In the end, the most successful value investors combine ………..

“…….In the end, the most successful value investors combine detailed business research and valuation work with endless discipline and patience, a well-considered sensitivity analysis, intellectual honesty, and years of analytical and investment experience….”

Seth A. Klarman in his preface to Security Analysis

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Ben Graham – Stock selection for the Defensive investor

In the book “The Intelligent Investor”, Benjamin Graham, the father of “value investing”, lists some criteria for stock selection by the defensive investor. Excerpts of the same are given here for easy reference

Excerpts from Chapter 14, Pages 348 – 349, of “The Intelligent Investor”, 2003 Edition , published by Harper with notes and commentary by Jason Zweig

Chapter title : Stock selection for the Defensive Investor

“………….. It is time to turn to some broader applications of the techniques of security analysis. Since we have already described in general terms the investment policies recommended for our two categories of investors, it would be logical for us now to indicate how security analysis comes into play in order to implement these policies ……………………………………………………………………………………………………… ……………………………………………………… [some paras snipped ………….]

1. Adequate size of Enterprise

All our minimum figures must be arbitrary and especially in the matter of size required. Our idea is to exclude small companies which may be subject to more than average vicissitudes especially in the industrial field. (There are often good possiblitities in such enterprises but we do not consider them suited to the needs of the defensive investor). Let us use round amounts: Not less than $100  million of annual sales for an industrial company and not less than $50 million of total assets for a public utility (ref Note 1 by blogger below )

2. A sufficiently strong financial condition

For Industrial companies current assets should be at least twice current liabilities – a so called two-to-one current ration. Also long term debt should not exceed the net current assets (or “working capital”). For public utilities the debt should not exceed twice the stock equity (at book value)

3. Earnings stability

Some earnings for the common stock in each of the past ten years

4. Dividend Record

Uninterrupted payments for at least the past 20 years

5. Earnings Growth

A minimum increase of at least one-third in per-share earnings in the past ten years using three-year averages at the beginning and end

6. Moderate price / earnings ratio

Current price should not be more than 15 times average earnings of the past three years

7. Moderate Ratio of Price to assets

Current price should not be more than 1.5 times the book value last reported. However a multiplied of earnings below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5 (This figure corresponds to 15 times earnings and 1.5 times book value. It would admit an issue selling at only 9 times earnings and 2.5 times asset value, etc.)

GENERAL COMMENTS : These requirements are set up especially for the needs and the temperament of the defensive investors. They will eliminate the great majority of common stocks as candidates for the portfolio, and in two opposite ways. On the one hand they will exclude companies that are (1) too small, (2) in relatively weak financial condition , (3) with a deficit stigma in their ten-year record, and (4) not having a long history of continuous dividends. Of these tests the most severe under recent financial conditions are those of financial strength. A considerable number of our large and formerly strongly entrenched enterprises have weakened their current ratio or over expanded their debt, or both, in recent years ……………………. ………………………………… ” [Ref blogger’s Note 3 below]

“………. The suggested maximum figure of 15 times earnings might well result in a typical portfolio with an average multiplier of, say, 12 to 13 times. Note that in February 1972, American Tel. & Te., sold at 11 times its three year (and current ) earnings, and Standard Oil of California at less than 10 times latest earnings. Our basic recommendation is that the stock portfolio, when acquired, should have an overall earnings / price ratio – the reverse of the P/E ratio – at least as high as the current high-grade bond rate. This would mean a P / E ratio no higher than 13.3 against an AA bond yield of 7.5%… ……………………………………………” [Refer blogger’s note 4 below]




Note 1 : Graham published this edition in 1972, 1973. This blog is written in 2013. There has been considerable money printing and inflation in the interim. Let us say we need to multiply Graham’s values by a factor of 10. Graham says “….Not less than $100  million of annual sales for an industrial company and not less than $50 million of total assets for a public utility ….” That should be $ 1 billion in revenue for an industrial enterprise and $ 500 million in assets of a public utility. These would mostly be mid and large caps today.

Note 2 : Foot notes from Graham and Jason are not included in this blog post. This post is just to summarize Graham’s filters and formulae as there are many variations floating on the net !!

