Every few months I like to go back and run a screen based on the investment approaches developed by Ben Graham. His most well-known approach involves buying stocks that trade for less than net current asset value. That is a screen I run on a regular basis.
Tthere are just a handful of very small companies on that list right now. I will look at some of his other stock selection techniques to see if I am overlooking any solid stock ideas.
Late in his life, Graham did a long 50-year study of stocks (by hand mind you. Ben didn't have a laptop that could pull up the data at high speed!) that showed that using simple models based on valuation and risk could help deliver outstanding returns for investors. In a interview with Hartman L. Butler Jr. in 1976 , not long before he passed away, Graham said:
"I have a considerable amount of doubt on the question of how successful analysts can be overall when applying these selectivity approaches. The thing that I have been emphasizing in my own work for the last few years has been the group approach. To try to buy groups of stocks that meets some simple criterion for being undervalued-regardless of the industry and with very little attention to the individual company."
His criteria were pretty simple. In the interview he also said:
"I have set two limits. A maximum multiple of 10 even when interest rates are under five percent, and a maximum multiple of 7 times even when interest rates are above seven percent as they are now. So typically my buying point would be double the current AAA interest rate with a maximum multiplier between 10 and 7. My research has been based on that."
Interest rates are of course well below 5% so the number now is going to be a maximum of 10%. Then, to create a margin of safety in the balance sheet, he looked for companies that owned as much as they owed. And he limited the universe to those companies with equity to assets ratios of .5 or higher.
Graham found that this approach worked well, delivering returns of 15% or so annually for the 50 -years prior to 1976. Wesley Gray and Tobias Carlisle updated the study in their book Quantitative Value and found that from 1976 to 2011, investors using this simple approach gained more than 17% a year. It is a very simple quantitative strategy that has delivered consistently high returns.
When I ran the screen this morning, using a trailing 12-months maximum price-to- earnings ratio of 10, the list is full of energy stocks. Given their high correlation to commodity prices, these issues probably deserve their own article, if not a special study or book. I decided to devote my time to scouring the list for those stocks that are not in some aspect of the energy business.
Sanderson Farms (SAFM) is in the chicken business. The company processes about 10 million pounds of chicken a week for consumer and food service markets around the U.S. Business is pretty good as the company had a strong fourth quarter. Sales were up and feed costs were down, driving decent profit growth.
Management has been fixing up the balance sheets as well and has paid off almost all of its long term debt. They have plenty of cash on hand and are in a position to expand the business via acquisition should the opportunity arise. The stock trades a 7 times earnings right now so it is a Graham style bargain based on earnings.
At times I feel like the last actual reader pf physical newspapers. I have two a day delivered to the house and usually pick up a cop of USA Today a few times a week. Because of that I was happy to see a newspaper company on the list. AH Belo (AHC) owns the Dallas Morning News, The Providence Journal, and The Denton Record-Chronicle. They also have a Spanish paper and the weekly publication The Journal Express as well as a printing and direct mail businesses. The company has equity to assets ratio of .70 and a PE of just 4, so it is a well-financed bargain stock. With a yield of 3.5% investors can get paid to wait for this stock to move higher over the next few years.
When you leave energy-related stocks out of the mix, the list of Graham's safe and cheap stocks is slim right now. Without turning their account into an energy fund, investors would be hard pressed to find the 30 or so stocks Grahm suggested would provide a solid portfolio.
