Ben Graham still packs a punch. Although the father of value investing passed away in 1976, his investment philosophies are still valid and cannot be dismissed as antiquated. I have long been a proponent and student of Graham's net-net strategy, but that was just the tip of the iceberg in terms of his investment criteria.
Back in late 2010, I wrote a column based on Graham's "Stock Selection Criteria for the Defensive Investor," which reveals larger and higher-quality names than the net-net search. Ben wrote about these criteria in his classic book, The Intelligent Investor.
Here are the criteria used for this screen. Please note that my list diverges from Graham's criteria in some respects, because of data limitations or changes in the value of the dollar since 1973.
- Adequate size: We are using minimum sales of $500 million on a trailing 12-month basis. (Graham called for minimum sales of $100 million and total assets of at least $50 million.)
- Strong financial condition: The company must have a current ratio -- current assets divided by current liabilities -- of at least 2, and long-term debt must be less than working capital.
- Earnings stability: The company must have positive earnings for the past seven years (Graham used a minimum of 10 years).
- Dividend record: The company must have paid a dividend for the past seven years (Graham used 20 years).
- Earnings growth: Growth must be at least 3% compounded annually over the past seven years (Graham used a minimum increase in earnings per share of one-third over the past 10 years).
- Moderate price-to-earnings ratio: The stock must have traded at an average P/E of 15 or less in the past three years.
- Moderate ratio of price to assets: The price-to-earnings ratio times the price-to-book ratio must be less than 22.5.
- No utilities.
The screen revealed just four names: The metals processing services company Reliance Steel & Aluminum (RS), the aerospace/defense company Curtis-Wright (CW), the pawn lending/check-cashing company Cash America International (CSH) and the tobacco products company Universal Corp. (UVV).
While that may not be an adequate sample size by which to judge the potential efficacy of this screen, the performance of these names has been quite good, with the average return greater than 27% since my original column ran. That's much better than the S&P 500 (+14.5%), S&P 400 Mid-Cap (+14.4%) and S&P Small Cap (+18.9%). Interestingly, the returns were also fairly consistent -- each name was in the positive mid to high 20% range. That consistency is atypical for most of the screens that I utilize; I usually find a couple of big winners and losers, and several in the middle.
I'll be re-running this screen over the weekend and will reveal the results next week. But since the criteria are so stringent, it's doubtful there will be many names this time around. Interestingly, when Ben Graham utilized this screen at the end of 1970, all 30 components of the Dow Jones Industrial Average made the cut. How times have changed.
