Since the stock market is down so much and lots of companies look cheap right now, I wanted to look at few good companies to invest for the long run. The problem is how to value a company in this shaky market. Therefore, I went back to The Intelligent Investor and read chapter 14, Stock Selection for the Defensive Investor. Here is the summary of the seven points to look at according to Graham.
1. Adequate Size of the Enterprise: Graham says company should have an adequate size and sales of $100 million per year. In today’s terms that probably means a company with a market cap of at least $1 billion and sales of at least couple hundred millions.
2. A Sufficiently Strong Financial Condition: A current ratio of at least two and long term debt less than working capital. Basically what this means is current asset should be twice the current liabilities (or more), and long term debt should be less than current assets minus current liabilities.
3. Earning Stability: There must be earnings in each of the 10 years, which means no loss in that period. I am assuming Graham means that in an annual level and not quarterly, since that would mean looking at 40 quarterly earning reports!
4. Dividend Record: There must be at least 20 years of continuous dividend payment record. A history of increase in dividends over time is even better.
5. Earnings Growth: According to Graham, the earning growth in last 10 years should be at least 33%. When looking at the earning, he wants us to look at three year averages from 10 years ago, and compare that with the average of last three years. I think we’ll have to look at average earning per share (EPS).
6. Moderate Price/Earning Ratio: This is self-explanatory. However, compare current price with an average earning of last three year, not of last year’s as they report in stock quote.
7. Moderate Ratio of Price to Asset: This one I thought was little confusing. He say’s current price should not be more than 1.5 times the book value of the stock. However, if P/E is less than 15, then P/E times Price/book should not be more than 22.5. That means, if P/E is 10, then price/book of up 2.5 is acceptable.
These are the basics of valuing a company Graham’s way. I’ll need to apply this and screen for stocks to see if any meet these criteria right now. I’ll let everyone know if I find any.
2 Comments until now.
I briefly read an article which stated something about investing in companies with smaller market cap? I can not seem to find the article any longer…read it either on cnn money or Forbes… anyways, what is your intake on that? I am not sure if you have read that article, but are you still going to be following Grahams’ way? Do you think your perception on the 1st point of Graham’s 7points will change as time/situation changes?
Also, this seems to be the time to start investing in “green companies”….. do you have any on your portfolio? Attached is a link to an article about finding the right green fund!
http://money.cnn.com/2008/11/05/magazines/fortune/levenson_greenfunds.fortune/index.htm?postversion=2008110606
Anyways, great writing! I will definitely be checking back to see what new/interesting information you provide.
Bubbles, You bring a good point about the small cap companies. People should definitely invest in small cap companies as they tend to outperform large cap in the log run, but they are also a little riskier. These seven points are for “defensive investor” who don’t want to take any risk with smaller companies. In my own portfolio, I want to have 20% in small cap, but it’ll be in some sort of mutual fund or ETF. For an average investor like me, looking at growth prospect of a small company is hard to do.
About the “green companies”. Of course we need to invest in them. But when I say “We” I mean we as a country, as a government, in the same manner as we need to “invest” in education and health care. I don’t think I am ready to invest in those company with my money yet.
Comment!