Use the Benjamin Graham Investing Checklist to Invest Like Him

March 11, 2013 | Comments (3)

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Jae Jun

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Benjamin Graham Investing Checklist

Benjamin Graham Investing Checklist

Benjamin Graham Investing Checklist

Benjamin Graham Investing Checklist – What to Expect

Benjamin Graham liked to keep things simple. In fact, his entire investing principles were simple and disciplined.

Buy a bucket of cheap stocks at a discount to fair value, sell when it reaches NCAV. Couldn’t be simpler.

When you think of Graham, he is usually associated with cheapness, but don’t forget he was an academic at Columbia University, worked at Wall Street and made $500k at the age of 25 in the early 1900′s, formed a partnership with Jerome Newman and then went on to write Security Analysis and the Intelligent Investor.


For such a savvy businessman and investor, Graham knew that he did not need to complicate things. He cut out the fat in investing and used discipline and simple ideas to generate his returns.

How?

He created a 10 point checklist (which I’ll call the Benjamin Graham investing checklist) during his Newman Partnership days. Graham filled out this checklist manually for hundreds of stocks over and over again.

He and Walter collected numbers from the Moody’s Manuals and filled out hundreds of the simple forms that Graham-Newman used to make decisions – pg 185 Snowball

You see, Graham was top of his class and he most likely had a higher IQ than you.

But, he invested like he had a low IQ and spent all his time manually writing numbers into a checklist to see whether it passed his investment checklist.

He was a master of the K.I.S.S (Keep It Simple Stupid) rule.

So what is this Ben Graham Investing checklist?

Here is the original checklist consisting of ten items.

1. An earnings-to-price yield at least twice the AAA bond rate

2. P/E ratio less than 40% of the highest P/E ratio the stock had over the past 5 years

3. Dividend yield of at least 2/3 the AAA bond yield

4. Stock price below 2/3 of tangible book value per share

5. Stock price below 2/3 of Net Current Asset Value (NCAV)

6. Total debt less than book value

7. Current ratio great than 2

8. Total debt less than 2 times Net Current Asset Value (NCAV)

9. Earnings growth of prior 10 years at least at a 7% annual compound rate

10. Stability of growth of earnings in that no more than 2 declines of 5% or more in year end earnings in the prior 10 years are permissible.

 Simplifying the Ben Graham Investment Checklist Further

But could the checklist be improved? That was the question I wanted to answer which ultimately led to the creation of the Graham checklist screen.

Here is a link where you can read how I went about fine tuning Ben Graham’s investing criteria.

Long story short, after multiple rounds of testing and fine tuning, the best results came by narrowing the ten point checklist down to four.

1. An earnings-to-price yield at least twice the AAA bond rate

2. P/E (excluding extraordinary items) ratio less than 40% of the highest P/E ratio the stock had over the past 5 years

6. Total debt less than book value

7. Current ratio great than 2

With the original list, there are some harsh requirements such as no.5. Trying to find a NCAV stock yielding at least 2.3% in dividends with stable growth and earnings is impossible in today’s market.

Some Stocks Passing the Contemporary Graham Investment Checklist

Here are some stocks in no particular order that pass the four point Graham checklist where current AAA bonds yield around 3.3%

Western Digital Corp (WDC)

Makes hard drives for digital content.

#1: Earnings Yield 2x AAA bond rate: Pass. Earnings yield is currently 17%.

#2: PE < 40% of highest in past 5 years: Pass.

#6: Total debt < book value: Pass. Total debt = $2.1b. Book value = $8.2b

#7: Current ratio > 2: Pass. Currently at 2.2

CF Industries (CF)

Manufacturer and distributor of nitrogen and phosphate fertilizer products.

#1: Earnings Yield 2x AAA bond rate: Pass. Earnings yield is currently 14%.

#2: PE < 40% of highest in past 5 years: Pass.

#6: Total debt < book value: Pass. Total debt = $1.6b. Book value = $5.9b

#7: Current ratio > 2: Pass. Currently at 2.3

HollyFrontier Corp (HFC)

Petroleum refiner.

#1: Earnings Yield 2x AAA bond rate: Pass. Earnings yield is currently 14%.

#2: PE < 40% of highest in past 5 years: Pass.

#6: Total debt < book value: Pass. Total debt = $1.3b. Book value = $6b

#7: Current ratio > 2: Pass. Currently at 2.22

Cooper Tire & Rubber (CTB)

Makes car and truck tires.

#1: Earnings Yield 2x AAA bond rate: Pass. Earnings yield is currently 14%.

#2: PE < 40% of highest in past 5 years: Pass.

#6: Total debt < book value: Total debt = $373m. Book value = $757.6m

#7: Current ratio > 2: Pass. Currently 2.2

 Apple (AAPL)

Since I hold Apple (AAPL), where does it stand against Graham’s checklist?

#1: Earnings Yield 2x AAA bond rate: Pass. Earnings yield is 10%.

#2: PE < 40% of highest in past 5 years: Fail. Current PE of 9.8 is 47% of highest PE in last 5 years. Forward PE is 8.1 so it will pass this criteria next year.

#6: Total debt < book value: Pass. No debt.

#7: Current ratio > 2: Fail. Currently at 1.5

Graham would not have bought AAPL, but he would next year. That is how you can use the Benjamin Graham Investing Checklist.

Disclosure

Long AAPL and HFC.

About Jae Jun


Jae Jun is the founder of Old School Value. He is on a mission to provide practical and actionable value investing tools, tutorials and educational material to help empower the individual investor. Keep in touch with Jae via any of the methods linked below.

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