Rev. Ed: The Definitive Book on Value Investing
0060555661
Benjamin Graham, Jason Zweig, and Warren E. Buffett
Notes
The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condition…the enterprising investor concentrate on the larger companies that are going through a period of unpopularity…the stock market’s attitude toward secondary companies tends to be unrealistic and consequently to create in normal times innumerable instances of major undervaluation…let us suggest that an issue is not a true “bargain” unless the indicated value is at least 50% more than the price…secondary companies, which we recommend for purchase when they can be bought at two-thirds or less of their indicated value.
Nonetheless we are convinced that our 50–50 version of this approach makes good sense for the defensive investor. It is extremely simple; it aims unquestionably in the right direction; it gives the follower the feeling that he is at least making some moves in response to market developments; most important of all, it will restrain him from being drawn more and more heavily into common stocks as the market rises to more and more dangerous heights.
An industrial company’s finances are not conservative unless the common stock (at book value) represents at least half of the total capitalization, including all bank debt. For a railroad or public utility the figure should be at least 30%.
The type of bargain issue that can be most readily identified is a common stock that sells for less than the company’s net working capital alone, after deducting all prior obligations.
Three contracts:
- Comprehensive financial plan – outlines how you will earn, save, spend, borrow, and invest your money
- Investment policy statement – spells out your fundamental approach to investing
- Asset-allocation plan – details how much money you will keep in different investment categories.
The company has a wide “moat,” or competitive advantage. Like castles, some companies can easily be stormed by marauding competitors, while others are almost impregnable.
Owner earnings – or net income plus amortization and depreciation, minus normal capital expenditures….If owner earnings per share have grown at a steady average of at least 6% or 7% over the past 10 years, the company is a stable generator of cash, and its prospects for growth are good.
…all suggest looking at the daily list of new 52-week lows in the Wall Street Journal or the similar table in the “Market Week” section of Barron’s. That will point you toward stocks and industries that are unfashionable or unloved and that thus offer the potential for high returns once perceptions change.
…always read the proxy statement before (and after) you buy a stock…the intelligent owner will vote against any executive compensation plan that uses option grants to turn more than 3% of the company’s shares outstanding over to the managers.
If you have formed a conclusion from the facts and if you know your judgment is sound, act on it—even though others may hesitate or differ…“In making decisions under conditions of uncertainty, the consequences must dominate the probabilities.
Quality and quantity criteria for the selection of specific common stocks
- Adequate Size of the Enterprise – Our idea is to exclude small companies which may be subject to more than average vicissitudes especially in the industrial field.($2BB)
- Sufficiently Strong Financial Condition – For industrial companies current assets should be at least twice current liabilities—a so-called two-to-one current ratio. Also, long-term debt should not exceed the net current assets (or “working capital”). For public utilities the debt should not exceed twice the stock equity (at book value).
- Earnings Stability – Some earnings for the common stock in each of the past ten years.
- Dividend Record – Uninterrupted payments for at least the past 20 years.
- Earnings Growth – A minimum increase of at least one-third in per-share earnings in the past ten years using three-year averages at the beginning and end.
- Moderate Price/Earnings Ratio – Current price should not be more than 15 times average earnings of the past three years.
- Moderate Ratio of Price to Assets – Current price should not be more than 1½ times the book value last reported. As a rule of thumb we suggest that the product of the multiplier times the ratio of price to book value should not exceed 22.5. (This figure corresponds to 15 times earnings and 1½ times book value. It would admit an issue selling at only 9 times earnings and 2.5 times asset value, etc.)
Filtering Criteria:
- Assets >$2BB
- Current Ratio >2
- EPS Growth past 5 yrs = >10%
- P/E <15
- P/B <2
Additional Filtering:
- USA
- Profitable
- P/FCF <10 Operating Margin >10%
- No – Financial, Healthcare, Oil & Gas