Benjamin Graham is widely considered to be the father of value investing. He effectively developed the strategy with the co-author of his first book, "Security Analysis," in the 1930s.
Before the publication of the book, investors rarely bought stocks based on fundamental analysis. Instead, they focused on hot tips and price action, which we would today call speculation.
Having lost a significant amount of money in the Great Depression, Graham wanted to develop a strategy based around the idea of minimizing risk and the risk of a permanent capital impairment as much as possible. He tried to develop a strategy for finding cheap stocks that had a zero, or near zero risk of wiping out shareholders.
Over the next few decades, he refined the strategy and passed his ideas on to the next generation value investors, which included Warren Buffett (Trades, Portfolio) and Walter Schloss.
After the recent market crash, there are plenty of stocks that look as if they meet Graham's value principles in my view. One company in particular stands out to me - cruise giant Carnival Corp. (CCL, Financial).
Looking for deep value
I think it is fair to say that of all the companies that have been affected by the Covid-19 crisis, Carnival has been one of the worst hit. There were several high-profile virus outbreaks on the cruise operator's vessels, which led to multiple deaths, especially since it is so easy for governments to bar ships from docking.
The company has suspended operations until the end of June and is rapidly running out of cash. It is burning through an estimated $1 billion a month, according to management, and the company was in heavy debt to begin with.
However, the stock does look cheap. At the end of its fiscal first quarter, the company reported shareholder equity of $24.3 billion. That's more than double its current market cap of $11.8 billion.
There are some adjustments that need to be made here, however. For example, at the beginning of April, the company issued $6 billion in new debt to keep the lights on. Adjusting for this debt gives us a shareholder equity value of $18.9 billion.
A cheap stock?
Does the company meet Graham's criteria for being a cheap stock? That is what I will attempt to determine in the next part of this article. In his book, "The Intelligent Investor," Graham laid out seven tests that defensively-minded investors should use when deciding to buy a stock.
To begin with, he suggested that any business considered by a defensive investor should not be a small one. "Our idea is to exclude small companies which may be subject to more than average vicissitudes, especially in the industrial field." Carnival passes this first test.
Next, Graham required that companies have a sufficiently strong financial condition. For this, he believed that industrial companies should have current assets that would at least exceed twice current liabilities, and long-term debt should not exceed net current assets. At the end of February 2020, Carnival reported total current assets of $2.9 billion and current liabilities of $10.7 billion. It seems that the business fails this test.
The third test was, as Graham described it, "Some earnings for the common stock in each of the past 10 years." The company has earned money for the past 10 years, so it passes this test.
The next was a dividend test. Graham would only consider companies that had paid dividends for 20 years. Carnival fails here.
Next, Graham wanted "A minimum increase of at least one-third in per-share earnings in the past 10 years using three-year averages at the beginning and end." Carnival passes this test, but only just. With earnings projected to collapse this year, you could argue the business does not meet this requirement.
For the sixth test, Graham was looking for companies with a price not more "than 15 times average earnings of the past three years." Carnival passes this test comfortably.
Finally, Graham would only look at businesses trading at 1.5 times book value. Carnival passes this test as well.
In conclusion, as the stock fails some of the key criteria Graham considered before investing, it's unlikely that he would have bought Carnival today, as it is simply too risky. Graham was only interested in businesses that looked deeply undervalued using a few critical criteria.
Disclosure: The author owns shares in Carnival.
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