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  • Graham Ratio And Application

    The core of value investing is to obtain an investment for less than its worth. Professional investors will typically focus on the price to earnings (P/E) ratio which compares the current share price with its per share earnings. Although this is a good gauge, more than one ratio should be considered when assessing an investment. Students of value investing should also be familiar with price to book (P/B) ratio. This ratio (P/B) compares the current share price to the current shareholder equity.

    In the book The Intelligent Investor, Benjamin Graham highlights a key concept which combined the two ratios [P/E and P/B] as a gauge on the valuation of a company. These combined ratios are known as the Graham ratio. The computation is elementary, simply multiply the P/E ratio with the P/B ratio. If the product is less than 22.5, the company may be of good value. This thesis is highlighted in Chapter 14 - Stock Selection for the Defensive Investor of The Intelligent Investor. We find this concept to be so compelling that we've decided to back test this ratio against our watch lists from 2012.

    We started with our U.S. Dividend Watch Lists from May 11, 2012 through August 24, 2012 and compared the share price after two years. Because many companies appeared on our list multiple times, we selected only the instances with the least amount of return. We then split the list into two sections, one with companies that meet the Graham ratio and others that fail. We believe the results are distinct and worth reviewing.

    Each list contains 31 companies. The list of companies meeting the Graham ratio criteria of less than 22.5 had an average return of +45%. The list of companies with a Graham ratio higher than 22.5 had an average return of +32%. As a result, by simply applying the Graham ratio criteria to our list, we were able to enhance investment returns by +13%. The results can be seen in the following link.

    Disclosure: The author is long WAG, UNM, AMAT, ABM, MCY.

    Aug 29 3:06 PM | Link | Comment!
  • Nasdaq 100 Watch List Review

    Below is the one year performance of our August 23, 2013 Nasdaq 100 Watch List stocks (8/23/2013 to 8/26/2014):

    SymbolName20132014% change
    SHLDSears Holdings Corp39.634.67-12.45%
    EQIXEquinix, Inc.170.01217.2527.79%
    TEVATeva Pharmaceutical38.352.2236.34%
    CHRWRobinson Worldwide57.268.4519.67%
    EXPEExpedia Inc.48.8487.4379.01%
    NUANNuance Comm.19.3117.17-11.08%
    MXIMMaxim Integrated27.7130.9111.55%
    BRCMBroadcom Corp.25.2438.8153.76%
    ISRGIntuitive Surgical390.09478.6822.71%
    NWSANews Corporation15.7517.6211.87%
       Avg. % change23.92%
    NDXNasdaq 100 Index  30.26%

    The watch list of stocks gained +23% versus a gain of +30% in the Nasdaq 100 Index. The best performing stock, with gains of +79%, was Expedia which was a strong interest stock featured on our July 26, 2013watch list. At the time, we said the following:

    Travel website operator Expedia (NASDAQ:EXPE) has suddenly dropped in on our watch list with a -27.38% decline in the stock price on Friday July 26, 2013. We're not sure that a -28% decline in quarterly earnings requires a -27% decline in the stock price. This type of activity suggests that since June 2012, investors had not sufficiently assessed the prospects of the company before acquiring the stock. Extreme swings in the price indicate that there is more downside risk.

    Applying Edson Gould's Speed Resistance Lines gives us a conservative downside target of $42.56 and an extreme downside target of $22.70.

    Our expectation is that there is a good chance that Expedia will decline to the $34 level. Once falling below $34, Expedia should be reviewed on a fundamental basis as a going concern. There may be significant opportunity for this stock as the performance has been in line with industry competitors.

    As is often the case, we were too conservative in believing that EXPE would achieve the rising $34.00 level. Instead, EXPE fell exactly to the rising $42.56 level and moved higher from there (updated chart below).

    (click to enlarge)

    Another strong interest stock in the same July 26, 2013 posting, Equinix (NASDAQ:EQIX) also fell only as low as the conservative downside target. From the peak price of $229.02, EQIX spent only four trading days below $158.37. It has been nothing but an uphill climb since.

