Would Graham Like These After All?

Last week, John Dorfman published a nice article on Bloomberg.com.  Mr. Dorfman annually selects 5 stocks he believes that Benjamin Graham would like.  Over the last 5 years, the stocks have averaged a 28% gain in the year following their selection.  This year, Mr. Dorfman selected Avnet Inc (AVT), USEC Inc. (USU), Furniture Brands International Inc. (FBN), LandAmerica Financial Group Inc. (LFG), and National Western Life Insurance Company (NWLIA).  These are all intriguing companies, and certainly fit Mr. Dorfman’s criteria, but would Graham really like them?  Let us examine each company Mr. Dorfman selected using Graham’s guide to stock selection for the defensive and enterprising intelligent investors (found in chapters 13 and 14 of The Intelligent Investor):

Avnet Inc. (AVT) – Avnet has a market capitalization of approximately $2.9 billion, so the company is of adequate size for the defensive investor.  The current ratio is higher than 2:1 so it has a sufficiently strong financial condition.  However, the company does not currently pay a dividend, has had negative earnings for two of the last 5 years, and has actually decreased its earnings per share over the last 10 years.  In addition, though the company is currently trading at a low PE ratio, if an average of the last 5 years’ earnings per share is used in the calculation (to smooth out irregular earnings), the PE is found to be above 40.  Clearly, the company is unsuitable for the defensive investor, and due to the lack of positive earnings for the last 5 years and the lack of a current dividend payment, it does not even fit for the enterprising investor.

USEC Inc. (USU) – USEC is not suitable for the defensive investor because of its limited size.  The company only has a market cap of approximately $900 million.  As for the enterprising investor, the company had a negative net income in 2002, and last year’s earnings were not greater than those 5 years ago – so this company does not pass the tests either.

Furniture Brands International Inc. (FBN) – Furniture Brands is actually adequate for the enterprising investor, but not for the defensive investor.  The company fails for the defensive investor because of its size (under $1 billion market cap), lack of consistent dividend payments for at least 10 years, and failure to increase earnings per share by one-third over the last 10 years.  Though the company may appear to be suitable for the enterprising investor, our next step in reviewing the company is valuation.  We believe the company is fairly valued and according to Warren Buffett, buying a good fairly valued company is better than buying a poor undervalued one.  As a result, Furniture Brands appears that it should be a candidate for further research.

LandAmerica Financial Group Inc. (LFG) – LandAmerica does not appear suitable for the enterprising or defensive investor.  For the defensive investor, the company is not of adequate size, and has not had a positive net income for the last 10 years.  For the enterprising investor, the company is not at a level of less than 150% of net tangible assets.

National Western Life Insurance Company (NWLIA) – Similarly to LandAmerica, National Western Life does not appear suitable for either type of investor.  The company is not large enough for the defensive investor, and has not paid a dividend for 10 straight years.  Also, because the company does not currently pay a dividend, it is unsuitable for the enterprising investor.

We believe that Benjamin Graham’s success is a direct result of his strict rules, and his devotion to following those rules.  If an investor wants to be an intelligent investor, it is necessary to develop a set of guidelines and stick to them through thick and thin.  According to our set of rules which are derived directly from Graham’s The Intelligent Investor but updated to fit the current market situation, we disagree with Mr. Dorfman’s assessment that Graham would like the above companies, with the possible exception of Furniture Brands Inc.

At the time of this publication, neither of us held any position in any of the companies mentioned.  Also, please read our disclaimer.

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