The Intelligent Investor
Stock Selection For The Enterprising Investor
To generate an average result equivalent to the performance of the DJIA, Graham says no one requires a special ability of any kind. All that is needed is 30 prominent securities, identical or similar to that of the DJIA. Surely then, it is possible to generate substantially better results with a detailed level of study, or experience than the DJIA. The above statement is very difficult to prove right even for the author because even the top funds have not been able to prove themselves as “superior” to others.
A typical investor would select stocks that have high growth industries and have high future expectations. This method, however, would omit all the lower-level stocks at lower prices.
The next method would include secondary companies that are making a good showing, have good past records but hold no charm for the public in general. The author then mentions some clues which can help us identify these stocks:
a) Price low in relation to earnings.
b) Current Assets at least 1.5 times that of current liabilities and debt not more than 110% of net current assets.
c) No earnings deficit in the last 5 years.
d) Should have a current dividend.
e) Price should be less than 120% of net tangible assets.
In addition, we might add high rating stocks from rating agencies and all the criteria that were applied for the defensive investor.
The author also did a little "experiment" by selecting some random stocks from the market and found out that companies of major size who have a large goodwill component do pretty well over a 2.5 year holding period. There is a momentum effect attached to these companies, i.e., companies that are doing well keep doing well and vice-versa.
An investor can also look for special situations or “workouts”.
Consider an example, Universal Marion Co., after ceasing its business operations, asked their shareholders to give formal consent for its dissolution. The treasurer had indicated that the common stock of this company had a value of $28.5 per share, most of which was liquid form. The stock closed at $21.5 in 1970, if the book value was realized in the liquidation process, a gross profit of more than 30% was realized.
These kinds of special situations always prove to be profitable for an investor but are not easy to predict or find.