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Sunday, Jun 26, 2022

John Dorfman—Heeding Advice From the Father of Value Investing

A year ago, I wrote a column called “Five Stocks That Would Make Benjamin Graham Choke.”

Graham, who died at 82 in 1976, is considered the father of value investing. He wrote two investment classics, “Securities Analysis” (1934) and “The Intelligent Investor” (1949), and, at Columbia University, taught several top money managers, including Warren Buffett.

Graham favored stocks with low debt and low ratios of price- to-earnings and price-to-book value (corporate net worth). A year ago, I said he would hate Amazon.com Inc., General Mills Inc., Exodus Communications Inc., Campbell Soup Co. and Colgate- Palmolive Co.

What happened? From Aug. 3, 2000 through Aug. 7, 2001, Exodus is down 96 percent, Amazon is down 63 percent and Colgate is down 4.9 percent. Campbell Soup has returned 0.6 percent because of its dividend (on price alone, it was down 2.5 percent). General Mills is up 26 percent.

On average, the five stocks have fallen 27 percent in a period when the Standard & Poor’s 500 Stock Index has dropped 16 percent.

The results make me yearn for another consultation with the master’s ghost, this time to find stocks he would like.

Since my psychic abilities are limited, I used Bloomberg software to find shares with a P/E under 13, a price/book under 1, and debt of less than 50 percent of stockholders’ equity as of the end of the last fiscal year. I set the minimum market value at $500 million.

Graham’s criteria were often tighter, but his investing was mostly in an era when bargains were plentiful.

The statistical criteria fit only eight stocks, or 0.4 percent of all stocks with the requisite market value.

Two of the eight Tommy Hilfiger Corp. and WorldCom Inc.- WorldCom Group are stocks I own for several clients at Dorfman Investments. Two others R.J. Reynolds Tobacco Holdings Inc. and LandAmerica Financial Group Inc. are in portfolios at Dreman Value Management, where I am a managing director.

Tommy Hilfiger was a hot stock for a while. From less than $6 a share in early 1993, it rose to more than $36 in mid-1999. The Hong Kong-based clothing manufacturer has since fallen back to $13.10.

Hilfiger now sells for only 9 times recent earnings, 0.86 times book value and 0.63 times revenue. Those are valuations that I think Graham would love.

Flat earnings

The company reported flat earnings in the last two quarters and earnings declines in the three before that. Its fashions have been missing with the young adult crowd, but I expect the company to regain its stride. In any case, at today’s stock price, there’s room for positive surprises.

WorldCom surged from under $5 a share at the end of 1992 to more than $56 a share in early 1999. But rate wars in long- distance telephone service have driven the stock back to $14.13.

Earnings reached $1.60 a share last year and are expected to be at $1.02 this year. In the latest quarter, debt was 57 percent of equity. Still, I like its valuations of 12 times earnings, 0.73 times book value and 1.07 times sales.

R.J. Reynolds is the second-largest U.S. tobacco company and Dreman Value Management is one of the larger holders with about 4 percent of the outstanding stock.

Reynold’s 6.6 percent dividend yield is an attraction and its balance sheet is pleasant, too, with debt only 20 percent of equity.

Tobacco litigation remains a threat, but we don’t think that’s fatal for Reynolds. In any case, that is why the stock sells for 12 times earnings, 0.63 times book value and 0.62 times revenue.

LandAmerica Financial sells title insurance and related services. Analysts expect the Richmond, Va., company to increase its earnings by about 11 percent a year over the next five years. Yet it sells for only 10 times earnings, 0.84 times book and 0.29 times revenue, according to Bloomberg data.

Pacificare Health Systems started the year at $15 a share, rose to $35.39 at the end of April, and today is back down to $15.25.

Recent results were poor. Second-quarter earnings were 45 cents a share, down from $2.01 last year. The largest U.S. operator of health maintenance organizations serving Medicare patients has said that costs are rising faster than premiums.

Yet the stock may be attractive. It sells for 11 times earnings, 0.26 times book value and 0.04 times revenue. Those are the sorts of ratios that might make Graham sit up and take notice, wherever he may be.

The other three stocks that met my statistical criteria were FBL Financial Group, Tecumseh Products Co. and Alleghany Corp.

FBL, based in West Des Moines, Iowa, sells life insurance and other financial products, mainly in rural areas. Tecumseh, based in Tecumseh, Mich., makes compressors used in air conditioning and refrigeration, gasoline engines for lawn mowers, and pumps. Allegheny, based in New York, is involved in insurance, reinsurance, industrial minerals and fasteners.

My failure to recommend these three stocks doesn’t mean I disapprove of them. I just don’t know them as well as the others.

John Dorfman is a columnist for Bloomberg News.

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