Note 3 : The para starting GENERAL COMMENTS is also in Graham’s own words and his inimitable classic style ! They are added to this blog, just to show how true they are even today, roughly four decades after Graham published this version of his book. Countless reforms, enactments and committees have not changed the “over expansion” of debt . On the other hand, they have made many a mighty much more indebted !!. I am not here to argue about eh virtue of vices of debt, but merely stating where we stand after four decades.

Note 4 : I have typed in Graham’s note / para about bond yields intentionally here. (1) Graham talks of “…AA rated bonds…. High-grade bond rate..” etc. I am of the opinion that the bond yields mentioned here also need to be some sort of long term averages as a value investor would wish to hold his stocks for a long period of time and it is only natural that he compares his returns to returns from alternate sources of investments. I am unable to come up with that magic figure of ” bond yields over xy number of years ..”, but would assume that average bond yields over 20 years may be reasonable if not cautious. I have seen many gurus use the current AAA rated government bond yields and then add a risk premium to arrive at a suitable discounting rate…. probably such a method could also be valid here

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Libor Fixing Scandal : Barclays Variance to Fixed Libor !!!

Libor Fixing Scandal : Barclays Variace to Fixed Libor !!!

How many million borrowers, credit cards holders, home owners got milked ???

How many billions were milked ??

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Ex VP Al Gore’s study, full of paper !! Is that green ???

Ex VP Al Gore's study, full of paper !! Is that green ???

Ex VP Al Gore’s study if full of paper !!
Is that green ???

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For all the talk about “Brands”, “Management”, Positioning etc… here is what the “Market thinks”

Same Same …. NOT different !! 🙂 , over the lat 19+ months

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How do you know that Ford isn’t a falling knife or some such thing today ? I don’t !!

– I don’t know.

– It could fall further. Just look at the last five year chart here and the max chart here ; you will notice that there are many months and years when Ford has been far below the $ 9.39 .. i.e. today’s price

– This isn’t the business of making Tablet computers , smart phones or the next Wonder drug. Things change slowly in this field, we change cars every 10 years or so on an average !! and so there may be no “known” reason for a pop tomorrow morning

– Unless you are some institution with 10s of millions of shares and have a plan, it would be difficult to know how deep the cut could be and how far the knife could fall or where it may turn

 – The Japanese have been in and out, oil spikes have come and gone, new emission rules keep comming, emerging market talk has been there for approx 10 years now …. and “Ford” has had been rolling along, rolling along rather well since Alan Mulally took over

Will “Ford” survive the next 10 years ? to me, it looks much more easier to say yes today, than it was 4 .. 5 years ago. Yes IF “Ford” survived the depths of the meltdown and customer fears in 2008 – 2012, it will survive the next 10

– North America is “Ford’s” forte. North America is the best place to be in today’s world. that’s another short to medium term plus for “Ford”

– Will cheaper Nat Gas help “Ford” ; yes if they are at it earlier;

– People like big cars, big homes …. many things big…. The downside to a big car is the fuel cost. Suddenly there seems to be abundance of fuel and all “Made in America”….with Natural Gas. so when this Natural Gas thing gets to passenger cars, that will help the American Automakers

– If there is one strong area for the American automakers, it is the large trucks and SUV ...basically the fuel guzzlers…. and now with cheap Nat Gas that niche could be turned into a win win. An advantage to “Ford” with better margins on bigger vehicles and an advantage (in terms of less cost for a given pride) to the customer

– So….. what is the outlook !! for Ford now ?

 – they are making lot of cash

– they have started paying dividends and IF they continue to be prudent they will increase shareholder paybacks

– The Europe thing is a distraction and will depress the share price … and advantage for the real long term buyer …

– Interest costs do not seem to be moving up in a hurry. Europe will take care of the sentiment in that area !! for at least an year or two

– “Ford” stock price is below the $ 10 mark, where I think the shares are prized with a 25% MOS [ meaning value in the $13.xy range ]

– they have had no major disasters like the Toyota or others ….


…. so …. don’t bet the house on it …. but don’t worry to take a sip

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Ford Max chart – July 3 2012

Ford Max chart - July 3 2012

Ford Max chart – July 3 2012

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