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Graham & Dodd - Security Analysis

May 20th 2016 – Written by Andrew Chorley

This book was published in 1934 and any serious investor should really take the time to read it; anyway shortly before his death Benjamin Graham devised a way of looking at equities that encompassed key components of valuation, financial security and growth that could be used to screen for shares.

Here is a list of them below (don't worry too much about some of the terminology): –

 

  1. Earnings yield greater than twice the yield on AAA Corporate Bonds
  2. PE of less than 40% of the Peak PE
  3. Dividend yield at least 2/3 of the yield on AAA Corporate Bonds
  4. Price of less than 2/3 of tangible book value
  5. Price of less than 2/3 of net current assets
  6. Total debt less than 2/3 of tangible book value
  7. Current ratio of more than 2
  8. Total debt less than or equal to twice net current assets
  9. Compound earnings growth of at least 7% p.a. over 10 years
  10. Two or less annual earnings declines of 5% of more in the past 10 years

 

So armed with this lets see what we can find in the FTSE-100 in the first table on the image. 

Now Mr Graham accepted that times were changing, back in the 1930’s the US Stock Market was dominated with firms that had a lot when it came to Tangible Book Value – typically they were railroad or steel firms that invested heavily in physical assets. Today is a different story many firms value is in their “intangible” assets such as a brand name, probably the best example is Coca-Cola.

With this in mind he suggested a focus on points 1, 3 and 6 and for good measure a Cyclically Adjusted Price Earnings (CAPE) ratio of less than 16 – the CAPE is a inflation adjusted measure of a firms earnings over 10 years and aims to iron out the peaks and troughs of a business cycle.

As we can see in the second table on the image, a total of two shares out of 100 (2%) and if we looked at the FTSE 350 a total of 16 shares appear (4.6%) – so for value investors pickings are slim.

Nick Train, the manager of Finsbury Growth & Income Fund follows a very value orientated strategy and recently bought his first share in four years!!

EST. 1999