Key Takeaway

• According to Graham, it’s tricky to project an earning's growth trend into the future due to the unpredictability of inflation rates, geopolitical wars, economic recessions.

• Graham states that projected earnings begin with the average past data. Such as sales volume, prices received, and operating margin. They are then grounded using economic and industry estimations.
• Graham identifies two main problems with growth stocks investing, which excellently explains why numerous growth investors have invested poorly over the years.

Introduction

Meaning of Graham's typical common stock analysis.

• Graham means that the analysis would be of positive or scientific benefit only when there is exceptionally common stock.
• And that is if the common stock is regarded either as a "questionable aid to speculative judgment or as a highly illusory method of aiming at values that defy calculation."
• The subject can also be clarified through the historical approach. "Such a survey will throw light not only upon the changing status of common-stock analysis but also upon a closely related subject of the major importance of the theory of common-stock investment."

Reasons Graham believe it is dangerous to project an earning's growth trend into the future

• According to Graham, it’s tricky to project an earning's growth trend into the future due to the unpredictability of inflation rates, geopolitical wars, economic recessions.
• High price/earnings show that investors are speculating the high growth of the firm's stock.
• This “high growth can lead to the stock being overpriced." 

Is it also dangerous to project a company's level of average earnings into the future?

• According to Graham, projected earnings begin with the average past data. Such as sales volume, prices received, and operating margin. They are then grounded using economic and industry estimations.
• He states that "valuations would ordinarily be found by estimating the average earnings over years in the future and then multiplying that estimate by an appropriate capitalization factor."

The challenges that Graham identifies with Growth Investing

• Graham identifies two main problems with growth stocks investing, which excellently explains why numerous growth investors have invested poorly over the years.

• Firstly, the growth stock gets expensive, and it’s difficult for stocks to sustain high valuations.

• And a business that has grown is now bigger. It becomes more difficult for it to grow when it's bigger than when it was smaller.

How a company's dividend track record and current policy impact its attractiveness as an investment

• According to Graham, the company's dividend track record and current policy impact its attractiveness as an investment because nothing "measures the value of management better than its track record of investing money."

When should a company be reinvesting earnings and when should it be paying them out as a dividend?

• Graham advocates for businesses to pay dividends to their shareholders instead of retaining all of their profits as retained earnings.
• Graham stated that" reinvesting a substantial part of the earnings must be clearly justified to the shareholders on the basis of concrete benefits exceeding the value of the foregone dividends."
• Companies seldom have no option but to return their earnings as dividends, "for only by doing so can the company maximize value to shareholders. In other instances, even profit opportunities abound, the company must retain all of its profits."
• A company should reinvest dividends when the real-life performance of their companies is growing, "rather than paying attention to the changing sentiments of the market."
• According to Graham, "When a company returns most of its earnings in the form of dividends, the company doesn’t have much in the way of reinvestment possibilities, and management is properly returning capital to shareholders. Therefore, an investor would be foolish to plow money back into the very same company through an automatic dividend reinvestment plan."