How To Find Cheap Shares - Ask Benjamin Graham

A couple of days ago I read the transcript of a speech given by Chris Browne (of Tweedy Browne fame) to the Columbia Business School back in 2000.  The speech was called Value Investing and Behavioral Finance (you can find a link to it on the Investing Resources page). While the title is a little dry, the ideas presented were very interesting.

The main message of the speech (for me at least) is that despite overwhelming evidence that value investing produces better results over the long term than other investment styles, very few investors (professionals and non-professionals alike) choose to apply the principles of value investing to their own investments.

He than concludes that one of the reasons could be the herd mentality. It hurts far less to be wrong about an investment if everyone else is wrong as well. It feels worse if you're the only one who gets it wrong.

But the main thing that struck me about the speech was the following description of Benjamin Graham's approach (considered by most to be the father of value investing) to investing:

He found that buying stocks below net current assets (current assets less all liabilities), buying stocks where the earnings yield was greater than the long-term bond yield by a margin of 50% or 100%, and buying stocks at two-thirds of tangible book value when stockholders’ equity was greater than all liabilities, produced better than market returns.

There are 3 very simple approaches to value investing described succinctly in that quote.  Despite the sophisticated and complex investment strategies being taught and practiced today, Graham found that a simple yet disciplined approach worked best.

Simple Stock Valuation Tool

This simple stock valuation tool is what I use to calculate a rough estimate of the return I would expect from an investment given the current price and some simple financial statistics about the company.

I should stress that even though the estimated return looks precise, it is necessarily based on figures which will prove more and more in-accurate as we look further and further into the future.

I use the tool as a sanity check.  Given my assumptions about the earnings power of the company, I want to know if the company looks outrageously cheap (or expensive).  So please keep this in mind.

How to use the tool

The following inputs are required by the tool:

• Current Price - this is the current price of the shares in dollars and cents
• Return on Equity - this is the ROE or Return On Equity generated by the company.  This is available on more stock research websites.
• Dividend Payout Ratio - the percentage of earnings paid out by the company as dividends
• Earnings Per Share - the current earnings per share
• Number of Years - the number of years over which to calculate the returns
• End PE - this is the estimated price earnings ratio the company will trade on at the end of the valuation period

Please note: the tool is still very rough.  Let me know if it is at all useful and I will polish it up a little.

Current Price ($)
Return on Equity (%)
Dividend Payout Ratio (%)
Earnings Per Share
Number of Years
End PE

Year	EPS	Dividend	Share Price
{{result.year}}	{{result.eps | currency}}	{{result.dividend | currency}}	{{result.price | currency}}

Total Return: {{totalReturn | number:1}}%
Annualized Return: {{annualReturn | number:1}}%

Cheap Shares August 2013 - Berklee Limited

Okay, I admit to trawling through the list of shares hitting new lows in the Financial Review occasionally.  Alright - every weekend.  But it's where I find some of my best ideas.  As a value investor I'm looking for cheap shares so the rolling year records list is a good place to start.

The following company caught my eye this week as a potential asset play with a time frame for realization of asset value.

Berklee (ASX:BER)

Berklee hit a low of $0.29 this week, down from a high of $0.50 last October.

Berklee Limited "is a manufacturer and distributor of exhaust systems and components for the automotive industry..." or at least it was until recently.  Due to deteriorating business conditions it sold its business (for $1) and is now in the process of collecting receivables and selling any remaining assets.  The plan is to return the proceeds to shareholders.

As far as I can tell the only remaining major asset is some commercial property in Wendouree.  There was a market update from the company this week which indicated the sale of the property would not be finalized until the end of June next year.  I presume this was longer than the market anticipated and was the reason for the price drop.

So where is the value?  Well, in an announcement in May this year, the company stated it had net assets of $7,076,000 (pro-forma, after business sale) which with 10 million shares on issue amounts to about 70 cents per share.  Since then it has been losing money and will obviously continue to incur operating costs until the property is sold and the company is wound up next year.

So the question is how much will be left over for shareholders at the end of the process?  I'll leave you to finish off the maths - I can't do everything for you.  There are certainly risks involved and the shares are very thinly traded so I'll let you draw your own conclusions.