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Dorfman: Getting into head of Benjamin Graham

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Tuesday, Aug. 12, 2014, 12:01 a.m.
 

In the pantheon of value investors, Benjamin Graham is a god.

Mentor to Warren Buffett, co-author (with David Dodd) of Security Analysis, hedge fund manager, and Columbia University professor, Graham (1984-76) has been a seminal influence on generations of investors who try to buy stocks for less than their intrinsic value.

I attempt to follow Graham's precepts when investing. Once a year, I pay homage to him by attempting to guess what stocks he would buy if he were alive.

For this exercise, I use a simplified version of his selection criteria. To be considered for my annual “Graham picks” article, a stock must:

• Sell for less than 12 times the company's earnings.

• Sell for less than the company's stated book value (corporate net worth per share).

• Sell for less than 1.5 times the company's tangible book value, which excludes intangible assets such as goodwill.

•Have debt less than 50 percent of stockholders' equity.

The history

This is the 12th column I have written attempting to channel Graham's ghost. The previous ones were published annually from 2001 to 2006 and from 2009 to 2013. My Graham-inspired selections have beaten the Standard & Poor's 500 Index nine times out of 11 and have been profitable eight times.

On average, the one-year return on my Graham selections has been 23.35 percent, compared with 11 percent for the S&P 500.

Please keep in mind that past performance doesn't indicate future returns. The results of my column recommendations are hypothetical and don't take into account trading costs or taxes. And the performance of my column picks shouldn't be confused with those of portfolios I manage for clients.

Last year, by proxy, the late Mr. Graham had another good year. My Graham-inspired stocks notched a 29.2 percent return, compared with 16.4 percent for the index.

First Solar Inc. (FSLR), which I was the most uncertain about (I said I wished I could ask Graham his opinion of it), did best, up 74 percent. MetLife Inc. (MET), which I felt pretty certain about, inched up only 7 percent.

Northwest Pipe Co. (NWPX) returned more than 24 percent, Tropicana Entertainment Inc. (TPCA), 22 percent; and Ingram Micro Inc. (IM), 18 percent. All figures are total returns, including dividends.

Fresh selections

What do I think Graham might buy if he were managing money in August 2014?

For starters, I believe he would be drawn to American International Group, the giant worldwide insurance company that was bailed out by the federal government in 2008. After a series of asset sales, American International has whittled its debt down to 38 percent of equity.

The government, which owned 90 percent of AIG at one point, sold the last of its shares in 2012, at a profit of more than $22 billion. But the company has lost the confidence of investors. Only a bold few, like Bruce Berkowitz — whose Fairholme Capital Management holds more than 5 percent of the shares — dare to own it. At about $52 a share, the stock sells for 0.7 times book value.

TravelCenters of America LLC (TA) sells diesel fuel and gasoline, repairs trucks, and operates restaurants (about 33 owned and more than 180 franchised), mostly along interstate highways. The company is unglamorous and steady; the stock is cheap at nine times earnings and 0.75 times book value. I think Graham would be tempted.

Likewise devoid of glamour but statistically appealing is Omega Protein Corp. (OME) of Houston. It makes fish meal, which is sold primarily as an additive to animal feed. About 13 percent of revenue comes from human nutrition products. At the current price of less than $12 a share, the stock fetches only seven times earnings and just under book value.

On a more speculative note, I think Graham might have put a little money into Lakes Entertainment Inc. (LACO), a small casino company based in Minnetonka, Minn. It owns the Rocky Gap Casino Resort in Maryland, runs several casinos for Native American tribes and owns pieces of several casinos in Mississippi and elsewhere.

The stock sells for seven times earnings and 0.9 times book value. The company has considerable cash and little debt.

With China now completely out of favor with U.S. investors — the opposite of the situation a few years ago — I think Graham would be intrigued by possible bargains in some of the Chinese shares traded in the United States.

For example, I think he might fancy Gulf Resources Inc., a chemical company based in Shouguong City, Shandong. It trades on the Nasdaq stock market at four times earnings and 0.3 times book value.

John Dorfman is chairman of Thunderstorm Capital LLC in Boston. He can be reached at jdorfman@thunderstormcapital.com.

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