What are the red stars
and grey stars
you see on Investinvalue.com ?
The red stars
indicate that a company passes Graham's qualitative filters
: if the star is red, the criteria is OK. If the star is grey (),
it's not. Each star relates to one of the 5 Graham's criterias :
Graham's qualitative
filters
For conservative investors : one
red star if...
For enterprising investors : one
red star if...
Financial condition
current ratio is above
2
long term debt / current assets is under 1
current ratio must be above
1.5
long term debt / current assets must be under 1.1
(Note that
a company has to pass both current ratio and long term debt ratio
tests to have one red star.)
Earnings stability
no losses in the past 10 years
no losses in the past 5 years
Dividends
15 years of dividends in the past 15
years
some dividends last year
Earnings growth
earnings growth above 33% in the past
10 years
Last year earnings above earnings 5
years ago
Valuation
P.E.R multiplied by Price/book ratio
under 22.5
Price/book ratio under 1.20.
The stars are always presented in the same order : the
first star from the left is for the financial condition criteria, the
second one is for Earnings stability, and so on… you can see what is
the filter for a star by rolling over the star with your mouse.
For example, a company with these stars :
-
:
this stock has a good financial situation, dividends, earnings growth
and valuation ok, but has a problem with earnings stability indicating
that the company may be weak at some stage of its cycle or that there
has been hard time in the business that may well come again.
-
:
this stock is cheap in terms of valuation but there are probably good
reasons for it...
- :
this company seems to be attractive but does not pass the financial
condition test : the reason may be because the business of the company
does not require high current asset or can be financed by long term
debt, but it could also be that the company is risky...
- :
this company seems to be attractive but has a short dividend history
(conservative investors) or no dividend last year (enterprising investors)
; dividend is often a good protection in bearish markets, and it shows
a "friendly" behavior of managers towards shareholders...
but some growth companies prefer to keep their results to finance their
developpement.
Types of Investors
Graham felt that individual investors fell into two camps
: "defensive" investors and "aggressive" or "enterprising" investors.
These two groups are distinguished not by the amount of risk they are
willing to take, but rather by the amount of "intelligent effort" they
are "willing and able to bring to bear on the task."
Thus, for instance, he included in the defensive investor category professionals
(his example--a doctor) unable to devote much time to the process and
young investors (his example--a sharp young executive interested in finance)
who are as-yet unfamiliar and inexperienced with investing.
Graham felt that the defensive investor should confine his holdings to
the shares of important companies with a long record of profitable operations
and that are in strong financial condition. By "important," he meant one
of substantial size and with a leading position in the industry, ranking
among the first quarter or first third in size within its industry group.
Aggressive investors, Graham felt, could expand their universe substantially,
but purchases should be attractively priced as established by intelligent
analysis. He also suggested that aggressive investors avoid new issues.
RULES
FOR DEFENSIVE INVESTORS
RULES
FOR ENTERPRISING INVESTORS
1
- ADEQUATE SIZE OF ENTERPRISE
Graham had a preference for large
companies.
He felt that large firms have the resources in "capital and brain
power" to carry them through adversity and back to a level of satisfactory
earnings. This concern came into play for Graham because he looked
at stocks of firms that became unpopular due to unsatisfactory developments
of a temporary nature.
When screening for company size, the three most popular criteria are
market capitalization (number of shares out-standing times market
price), sales, and total assets.
Graham focused on sales for industrials and total assets for utilities
because they reflect company activities and size directly, while market
capitalization is tied to overall market levels.
Graham specified that the defensive investor should exclude small
companies with less than $100 million of annual sales for industrial
companies and $50 million in total assets for public utilities.
2
- STRONG FINANCIAL CONDITION
Graham used different measures of financial
strength depending upon the industry.
As a test of short-term liquidity, Graham specified a current ratio
(current assets divided by current liabilities) of 2.0 or higher for
industrial firms.
No current ratio requirement was specified for the utility sector.
