In 2000, Joseph D. Piotroski was a young associate professor of accounting at the University of Chicago Graduate School of Business, having obtained his Ph.D. from the University of Michigan the previous summer. That year he published a paper called “Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers” in the Journal of Accounting Research. Seldom has an accounting paper made such a huge splash.
The calculation of intrinsic value has become a forbidding and abstruse practice. It seems reserved for nerds and members of the Warren Buffett cult. As Aswath Damodaran, one of its most elegant and charismatic practitioners, and perhaps the person who has promoted it more than anyone of late, wrote recently, “uncertainty underlies almost every part of intrinsic value.” . . .
The fact that mature companies grow at a steady rate gives us a way to calculate the discount rate without depending on guesses as to the return of an equally risky investment. We know that the present value of an investment that pays dividends in perpetuity with a constant growth rate equals its dividend divided by the difference between the discount rate and the growth rate. So let’s take all mature companies—companies with fourteen or more years of annual reports—and find out what they’re actually returning to shareholders (shareholder payout).
Before we get into multi-stage analysis, let’s contrast young and mature companies. We shouldn’t look only at how many annual statements a company has filed to determine this; instead we should also use a company’s characteristics. There are plenty of companies that have reinvented themselves and gone from old age to infancy in terms of their growth rates.
In 2005, Joel Greenblatt published a book called The Little Book that Beats the Market. Its explicit aim was to “explain how to make money in terms that even my kids could understand (the ones already in sixth and eighth grades, anyway).” Although it used language and examples that were aimed at children, it was widely read by folks of all ages. The first five chapters, before Greenblatt gets into his investment strategy, comprise an excellent introduction to value investing. Clearly written, easy to understand, it’s principled and right.
Benjamin Graham, who has often been called the father of value investing, published The Intelligent Investor in 1949 and revised it several times, most recently in 1972. In that last and fourth edition, published in 1973, he included three different sets of guidelines, which could be called “checklists” or “screens.” The first was for the “defensive investor,” and it’s the most famous. The second was a rule for investing in “Net-Current-Asset (or ‘Bargain’) Issues.” And the third was for the “enterprising investor.”