    The worst performing stock was Sears Holdings (NASDAQ:SHLD). Sears has essentially traded with descending peaks since 2007 with price support at around $30. A break below $30 could result in significant loss for any remaining shareholders. Private equity firms must be circling Sears at the prospect of a decline below the long-term support.

    (click to enlarge)

    The strong interest stock from the August 23, 2013 watch list was Maxim Integrated Products (NASDAQ:MXIM). At the time we said of MXIM:

    "The stock of most interest to us is Maxim Integrated Products (MXIM). Maxim has had a great run since our March 20, 2010 highlight of the chip sector as potential investment candidates (found here). In the chart below, since the 2008 trough, Maxim has maintained a consistent ability to rebound from the conservative downside target of $26.97. However, if the stock cannot hold the line at $26.91, then we expect that the stock will fall to the $19.03 level. The extreme downside target is $11.10, however, we don't expected this to be achieved. Potential investments at the current level along with stepped up amounts of capital at $19.03 and $15.87 is recommended."

    Since August 23, 2013, Maxim increased as much as +29.05% before falling to a 1-year gain of "only" +11%. If we include the dividend of 3.80%, the total return would be +15% for the last year. Below is the updated SRL for MXIM with new conservative and extreme downside targets.

    (click to enlarge)

    Although Maxim has fallen considerably since the June 2014 peak, we're only willing to re-consider the stock after falling at or below the rising $27.79 level.

    Aug 27 1:56 PM | Link | 1 Comment
  • Apple Meets NLO Upside Target

    On August 19, 2014, Apple (NASDAQ:AAPL) stock price rose as high as $100.66. When Apple was trading at $61.61 on March 9, 2013, we said the following with the accompanying chart:

    "Apple Inc. (AAPL) is at the top of our watch list as it is within 5% of the one year low. In our April 14, 2012 test of the quality of Edson Gould's Speed Resistance lines, Apple fell from $636 [adjusted price of $90.85] to our projected level of $424.15 [adjusted price of $60.59] (found here). Now that the stock has achieved our downside target, we expected that a reaction to the upside is likely."

    (click to enlarge)

    On July 17, 2013, when Apple was trading at $61.47, we re-affirmed our view of the upside potential for Apple with the following commentary:

    "Currently, Apple is demonstrating a basing pattern that if successful, could result in a breakout to the upside. At the current levels, we wouldn't be opposed to buying some shares of Apple with the expectation that the stock could decline an additional -25% to -35%."

    The work of Edson Gould has proven to be astounding when considered in its context. On April 14, 2012, we posted an article titled "Considering the Downside Prospects for Apple". At that time, we were revising the previous estimates of downside risk done on February 5, 2012 (third party source available here).

    What was mentioned on February 5, 2012 is critical to understanding how Edson Gould's downside projections work. At the time, we said:

    "The very first thing that we look for, to determine speed resistance lines, is the most recent peak in the price. Because AAPL is continually making new highs, we only need to use the latest price of $455.68 [post split price of $65.09] as our starting point….As the price of Apple increases, so too does the SRL lines based on the work of Edson Gould."

    This means that as long as the price of the stock increases to a new high the speed resistance lines are expected to increase as well. Only when the stock starts on a declining trend can we expect that the stock price might go to the conservative and extreme downside targets.

    (click to enlarge)

    On April 14, 2012, when Apple was trading at $90.89 (pre-split price of $636.23), we said the following:

    "…we believe that, based on the current speed resistance lines, no one would expect Apple to decline to our conservative downside target of $424 (post split price of $60.57)…"

    The strength of Gould's downside risk estimates is that we didn't even have the peak price of $100.71 set on September 18, 2012 but we were still able to see the conservative downside target of $60.57 achieved. Had we used the peak price, we would have achieved the $67.14 conservative downside target much earlier than the $60.57 level

    Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: AAPL
    Aug 20 11:16 AM | Link | Comment!
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