Investors looking for attractively priced, quality stocks might borrow a page from Warren Buffett and ‘Value Daddy’ Benjamin Graham, but only with the help of a stock screener.
When I was young, my hometown dedicated the weekend near the 4th of July holiday to day-long baseball and volleyball tournaments. But it was the break in tournament action that thrilled the kids. That’s when the town held nickel hunts.
We were turned loose on a huge mound of sand that hid hundreds (thousands? ... who can remember?) silver five-centers and we could keep as much as we could grab. One nickel equaled one piece of taffy and so with a sugar fix as motivation, I dug with abandon—20 or 30 nickels was a pretty good haul.
One year, I glanced down at the little guy working the mound next to me. He had hundreds of nickels to my couple dozen. I demanded answers. It didn’t take long to get them. This kid brought a sand screen. He would pile sand onto his screen, jostle it a few times, and end up with a handful of shiny nickels. He’d repeat this scoop-and-shake action again and again. Really, it was one additional step to my approach, but it paid dividends (or rather, nickels). Genius!
Eventually, my monetary motivation switched from taffy to less-colorful things like tuition and mortgages. Nickel mounds became the stock market. But the lessons? They still apply.
Enter: Stock Screener
Investing in stocks can be a daunting prospect when you think about the sheer number of companies publicly traded. Tools, such as a stock screener, can help you simplify the process. Screeners, which narrow criteria to industry, price, or analyst ratings, for example, can cull a list of thousands to a more manageable number.
A screener might help with a variety of strategies, but I find them particularly useful when I implement a value-based strategy. Value investors actively seek stocks that they believe the market has priced too low—in other words, current pricing is not in step with the company’s long-term fundamentals. This means they’re looking for stocks that trade for less than their intrinsic value. The challenge? There’s no “correct” intrinsic value.
Mentor To The Mentor
Like many value investors, I’m a Warren Buffett fan. But knowing that investors are typically created, not born, I was curious who taught “value” to Buffett. The “Oracle of Omaha” credits Benjamin Graham. He was Buffett’s Columbia Business School professor, former boss, long-time friend, and a guy who Wall Street anointed the “Father of Value Investing.”
Graham died in 1976. His mentoring lives on in his still widely followed The Intelligent Investor which Buffett champions, “By far, the best book on investing ever written.”
Graham dedicates Chapter 14 to his value stock-picking criteria and I’ll highlight two of those requirements.
First, Graham targets a stock’s price-to-earnings ratio below 15, and its price-to-book ratio below 1.5. Combined, these valuation metrics have since become known as “The Graham Number.”
Theory In Action
Below, in steps 1-5, let’s tackle this concept using TD Ameritrade’s Stock Screener.
1. Click on the RESEARCH tab. Click on SCREENERS and choose CREATE A STOCK SCREEN.
2. You’ll see several categories on the left. Under BASIC, put a check mark next to INDEX, and select S&P 500. For this example, we’re starting here because Graham tended to avoid small companies (smaller than the S&P 500) that might easily come under financial duress.
3. Add a check mark to SECTOR, INDUSTRY and SUB-INDUSTRY. While holding down your keyboard’s Control key, click on every sector except Financials. Graham liked to focus on valuing a company’s tangible assets, which could be sold if a company needed to sell them. Since many financial companies are valued on account balances and goodwill rather than a delivery-truck fleet and warehouses, we’ll avoid them here.
4. Next, click on the VALUATION category and check mark P/E RATIO. Click on ENTER SPECIFIC VALUES. Click the dropdown box and choose “LESS THAN OR EQUAL TO.” Type 15 in the box to the right. Check mark PRICE TO BOOK and click on ENTER SPECIFIC VALUES. Select “LESS THAN OR EQUAL TO” under the dropdown. Type 1.5 in the box to the right.
5. Finally, click on the GREEN BUTTON at the bottom to save your results.
Just The Beginning
Graham purists will want to take screen results and put them to other tests, including earnings growth and dividend consistency. You may opt for that routine as well. The point here is to give aspiring value investors a jumping-off point. Now grab that stock screen and try to grow your pile of nickels.