# Value investing-Benjamin Graham- p/e's and company debt



## punter (May 6, 2012)

Hey all. I just started reading The Intelligent Investor and I have a couple questions. At the end of Chapter 5, Graham states that "an industrial company's finances are not conservative unless the common stock (at book value) represents at least half of the total capitalization, including all bank debt". When he says total capitalization, what does he mean exactly? Is it the total liabilities on a balance sheet?

Also, in chapter 7 while Graham is talking about growth companies, he mentions calculating the P/E ratio by using the EPS average for the last 7 years, to display a more accurate picture of the earnings. I was just thinking, isn't this a better way to determine p/e for most companies in general?


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## dubmac (Jan 9, 2011)

punter said:


> I was just thinking, isn't this a better way to determine p/e for most companies in general?


Divide the price of the stock by the Earnings per share. Both these numbers can be derived easily by any stock filter (Google Finance)


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## Spudd (Oct 11, 2011)

For the long-term P/E question, here's an article that was recently written about that very question:
http://www.theglobeandmail.com/glob...ng/taking-the-long-term-view/article13461017/


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## avrex (Nov 14, 2010)

*Total Capitalization*

Let's looks at an example, 
using POT's latest Quarterly Financial Balance Sheet



Total Capitalization = Long-term debt + Shareholders equity
or to be clearer,
*Total Capitalization = Long-term debt + (Total Assets - Total Liabilities)*

Plugging in the latest numbers from POT, we get,

Total Capitalization = 2968 + ( 18025 - 7708 )
Total Capitalization = 13285


Financial Analysts will take this figure and look at metrics, like the Debt to Total Capitalization Ratio, to evaluate how a company is funding it's operations.

Debt to Total Capitalization Ratio = Long Term Debt / Total Capitalization = 2968 / 13285
*Debt to Total Capitalization Ratio = 22.3 %* (which looks pretty low)


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## doctrine (Sep 30, 2011)

To be conservative, I always monitor the total debt to capitalization, not just long term debt. For Potash, that is 42.7%, which looks to me to be fairly conservative and less than the 50% margin that Graham looks for.

Another tip Graham has is to compare the long term debt to total property/plant/equipment assets; a company with far more debt than property/plant/equipment assets is a warning sign. Theoretically, this property and equipment can be sold off to pay down debt and not leave shareholders with zero or negative book value.


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## punter (May 6, 2012)

Thanks guys. I appreciate it.


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## londoncalling (Sep 17, 2011)

great thread. thanks for the wonderful example avrex.

Cheers


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## avrex (Nov 14, 2010)

no problem.


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## Toronto.gal (Jan 8, 2010)

londoncalling said:


> great thread. *thanks for the wonderful example avrex.*


+10 from a spatial learner! [but not when it comes to maps, lol]. :rolleyes2:


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## balk (Dec 6, 2010)

avrex said:


> *Total Capitalization*
> 
> Let's looks at an example,
> using POT's latest Quarterly Financial Balance Sheet
> ...


Quick question from the above example. Should you not subtract lt debt from total liabilities as you are now counting it twice?


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## avrex (Nov 14, 2010)

balk said:


> Should you not subtract lt debt from total liabilities as you are now counting it twice?


As another way of looking at this, I guess you could rearrange the formula and remove Long Term Debt from the denominator.

Debt to Total Capitalization Ratio = Long Term Debt / Total Capitalization
Debt to Total Capitalization Ratio = Long Term Debt / (Long Term debt + (Total Assets - Total Liabilities))
Debt to Total Capitalization Ratio = Long Term Debt / (Long Term debt + (Total Assets - (Liabilities that are not LTD + Long Term debt)))
Debt to Total Capitalization Ratio = Long Term Debt / (Long Term debt + Total Assets - Liabilities that are not LTD - Long Term debt)
Debt to Total Capitalization Ratio = Long Term Debt / (L̶o̶n̶g̶ ̶T̶e̶r̶m̶ ̶D̶e̶b̶t̶ + Total Assets - Liabilities that are not LTD - L̶o̶n̶g̶ ̶T̶e̶r̶m̶ ̶D̶e̶b̶t̶)
Debt to Total Capitalization Ratio = Long Term Debt / (Total Assets - Liabilities that are not LTD)
Debt to Total Capitalization Ratio = 2968 / (18025 - (7708-2968))
Debt to Total Capitalization Ratio = 22.3%

..... but it doesn't matter, either way. That is just how this financial ratio is defined.


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