much. Set a ceiling on the price you will pay, so excitement cannot run wild.
Where it flips
But a strict ceiling can make you miss truly great companies that deserve a higher price. The fix is to use the ceiling as your careful default, and lift it only for quality you can really prove.
There is a price above which even a fine company becomes a poor buy. Graham gives the careful investor a simple ceiling. Pay only a modest price compared to earnings, and a modest price compared to book value, and keep the two multiplied together low. That way no thrilling story can talk you into a price that leaves no room for a mistake.
A worked example
A company trades at 30 times earnings and 5 times book value. Multiplied, that is 150, far above the safe limit of about 22.5. Even loving the business, Aayra walks away. At that price it already assumes years of perfection, so any slip hurts. [illustrative]
How to spot it
- ·a very high price versus earnings or book value
- ·the high price backed only by the growth story
- ·no limit on what you are willing to pay
Benjamin Graham · The Intelligent Investor