Before we move on from the Graham stock selection criteria, I want to look at another recombination of his criteria that has provided solid results over the past 25 years or so that I have been around the markets.
Instead of earnings yield this time, we will focus on my favorite tool: price-to-book value. We then look for those that are profitable and pay dividends to assemble our list of stocks. This has been part of my approach for many years now and it works as well for me as it did for Graham many years ago.
Curiosity got the best of me this morning, so I ran a quick and dirty back test of the approach. Over the past 25 years this approach has yield an average annual return of 40% more than the broad market. Only four years staying fully invested and using this approach showed a loss and in the year following a loss the asset-based approach outperformed the market by an average factor 3-to-1. It requires a great deal of patience and discipline, but it works extraordinarily well.
My first observation upon looking at the current list is that is it absolutely dominated by small banks. Of the 81 names returned by screen, 34 of them were small community and regional banks. Most of them are my tiny banks but a few are large enough to be familiar to readers. Republic Bancorp (RBCAA) has risen in price since I first talked about the Kentucky-based bank, but it is still statistically cheap. Fox Chase Bancorp (FXCB) is not the most exciting stock I have ever owned, but it has moved steadily higher and is still very cheap. But the next bargain issues are the smaller institutions. The industry faces short-term headwinds, but many of the stock are too cheap not to own.
One of the cheapest non-financial stocks on a book value basis is Kelly Services (KELYA). The staffing company currently trades at just 70% of tangible book value as a weak global economy weighs on the business and stock price. Not only has the company been profitable since the end of 2009 in a very weak global economy, Kelly has reported a full-year loss just twice in the past 10 years and that was in the near-depression years of 2008 and 2009. There is a slow recovery starting in jobs in the U.S., although Europe remains weak. Much of the hiring is temporary and that favors Kelly Services. This is a too-cheap-not-to-own stock and one of my top picks for a tough market.
American Greeting (AM) is also a very cheap stock, with the stock at 70% of tangible book value. The entire greeting card industry has suffered as much of the communication world has gone online, but there will always be birthdays, anniversaries and other occasion where online simply will not do and eventually American Greetings should see its business recover. They are the second-largest global and only publicly traded greeting card manufacturer. It is not a sexy or exciting business, but it is a cheap stock with a solid balance sheet as evidenced by its Altman Z score of more than 3. Greeting card sales will grow in line with the economy and when this happens, the cost reductions and structural changes implemented over the past few years will turn the company into a steady growth stock with an increased valuation.
The stock selection techniques outlined by Benjamin graham back in the 1970s still works today. Although many talk about the Graham approach to picking stocks, almost no one actually uses his approach and that suits me just fine. Buying cheap stocks requires a great deal of fortitude and patience. As an Orioles fan and value investor I have perfected both traits.