My Key Takeaways From Chapter 16 Commentary 16 of the Intelligent Investor. Part 15/16. To Be Continued.

Chapter 15 Stock Selection for the Enterprising Investor

A Summary of the Graham-Newman Methods Between 1926 and 1956

1. Arbitrages The purchase of a security and the simultaneous sale of one or more other securities into which it was to be exchanged under a plan of reorganization, merger, or the like.
2. Liquidations Purchase of shares which were to receive one or more cash payments in liquidation of the company’s assets.
3. Related Hedges The purchase of convertible bonds or convertible preferred shares, and the simultaneous sale of common stock into which they were exchangeable.
4. Net-Current-Asset (or “Bargain”) Issues The idea here was to acquire as many issues as possible at a cost for each of less than their book value in terms of net-current-assets alone-i.e., giving no value to the plant account and other assets. Our purchases were made typically at two-thirds or less of such stripped-down asset value.

A Winnowing of the Stock Guide

Suppose we look for a simple prima facie indication that a stock is cheap. The first such clue that comes to mind is a low price in relation to recent earnings. This would make a goodly number of candidates for further selectivity.

So let us apply to our list some additional criteria, rather similar to those we suggested for the defensive investor, but not so severe. We suggest the following:

1. Financial condition (a) Current assets at least 1.5 times current liabilities, and (b) debt not more than 110% of net current assets (for industrial companies)
2. Earnings stability No deficit in the last 5 years covered in the Stock Guide.
3. Dividend record Some current dividend.
4. Earnings growth Last year’s earnings more than those of 1966.
5. Price Less than 120% net tangible assets.

Note also that we set no lower limit on the size of the enterprise.

Single Criteria for Choosing Common Stocks

An inquiring reader might well ask whether the choice of a better than average portfolio could be made a simpler affair than we have just outlined. Could a single plausible criterion be used to good advantage-such as a low price/earnings ratio, or a high dividend return, or a large asset value? The 2 methods of this sort that we have found to give quite consistently good results in the longer past has been (a) a purchase of low-multiplier stocks of important companies (such as the DJIA list), and (b) the choice of a diversified group of stocks selling under their net-current-asset value (or working-capital value). We have already pointed out that the low-multiplier criterion applied to the DJIA at the end of 1968 worked out badly when the results are measured to mid-1971. The record of common-stock purchases made at a price below their working-capital value has no such bad mark against it; the drawback here has been the drying up of such opportunities during most of the past decade.

Commentary on Chapter 15

“It is easy in the world to live after the world’s opinion; it is easy in solitude to live after our own; but the great man is he who in the midst of the crowd keeps with perfect sweetness the independence of solitude.” – Ralph Waldo Emerson

Practice, Practice, Practice

You can use “portfolio trackers” at websites like www.morningstar.com, http://finance.yahoo.com, http://money,cnn.com/services/portfolio/ or www.marketocracy.com (at the last site, ignore the “market beating” hype on its funds and other services.

Looking Under the Right Rocks

You can use websites like http://finance.yahoo.com and www.morningstar.com to screen stocks with the statistical filters suggested in Chapter 14.

My Key Takeaways From Chapter 14 Commentary 14 of the Intelligent Investor