Looking for potential investments? With thousands of stocks to research, getting started can seem a bit overwhelming. Here are a couple screens (and the companies that made it through) using sets of criteria utilized by the “Dean of Wall Street” and “Godfather of Value Investing”, Ben Graham.
The significance of Ben Graham’s Wall Street career cannot be overstated. His investment partnership averaged 17% annual returns over its existence. He created and mentored some of the most successful investors ever to live and has been responsible for the education of more investors than almost anyone with his 2 best-selling investment books, The Intelligent Investor and Security Analysis. He had a very disciplined, rule-based approach to investing that focused on only one thing: A company’s intrinsic value.
The following comes from the book, “Einstein of Money”, a great biography of Ben Graham that is also focused on his investment work. Every other chapter breaks from the life story of Graham to detail a main concept in his investment philosophy. Whether it is his concept of Margin of Safety, Fundamental Analysis or advice on dealing with “Mr. Market”, the author does a great job mixing in the life of Benjamin Graham and the ideas behind his work.
Ben Graham Screen 1 – For the Defensive Investor
Remember from his book The Intelligent Investor, “Defensive” does not mean “safe” like would be implied today. Graham split all investors up into 2 categories, defensive and enterprising. Defensive investors do not spend a lot of time on their investments (much more passive in their investment actions), enterprising investors follow their investments constantly, (and are much more active day to day monitoring their investments). For this reason, you will see that this “Defensive” screen is much more limiting as the investors who buy these will not be paying as close of attention to their investments. These stocks would theoretically have a little extra margin of safety to compensate for this.
- Size: Over $500 million market cap.
- Current Ratio: Greater than 2
- Earnings Stability: Positive earnings over last 10 years
- Dividend Record: 20 years of dividend payments
- Earnings Growth: 33% growth over last 10 years.
- Price-to-Book (P/B) Ratio: Less than 1.5
- Price-to-Earnings (P/E) Ratio: Less than 15.
How many companies pass this test today as I write this? (Mid April 2016). Not many. Out of the thousands and thousands of stocks in the investing universe, only 8 pass the test using AAII Stock Investor Pro screening.
But; my screening software can only go back 7 years, which is much less restrictive than the long histories required by Graham’s screen. Who is left when you look back 10 years for profits and 20 years for dividends? Only 2 companies make the cut!
Corning Incorporated (Ticker: GLW)
Wolverine World Wide, Inc. (WWW)
Who gets cut and why?
Finish Line (FINL) – Has only paid a dividend since 2005.
Huntsman Corporation (HUN) – Has only paid dividends since 2007.
Sasol Limited (SSL) – Has paid a dividend since 2003 when it had its IPO on the New York Stock Exchange. I am unable to find history prior to 2003.
Textainer Group Holdings (TGH) – Has only paid dividends since 2007. However it should be noted that 2007 was Textainer’s IPO. Financial disclosures at its IPO had records of dividends paid to shareholders since 2003. I can’t find history past that. Does this technically meet Graham’s criteria? No, however it seems better than a company that had cut its dividend in the past. The company does seem to value its dividend payments. I will leave this up to you whether it should make the final cut or not.
Triumph Group (TGI) – Started paying dividends in 2008.
Maybe Sasol and Textainer can make the list if you consider they have not been around for 20 years. Personally, I don’t mind the lack of dividend history since the companies have not been around long.
I also don’t mind the lack of dividend history for the other companies either as long as the companies have adequately allocated their capital. I use a quick and dirty test like the Buffett Test to see how management has fared.
We have eliminated thousands of companies and arrived at these 2 (or 4).
Why would Graham seek out companies like these ones above?
Ben Graham considered value investing as “buying a dollar for less than a dollar.” Graham would screen out companies that were trading at too high of a price to arrive at companies that were “deals”. At these cheap prices Graham considered that he had both a margin of safety because he was buying the companies at reduced prices and a chance for investment gains as the securities would eventually rise in price to reflect their true value.
And the concept worked. Graham’s investing philosophies gave him a very respectable return over his career, and was also responsible for Buffett’s early partnership results as well. (Since Berkshire Hathaway has become bigger, Buffett has relaxed from Graham’s more stringent criteria.)
So this should give you a great starting place for some reading. Check out these 4 companies latest annual reports, 10-k, 10-qs and see what has led them to have such a competitive advantage over the last couple decades, and why they are so cheap today.
Next, Graham also gives us another set of criteria for Enterprising Investors:
Screen 2 – For the Enterprising Investor
- Current Ratio: Greater than 1.5
- Earnings: Must be positive over the last 5 years
- Dividend Record: Must pay a dividend currently
- Earnings Growth: Must be positive over last 7 years
- Price: Must be less than 1.2x TBV (Tangible Book Value)
As expected, this screen lets a few more names pass by, but still not many. In total, 23 companies pass the test:
As we relax the requirements, more companies pass by. These companies trade at nearly equivalent values (under 1.2X book value), but do not have the histories or financial strength of the companies on the previous screen.
But, if the 4 companies on the previous screen did not provide you with enough reading material, this will surely keep you busy.
I will leave the investigative work of these 23 companies to you. Good luck!