Stock Market Correction: What will Benjamin Graham buy today?

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Smallcaps have fallen like a pack of cards. Correction has been severe but much awaited after sharp rally over the last couple of years. This correction has also opened up many exciting opportunities. This is the time when ace investor will buy promising smallcap stocks to enjoy multibagger returns in 2022-23.

We have seen a full cycle within smallcaps. This cycle gets repeated every 5-6 years. Last time it happened around 2012-13 and ace investors enjoyed returns few years later. However, mastering this is not easy since in every cycle, multibagger stock name will change. Today’s multibagger may not necessarily survive this correction. So, key to superlative gains is to wisely choose next set of multibagger stocks.

@ AI post, we are writing a series of posts in which we will publish a stock watchlist of famous investors. It may be wise to analyse what legends will buy in today’s market post correction. This list is curated by us based on their principles. More than stock list, there is a lot of learning as we touch upon investment principles of these legends.

We want everyone to understand the concepts and since we know that people don’t have more than 5 minutes of attention span, so we are keeping the language simple and contents precise. For the purpose of this study, we are running filters only on smallcaps, so midcap & largecap are not considered. True to our ace reader’s interest!

Today, we have Benjamin Graham. Next week will be his disciple Warren Buffet.

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What’s so special about Benjamin Graham?

Benjamin-Graham-fundamental

For folks who don’t know Benjamin Graham, he is called as father of value investing. One of legends who defined tenets of value investment and margin of safety. He wrote a book “The Intelligent Investor” in 1949 which is considered as a bible of equity investments. He was an economist and professor at Columbia University. He employed his former student Warren Buffet when he founded Graham-Newman Partnership firm.

The thing which makes Benjamin Graham so famous is his value investment principles which were introduced to the world when stock market was majorly speculative. He wrote about these concepts in 1934 just after the great depression.

Mr. Graham himself learnt value investment principles after he lost money in 1929’s great depression. Indeed market is the biggest teacher!

What made Graham even more popular in modern times was success of his followers like Warren Buffet,  William J. Ruane, Bert Olden, Irving Kahn and Walter J. Schloss. They deservingly gave credit back to Benjamin Graham and his principles. This ensured Graham’s legacy continued and more and more people are following his value investing principles.

Investment Philosophy

Benjamin Graham’s investment philosophy revolves around investment behavior rather than technicals. He believed that low debt, undervalued companies will eventually recover as he believed in efficient market theory. In efficient market theory, it is believed that market is efficient and sooner or later, it will give proper valuation to a company which deserves.

While market is efficient but its participants are often consumed by fear & greed. This provides an opportunity to buy stocks which are trading below their intrinsic value and hence provide adequate margin of safety.

The original Benjamin Graham Formula for finding the intrinsic value of a stock was:

V = EPS x (8.5 + 2g)

Where V = intrinsic value

EPS = Trailing 12 months EPS (earnings per share) of the company

8.5 = P/E ratio of a zero-growth stock

g = long-term growth rate of the company

Later in 1949, this formula was revised to factor the spread between risk free average returns of corporate bonds vs the current yield of corporate bonds.

If we apply this formula on Amara Raja Batteries at current market price of  ₹ 728 (at the time of writing this post), considering EPS of 27.59, 12 as P/E for a zero growth stock and 17.3% as company’s last five year EPS growth rate, we get ₹ 1285. If we correct it with spread of corporate bonds, intrinsic value becomes ₹ 1017.

This idea is simple but works very well to find out undervalued company based on pure statistics. The only problem is that it factors only quantitative data while qualitative aspects like management quality, industry structure and outlook can not be measured by any formula.

In our example of Amara Raja batteries, stock is quoted below its intrinsic value because investors are fearful of elevated lead (Pb) prices which is a key raw material for the company, thereby discounting long term EPS growth rate by a few percentage points.

If we summarize, the basic principle of Benjamin Graham are as follows:

  • Trading below intrinsic value
  • Less or no debt on books
  • Concentrated yet diversified approach (not too many stocks)
  • Long holding periods
  • Always buy with sufficient margin of safety
  • Contrarian mindset (Contra bets. Buy what market is rejecting a deserving stock)

These principles are deciphered in different ways by different researchers. Some will assume margin of safety as 20% of intrinsic value, for some it may be 10% or 25% of intrinsic value. Similarly for debt, some people prefer stocks with D/E less than 1, for some it is 0.5 or 0.8

Stock Watch-List

Based on Benjamin Graham’s principles and our own set of filters, we arrive at below sets of stocks which pass the criteria at current valuations.

Please take a note that this is not an investment advice as analysis is done purely on numbers and not on qualitative aspects. Further, if a stock has performed poorly in the past but is poised for a turn-around, it will be unable to clear the filters since they are based on past performance.

We have selected stocks with a market capital of above ₹ 100 Cr but less than ₹ 1000 Cr which means that large cap & mid-caps are excluded from thsi list.

  • Pressman Advertising Limited (Market Cap: ₹ 102 Cr)
  • Kesar Petroproducts Limited (Market Cap: ₹ 193 Cr)
  • Veljan Denison Limited (Market Cap: ₹ 225 Cr)
  • SQS India BFSI (Market Cap: ₹ 527 Cr)
  • Cheviot Company Limited (Market Cap: ₹ 531 Cr)
  • Kitex Garments Limited (Market Cap: ₹ 968 Cr)

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