Calling for a Substitution

 | Jun 11, 2013 | 3:30 PM EDT  | Comments
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In addition to using simplified price-to-earnings and debt metrics to pick stocks in the 60-year study he completed in the mid-1970s, Ben Graham also noted that you could substitute asset-to-price measures and achieve similar results.

This is something of a relief to me as I have found that over the past 40 years the reliability of earnings measures has become somewhat suspect. Using the generous accounting standards, strategic buybacks and other financial engineering shenanigans, most CFOs can make the earnings number come out where they want each quarter. Not everyone does this, but enough do that earnings, and consequently price-to-earnings ratios, are a bit trickier to use when searching for stocks. It will come as no shock that I prefer to use book value in my search for stocks.

During last night's extensive rain delay in Baltimore, I sat down and ran a screen for income stocks substituting a low price-to-book value for earnings for low price to earnings. I think investors looking for a decent income from their portfolio in these yield-starved times should do both in order to find as many stocks as possible. The trick to making a cheap-stock, income portfolio to work over the long run is to own a bunch of them and let time and value work for you while you cash the quarterly checks.

I found some names that are worthy of inclusion in a long-term income portfolio that should also have long-term upside appreciation potential. I have been a long-term fan of California First National (CFNB) for several years now. The stock has not had any spectacular appreciation, but it has steadily cranked out dividends and the shares currently yield 13%. The finance company takes in deposits via telephone, the Internet and mail and uses the funds for its leasing business that specializes in high-technology assets. Like every other lending or leasing institution in the U.S., it is seeing some compression in net interest margins and this is keeping earnings in check for now.

The actual leasing business is starting to see some strength as the economy slowly recovers and this should continue as we move from better to good over the next few years in terms of economic activity. The stock trades at 95% of book value right now. Insiders own 82% of the shares and have a vested interest in seeing the stock move higher over the next several years. I think it will, and in the interim we get paid to wait.

Old Republic Insurance (ORI) is probably not going to be the most exciting stock you ever own in your lifetime. The company sells insurance such as aviation, marine, commercial auto and general liability policies. They also sell extended auto warranties policies and title insurance. But it is a classic high-yield value stock trading at 93% of book value with a yield over 5.4%. Insiders like the long-term prospects of the company, as several of them have been buying the shares this year. It may not be exciting, but is should be enriching over the next several years. The insurance business should grow a little faster than the economy and, as growth picks up, earnings and revenues should rise.

Ampco Pittsburgh (AP) is another stock that is not likely to make the most exciting list any time soon. The company makes custom-engineered equipment and business has basically been flat for some time now. Both forged, hardened steel and air processing equipment divisions need to see the economy move from the somewhat better to pretty good before business can really pick up. Until then the stock is trading right around book value, the balance sheet is strong and the share yield almost 4% at the current quotation.

The search for income stocks is one of the most frustrating endeavors for investors right now. The market has moved straight up without a significant correction for over a year now. Interest rates are low and, in spite of recent gyrations in the long-term bond prices, are likely to remain so for an extended period of time. It is critical that investors avoid the product push of Wall Street and use common sense in assembling a portfolio of income securities. Adding an income component to the stock selection techniques developed by Ben Graham makes a lot of sense to me.

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