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.