Every year I pay homage to Ben Graham, the father of value investing.
Graham, who lived from 1884 to 1976, was a pioneer in the art of finding undervalued stocks. He was a Columbia University professor (one of his pupils was Warren Buffett (Trades, Portfolio)), hedge fund manager and writer of seminal investment books such as Security Analysis (co-written with David Dodd).
I try to emulate Graham’s methods when I invest. In addition, I dedicate one weekly column to him each year, trying to pick a few stocks that I think he might favor if he were still alive. The column you’re reading is the 13th in that series.
Nine of the previous 12 columns have been profitable, and ten of the 12 have beaten the Standard & Poors’ 500 Index. The average 12-month return has been 22.9%, compared to 10.9% for the index.
Last year’s batch returned 18.2%, versus 9.6% for the S&P 500. TravelCenters of America Ltd. (TA) led the way, up 42.2%. Gulf Resources Inc. (GURE) brought up the rear, down 2.5%. All figures are total returns, including capital gains (or losses) and dividends.
A few cautions: Not all my recommendations do this well. Past performance is no guarantee of future success. The record of my column picks shouldn’t be confused with real-life results. And the results of my column recommendations are theoretical, not reflecting actual trades, trading costs or taxes.
Graham’s Methods
Graham believed that stocks have an intrinsic value, which can be estimated using factors such as earnings and book value. For this column, I use a simplified version of Graham’s criteria. To be considered for inclusion a stock must:
- Sell for 12 times earnings or less.
- Sell for 1.0 times book value (corporate net worth per share) or less.
- Have debt less than 50% of stockholders’ equity (which is essentially synonymous with book value).
By comparison, the average stock currently sells for almost 21 times earnings and 2.9 times book value, both of which are expensive compared to historical norms.
Here are five stocks that I believe the Ben Graham might buy if he were alive today.
MetLife
MetLife Inc. (MET, Financial) was on this list in 2013-2014, eking out a small gain. I believe interest rates will rise in the next couple of years, which is a mixed blessing for MetLife. It will suffer paper losses on its existing portfolio of bond investments, but will be able to invest new incoming insurance premiums at successively higher rates. The stock sells for nine times earnings and 0.8 times book value, making it attractively cheap in my view.
Century Aluminum
Century Aluminum Co. (CENX, Financial), based in Chicago, started in 1995 and sold for more than $70 a share in May 2008. Today the shares go for a little over $5, wounded by declining commodity prices, rising Chinese imports, and high-cost electricity (a major issue for aluminum producers).
On Friday the shares were slammed because the company missed June-quarter estimates, due mostly to the expenses of closing a plant. But sales and earnings rose in 2013 and 2014. Makers of planes, locomotives and cars are looking for light, strong materials. The stock sells for about three times recent earnings and 0.6 times book value. I own it for one client.
Kulicke & Soffa
I found only one company that meets my three Graham criteria and is debt-free. That is Kulicke & Soffa Industries Inc. (KLIC), which makes wire bonding machines, wafer saws and other equipment used to make semiconductor chips. The company’s earnings history is choppy, with no underlying upward trend. But it has made a profit in seven of the past eight years (the exception being 2009, when few companies were profitable.)
EZCorp
Who wants a pawn shop when the economy is recovering? I think Graham might. EZCorp., one of the largest pawn-shop operators and payday lenders, sells for five times earnings and 0.4 times book value. Why so cheap? Well, the company lost money last fiscal year (ended September 2014). Also, the federal government may slap new regulations on payday lending.
However, analysts predict a return to profitability this fiscal year and rising profits next year. New regulations would no doubt cut into profitability, but I doubt the ultimate rules will be as strict as some early proposals. Like cockroaches and sharks, pawn shops have been around for a long time.
Domtar
I’ll close with a Montreal-based paper company, Domtar Corp. (UFS, Financial). Among other things, it makes copier paper, packaging and paper for tampons. At six times earnings and 0.94 times book value, it is out of favor, which is the way I prefer my stocks. While you’re waiting for it to return to favor, you can enjoy the dividend yield, which is approximately 4%.
