While I am aware that I should be pontificating today about the jobs number and its likely impact on the prospects that the Federal Reserve eases up on its quantitative easing programs.
I decided that adding my voice to the noise wouldn't help matters much, especially since I haven't read the release. I am more interested in all the Ben Graham interviews I read last night and the direction those led me this morning. I will read the report but it won't have any impact at all on my investment decisions -- unless at the wonks decide it is horribly bearish and creates an opportunity for me to buy cheap stocks.
In the September 1976 editions of Medical Economics, Ben Graham, often called the father of value investing, outlined a simple approach to picking stocks that he had tested by hand. He used low price-to-earnings ratios and strong balance sheets that he had found easily beat the market over the past 50 years. I reread this article last night and recalled that earlier that year he had mentioned the study and said that one could apply a dividend or asset criteria in place of earnings and also get good results.
I immediately sat down and started running quick and dirty back tests of the approach, substituting price-to-book value for price-to-earnings ratio. He suggests holding the stocks for two years for a gain 50% in value
The criteria are simplistic. I tested for stocks that traded below book value and had equity-to-asset ratios of at least 50%. Over the last 10 years this simple approach returned 27% annually vs. 9% for the broader market, according to my quick test. It doesn't lose much with time, either, as over the last 20 years the simple approach earns 18% annually on average. There are just two down years out of 20. The problem most people will have with this approach is that there are years where no stocks can be found and you are in cash.
I am, of course, a devoted follower of Mr. Womack the pig farmer, so being completely out of stocks in years like 1998-99 and 2006 to 2007 is not a huge problem for me!
I am well aware that back tests don't necessarily lead to future results, but this simple screen seems to have real potential to find possible bargain-winning stocks capable of producing solid returns. When I ran the screen this morning, I was gratified to see that according to the asset version of Graham's simple stock picking theory, I am pretty much on the right track with my deep value approach. The list came up with many of the stocks I already own and have written about over the past few months.
Miners are very well represented with companies like Couer Mining (CDE), Pan American Silver (PAAS), and Hecla Mines (HL) all make the cut. I have no idea when silver prices will rise again. Even it takes 10 years, buying the miners at these levels should give me substantial profits over the long run when metals prices do improve at some point in time. Several gold miners make the list, but I have a strong preference for the silver miners right now.
Energy companies on the list include two of my favorite oil and gas stocks. Both Penn West Petroleum (PWE) and WPX Energy (WPX) trade at steep discounts from book value and have adequate equity-to-asset ratios. I actually expect to make lot more than 50% from them over the next several years. Energy demand will improve along with the global economy and these stocks should appreciate by multiples of this prices rather than just percentages.
Other stocks of note that make the grade include companies like MFC Industrial (MIL), Alpha and Omega Semiconductor (AOSL) and Transworld Entertainment (TWMC) that I have mentioned recently. They all trade well below book value. Using my asset-based version of Graham's simple stock picking market, I find they are all worthy of buying right now for long-term value investors.
Graham suggested spreading the money across 30 or so stocks in different industries. It would be tough to get fully invested using this approach right now as energy-and mining-related stocks dominate the list. I do not necessarily view that as a bad thing given current market levels and conditions but I am very comfortable owning the stocks that do pass the screen right now and which are holding a high level of cash.
I am always amazed more people do not use the techniques developed by Benjamin Graham, but I am really glad they do not as it makes it a lot easier for me to uncover safe and cheap stocks.
