The Canadian Benjamin Graham

Aastra Technologies

2010-09-11T00:54:00.000-04:00

Aastra Technologies(TSX:AAH)is in the telecom equipment industry and closed today at $22.78 per share. With 14.03 million shares outstanding, the market capitalization is $320 million. Cash and short-term investments total $104 million, while debt is just $23 million. So...enterprise value is: 320 - 104 + 23 = $238 million.

Cashflow has been impressive. The past 5 years, operating cashflow has averaged $59 million, while capital expenditures have averaged only $14 million. So that's about $45 million in free cashflow annually. Not a bad return on $238 million dollar investment!

A lot of the free cash has been used to make acquisitions and revenues have grown from $500 million in 2005 to $833 million for 2009. However, management has been pretty good at returning some cash to the shareholders, buying back about 20% of the outstanding shares over the past few years and paying a dividend of 20 cents per share quarterly for a yield of 3.4%.

So cash generation and utilization have been good, especially relative to its current enterprise value.

On top of that the balance sheet looks fine. Net current assets after deducting ALL liabilities (Graham's net-net) are $9.78 per share.

This site is all about stocks that are cheap relative to cash and assets, and Aastra fits the bill.

Be sure to your own due diligence before making any investments. And of course, I own shares in Aastra.

Chartwell Technology

2010-02-03T00:22:00.002-05:00

Chartwell released its year end numbers. They've discontinued their Poker community and delayed "indefinitely" their Bingo community launch. So sounds like the company has bailed on some losing projects. Not a good reflection on management but I guess everyone is a Monday morning quarterback. While the reclassification makes the numbers a little harder to follow, it appears the company burned through $342K last quarter. This is based on the fact at end of Q3 they showed they were down $1,004K for the year, and at the end of Q4 they were down $508K. So that's a gain of $495K in cash; however, the company converted $837K in investments into cash this quarter, so the loss would be the $837K gained on the sale of investments less what remains, the $495K. So that's not so good. I prefer to see my companies cashflow positive.

Quarterly revenue was down both on a year-over-year and sequential basis. The company claimed a small profit of 1 cent per share for the quarter on its continuing operations, and a 2 cent loss per share including discontinued operations.

The balance sheet remains strong with $19 million in cash and little debt, which works out to around $1 per share. On that basis, despite the weak quarter, I think Chartwell, at $1.10, still represents good value and I continue to hold my shares.

Goodfellow Update

2010-01-23T00:15:00.001-05:00

Goodfellow posted a good first quarter. Revenue was down slightly, but management reduced expenses even more, improving margins substantially, from 0.9% net in Q12009 to 1.9% in Q12010. Quarterly earnings per share doubled from 12 cents to 24 cents. Cashflow from operations was positive before changes in non-cash working capital, but substantially negative after. Overall, including investing cashflows, the company used $8.4 million dollars, financed by bank debt. However, this was largely due to a seasonal increase in inventory.

Goodfellow remains good value at its current price.

Update on Caldwell Partners (CWL.A)

2010-01-21T18:07:00.002-05:00

Caldwell released their first quarter results. The company burned through another $677K, leaving $9.4 million in cash and securities. Revenue increased slightly, but expenses increased more. Management continues to claim this is just them shoring up to take advantage of the recovery. I hope that's true. The company remains good value on paper, but time will tell if this a value trap or not. I continue to hold my shares.

Miranda Technologies (MT)

2010-01-21T17:23:00.002-05:00

Miranda Technologies (TSX:MT) is another stock that shows up on our value screens. Miranda "develops, manufactures and markets high-performance hardware and software for the television broadcast industry. Its solutions are purchased by content creators, broadcasters, specialty channels and television service providers to enable and enhance the transition to a complex multi-channel digital and HD broadcast environment." According to the latest balance sheet, MT has $48 million in cash, $23 million in accounts receivable and $17 million in inventories. Property, plant and equipment equal $30 million. Applying some rough Graham mutiples (discussed previously) this gives us a liquidating value of around $85 million.

