But with so many trying to copy his techniques, many have misread facts, often looking for quick fixes to beat the market and get ahead of the game. It is not that simple.
Still, opportunities exist, and we’ll take a look at three stocks that might have been to Graham’s liking below. But first …
Ben Graham’s criteria
These are the original criteria that Graham set out in his book in order to find securities that are suitable for the defensive investor.
1. Adequate size of enterprise
- $100 million annual sales for industrial company; $50 million for public utility
2. Sufficiently strong financial position
- Current ratio of no less than 2
- Long-term debt should not exceed net current assets (working capital)
- Utilities debt should not exceed twice the stock equity
3. Earnings stability
- Some earnings for the common stock in each of the past 10 years
4. Dividend record
- Uninterrupted payments for 20 years
5. Earnings growth
- A minimum of 30% increase in earnings over 10 years (with beginning and end values taken as averages over three years)
6. Moderate P/E ratio
- No more than a P/E of 15 of average earnings over the past three years
7. Moderate ratio of price to assets
- Book value should be no more than 1.5 times
The criteria are very strict and many investors nowadays do not bother to conduct such in-depth analysis when considering a prospective investment.
It is also useful to note that Graham uses three-year averages when evaluating a company on its P/E ratio, which helps to smooth out any one-off items that could cause the P/E to give an abnormally high or low figure for the year in question.
Are there opportunities that meet the criteria?
With both the Dow and S&P 500 currently bouncing around their all-time highs, there are very few opportunities in the market that meet Graham’s criteria.
However, after some careful research, I have come up with three stocks that almost meet the criteria, although I have had to bend the rules a bit as some of my data does not go back far enough.
Note: At the time of writing, the ratios for these companies were correct. It is possible that the share prices will move significantly between writing and publication. If that is the case, it is possible that the companies below could no longer meet the strict criteria set out above.
Contender number 1: HollyFrontier Corp (NYSE:HFC)
Petroleum refiner HollyFrontier Corp (NYSE:HFC) meets the first criteria easily with $20.2 billion in revenue during 2012. The company has a strong financial position with a current ratio of 2 and working capital of $2.8 billion, which is more than double the company’s long-term debt of $1.3 billion.
The company has produced some positive earnings in each of the past 10 years and has paid a dividend for 10+ years, which is as far back as my data goes.
In respect to EPS growth, the company had average earnings per share of $0.73 between 2003-2005 and average EPS of $5.30 between 2009-2012. Although this is not a 10-year period, it is as far as my data goes and it is a staggering rate of growth, far exceeding the 30% growth required for Graham’s criteria.
In terms of financial ratios, the company has a P/E of 6.1 at the time of writing and a price-to-book ratio of 1.7. That’s higher than the ratio of 1.5 that Graham requires. However, Graham does state that it is possible to use a P/B that is higher than 1.5, as I’ll explain below.
