Danier Leather

Well, I've been poring over The Intelligent Investor the last couple of weeks, while trying to build a model for ranking stocks based on Graham's principles.

But while perusing stocks I came across what is quite a rarity these days, a common stock selling for "less than the company's net working capital alone, after deducting all prior obligations." (Intelligent Investor, 4th Revised edition, p 85 - note this ISN'T the version with the Jason Zweig commentary). Graham says his experience with this kind of investment selection - on a diversified basis - was uniformly good.

The stock is, of course, Danier Leather (TSX:DL), the Canadian leather retailer . Here are the latest financials. The current assets are $47.7million, the total liabilities only $14.0million. With 6.4 million shares outstanding, that leaves a "net net" working capital of $5.22 per share against a stock price of $3.60. (That $5.22 excludes all fixed assets, primarily leasehold improvements, which would not be so valuable in a liquidiation, but also some land, buildings and furniture, which would have some value). So this is definitely a cheap stock. The caveat is that Danier has been struggling for years to make money. They were profitable last year only because of a $20million lawsuit reversal. Still, for their first few years as a publicly traded company they performed quite well, and according to their annual report they have been around since 1972. So presumably they were profitable for a while. Perhaps the lawsuit, which dragged on back and forth for years, was a distraction, and now, with it finally over, management will get back to business and start turning a profit? Only time will tell.

Remember though, this is just one stock. Graham was quite adamant that following this sort of approach required diversification to ensure some level of safety. Unfortunately, there aren't a whole lot of these types of bargains available. Jonathan Heller at http://stocksbelowncav.blogspot.com/ tracks these types of bargains in the U.S., so if you have some U.S. dollars to invest, or don't mind paying up right now for the greenback, you could diversify that way.

Of course, it is important you do your own research and/or consult a professional before buying any stocks or making any investments. I do not presently own any Danier Leather myself, but might consider making purchases in the near future.

Welcome to The Canadian Benjamin Graham

Hello, and welcome.

This blog intends to apply the principles of famed value investor Benjamin Graham to the Canadian stock market in an effort to find undervalued stocks that will hopefully provide above-market returns.

For those not familiar with Benjamin Graham, he was a legendary value investor and Columbia professor, whose students include Forbes' richest man, super-investor Warren Buffett. He was the lead author (with David Dodd) of what is widely considered the bible of value investing, "Security Analysis," first published in 1934 and still in print today in its sixth edition. He also authored The Intelligent Investor: The Definitive Book on Value Investing,
which Warren Buffett has called "by far the best book about investing ever written."

Graham had a lot to say on the subject of investing. For now, this site will focus on seeking out companies that meet the criteria he outlines in Chapter 14, Stock Selection for the Defensive Invesor, of the fourth revised edition of The Intellgent Investor. The criteria are:

1. Adequate size of the Enterprise. Graham suggests a minimum of $100 million in annual sales for industrial companies. The book was written in 1973 when the CPI-U was 44.4; the average CPI-U for the 12 months ending August 2008 was 213.6 (source here). So that's an increase of 4.8x. We'll round that off to $500 million and ignore exchange rate issues. For public utilities, Graham suggests a minimum of $50 million in assets, with inflation that's $250 million.


2. A sufficiently strong financial condition. Graham calls for a current ratio (current assets to current liabilities) of 2 or higher and long term debt less than working capital (current assets minus current liabilities). The current ratio criteria is probably the one that we question the most. Cashflow management principles of today would generally frown upon such a high ratio. It could be indicative of a company carrying too much inventory or too many receivables and may not be a sign of financial strength. Dell has used a low current ratio as a way to finance their business for years and with $4.61 in cash per share against $0.94 in long term debt, Dell is certainly financially sound. While we hesitate to tinker with the master's rules, a strong financial condition could probably be defined by some other, less restrictive method. This is something that will be explored in future posts.


3. Earnings stability. Some earnings for each of the past 10 years.


4. Dividend record. Uninterrupted dividend for the past 20 years. This is a tough test for Canadian stocks. We might reduce this hurdle to just 10 years.


5. Earnings growth. Graham calls for at least a 33% increase in per-share earnings over 10 years, using three-year averages from the beginning and the end.


6. Moderate Price / Earnings Ratio. Stock should trade at no more than 15 times the average earnings of the past three years.


7. Moderate Price / Book Ratio. Maximum price-to-book ratio of 1.5. Graham allows for higher price-to-book so long as the product of the price-to-book and price-to-earning ratios does not exceed 22.5.

As far as I know, there are no stock screeners available that will screen on these exact criteria. However, there are various screeners will allow us to reduce the pool of stocks to a manageable level. We will scour the financial records and post our findings here. Then we will track our picks to see how they perform. We suspect Graham's rules will prove timeless and over the long term, hope to beat the market indices.