With the current share price of $5 against 22 million outstanding shares, that's a market cap of $110 million. Total liabilities are $37 million. So in theory you could buy the company outright for $147 million and liquidate it for $85 million. Obviously, this would be a stupid thing to do, but it does indicate that an investment in MT has some downside protection.

However, in the case for MT, the relatively cheap price vs. assets is only a bonus. The primary reason we like MT is that it has been a great cashflow generator. Cash flow from Operations over the past 5 full fiscal years (including changes in non-cash working capital) have averaged $21 million per year over the past 5 years; meanwhile capex has averaged only $3 million. That's a free cash flow of around 80 cents per share, on average, over the past 5 years. So far in 2009 the company remains cashflow positive at just under $2 million through Q3, despite the recessionary environment.

I profess no special knowledge -- actually, make that no knowledge at all -- about the future of MT's industry. Perhaps the recent glut of cash is a one-time thing driven by conversion of existing analog equipment to digital. Probably this is something a more enterprising investor should look into. But since I have a full time job and a family, it's not always possible to spend the time researching details such as this. Instead I assume that if that is indeed the case, that MT is facing terrible headwinds, then this fact is most likely already priced into the stock. After all, it is trading cheap by almost any standard, so the market is certainly pricing in a poor outlook. But, as Ben Graham and his followers have demonstrated time and time again, a diversifed portfolio of stocks that trade cheaply relative to their net asset value and past cashflow can deliver healthy returns. When the forecasted bad news becomes reality, the stock doesn't get hit much, it's already beaten down. But if there is any positive news, then the stock can come alive and increase substantially.

I do own shares in MT. This is not a recommendation that you purchase shares in MT. Please verify all the facts in this article yourself and consult an investment professional before making any purchases. As an amateur investor, I don't know if I have to put this stuff in or not but I figure better safe than sorry!

Chartwell Technology Inc. (TSX:CWH)

2009-12-14T00:19:00.007-05:00

Chartwell Technology "develops, markets, licenses, implements and supports gaming applications and entertainment content for the internet and remote platforms. Chartwell’s JAVA and Flash based software products and games are designed for deployment in gaming, entertainment and promotional applications."

Balance Sheet: Current assets after deducting ALL liabilities listed on the balance sheet are $1.19 per share. Most recent share price was $1.15. So the company trades at a slight discount to it's "net-net" value (net of current and non-current liabilities). The current assets are primarily cash. The company has $19.5 million in cash, or $1.06 per share. There is no debt (although there is $234K obligation under capital lease. Relative to the cash balance this is insignificant). Using Graham's liquidation value formula (as discussed here), the liquidating value for Chartwell is $1.13 per share. Liabilities per share are 7 cents. So our balance sheet multiple is (1.15 price per share + .07 liabilities per share)/(liquidating value of $1.13) = 1.22/1.13 = 1.08. There are certainly a lot of very liquid assets backing the current share price and this provides a significant level of safety to the share value. Cash burn is a potential concern, with the company cashflow negative the past 3 quarters. Longer term, operating cashflow has been postive, if somewhat volatile.

Cashflow: over the past 5 years (20 quarters), Chartwell has generated an average of $1.93 million in CFBIT (Cashflow before Interest and taxes) per year. The enterprise value is about $2 million (that's the market cap less net cash). So our cashflow multiple is 2/1.93 = 1.04. This is a very low multiple. Bear in mind that earnings have only been about breakeven during this time. The company has substantial non-cash charges in the form of amortization, depreciation and write-offs and this accounts for the majority of the difference.

Cash usage: The company generated $9.7 million in cash flow from operations before interest and taxes, plus $2.9 million in interest income and a net $7.6 million from share proceeds (primarily from an $11 million private placement back in December 2004, net of share re-purchases over the 5 years). This cash was used to pay taxes ($2.5 million), repay debt ($1.1 million) and make acquisitions ($4.6 million). The difference of around $11.8 million remains as cash on the balance sheet. No dividend has ever been paid and there has not been significant share buyback activity except to offset option activity. Overall the cash usage is neutral. Chartwell has not returned cash to shareholders as yet but at the same time they do not seem to be squandering it either. The 2005 Micropower acquisition resulted in an $870K impairment charge in fiscal 2007.

