Thursday, September 04, 2008

Book review - Benjamin Graham on Value Investing by Janet Lowe

It's been quite a while since I did a book review. Having finished a big portion of what I wanted to read as I began my journey in fundamental analysis, I found that there are less and less things worthy of writing down. Most are pretty much the same, perhaps only the tone and the examples used are different. Once a while, I'll come across a gem worth blogging about and it is this book - Benjamin Graham on Value Investing - by Janet Lowe that I am pleased to review here.

My gf told me a very interesting insight. I asked her if she had heard of Warren Buffett, which she replied yes. Then she told me that she will be more interested in reading how his family raised him as a child to make him who he is today, rather than read about all his techniques or methods of investing (all written by others, by the way - he had yet to write a book on investment himself, save his annual berkshire hathaway reports and shareholders's letters). I think the same can be applied here on this book about the Dean of wallstreet - Benjamin Graham.

This book chronicles the life of Ben, including his encounters and various relationships with women. I find his life extremely interesting - though a bit unlucky and unfortunate. While I will not elaborate parts of his life in this review, suffice to say, Ben is a very smart and practical investor, who also had the clarity of thought and eloquence to write in the most convincing and simple way. He is also very generous, to the point of being easily taken advantage of (though he do not seem to mind). This book came with some pictures of the "superinvestors of grahamsville and doddsville", referring to the class that Warren Buffett is part of, in which Ben taught in Columbia Business school.

Having read his autobiography in this book, I was tempted to re-read The Intelligent Investor the second time, and Security Analysis the first time. I'll do Security Analysis (1951 edition) first, of course. I find that I can relate to Ben better, having understood why he did certain things. Musicwhiz is right. He mentioned, having read my analysis, that I am more graham and less buffett. Now, I agree totally with him. Perhaps my inherently shy nature makes it hard for me to ask anything during AGM (I confess I still haven't attended one!). It helps that I'm very comfortable with numbers too.

Perhaps in such a market time, we all need to remind ourselves of the teachings of Ben. Below are but 10 simple steps to select undervalued stocks:

1. A earnings yield (reverse of PE) that is double the triple A bond yield - if the triple A bond yield is 6%, then the earnings yield will have to be 12% (giving a PE of 8.3x too)

2. A PE ratio that is four-tenths of the highest PE achieved by the stock in the most recent five years - PE is defined as average stock price for a given year divided by earnings for that year

3. A dividend yield of two-thirds the triple A bond yield - stocks that do not pay dividend or with no current profits to pay dividends are excluded

4. A stock price of two-thirds the tangible book value per share - TBV is defined as all assets excluding intangibles like goodwill, patents etc, subtracting all liabilites and debts, then divided by total number of shares

5. A stock price that is two-thirds of the net current asset value or the net quick liquidation value - the net quick liquidation value is current assets less total debts then divided by total number of shares

6. Total debt is less than tangible book value

7. Current ratio of 2 or more - current ratio is current assets over current liabilites. This is an indicatioin of the company's liquidity, or its ability to pay its debt from its income

8. Total debt at or less than the net quick liquidation value

9. Earnings that have doubled in the most recent ten years

10. No more than two declines in earnings of 5% or more in the past ten years

Criteria 1 - 5 measures risk; 6 and 7 define financial soundness; 8 - 10 show a history of stable earnings. Not all companies will have all 10 criteria. I found that this is a good guide to screen stocks, though take note that the usual graham holdings is no less than 10 stocks and is widely diversified (30 or more stocks in portfolio is ok).


kennynah said...

lapap : k from huatopedia here.. i responded you but somehow the message just got stuck at the outbox...just wont go out..i tried it 3 times...

we comms again...soon

la papillion said...


Not to worry, I got all 3 messages :)

Anonymous said...

Hmmm,, criteria fits

SPC below $4.50? ;)

Financial Journalist said...

When I was working in an equity fund house few years ago, I asked one of the senior fund manager if Ben Graham investment style is still valid in today's world. The senior fund manager replied me that it is outdated.

Of course you or me may not agree with him, but just for your information only.

So what are the stocks that you think fit into those criterias?

la papillion said...

Hi Kuan Han,

Haha, I've no idea if SPC fits into the criteria, having not studied into the company at all :)

la papillion said...

Hi Brendan,

Thks for your info :) I kind of think that it's a little outdated too, because Ben focuses too much on the tangible assets of business while ignoring the intangible assets parts. While it is true in his times (railroads, which Ben is very familiar with, is an example of heavy tangible assets type of company), it might not be so true in today's franchise type of business that Warren Buffett loves.

Nevertheless, the idea of differentiating between price and value and the margin of safety are timeless principles in fundamental analysis. I believe it is true now, and will continue to be true in the future.

I think one can't get poor using Ben's method, which is a little too conservative. As for which stocks fit into those, I've no idea :) I thought it might be a good idea to screen future undervalued stocks though :)

Mike Dirnt said...

lol i thought of following all of Ben criteria on our local market. if you are to do that, non of the stocks fit into the criteria. AFAIK

in US they got so many stocks to choose from. so i think its more easier to shortlist some.

but i just dont like to own overseas stocks because i feel that i dont have the "home" advantage. i rather go for overseas etf instead

la papillion said...

Hi mike,

Can't follow all of them :) He said that it's very very rare to see a stock with all the 10 listed. Anyway, these are just guidelines, so I'm sure even Ben himself won't be so rigid on them :)