Daily Speculations The Web Site of Victor Niederhoffer and Laurel Kenner

12-Feb-2006
Stefan Jovanovich on Sir John Templeton

I think Templeton's choice of a five-year horizon is sensible because it looks to the average duration of a complete business cycle. I agree with you that his 4-times multiple is not applicable to the present day. For one thing, GOOG and every other company with a market capitalization over $2B each have more liquidity by themselves than the entire Japanese stock market did when Sir John was using his 4x5thYr metric.

That is why I posed the question -- what is an appropriate multiple now for a company like GOOG? My own answer has been a scale of multiples from 4 to 12 depending on the market capitalization of the company. As far as I can determine, Templeton never bought anything selling for more than 12 times future earnings, and market capitalization seems like a decent proxy for determining relative liquidity.

Comparing Templeton to Ben Graham seems a bit unfair. Sir John bought companies selling for as much as 10 times book, and the only other yardstick that he seems to have used was to avoid companies whose enterprise value was significantly different from its equity market cap. That seems to be the main reason that he consistently preferred insurance companies to banks. I think Templeton's valuation ideas about price to book and equity to enterprise value are robust for the same reason you refer to the memoirs of traders from the 1870s. Templeton's yardsticks have a pedigree that can be traced back to Morgan and Peabody. Whatever the changes that have occurred since the 1950s, they are no greater in scale or scope than the ones that occurred in the 100 years before Sir John made his forays to the Tokyo exchange.

One thing we can agree on is that the wisdoms of Graham & Dodd are mostly sophistry. In my case, the skepticism is based on the 30 years experience of owning small, private companies. In all that time I have never seen one available for "half book" that did not have either bad accounting or crushing debt. Their notion about buying companies for less than liquidating value is equally improbable.

I think Templeton's notions are of an entirely different class. So, along with using his multiple of fifth-year earnings valuation, I follow the two other "Templeton rules" that I have found from my researches:

1. Stay away from companies selling for more than 10 times book. That keeps one from buying sound companies like GOOG, but it also avoids the kind of soap bubble companies that were so common during the last period of general euphoria.
2. Only buy companies with a equity market cap/enterprise value of less than 1.25 or 0.75. That avoids interesting speculations like GM and F, but it also keeps one from owning them on the way down.