I have a confession to make. I must be one of the few serious investors who never finished the Intelligent Investor by Benjamin Graham. I didn’t enjoy reading what I recall was the second edition and decided I might enjoy the Jason Zweig revised edition more. So I returned the book to the library half read and put the Zweig edition on my Amazon wish-list. In my defence that was 2007 and at that time there was little prospect of scoping up the bargains preferred by Graham. For my sins against value investing I recently bought a copy of The Classic 1940 Second Edition of Security Analysis by Graham and Dodd. I’ll let you know if it is a classic when I’ve finished working my way through it.

I only mention this now as the other day a TMF poster asked about Ben Graham’s checklists and I tracked down the following for him at Capital Ideas Online.

In a great book Benjamin Graham on Investing: Enduring Lessons from the Father of Value Investing, the author, Janet Lowe, writes on Graham’s attributes for an undervalued stock.

1. “An earnings-to-price yield (reverse of the P/E ratio) that is double the triple-A bond yield. If the triple-A bond yield is 8 percent, the required earnings yield then will be 16 percent.
2. A price-to-earning ratio that is four-tenths of the highest average P/E ratio achieved by the stock in the most recent five years. (To get the average P/E ratio, an average stock price for a given year is divided by the earnings for that year.)
3. A dividend yield of two-thirds the triple-A bond yield. Stocks paying no dividends or those that have no current profits from which to pay dividends are excluded.
4. A stock price of two-thirds the tangible book value per share. This is calculated by adding up all the assets, excluding intangibles such as goodwill, patents, etc, subtracting all liabilities and dividing by the total number of shares.
5. A stock price that is two-thirds of the “net current asset value” or the “net liquidation value.” The net quick liquidation value is current assets (those assets that are immediately convertible into cash, fixed assets omitted) less total debt. This, of course, was the foundation of Ben’s original theory.
6. Total debt that is less than tangible book value.
7. A current ratio of two or more. The current ratio is current assets divided by current liabilities. This is an indication of the company’s liquidity, or its ability to pay its debt from its income.
8. Total debt at or less than the net quick liquidation value.
9. Earnings that have doubled in the most recent ten years.
10. No more than two declines in earnings of 5 percent or more in the past ten years.”

I found those investing criteria interesting, but what tickled my fancy even more was a link provided by another poster. Benjamin Graham’s Lost Magic Formula In 1976? is a entertaining article on interviews of Graham late in his life. One of attributes I most admire about Graham is his open inquisitive mind, which I think GuruFocus illustrated in the following passage.

After 60 years of analyzing financial statements and managements, Graham said this about projecting earnings, evaluating market share, and analyzing individual companies:

“Those factors are significant in theory, but they turn out to be of little practical use in deciding what price to pay for particular stocks or when to sell them. My investigations have convinced me you can predetermine these logical “buy” and “sell” levels for a widely diversified portfolio without getting involved in weighing the fundamental factors affecting the prospects of specific companies or industries.”

This is not what you’d expect from the author of the bible of value investing and the original advocate of the Chartered Financial Analysts organization, renowned for their high analytical standards. Human nature would be to defend his 60 years of investment contributions which preached steadfast adherence to rigorous analysis. Instead, at 82 he was still open to new ideas while in search of the simplest method of selecting bargain stocks. His formula went through two iterations. He introduced the first formula at age 79 and concluded from his results that one would have performed quite well from 1961-1976 by buying stocks with the lowest values of these three criteria:

• A low multiple (e.g.,10) of the preceding year’s earnings;
• A price equal to half the previous market high (“to indicate that there has been considerable shrinkage”);
• Net Asset Value. (I presume this is the lowest price relative to book value)

In his next interview published in Medical Economics, September 20, 1976 titled “The Simplest Way to Select Bargain Stocks” Graham, then 82, proposed a simpler, more refined formula that consisted of:

• PE Ratio of 7x-10x or less (Based on 2x current AAA bond rates)*;
• [Equity/Asset Ratio of .5 or more (e.g. Debt/Equity <1)].

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