The industry is highly competitive and subject to substantial legal and regulatory risk. So be forewarned. Still, at the current price, Chartwell deserves a close look by the serious value investor.

Disclosure: I own shares in Chartwell Technology

Still More on Goodfellow Inc.

2009-12-12T01:41:00.008-05:00

I found an article at Seeking Alpha on Goodfellow Inc. The author, Jonathon Goldberg, make some interesting points. But I have to dispute one thing he says. Mr. Goldberg writes "The fact that GDL can be bought for less than its current assets (after satisfying all liabilities) has no implications for an investor." At the time of writing of the article, Goodfellow was trading for $7.90 agains net current assets of $8.43 per share.

I believe this fact actually does have some implication to the investor, as would, I believe Benajamin Graham, who devotes an entire chapter of Security Analysis to the importance of net current assets and the implications when they exceed the stock price. In the case of Goodfellow, the net current assets have acted quite effectively as a floor to the stock price. The chart below shows the year-end net current assets per share (split adjusted) for Goodfellow back to 1996 (the blue line). The pink line represents the low price for the stock the following year (for the stock prices I used Nov - Oct -- Goodfellow's year end is August, so by the end of October we can safely assume that the market is fully aware of the net current assets per share). The graph clearly shows that the share price rarely falls below net current assets and when it does (only during the recent market meltdown), it has been a buying opportunity. Please note that the years along the x-axis run backward, from 2009 to 1996. Also note that the 2009 low share price is for the past month and a half only.

Obviously just because this has held in past is no guarantee it will hold in the future. During this period Goodfellow showed a very steady increase in its net current assets and this trend was likely also a contributor to keeping a floor on the share price. But still, the graph demonstrates that the net current assets clearly have some relevance to the investor.

Disclosure: I own shares in Goodfellow Inc.

More on Goodfellow from a Different Perspective

2009-12-10T00:50:00.003-05:00

There's not a lot of analysis out there on some of these smaller stocks, but I was pleasantly surprised to come across Susan Brunner's blog, which offers an interesting and detailed analysis (complete with spreadsheets) of Goodfellow Inc: Part 1 and Part 2 and here's the spreadsheet.

Insider Ownership

2009-12-09T16:48:00.002-05:00

A lot of value investors place great emphasis on insider ownership. They believe that if management and/or the board of directors are significant shareholders, then the decisions they make will be based on the best interests of all shareholders. They won't, for example, attempt to raise the share price in the short term by engaging in massive share repurchases at a high share price in order to increase the value of their options. They might also be more prudent with capital investments and acquisitions since it is literally their own money they're investing.

But it can also happen that insiders who own significant stakes in the company may not actually have long term share price appreciation as their primary goal. Instead their goal might be simply to fleece the other minority shareholders by taking a bigger piece of the profits for themselves. This could be hidden in various related-party transactions such as leases or consulting fees or exorbitant compensation. It's true that this sort of abuse could be practiced by insiders even if they were not large shareholders, but it's easier to get away with this sort of thing when you're the boss.

I think the best thing would be to judge the past record of a company that has significant insider ownership. If the same owners have been around a while and have done things in the past that have benefited all shareholders, not just themselves, then I would view that as a very positive sign. After all, as psychologists will tell you, the best predictor of future behaviour is past behaviour.

The academic studies looking at firm performance vs. insider ownership are ambiguous. This study from the Journal of Corporate Finance argues that the amount of insider ownership is actually a function of firm performance as well as vice-versa, which just demonstrates how difficult it is to judge whether insider ownership is a good thing or not. The article's appendix includes summaries of past studies done in this area.

Bottom line, insider ownership in and of itself is probably not a bullish indicator while insider ownership combined with a long history of shareholder-friendliness probably IS a bullish indicator.

Caldwell Partners (TSX:CWL.A)

2009-12-08T13:07:00.006-05:00

Caldwell Partners (TSX:CWL.A) is an executive search consulting firm. Its shares last traded at 52 cents and with around 16.5 million shares outstanding, that's a market capitalization of just $8.5 million. The company carries $10 million in cash and marketable securities and has no debt. So it actually has a negative EV. That's cheap!

