Want to know one type of investment strategy that forms part of my own stock market investment plan?
New investors can implement this strategy immediately, without the need for experience in the stock market.
New investors please adhere to Ben Graham’s advice:
paper trade for at least twelve months before committing real money to your stock market investments.
In a previous post, I looked at how investors can take a tried and tested stock market strategy based upon the experiences of Graham and Schloss and use ADVFN to screen for companies using this strategy.
Today, I will show you a different yet simple approach of finding undervalued companies, the hallmark of value investing.
The Relatively Unpopular Large Company
This method of investing was first popularised by Ben Graham in The Intelligent Investor. The basic premise of the method can be summarised from Graham himself:
If we assume that it is the habit of the stock market to overvalue common stocks which have been showing excellent growth or are glamorous for some other reason, it is logical to expect that it will undervalue – relatively, at least – companies that are out of favour because of unsatisfactory developments of a temporary nature.
Put simply, Graham is suggesting and rightly so, that the stock market will sometimes overvalue and undervalue companies. The smart thing to do is buy shares when they are undervalued. The idea being that the company’s shares should rise to at least fair or higher value at some point in the future.
How Does The Strategy Work?
As I invest in both the US and the UK stock market I would need to extend this strategy by buying the first thirty three companies in the FTSE 100 that were selling at their lowest P/E ratio.
Graham tested this method over a 53 year time period as did an investment bank called Drexel and they both found the strategy lost money each year infrequently but for the vast majority of years, the method provided an excellent return on investment.
For example, Drexel found that over a 34 year period, 3 years did worse than the Dow Jones, 6 years returned about the same and for 25 out of the 34 years, the method outperformed the Dow Jones. For more details about this method, please refer to page 163 of The Intelligent Investor.
How To Find Relatively Unpopular Large Companies
I do not use ADVFN to screen for relatively unpopular large companies because currently, there is no easy way of doing so. I also do not follow Graham’s advice of buying the cheapest companies by P/E ratio either.
Instead, I use the popular press to find relatively unpopular large companies.
The reason I do this is because the popular press only covers well know (large) companies and they usually only cover them when they are in some kind of trouble (unpopular). Here is an example that I posted to Facebook.
Take the BP oil spill.
When the story of the Gulf of Mexico disaster happened, news wires were bombarding the public with minute by minute coverage of events as they unfolded.
I did not need ADVFN or any other financial website to tell me that BP was both large and unpopular.
The thing that differentiates the BP story from other unpopular large companies was just how unpopular BP became.
Bottom line is this: stay tuned to your favourite news service and watch out for any stories on large companies going through a bad patch.
There is no correlation between which news service to use and the results of your investments. What matters is using your own judgement to decide if a company meets Graham’s criteria.
How is this done?
Simply watch/read the daily news with a bias towards looking for stories that involve big businesses that are going through a period of trouble.
What criteria must a company meet to be large and relatively unpopular?
To begin with, there are many reasons why a company becomes unpopular:
- reduced earnings
- a scandal
- accounting gimmicks
- high ranking employee resignations
The list is almost endless, but these are the kinds of things you should look out for.
Also, a company is large if it has global sales such as Tesco.
Tesco announced a terrible set of Christmas trading results in January 2012 which drove the share price down, presenting an opportunity for investors to purchase a relatively unpopular large company. Warren Buffett did exactly that and bought in.
If a company does not have global sales, it can still qualify as large if it has a market cap of more than $10 billion for the US or it is a FTSE 100 company for the UK.
The FTSE Index Company provide an updated list of the FTSE 100 constituents on their website which you can find here.
To identify a US company that is large (a market capitalisation of over $10 billion) simply click the shares A-Z box on the front page of ADVFN after you login as shown below:
The next page you will see is reproduced below.
Make sure that you choose the correct exchange (NYSE, NASDAQ, AMEX), then choose the first and second letter of the company name using the drop down menus, then click filter.
The graphic shows me looking for the company Coca Cola on the NYSE:
Click on your company ticker symbol then click the financials tab as shown in the image below:
Clicking this tab gives you a host of information about your company including the market cap 🙂
To know when the share price is at the right price for you to actually buy, Ben Graham stated that ‘the price should be low in relation to past average earnings (P/E ratio)’.
Graham also advised that the current P/E ratio should be 20 or below to avoid overpriced (overvalued) ‘growth’ stocks.
P/E ratio information can be found on the ‘financials’ tab.
For US companies, ADVFN lists the five year average P/E ratio. For UK companies, ADVFN lists the past average of only those years when the P/E ratio has been positive.
In either case and to simplify matters, make sure that the P/E ratio is at least at the lower end of or below the average P/E ratio of the past 🙂
That’s pretty much it. The rest is down to you. Just make sure that:
- your company is large
- your company is going through a period of unpopularity
- your company’s share price has declined;
- your company is at the lower end of or below its past average P/E ratio and;
- your company’s current P/E ratio should be 20 or below
In the free Shares And Stock Markets Newsletter, I often mention companies that are going through some sort of trouble.
Subscribe now to take advantage of this exclusive content.
One final tip is that when I do find these undervalued giants, I tend to just buy the shares without further research – I like a simple way to invest for my daughter’s future: large companies often pay dividends. Literally.
Thanks for reading The Shares And Stock Markets Blog and good luck with your investments.