Graham stated that this "working capital [current assets minus current
liabilities] factor takes care of itself in this industry as part
of the continuous financing of its growth by sales of bonds and shares."
To measure the use of long-term debt, Graham required that long-term
debt for industrial firms not exceed net current assets, or working
capital.
Financing is an important consideration for utilities, so Graham specified
that investors look at the debt-to-equity ratio for this sector. He
specified that debt should not exceed twice the stock equity (at
book value, not market value). This turned out be a much less restrictive
screen than the financial condition screens for non-utilities.
For the enterprising investor, Graham
relaxed his tests of the firm's financial position.
For the current ratio the minimum of 1.5 was specified, while long-term
debt was not to be higher than 110% of net current assets.
3
- EARNINGS STABILITY
Graham liked to look at the historical
company performance over an extended period of time. He had a preference
for companies that avoided losses during recessionary periods.
Graham recommended 10 years of positive earnings in his screen
for the defensive investors.
Graham also loosened the requirement
of earnings stability, specifying that earnings be positive for
each of the last five years.
4
- STRONG DIVIDEND RECORD
A common test for financial strength
over time is a long period of uninterrupted dividends.
In the defensive investor screen, Graham recommended uninterrupted
payments of at least the past 20 years.
For the enterprising investor, Graham
only specified that firms pay some level of current dividends.
5
- EARNINGS GROWTH
Graham recommended a minimum increase
of at least one-third in per share earnings in the past 10 years,
which translates into about a 3% annual growth rate .
Without such a criterion, a screen looking for companies with low
multiples may list companies with poor prospects. While Graham felt
that even companies in a state of "retrogression" could be of interest
if they could be purchased at a low enough price, this was not the
domain of the defensive investor.
When it came to earnings growth, Graham
again was less restrictive for the enterprising investor, requiring
only that earnings for the latest year be higher than earnings
five years ago.
6
- MODERATE PRICE-TO-EARNINGS RATIO
Graham seemed to express frustration
with the impact of special charges on the earnings per share calculation.
He felt that management's discretion in establishing reserve accounts
makes it difficult for the investor to determine whether they truly
reflect the operation of the firm for a specific time period.
To help get around this problem and to smooth the impact of the business
cycle, Graham often averaged earnings over a period of several years.
In specifying the price-earnings filter, Graham required that the
price to average earnings over the last three years be no more
than 15.
One of the keys to selecting secondary issues is
to purchase them at a significant discount--Graham felt these stocks
tended to almost always trade below their intrinsic value.
It was only during a bull market when little distinction was made
between primary and secondary issues that the prices of these secondary
issues approached or exceeded their intrinsic value.
Graham's first screen for the enterprising investor was to look
for companies trading with price-earnings ratios in the lower 10%
of all stocks.
One warning that Graham gave of the low price-earnings
filter was for cyclical firms with widely fluctuating earnings.
These firms often trade at high prices and low price-earnings ratios
in good years when they should be sold, and low prices and high
or non-existent price-earnings ratios in bad years when they should
be considered for purchase. For these firms, Graham recommends a
test of price low to past average earnings as suggested for the
defensive investor.
7
- MODERATE PRICE-TO-BOOK-VALUE RATIO
Graham was a believer in using low price-to-book-value
ratios to select stocks and normally required a price-to-book ratio
below 1.5 for the defensive investor.
However, he also felt that a low price-earnings ratio could justify
a higher price-to-book-value ratio. Therefore, he recommended that
investors multiply the price-earnings ratio by the price-to-book-
value ratio and not let that value exceed 22.5 --the product of
a current price-earnings ratio of 15 and a price-to-book-value ratio
of 1.5.
The final criterion specified that the current
price be less than or equal to 120% of tangible book value.
This requirement is more restrictive than
for the defensive investor and makes no adjustment for the level
of the price-earnings ratio. Since Graham felt that secondary firms
normally trade at a discount to their intrinsic value, it is not
surprising that a tougher filter was specified.
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and grey stars 
you see on Investinvalue.com ?
