Stock Evaluation 2 – Benjamin Graham method

In my first post, I talked about some of the rules that Benjamin Graham used to sort through the stocks to identify. Back in June, I used the decision criteria from “The Little Book of Value Investing.” I used these to identify seven potential stocks at the time, and saw which stocks matched the most criteria (shown in green)

 

OTEX TSN PAG LYB GILD SYMC ALK
Name Open Text Corp Tyson Foods Inc Penske Automotive Group Inc LyondellBasell Industries NV Gilead Sciences Inc Symantec Corp Alaska Air Group Inc
Dividend Yield 1.4% 1.4% 2.3% 3.7% 3.0% 1.0% 1.2%
Greater than $2B market value $8.81B $17.99B $4.40B $37.21B $91.62B $17.85B $11.96B
2-1 ratio of current assets vs liabilities 3.3 1.8 1 2.2 1.9 1.8 1.7
Positive earnings in each of last 10 years 5 5 5 5 5
Paid a dividend at least 20 years, raised over last 20 years No Yes Yes No No
Increase their earnings per share by at least 1/3, over 10 years Yes Yes Yes Yes Yes
P/E of 15 7.4 13.8 13 10.1 7 9.2 14.8
Price-to-book of 2.5 or less 2.52 2.33 2.51 6.12 5.43 4.52 4.18

 

The next step from there was to look through the stocks, get information and try and see which ones you understand. It does you no good to evaluate a company’s performance if you don’t really understand what they do. Warren Buffet is well known for not investing in technology, because he doesn’t really understand it. He understands Coca Cola, Geico insurance, etc. – so that is what he invests in. In this case, I understood OTEX, Tyson, PAG, Lyb and Gilead, so I chose to concentrate on them.

Graham had a formula for determining intrinsic value. Value = E * (2g + 8.5)  * 4.4/Y

  • E = current earnings per share, after taking out dividends
  • G = annual earnings growth – with 5 percent figured as a “5”. Typically for young, growth companies he used 10% growth, while using 6% for companies in a mature industry
  • 8.5 is the base P/E ratio for a stock with no growth
  • Y is the current interest rate, represented as the average rate on high-=grade corporate bonds

An example would be a company with a current earnings of $2.30, a growth rate of 10 percent, and a corporate bond rate of 6 percent. The intrinsic value is $2.30 * ((2*10)+8.5) * (4.4/6) or $48.07 per share

 

When I took the list above, using this equation, I came up with the following intrinsic value

Intrinsic Value OTEX TSN PAG LYB GILD
Earnings w/o dividends $0.75 $3.93 $2.69 $6.58 $7.13
Growth rate 10% 6% 6% 6% 6%
Bond yield 3.7% 3.7% 3.7% 3.7% 3.7%
Graham’s Value $25.42 $95.81 $65.58 $160.41 $173.82
Current Stock $33.48 $62.50 $51.88 $91.80 $72.06
Variance ($8.06) $33.31 $13.70 $68.61 $101.76

After this analysis I took the opportunity to look through Gilead’s annual reports. While their stock price had dropped dramatically, their overall economic position was strong, and they had a lot of excess cash. By the time I ended up deciding on the stock , Gilead had actually dropped to $66.46 (almost $6 less than my original analysis).  Using Graham’s numbers, it appears to have a tremendous amount of “up” (it had a P/E ratio of 7, or if inverted, a yield of 14%!). Since I purchased it in late June 2017, it has gone up to $83.27 (a 25.3% jump). Supposedly, based on it earnings, it could go as high as $173.82. I will have to keep track of it going forward.

In August and September, using the same concept, I’ve purchased TAHO (a mining company) and CSS (consumer products) both selling below book value, and seemingly underpriced. While I haven’t gotten a big “jump” on either (TAHO up 6% in 2 months, CSS up 2% in 1 month), they are both doing fairly well. I will keep them until they come close to their intrinsic value – which may be several years.

What systems do you guys use to pick stocks or mutual funds?

 

Mr.39 Months

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