John Dorfman, the well respected Bloomberg columnist and chairman of Thunderstorm Capital, discusses Ben Graham’s contribution to investing and his value-based investment approach.
Dorfman outlines Graham’s strategy, which includes looking for stocks that trade for less than book value and less than 12x earnings. Graham, according to Dorfman, also wanted to see “earnings power over a prolonged time span” (7-10 years). By looking at earnings over a longer period of time you can feel comfortable that a firm’s earnings power is sustainable through all different types of market environments.
By combining these criteria, Dorfman comes up with four of stocks that Graham might buy should he be alive today.
- Tutor Perini Corp (TPC)
- Boston Scientific Corp (BSX)
- Rowan Cos. (RDC)
- Cabela’s Inc. (CAB)
When we looked at these stocks through Validea’s (the firm that powers this blog) Graham model, they stacked up well. The two top scoring names were Rowan and Cabela’s, which both obtained a score of 86% (out of a 100%).
Below is a detailed analysis from Validea’s Graham model using Cabela’s (CAB) as an example.
CAB is neither a technology nor financial Company, and therefore this methodology is applicable.
The investor must select companies of “adequate size”. This includes companies with annual sales greater than $340 million. CAB’s sales of $2,592.5 million, based on trailing 12 month sales, pass this test.
CURRENT RATIO: [FAIL]
The current ratio must be greater than or equal to 2. Companies that meet this criterion are typically financially secure and defensive. CAB’s current ratio of 1.97 fails the test.
LONG-TERM DEBT IN RELATION TO NET CURRENT ASSETS: [PASS]
For industrial companies, long-term debt must not exceed net current assets (current assets minus current liabilities). Companies that meet this criterion display one of the attributes of a financially secure organization. The long-term debt for CAB is $374.0 million, while the net current assets are $655.8 million. CAB passes this test.
LONG-TERM EPS GROWTH: [PASS]
Companies must increase their EPS by at least 30% over a ten-year period and EPS must not have been negative for any year within the last 5 years. Companies with this type of growth tend to be financially secure and have proven themselves over time. CAB’s EPS growth over that period of 243.1% passes the EPS growth test.
P/E RATIO: [PASS]
The Price/Earnings (P/E) ratio, based on the greater of the current PE or the PE using average earnings over the last 3 fiscal years, must be “moderate”, which this methodology states is not greater than 15. Stocks with moderate P/Es are more defensive by nature. CAB’s P/E of 10.47 (using the current PE) passes this test.
PRICE/BOOK RATIO: [PASS]
The Price/Book ratio must also be reasonable. That is, the Price/Book multiplied by P/E cannot be greater than 22. CAB’s Price/Book ratio is 0.89, while the P/E is 10.47. CAB passes the Price/Book test.