So what's the catch? Cash burn. The company had built up a pretty large stockpile of cash and investments over the years while it was cashflow positive. At the end of Q32008 there was over $20 million in cash and investments on the balance sheet but today that number has been cut in half due to a combination of investment and operating losses. Prior to the recent downturn in the company's fortunes they had been generating around $2 million a year in CFBIT (cashflow before interest and taxes).

The company claims the recent losses are due in part to the recession, which makes sense, and also to increased expenses relating to the investment "in the addition of new search partners" and "aggressive expansion into the U.S." They say these investments will "build a solid platform for sustainable and profitable growth." If those statements are actually true and the company returns to profitability quickly, then the shares will likely see a significant rise.

Besides significant operating losses over the past several quarters, another red flag is the possibility that management is not of the highest ethical calibre. Last year a lawsuit with 3 shareholders (JC Clark Ltd, Tailwind Capital Inc. and McElvaine Investment Management) was settled with part of the terms being that Caldwell will move to a single share class effective November 2011. The class B voting shares will be converted at a rate of 1.149 class A non-voting shares for each class B. Based on the most recent share counts, this would increase the shares outstanding to 18.3 million. The action alleged that "Mr. Caldwell and members of the Board of Directors...[engaged in] a series of related-party transactions that are alleged to have benefited certain members of management at the expense of Caldwell Partners and its minority shareholders." The statement of claim also asked that "the Company declare and pay a dividend from the Company's excess cash reserves."

I don't know the details behind all of this, other than what's noted above. I do know that there was no extra dividend paid out and instead the excess cash reserves have been "invested" in growing the business and another $2.6 million was lost on investments during the market crash.

Are the current woes simply a temporary setback caused by the recession? Will the new capacity built in the last year actually add to the bottom line in future? Unfortunately these are questions I'm not qualified to answer. We would definitely welcome input from anyone with more knowledge on the economics, opportunities and outlook in the executive search space. In the meantime, even with the uncertainty, the rock-bottom valuation is very compelling.

What Does the Company Do With Its Cash?

2009-12-08T00:24:00.006-05:00

Free cashflow is a big part of the way we analyze stocks here. The more cash, the better. But just generating cash is not enough (although it is essential). We need to know what the company has done with its cash. Sure, some will go to pay taxes, and, if the company is capitalized with debt, some will go to make interest payments. But what about the rest? Was it used to pay down debt? As conservative investors, we see this as a positive action, although modern finance theory might debate that. Was it used for dividends? That's always good, we like to see cash returned to the owners. Was it used for share repurchases? That can be good if the shares were repurchased at reasonable valuations. But was the cash just used blindly to buy back shares, regardless of price? Were there acquisitions made? If so, how did those acquisitions turn out? Did revenues and profits increase as a result of the acquisition? If not, it could mean the acquisition hasn't had time to bear fruit, or it was simply a bad one, or it could mean the original business is on the decline and acquistions are required just to keep the business from shrinking. Is the cash building up on the balance sheet? If so, why? Is the company planning an acquisiton? Often with smaller companies, a significant build up of cash can be the precursor to the start of a regular (or special) dividend payment.

These are some of the questions we ask as part of our analysis, and if we don't like the answers, we'll think twice before investing our money and/or demand a larger margin of safety.

Liquidation Value

2009-12-07T21:18:00.004-05:00

The second part of my valuation system is to look at the liquidation value. To calculate liquidation value, I simply use the model described by Graham in Security Analysis: 1 x cash + 0.8 x accounts receivable + 0.67 x inventories + 0.25 x tangible fixed assets. Graham actually offers up .15 as the "rough average" for fixed assets, but I upped it to 0.25. He offers a range of from 1 to 50%, and I thought I'd use something in the middle of that.

Obviously, this is a very crude estimation, but should be effective for screening large quantities of stocks. An example of a more intricate methodology, practiced by Marty Whitman's team over at Third Avenue Management, is outlined in this article.

