6 Points In A Stock To Look Out For From Warren Buffett’s Legendary Mentor, Benjamin Graham
The late Benjamin Graham, who was the legendary investing mentor of billionaire investor Warren Buffett, was one of the fore founders of stock market analysis. Throughout his esteemed career, he took the time to pass down his vast amounts of knowledge on investing via lecturing in colleges, numerous speeches, and the writing of books.
One of the most appealing characteristics of Graham’s writings was his ability to explain complex topics in a way that the layperson would easily understand. In his book The Intelligent Investor, Graham preached about how investors should invest in stocks that were priced lower than their intrinsic value. We now know this approach as value investing.
Graham also introduced six vital business characteristics for investors to assess about a stock. They are a stock’s profitability, stability, growth, financial position, dividends, and price history. Here’s more about the characteristics and what to look out for:
1. Profit margin as an indicator of business strength
Graham believed that a company that was able to generate a larger profit per dollar of sales showed comparative strength. This is useful in comparing companies within the same industry. A company generating higher profit margins than its competitors could mean it has better footing among customers and could sell its goods or services at a higher price.
2. Comparing average per share earnings as an indicator of stability
Comparing a company’s average per share earnings over the last 10 years versus the last three years could give investors clues on the stability of the company’s business.
If a company’s three-year-average earnings was similar – or even higher – than its 10-year-average earnings, that showed stability in its business. Graham preferred using averages, as he thought it was more reflective of a company’s business compared to using single-year profit numbers which could be distorted by one-time events.
3. Comparing earnings growth of a company to an index
A good way to find out if a company is growing at a good pace would be to compare its growth with a relevant index. In Singapore, we can compare a company’s earnings growth against what the Straits Times Index (SGX: ^STI) produces.
4. A company’s debt to asset ratio
We can assess the financial position of a company by studying its net debt to current asset ratio. In Graham’s opinion, a company should not have more than 50 cents of debt for each dollar of current assets. A company that is overleveraged is at risk of running into liquidity issues that can harm its business.
5. Dividend consistency is key
Companies that can consistently deliver dividends without interruption over a long period of time show stability and durability in their business. It is also important that a company pays its dividends through its operating profits and not through debt or other means. If a company is able to show dividend growth over time, it is even better.
6. Price history
Stock price fluctuations are bound to occur over the short-term. But if a company has displayed stable stock price growth over a long period, that is usually indicative of a fundamentally strong company that is growing its intrinsic value.
Graham was ahead of his time in the analysis of stocks and he was able to deliver consistent market beating returns in his partnership fund. Even though more than 50 years have passed since the first edition of The Intelligent Investor was published, the principals of his teachings still hold true.
As investors, we can use Graham’s six-point checklist to assess a company’s strengths and weaknesses before we make an investment decision.