Benjamin Graham, the patron saint of value investing, died 34 years ago. His classic books -- “Security Analysis” (1934) and “The Intelligent Investor” (1949) -- are still read by scores of value managers who keep his name and stock-picking methods alive.
From time to time, I try to guess what stocks Graham would buy today if he were alive. A streamlined set of criteria intended to resemble those Graham used as a hedge-fund manager helps me identify the possibilities.
My Graham-inspired picks sell for less than book value (corporate net worth per share) and less than 12 times earnings. They also have debt less than 50 percent of stockholders’ equity.
A year ago I recommended Boston Scientific Corp. as a stock I believed Graham would have liked. A reader reprimanded me, saying that while the company did sell for less than book value, a big part of that book value was goodwill, which is a squishy and intangible asset.
When one company acquires another, and pays more than book value for it, the excess payment is called goodwill. Presumably, it represents the value of the acquired company’s intellectual property, customer relationships, brand recognition and other intangible factors. Goodwill goes on the acquirer’s books as an asset.
Graham, the reader said, wouldn’t be willing to pay much for goodwill. I decided it was a valid point, so this year’s list screens out stocks that sell for more than 1.5 times tangible book value, which excludes goodwill.
I found four stocks that I believe Graham would view favorably.
Most of the companies that survived my screens were insurers. I’ll pick two of them here. One is New York-based Travelers Cos., which specializes in commercial property and casualty insurance and also underwrites automobile and homeowner insurance for individuals.
Graham liked to base his decisions on 10 years of a company’s data. In the case of Travelers, revenue rose to almost $25 billion in 2009, from less than $8 billion a decade earlier. Net income has reached $3.6 billion, up from less than $1 billion.
Travelers merged with rival St. Paul Cos. in 2004 and joined the Dow Jones Industrial Average last year. The company remained profitable during the financial crisis. That wasn’t the case at some other insurers, including American International Group Inc., Allstate Corp. and Progressive Corp.
Another insurer that I think would appeal to Graham is Lincoln National Corp. The Radnor, Pennsylvania, company sells life insurance, long-term care policies and various types of group coverage. It also has a large financial services component, offering annuities, 401(k) retirement savings plans and other financial products for businesses and individuals.
Unlike Travelers, Lincoln National did suffer a loss during the recession, in 2009. But it has shored up its finances by selling assets.
Now, Lincoln is coming back. This year revenue should exceed $10 billion, a level last seen in 2007. Analysts estimate that Lincoln will report fully diluted earnings per share of $2.66 this year, compared with a loss of $1.85 last year and a gain of only 22 cents a share in 2008.
Were Graham alive today, I think his eyes would light up to see that Lincoln National sells for 0.6 times official book value, and 0.9 times tangible book value.
Fewer Empty Beds
Kindred Healthcare Inc., with headquarters in Louisville, Kentucky, operates hospitals and skilled nursing centers and offers rehabilitation services. Almost everyone in the health-care business today gets a meaningful slice of revenue from government programs, and I view that as a problem since Uncle Sam is likely to get stingier as budget pressure tightens.
Yet I think Kindred’s advantages are considerable. Occupancy rates at its hospitals might improve as the new health-care laws expand insurance coverage to more people. Its rehabilitation business may benefit as the population and the workforce grow older.
And Kindred stock is cheap. It sells for only 0.8 times tangible book value, and only 0.14 times revenue.
MVC Capital Inc., located in Purchase, New York, might look stagnant at first glance. Its stock price is little changed from four years ago. With dividends, however, the stock has returned about 18 percent -- respectable performance considering that a financial crisis ripped the nation during much of that period.
By comparison, Citigroup Inc.’s stock has fallen about 90 percent in the past four years even after including dividends and Bank of America Corp.’s stock has dropped about 74 percent.
MVC makes loans to small and medium-sized businesses, taking equity, debt or both in return. It also makes loans for management buyouts, recapitalizations and acquisitions.
Michael Tokarz spent 17 years at Kohlberg, Kravis, Roberts & Co. before he became MVC’s chief executive officer.
MVC is not what I would call a safe investment. The company’s diluted earnings per share declined the last two years. Yet I think it’s significant that it hasn’t had a loss since 2003, while the competitive landscape the past few years has been as treacherous as ice with an oil slick on top.
Disclosure note: I have no long or short positions in the stocks discussed in this week’s column, either for myself or for clients.
(John Dorfman, chairman of Thunderstorm Capital in Boston, is a columnist for Bloomberg News. The opinions expressed are his own. His firm or clients may own or trade securities discussed in this column.)
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