The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [145]
The suggested maximum figure of 15 times earnings might well result in a typical portfolio with an average multiplier of, say, 12 to 13 times. Note that in February 1972 American Tel. & Tel. sold at 11 times its three-year (and current) earnings, and Standard Oil of California at less than 10 times latest earnings. Our basic recommendation is that the stock portfolio, when acquired, should have an overall earnings/price ratio—the reverse of the P/E ratio—at least as high as the current high-grade bond rate. This would mean a P/E ratio no higher than 13.3 against an AA bond yield of 7.5%.*
Application of Our Criteria to the DJIA at the End of 1970
All of our suggested criteria were satisfied by the DJIA issues at the end of 1970, but two of them just barely. Here is a survey based on the closing price of 1970 and the relevant figures. (The basic data for each company are shown in Tables 14-1 and 14-2.)
Size is more than ample for each company.
Financial condition is adequate in the aggregate, but not for every company.2
Some dividend has been paid by every company since at least 1940. Five of the dividend records go back to the last century.
The aggregate earnings have been quite stable in the past decade. None of the companies reported a deficit during the prosperous period 1961–69, but Chrysler showed a small deficit in 1970.
The total growth—comparing three-year averages a decade apart—was 77%, or about 6% per year. But five of the firms did not grow by one-third.
The ratio of year-end price to three-year average earnings was 839 to $55.5 or 15 to 1—right at our suggested upper limit.
The ratio of price to net asset value was 839 to 562—also just within our suggested limit of 1½ to 1.
TABLE 14-1 Basic Data on 30 Stocks in the Dow Jones Industrial Average at September 30, 1971
If, however, we wish to apply the same seven criteria to each individual company, we would find that only five of them would meet all our requirements. These would be: American Can, American Tel. & Tel., Anaconda, Swift, and Woolworth. The totals for these five appear in Table 14-3. Naturally they make a much better statistical showing than the DJIA as a whole, except in the past growth rate.3
Our application of specific criteria to this select group of industrial stocks indicates that the number meeting every one of our tests will be a relatively small percentage of all listed industrial issues. We hazard the guess that about 100 issues of this sort could have been found in the Standard & Poor’s Stock Guide at the end of 1970, just about enough to provide the investor with a satisfactory range of personal choice.*
The Public-Utility “Solution”
If we turn now to the field of public-utility stocks we find a much more comfortable and inviting situation for the investor.† Here the vast majority of issues appear to be cut out, by their performance record and their price ratios, in accordance with the defensive investor’s needs as we judge them. We exclude one criterion from our tests of public-utility stocks—namely, the ratio of current assets to current liabilities. The working-capital factor takes care of itself in this industry as part of the continuous financing of its growth by sales of bonds and shares. We do require an adequate proportion of stock capital to debt.4
In Table 14-4 we present a résumé of the 15 issues in the Dow Jones public-utility average. For comparison, Table 14-5 gives a similar picture of a random selection of fifteen other utilities taken from the New York Stock Exchange list.
As 1972 began the defensive investor could have had quite a wide choice of utility common stocks, each of which would have met our requirements for both performance and price. These companies offered him everything he had a right to demand from simply chosen common-stock investments.