This book is considered as a classic in the investment field. Early in 2018, I bought this book while browsing the Amazon Kindle store. After finished reading the book, I would like to share some lessons that I have learnt in this book.
First, a bit about this book. This is a book written by Benjamin Graham, the mentor of Warren Buffett. If you do not know the author, I assume you should have at least heard about Warren Buffett. This edition includes commentary by Jason Zweig. It is published in 2003 with the main text taken directly from 1973 revised edition of the original book.
Below are the stock picking criteria espoused by this book.
Adequate size of the enterprise
The minimum amounts set are arbitrary. In the book, Graham suggests $100 million of annual sales for an industrial company and $50 million of total assets for a public utility company.
My view: Bear in mind that this was written in the 70s and in the US setting. Thus, it can be quite hard to set such a criterion in Malaysia now. Maybe we can just decide to use micro-cap, small-cap, mid-cap or large-cap as the separators. Micro-cap can be defined as stocks with market capitalisation of below RM200 million. For example, we might decide not to go for micro-cap stocks.
Sufficiently strong financial condition
This is related to the current ratio (current asset divided by current liabilities). The ratio should be at least two for industrial companies. The long-term debt should not exceed working capital (current assets less current liabilities ). For public utilities, the debt should be less than twice the stock equity.
My view: This criterion is to make sure that the company would not go under suddenly.
Earnings stability
There should be positive earnings in each of the past 10 years.
My view: I find 10 years to be very conservative. Thus, positive earnings in the last five years are good enough for me.
Dividend record
There should be uninterrupted dividend for at least the past 20 years.
My view: Again, this might be quite hard to find in our local market. I look for companies with at least five years of dividend payment.
Earnings growth
A minimum increase of at least 33% in earnings per share (EPS) in the past 10 years using three-year averages at the beginning and the end.
My view: Averages are used so that the occasional drop in earnings would not significantly impact the result. This criterion is imposed to make sure the company is growing and not shrinking.
Moderate price/earnings (P/E) ratio
Current P/E should be less than 15 of the average earnings of the past three years.
My view: The historical P/E ratio of Malaysian stock market is around 17. By taking this as a cut-off point, we are more likely to be not overpaying for the stock.
Moderate ratio of price to assets
Current price should not be more that 1.5 times the book value last reported. A P/E ratio of below 15 could justify a correspondingly higher multiplier of assets. In the book, he suggests the product of the P/E ratio times the price-to-book ratio should not exceed 22.5.
My view: This is actually new for me too. Normally, I would calculate the net asset per share of a stock and compare it with the share price but I do not have a hard criterion for it. By following this criterion, I think we would have a larger margin of safety.
End
These are Graham’s criteria for stock selection. You can choose to follow them rigidly or modify them according to your own needs. Remember that a single sure-fire way of investing does not exist. All the said rules are references in our investing journey. What is important is we find one set of rules that suits us the most.
Before I end this article, I would like to quote two advices that I find particularly true while reading the book.
“Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop.”
“And a true margin of safety is one that can be demonstrated by figures, by persuasive reasoning, and by reference to a body of actual experience.”
In conclusion, this book is definitely a good read for investors. If you still have not read this book yet, I strongly recommend you to get one right now.
Recommended book
If you are interested in The Intelligent Investor, you may get the book from Kinokuniya Malaysia through the link below*.
*Disclosure: The above link is Involve Asia affiliate link. Thus, I may earn a small commission when you purchase the book through this link.
