Stocks That Ben Graham Would Like Here

Benjamin Graham is widely regarded to be the founder of modern value investing. His greatest student, Warren Buffett, attributes much of his success to Graham's teachings.

Though Graham believed that much research is necessary and that no stock screening methodology is perfect, he did give us some guidelines on how to perform initial screening techniques to limit the number of investments that should be researched further. The following is a list of the attributes he suggests investors look for first. The italics represent our changes to his methodology based on the current market:

1. Price-to-book (P/B) ratio of less than 1.2.

Intangible assets such as intellectual property, brand name recognition, and customer base, are not reflected in the price-to-book ratio, so we suggest a P/B of less than 1.5, rather than 1.2 that Graham discusses. He recognized this fact as well and commented that the P/B could be up to 2.5 if the company has significant intangible assets.

2. Earnings per share [EPS] should have grown by 33% in the past 10 years.

Earnings thus should have grown around 3% per year. In this exercise, we go back 5 years, looking for 3%+ growth in earnings.

3. The price-to-earnings (ttm) ratio should be below 15.

Perhaps the most common valuation metric, the price-to-earnings ratio allows us to understand the earnings power of the company compared to its price. A high P/E ratio is common among "growth" stocks who are expecting phenomenal growth, but Graham believed that there is no way to be sure growth will continue at a pace that justifies the high price.

4. The current ratio should be above 1.5.

The current ratio represents the current assets divided the current liabilities. This ensures that if the company faces a crisis, they have 50% more assets than liabilities to work with. For this exercise, we are going to use the quick ratio instead, which is a more conservative number because it disregards any current assets that might be difficult to unload in a tight situation, such as inventory.

5. The company should pay out a dividend.

Dividends, in Graham's opinion, are a very important indicator of a company's financial health. Not only that, but they indicate a shareholder friendly management team, without which can spell disaster for shareholders.

The Results

Now that we have mapped out what Graham thinks makes a good starting point for a list of investments, we will show you the results of running such a screener in today's market

The following companies meet or exceed Graham's initial test and should be considered for review by the intelligent investor. Click to enlarge:

Comments

[helplessobserver]

I've copied this table into the iPhoto library for future reference and will put the stocks in a Bloomberg tracking portfolio to see how they do.

[Ryan Freund]

Cool. It's important to note that I'm not suggesting them as "buys," but rather suggesting them for further review. If they don't have an economic moat, either through patents, economies of scale, etc... then they shouldn't be further considered.

Ryan
freundinvesting.com

[DanielAgramonte]

Good article; similar to one I published recently (albeit with criteria somewhat modified for microcaps). I've looked at many of these before. One stock on the list is very interesting: Temple-Inland. Suffice it to say they've done a lot of good stuff recently (I dealt with them professionally for several years), but they have the same problem as most of the others in the forest products group: too much debt (a paper machine costs about $900 million).

By the way, I've always loved the irony about dividends: a sign of overall health, but Brk.A and Brk.B have never paid one (go figure). All in all a good read.

[BFA]

I'll have to crack my Intelligent Investor book, but I could swear that Graham said current ratio of at least 2 -- not 1.5. Also, it should be Price-to-Average Earnings for last 3 years.

[BFA]

Also, I'm using the Compustat database and come up with 44 names. Maybe it's because you are using 5 years of data (versus the 10 recommended).

[Chungst]

I still can't believe people use accounting numbers at face value. I used to follow OSG on the debt side and it's earnings and cash flow were highly dependent on the tanker market -- it was feast or famine at times.

It just goes to show why people need to be careful about accounting numbers. It's just a starting point in the analysis.

[User 154620]

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[marcoprem]

I bought KELYA and ARCC recently and i have had ASH for a while, glad to see them in a list of presumed "Graham picks", which confirms somehow my own due diligence on them. I sold ASH because i think the company has serious issues in management strategies but i could reconsider a buy at present levels as this, like many of the companies of the list, had been way too beaten down. I agree on the fact that face accounting numbers are only one side of the coin, and many of those companies are down for a reason, beside overall market direction. Still, i think there is value that is neglected when the market overreact and i wait to see if this could be again an example.