Once we have the liquidation value, we can compare that to the market price of the shares plus all outstanding liabilities. Let's call this Full Enterprise Value (FEV), as opposed to Enterprise Value (EV) which normally includes only debt from the liabilities and deducts any cash balances. In other words, if we bought up all the shares and then paid off all the outstanding liabilities, we should own all the companies assets, at which point we could realize the liquidation value. I generally divide the FEV by the liquidation value to come up with a "balance sheet multiple." (I guess I need to work on some catchier names for these metrics) which would be analogous to the commonly used price-to-book ratio, but hopefully a little more meaningful.

Putting It All Together
Once I've derived the cashflow multiple and the balance sheet multiple, my next step is to multiply the two together to come up with an "overall value" (OV) rating. The lower this number, the better value the stock represents. Overall value ratings below 20 often represent very good bargains and are the primary vein I use to mine for good stocks. However, certain characteristics, such as company size, stability of cashflows, the competitive advantages of the business, etc., can justify higher valuations and there may well be very attractive bargains found at higher levels. In any event, once you're down to a manageable list of possible value stocks, the next step is to look at each stock in more detail, examining the financials and the news reports closely, to verify that the numbers are correct (again I use MSN data and it occasionally has errors) and to get a better feel for what the future might hold. Is the company teetering on bankruptcy? Were the significant cashflows of the past 5 years generated from a now-spent mine or oilfield? Has the company sold off significant divisions or made a recent acquisition? Has there been a significant change to the balance sheet since the last financials were reported? Etc., etc.

Goodfellow Inc.

2009-12-07T00:05:00.002-05:00

Goodfellow (TSX:GDL) bills itself as "The Wood Specialists" and claims to be "one of Eastern Canada's largest independent remanufacturers and distributors of lumber products and hardwood flooring products." The company is based in Delson, QC,with regional offices and distribution centres across Canada.

When we calculate CFBIT (Cashflow Before Interest and Taxes) for Goodfellow over the past 5 years, we first look at the average cashflow from operations, which has been $16.8 million. To this we add the taxes reported on the income statement, which averaged $7.5 million, as well as the net interest reported on the income statement. Unfortunately the income statement for Goodfellow does not report interest expense directly, but rather has a line item labeled "financial" which we'll use as a proxy, and it has averaged $2.3 million per year. Cashflow adjustments relating to income taxes add back another $0.7 million. From this we now deduct the capital expenditures, which averaged $2.5 million. So, over the past 5 years, Goodfellow Inc. generated an average of $24.8 million each year in free cash, before interest or taxes.

The shares last traded at $9.85 and there are 8.6 million shares outstanding, so market cap is $84.4 million. Debt on the most recent balance sheet (August 31, 2009) stands at $5.4 million, offset by $0.6 million in cash and short-term investments. So that gives us an enterprise value (EV) of $89.3 mllion. Dividing our EV by our average CFBIT gives us an earnings multiple of just 4.0. In other words, a historical return at current prices of a whopping 25% before taxes and interest. How many investments do you know that have that kind of yield?

Of course there are caveats. Revenue has fallen dramatically the past two years, from $518 million in fiscal 2007 to just $438 million in fiscal 2009. The outlook for the housing industry is cloudy. But it's these very uncertainties that create such an intriguing investment opportunity.

5-Year Cash Flow

2009-12-06T08:40:00.003-05:00

Ben Graham spends a good portion of the common-stock section of Security Analysis outlining proper analysis of the income statement. He warns of companies charging costs directly to equity accounts, completely bypassing the income statement and thereby inflating reported earnings; of companies taking huge reserves in one year with the intent of using the reserves to inflate earnings in subsequent years; of deferred charges that should really be expensed; and so on.

Since the small investor today must filter through thousands of stocks with the tools he or she has on hand, often with limited time since for most this is a part-time endeavour, I decided that in order to circumvent any tomfoolery going on in the income statement, I would use cashflow as my earnings proxy.

I start my cashflow with the total Cashflow from Operations as reported on the cashflow statement. From this I deduct any capital expenditures. Now because I want to compare the ability of companies to generate cash irrespective of their capital structure, I next add back the net interest expense. By net interest I mean the interest expense less any interest earned from cash balances. I also want to ignore differences in cashflow caused by different tax rates, so I remove any cashflows relating to income tax. This would be income taxes charged on the income statement adjusted for changes in deferred taxes and/or taxes payable/receivable. While it is important to recognize and consider permanent differences in tax rates and the value of tax assets, for the initial filter I feel it's better to remove these effects and consider them afterward.

