r/valueinvesting
The Graham Dodd P/E Matrix
Shares Graham-Dodd P/E matrix showing how bond yields and growth rates determine fair valuation multiples.
- Lower interest rates significantly expand justified P/E multiples for growth stocks.
- Provides a quantitative framework to identify undervalued stocks relative to current bond yields.
- Highlights that even no-growth companies have a baseline valuation floor based on risk-free rates.
- High corporate bond yields compress P/E multiples, making equities less attractive.
- Reliance on projected growth (G) introduces significant estimation risk if earnings miss expectations.
- Current high-rate environments structurally lower the ceiling for equity valuations compared to historical lows.
Graham’s adjusted earnings-multiple formula:
P/E = \[8.5 + 2G\] \* (4.4/Y)
Where:
G = expected annual earnings growth percentage. (Initially, no-growth stocks have a P/E of 8.5; each 1% growth adds 2 points.)
Y = the AAA corporate bond yield.
Why it matters:
Interest rates significantly influence P/E ratios; the same growth can justify different valuations depending on yields.
| Bond Yield | 0% | 5% | 10% | 15% | 20% | 25% | 30% | 35% | 40% |
|------------|-----|-----|-----|-----|-----|-----|-----|-----|-----|
| 1% | 37.4 | 81.4 | 125.4 | 169.4 | 213.4 | 257.4 | 301.4 | 345.1 | 389.4 |
| 2% | 18.7 | 40.7 | 62.7 | 84.7 | 106.7 | 128.7 | 150.7 | 172.7 | 194.7 |
| 3% | 12.5 | 27.1 | 41.8 | 56.5 | 71.1 | 85.8 | 100.5 | 115.1 | 129.8 |
| 4% | 9.4 | 20.4 | 31.4 | 42.4 | 53.4 | 64.4 | 75.4 | 86.4 | 97.4 |
| 5% | 7.5 | 16.3 | 25.1 | 33.9 | 42.7 | 51.5 | 60.3 | 69.1 | 77.9 |
| 6% | 6.2 | 13.6 | 20.9 | 28.2 | 35.6 | 42.9 | 50.2 | 57.6 | 64.9 |
| 7% | 5.3 | 11.6 | 17.9 | 24.2 | 30.5 | 36.8 | 43.1 | 49.3 | 55.6 |
| 8% | 4.7 | 10.2 | 15.7 | 21.2 | 26.7 | 32.2 | 37.7 | 43.2 | 48.7 |
| 9% | 4.2 | 9.0 | 13.9 | 18.8 | 23.7 | 28.6 | 33.5 | 38.4 | 43.3 |
| 10% | 3.7 | 8.1 | 12.5 | 16.9 | 21.3 | 25.7 | 30.1 | 34.5 | 38.9 |
| 11% | 3.4 | 7.4 | 11.4 | 15.4 | 19.4 | 23.4 | 27.4 | 31.4 | 35.4 |
| 12% | 3.1 | 6.8 | 10.5 | 14.1 | 17.8 | 21.5 | 25.1 | 28.8 | 32.5 |
| 13% | 2.9 | 6.3 | 9.6 | 13.0 | 16.4 | 19.8 | 23.2 | 26.6 | 30.0 |
| 14% | 2.7 | 5.8 | 9.0 | 12.1 | 15.2 | 18.4 | 21.5 | 24.7 | 27.8 |
| 15% | 2.5 | 5.4 | 8.4 | 11.3 | 14.2 | 17.2 | 20.1 | 23.0 | 26.0 |
| 16% | 2.3 | 5.1 | 7.8 | 10.6 | 13.3 | 16.1 | 18.8 | 21.6 | 24.3 |
| 17% | 2.2 | 4.8 | 7.4 | 10.0 | 12.6 | 15.1 | 17.7 | 20.3 | 22.9 |
| 18% | 2.1 | 4.5 | 7.0 | 9.4 | 11.9 | 14.3 | 16.7 | 19.2 | 21.6 |
| 19% | 2.0 | 4.3 | 6.6 | 8.9 | 11.2 | 13.5 | 15.9 | 18.2 | 20.5 |
| 20% | 1.9 | 4.1 | 6.3 | 8.5 | 10.7 | 12.9 | 15.1 | 17.3 | 19.5 |
Disclaimer: all common stocks have a nominal legal minimum price value equal to or less than Par value of $0.01.
Not all growth is equal, organic growth should be prioritised higher than growth via capex as it means profits can be returned to shareholders
Yep. I just wrote about this actually.
Capex growth provides less value than organic growth. And it can be deceiving because growth up to the cost of capital actually creates no value at all.
If a stock pays a dividend of 4 with r = 10% and g = 5% value is:
= 80
But if g increases slightly to g= 6%
(4)/(0.10 - 0.06) = 100
So a A 1% change in growth increases valuation by 25%, highlighting how unstable the GGM model can be
My preference, Net income that the business reinvests ILO dividends
You prefer that it costs money to grow instead of not costing money to grow?
Feels like you just read something that Buffett said about liking companies that have lots of room to deploy capital at high rates of return and assumed it’s the best path for growth?
Snowball lol.
I guess I made too general of a statement.
I own equities that still have cofounder owner operators. They use profit to grow the topline, not as a share buyback.
Therefore a large equity over debt is necessary.
Money cost money, there is no risk free rate.
Is this a regurgitation of the oracle
As an example
Let’s assume a 5% bond yield
And we expect 5 year annual earnings growth rate of 15%
the P/E multiplier would be:
P/E = \[8.5 + 2(15)\] × 4.4/5
= 38.5 × 0.88
≈ 30.89
Thanks for the reminder. The higher the interest rate, the greater the downward pull.
Tldr: "Interest rates are to asset prices, you know, sort of like gravity is to the apple. They power everything in the economic universe." Buffett 2013
Conclusion: buy $RDDT
No it wont
Honestly, the yield part is what I find most useful here.
Most people never adjust their thinking when rates move, which is exactly how you end up overpaying in a low-rate environment.
The G input is where I'd be careful, though.
That number does all the heavy lifting, and I've never met an investor who thought their growth estimate was too high.
Very interesting. Didn’t know this existed. Thanks OP!
you wanna provide ... like ANYTHING resembling reasonable explanation of this? Your "Why it matters" is pretty useless without any context.
What is this? What is it used for? How do we apply it in our research?
Updated the table for you
Thanks for the update, but now I'm confused more than ever. Is this supposed to be a matrix for the stock market as a whole? Applied to individual stocks? No adjustment for industry or sector?Outlier P/E ratios among peers are easy to spot so I'm not sure why I'd need this.
Or are you saying it goes the other way ... for a given current yield and current P/E ratio, this matrix is a lookup that gives you the growth rate needed to justify that P/E ratio?