Today’s post is part 1 of 2 in which I share with you how Walter Schloss took Ben Graham’s balance sheet approach to investing and made it his own.
This is important because Schloss’ track record is well documented as the image below testifies:
Using a screener like ADVFN is awesome for two reasons:
- Its free
- It drastically cuts down the amount of time required for investment research*
*Always perform thorough research before making an investment of any kind
Ben Graham And The Newbie Investor
In The Intelligent Investor Ben Graham set forth a number of different strategies that new investors can implement straight out of the box.
For this, Graham wanted to make investing as simple as possible. For example, he argued that newbies can use one criteria that can be applied to all companies that if met, was sufficient to warrant a purchase of its shares: companies selling under their net-current-asset-value.
Today, investors both new and professional use a variation of this net-current-asset-value called book value.
For a jargon-free beginners guide to balance sheet valuations take a look at what is book value.
Walter Schloss’ Asset Based Valuation Method
From written sources, it appears that Schloss made the distinction between net current asset value (current assets minus total liabilities) and tangible book value (total assets minus goodwill and intangibles, minus total liabilities) on the basis that inventories and receivables are less relevant to an asset based valuation of a company.
The document below produced by Schloss in 1994 gives more details about his investment philosophy and strategy as a whole and is an excellent resource for new investors:
Including stocks and shares selling below tangible book value, this document shows that we need to add a debt to equity ratio of 100% or less to our screen as Schloss did.
Debt to equity as the link explains, measures a company’s financial leverage; how much debt it has compared to its assets. It allows us to include in our screen only those companies that have a managable amount of debt.
Ben Graham’s Balance Sheet Approach To Security Analysis
On page 385 of The Intelligent Investor, Ben Graham gave a set of criteria for new investors to screen for a list companies from which an investor could purchase a diversified portfolio of 15-20 cheap companies that are in a relatively good financial position.
Graham called it ‘A Winnowing of the Stock Guide‘.
- The P/E ratio must be nine or less
- Current assets must be at least 1 and a half times current liabilities (current ratio of 1.50)
- Debt must not be more than 110% of net current assets
- No negative EPS in the last five years
- The company must be paying a dividend
- The current annual EPS should be more than the EPS 5 years earlier
- Price should be less than 120% of tangible book value
I have replaced this criteria with Schloss’ debt to equity ratio filter and the 5 year compounded EPS growth rate respectively.
In regard to the EPS growth rate, I have set the screener to return companies that have a positive EPS growth rate over 5 years which will rule out companies whose managers are unable to increase earnings to shareholders.
It is worth revisiting what Graham said about this method of investing:
One might say that a group of issues (companies), of at least average quality, meeting criteria of financial condition as well, purchasable at a low multiplier of current earnings (P/E ratio) and below asset value (tangible book value), should offer good promise of satisfactory investment results.
Do not worry if you get the feeling that the jargon overwhelms you; we have identified a set of criteria from which we can derive a list of companies for potential investment – in short, an investing strategy.
If you have not already, I suggest at this stage that you create your free ADVFN account in readiness for part 2 of this series of posts that shows you how to use ADVFN to invest like Ben Graham and Walter Schloss.
Thanks for reading The Shares And Stock Markets Blog and good luck with your investments.
Contact me via the comments form below if you have any questions, I will always respond. 🙂