Invest Like the Father of Security Analysis

Physician's Money Digest, September 2005, Volume 12, Issue 13

Benjamin Graham is a Wall Streetlegend. Widely recognized as thefather of security analysis, hesought prominent, large companies indominant positions within their industrieswhen looking to invest. Grahamdid not like stocks that traded at morethan 20 times their prior 12-monthearnings, even though that meantexcluding growth stocks, and insteadfocused on bargains. Throughout hislife as a successful investor and financialadvisor, he emphasized the importanceof understanding the difference betweenprice and value. His strategy states thatthe market in general will not producevalue for the investor in the long term—only the company will.

Value the Undervalued

The Intelligent Investor

In his book (HarperCollins; 2003), Graham stronglyargues for investing in stocks that aresignificantly undervalued relative totheir intrinsic worth, which he measuresprincipally by future earnings potential.

Graham's methodology is appropriatefor the conservative physician-investorwho worries about the highvaluations currently accorded to manystocks, but is unwilling to settle forinvesting in cash or bonds only. Thesetypes of investors are known as valueinvestors. They want to buy at a discountand are willing to hold for a longperiod of time.

Graham's Methodology

The strategy first involves looking forcompanies whose annual sales aregreater than $340 million. According toGraham, each company selected shouldbe large, prominent, and conservativelyfinanced. Furthermore, the company'scurrent ratio (ie, current assets dividedby current liabilities) must be greaterthan or equal to two, proving that it canpay its current obligations from its currentresources. Companies that meetthis criteria are typically financiallysecure and defensive. For industrialcompanies, long-term debt must notexceed net current assets, which is consideredan attribute of a financiallysecure organization that can meet itslong-term obligations.

This strategy also looks for companiesthat increase their earnings-pershare(EPS) by at least 30% over a 10-year period and whose EPS must nothave been negative for any year withinthe last 5 years. In addition to provingthemselves financially secure, thesecompanies have established themselvesover a long period of time.

John P. Reese is CEO of Validea Capital

Management,West Hartford, Conn, a money

management firm that utilizes the principles

on Validea.com to manage money for high

net-worth individuals. Mr. Reese's book The

Market Gurus: Stock Investing Strategies you can use from

Wall Street's Best (Dearborn; 2002) has sold over 30,000

copies. A columnist for RealMoney and MSN Money, Mr.

Reese is a graduate of Harvard Business School and holds

two US patents in the area of automated stock analysis. He

welcomes questions or comments at 800-730-3457 or at

johnreese@valideacapital.com