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I wanted to write a stock screen as homage to one of the founding fathers of value investing, Benjamin Graham. Most know him for his books, "Security Analysis," "The Intelligent Investor," or his depiction of Mr. Market that offers you stock on your doorstep every day.

Value stocks (the Fama French model, 1996) have been tested to outperform the market as a whole. How might the decades-old methods of Benjamin Graham hold up today against these newer value theorems?

Two Types of Graham Investing

Benjamin had at least two types of value investing: aggressive and a defensive.

The defensive would be for the conservative investor buying large industry leaders meeting his criteria. The filter for aggressive or enterprising investors was similar, but with looser standards. Today, we are going to use his stock picking methods as a base concept, and modify them somewhat.

Stock Selection Rules

The first rule to be put on the chopping block is dividends. We will not exclude dividends, per se, but we will not make it a requirement. On this issue I need to side with Benjamin Graham’s greatest pupil, Warren Buffett. A good firm should be allowed to re-invest retained earnings in profitable growth opportunities if it chooses.

We are also going to shy away from selecting only giant companies. Research has shown that while small caps are more susceptible to seasonal variations (Chen and Jindra May 2001), with lowest prices around mid-December and highest by mid-summer, they can also be more profitable than their large cap counterparts (Fama French 1996). Some of these findings were that small stocks have higher returns than big stocks in 11 of the 16 emerging markets and the difference for equal-weight portfolios is 8.7%(14.89% on value-weight). While small caps often have a value premium associated with them, Fama and French found that it was still a net positive when compared with the returns. We will include a wider range of stocks from small cap ($300billion) and up.

What parts of Benjamin’s Graham's filtering rules will we keep? It will be a mix from his defensive and aggressive filters.

  • Current ratio 2 or higher
  • Positive earnings over the past 5 years (check by hand)
  • Earnings growth positive when comparing today’s to 5 years ago (actually, we'll screen for 5 years average growth instead)
  • Price to book ratio 1.2 and under
  • Long-term debt to equity ratio less than 1 (tighter than his 1.1)

The New List of Benjamin Graham Stocks?

  1. (NYSE:UVV) Universal Corp.
  2. (NYSE:OMG) OM Group Inc.
  3. (NYSE:PMC) PharMerica Corporation
  4. (NYSE:GLT) PH Glatfelter Co.
  5. (NASDAQ:FSIN) Fushi Copperweld, Inc.
  6. (SPWRA) SunPower Corporation
  7. (NYSE:CKH) Seacor Holdings Inc.
  8. (NASDAQ:XRTX) Xyratex Ltd
  9. (NYSE:GLF) GulfMark Offshore, Inc.
  10. (NASDAQ:GLBL) Global Industries Ltd.
  11. (NASDAQ:FORM) FormFactor Inc.
  12. (NYSE:TDW) Tidewater Inc.
  13. (NASDAQ:SIGM) Sigma Designs Inc.
  14. (NYSE:SMA) Symmetry Medical
  15. (NASDAQ:ELNK) EarthLink Inc.
  16. (NYSE:UMC) United Microelectronics Corp.

One rule that we will also slacken is his earnings/price yield being twice the value of AAA bonds. If the AAA bonds yield is 5%, a comparable PE ratio would be 20. Half of that number is 10. While we are looking for deep value stocks, we will simply try to pick stocks with forward PE ratios under 25. In general the trailing PE will be quite low, but this is one standard we will slacken.

Showcasing Four Picks

(UVV) – Earnings have grown over the past 5 years although there was a slight drop in 2010. All the while the PE ratio has steadily declined creating interesting divergence between earnings and share price. Both dividends and dividend yields have seen an incline over the past 10 years with the current yield over 5%. Price to sales has dropped to 0.38, PE is at 7.44, while profit margins have generally risen. Book value per share is over $10 higher than share price. Debt and liabilities are dropping while shareholder equity is rising. Payout ratio is only 37%. The short ratio of 13% could provide a boost if this stock can find its legs. And the company has the ability to increase dividends for a sustained yield even if PE ratios climb.

(OMG) - Debt and liabilities have steadily decreased over the past 10 years while book value has continued to rise, above share price in fact. Over the past 10 years however, the earnings and revenue has remained fairly flat. With a PE of only 15, I find this stock fairly valued on most levels. While this is one to keep on my radar, I do not find an overwhelming reason to buy it right now. Perhaps when Mr. Market comes back with better valuations. Also keep in mind that earnings did dip into the negatives during the past 5 years.

(PMC) – This stock is too new to be a true Benjamin pick. Sliding growth is alarming, but with valuations like a price to book ratio under 1, and price to sales at 0.21, EPS growth this year at 738%, with 5 year growth expectations at 13% per annum, the nose-diving PE could really help this stock pop with stabilized growth. However, with less than 4 years of volatile trading, it's only suitable for much higher risk investors than Graham would’ve likely encouraged.

(GLT) – Book value is rising on this stock even while prices drop. This could be partially to the long term trend of increasing debt and expenses. Revenue growth seems a bit more stable than earnings growth as there was a brief negative EPS in the past 5 years. While the long-term EPS trend is up, the past year has seen a decline. Based on increasing revenue, this could be a good long-term holding if net profit margins hold the same or increase.

Further Refinement on Stock List Needed

As you look over the rest of the picks, be on the alert for missed earnings in the past 5 years, such as (GLF). Increasing revenue creates a strong backbone for earnings. While an increase in debt is not desired, focus more if the debt to equity ratio drops (positive sign). High free cash flow is also a desired component if the company pays dividends. Not all the companies on the above list are defensive or even aggressive Benjamin Graham selections, some are just plain 'high-risk' with implied relative value ratings. But all the above stocks do share some of this investing criteria and it would be interesting to see how many of the above stocks would make it into his two portfolios (defensive/aggressive) if he were alive today. Also, just because the stocks are on this list, it doesn't mean Mr. Market is giving us a good price today. You can use the Graham-style calculator here or use the Discounted Cash Flow calculator on any of these

Are there any of the above stocks that you are bullish or bearish on? Feel free to let me know in the comment section.

Source: Would Benjamin Graham Buy These 16 Deep Value Stocks?