Finweek English Edition – August 15, 2019

(Joyce) #1
By Simon Brown

marketplace invest DIY


INVESTMENT STRATEGY


The search for true value


b


ack in March, I wrote about
Barloworld* in one of my
‘House View’ columns. I picked
this stock because it is the
only local stock that meets the classic value
investing definition.
Value investing is a phrase thrown around
with abandon in the investment world, but in
truth we have very few true value investment
managers. Even Warren Buffett, who studied
under the father of value investing, Benjamin
Graham, is no longer a value investor in the
classic sense.
There is also an argument that value no
longer has a place in investing, but I disagree
with that. But at the same time, finding true
value stocks, especially on the relatively small
JSE, is often difficult.
The original concept of value investing
is Benjamin Graham’s book, The Intelligent
Investor. First published in 1949, it remains the
default guide for value investing.
In the book Graham details the criteria a
stock must meet in order for it to be considered
a defensive value investment (he also deals
with enterprise stocks, but for the purpose of
this article, I am focusing on the defensive side).
The first rule is that the company should
have a market cap of R10bn (as at the time of
my search). So, immediately, it knocks out the
majority of JSE-listed stocks, but it does leave
a decent enough sample.
The second rule deals with
balance sheets and states
that current assets (remember
current means those that can
be cashed in within a year) must
be twice that of current liabilities
(short-term debt), while long-
term debt (more than a year to
maturity) must not exceed net
current assets (current assets
less current debt). In other words,
the company is in a position where
it can liquidate the current assets
and pay off the debt.
The stock must also have made a profit
for at least the last ten years and must have
paid a dividend every year for the last 20
years. Again, these time metrics immediately
disqualify the majority of JSE-listed stocks.

However, they do give us a short list of stocks
that have long-term profitability and dividend
payments. This tells us a lot about the quality
of the stock and is therefore important.
The current price-to-earnings ratio (P/E)
must not be above 15 times, while price-to-net
asset value (NAV) must not exceed 1.5 times.
These are fairly standard valuation ideas to
select ‘cheaper’ stocks.
Then we get to the ‘Graham number’ or
equation. This is how it works: One takes
headline earnings per share (HEPS) and
multiplies it by the tangible net asset value
(TNAV). Then multiply that number by 22.5.
(Graham uses 22.5 as the preferred P/E of
15 times, multiplied by the preferred 1.5 times
price-to-book.) Finally: Find the square root
of this equation.
That answer is what Graham considers
the fair value. One then wants to buy at a
discount to that value.
Lastly, Graham suggested a portfolio of ten
defensive stocks using the above methodology.
This means an exposure of no more than 10%
in each stock at inception. Thus, JSE investors
hit a wall because my recent search yielded only
Barloworld rather than a list of ten.
For those wanting to really dig deep and
hunt for what Graham called the ‘enterprising
stocks’, the rules are even tighter in certain
regards. But it does provide a little more scope
in other criteria. Through my search,
I indeed managed to find a few
smaller stocks that meet the criteria.
But they’re not as attractive as the
Barloworld discount – according to
Graham’s equation, the fair value for
Barloworld is R200.
There is another (easier)
approach, and that would be to
just buy the Absa value exchange-
traded fund (NFVAL). But they’re
using their own idea of value rather
than the classic Graham theory.
But for a slice of a portfolio, they
are focusing on issues such as low debt and
whether stocks trade at, or below, NAV. Both
are attractive valuation theories and worth a
space in a diverse portfolio. ■
[email protected]
*The writer owns shares in Barloworld.

Value investing is a


phrase thrown around


with abandon in the


investment world,


but in truth we have


very few true value


investment managers.


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Using Benjamin Graham’s original concept of value investing, Simon Brown searches for value stocks on the JSE.
Turns out they are hard to come by on our local bourse.

@finweek finweek finweekmagazine finweek^ 15 August 2019^17
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