Once I've made these adjustments (or come as close as I can since I don't have the resources to pull this information exactly; instead I use MSN's on-line financial data, which I can access for free. It often pays to be stingy in the investment game, particularly if you're a small investor) I have what I call CashFlow Before Interest and Taxes, or CFBIT. I look at the average value over the past 5 years, since that's how far back MSN data goes. As mentioned previously, Graham was adamant that several years' earnings be considered, not just the most recent year. He writes "The [earnings power] record must cover a number of years, first because a continued or repeated performance is always more impressive than a single occurrence, and secondly because the average of a fairly long period will tend to absorb and equalize the distorting influences of the business cycle." Good advice that's rarely followed by small investors.

So once I have my average CFBIT, I compare it to the firm's Enterprise Value (EV) to derive an Earnings Multiple. The EV is calculated as the total value of the outstanding shares at the current market price plus the book value of debt plus the value of any outstanding preferred shares, less any cash and short term investments. The idea of EV is to estimate what it would cost to purchase the entire firm so that all the CFBIT returns to you. Some analysts use the market value of debt in the EV calculation but since we're looking at this from the position of an equity investor, it makes more sense to me to use the book value. After all, the bondholders and other creditors would have first claims on the company and if you really did plan to buy the entire firm, you'd likely have to pay out the book value. Obviously there are exceptions but we want to keep this simple.

So with the Earnings Multiple we are halfway to coming up with a "cheapness rating". Next we turn our attention to the balance sheet.

An Updated Model

2009-12-06T00:40:00.003-05:00

Well, I've been away for a while. But the time away was not completely wasted. After poring over the 6th edition of Security Analysis (which is really the 2nd edition with some additional editiorials by current Graham-esque investment professionals) I have developed a model for judging whether a stock is cheap or not based on Graham's ideas. This post gives a high level outline of how the model works.

First, let me summarize what I believe are the main points made by Graham in Security Analysis with respect to judging equity investments. First, Graham emphasizes that a company's valuation should never be based on just a single year's earnings, particularly when those earnings are record-high. He states several times that 5 to 10 years' worth of history must be considered when coming to a proper valuation. Secondly, Graham says that although it's true there is little correlation between book value and market value, there must still be some consideration given to a company's tangible book value when considering a fair price for its stock. Finally, Graham warns against accounting deception and spends a good deal of time instructing the analyst on how to derive a realistic, more-standardized earnings number from the financial statements.

With those 3 points in mind, I devised a model that attempts to incorporate these ideas into a single valuation metric. While it's still in development, the early results seem promising. I use 5 years of earnings data instead of just a single year (a single year's earnings is the standard practice when determining price-earnings ratios nowadays). I also use adjusted cashflow instead of earnings in an effort to filter out any accounting gimmickry (or even legitimate differences in accounting methods used between companies) that Graham warns against. I will expand on what I mean by 'adjsuted cashflow' in future. I also calculate a liquidation value for the company, based on formulas Graham provides. The 5-year cash flow and the liquidation values are then compared to the enterprise value of the firm (basically the enterprise value is the value of all outstanding shares plus all outstanding debt) and we can then tell if the firm is trading at a good price.

I will go into more specifics of the model in future posts and advise readers which stocks the model says represent good value and why. For a taste, here are three small cap Canadian stocks that Graham may have liked: Chartwell Technologies (CWH), Goodfellow Inc (GDL) and Caldwell Partners (CDL.A). All have generated ample cash in the past and all have strong balance sheets. It's true that these companies may be suffering hard times right now (some, such as Caldwll Partners, more than others, such as Goodfellow), but what makes them compelling is that these hard times are already priced into the shares. If things can turn around for these companies, their stock prices could improve dramatically.

And for the record, I own shares in all three of these companies.

Danier Leather

2008-10-22T22:35:00.002-04:00

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

2008-10-14T21:22:00.001-04:00

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:

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.

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.

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

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.

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.

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

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.