Canadian stocks that Benjamin Graham might like
I like to hunt for U.S. value stocks using Benjamin Graham's criteria for defensive investors. The method focuses on solid companies trading at modest prices. You can read all about it in Graham's book The Intelligent Investor which deserves a spot on every investor's bookshelf. But I'm often asked for Canadian stocks that pass Graham's test. This month I've found five candidates that the master might like.
Before getting into the details, you can discover why Graham stocks are interesting by perusing this year's U.S. Graham picks in the November 2006 edition of the Canadian MoneySaver. You'll find that past U.S. picks gained 351.4% since 2000 versus a 1.0% gain for the S&P500. Also, the 2007 U.S. Graham stocks are up about 21% in only a few months. So far, the best performers have been Blair (BL) which is up about 67% on a takeover offer and Seaboard (SEB) which has gained 56%.
Given the method's recent success, you can see why I often get requests to apply it to Canadian stocks. Indeed, I scan the Canadian markets and even mentioned ATCO as an interesting Graham pick in the March 2004 edition of the Canadian MoneySaver. In 2004, ATCO traded at a split-adjusted price of $25.32 per share and closed at $47.97 per share on February 9, 2007. That's a capital gain of 89.5% vs. a gain of 51.4% for the S&P/TSX Composite over the same period.
The problem is, Graham's original method is very exacting and often excludes all stocks. Even in the U.S. I softened his rules to the eight criteria shown in Table 1. In Canada the pickings are slim with approximately eight times fewer large stocks to choose from. Because writing articles about a method that routinely unearths no stocks is less than exciting, I added a little more water to my Grahamian wine. I decided to start with the four criteria shown in Table 2.
The first two rules are classic value criteria and they should ensure that only relatively cheap stocks pass the test. A low price-to-earnings ratio indicates that a stock has earned a large amount over the last twelve months compared to its current price. Similarly, a low price-to-book-value ratio indicates that one can buy lots of assets on the cheap. Neither ratio is perfect (earnings may be due for a decline and assets could be inflated) but they've generally been shown to be quite useful. The next two criteria are arguably more focused on safety. I decided to seek stocks that pay dividends under the theory that only stable firms pay dividends. I stuck to firms with revenues of more than $500 million under the theory that large firms tend to be less rickety. There are of course many times when both theories have failed in practice.
But I didn't stop there. I also include a pinch of judgement as a final safety check in an effort to further screen out duds and peculiarities. Again, this might sound good in principle but I wryly note that judgement hasn't always saved my bacon in the past.
With the method in hand, I used the stock screener at globeinvestor.com to do most of the hard work. A little more deliberation narrowed down the list to the five stocks shown in Table 3 which are ordered with larger stocks at the top of the list. Of the five, three are insurance companies and they are joined by Empire, a conglomerate which owns Sobeys, and auto-parts firm Linamar. (For the sake of full disclosure, insurer Northbridge Financial (NB) is a subsidiary of Fairfax Financial (FFH) which is a personal holding.)
Be sure to examine any stock in great detail before investing and remember that five stocks can't be said to form a well-diversified portfolio. Always be cautious before jumping into any investment and talk over potential purchases with your investment advisor. (Also be aware that these Graham-inspired stocks may be in our personal and client portfolios.)
It is useful to remember that value stocks can be psychologically difficult to hold. In many ways, value investors try to trade comfort for good performance. However, a few value stocks inevitably fail entirely. The hope is that the failures will be made up by gains elsewhere. So, be sure you understand what you're getting into before diving in.
First published in the March/April 2007 magazine.
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