DLA and ESP - Graham's five rules

**springsnailt** Mon Feb 27, 2006 11:12 pm

DLA and ESP - Graham's five rules
blast, I was filtering stocks using Graham's five rules and got two companies: DLA and ESP.

Would like to hear your comments. Thanks.

**blast_investor** Mon Feb 27, 2006 11:13 pm

Hi springsnailt,

Can you describe your screening 5 rules on these 2 stocks?

**springsnailt** Mon Feb 27, 2006 11:23 pm

1. Financial conditions: (a) current assets at least 1.5 times current liabilities, and (b) debt not more than 100% of net current assets.

2. Earnings stability: No deficit in the last five years.

3. Dividend record: some current dividend

4. Earnings growth: earnings larger than five years ago (I used >2% average annual growth in operating income during the past five years).

5. Price: Less than 120% net tangible assets (I used <150%).

It as he described in The Intelligent Investor.

**blast_investor** Mon Feb 27, 2006 11:25 pm

Here is my comment on Delta Apparel (DLA):

I like what I see. The PE is low at 9. The past serveral years earning growth was huge. The return on equity is very high at 16.8%.

The upside from this stock will be from future earning growth and potentially multiple expansion into PE = 15 to 20 range.

On the other hand, apparrel business is type of business I do not understand that well. Depending on how you want to invest into DLA, if you use very diversified portfolio approach with your screening method, then this pick is not going to be problem, some picks will miss and some will hit. But if you want to invest into DLA with focused portfolio of 10 stocks or less, then you would really need to understand the business of DLA and its future prospect.

**blast_investor** Mon Feb 27, 2006 11:33 pm

I see, That was the criteria Ben put out for "passive investors". I believe he meant this criteria for a really diversified portfolio, 30 or 50 more stocks.

Ben claimed that this approach would beat index. I wonder if there was any researcher that did a backtesting on this approach to test the performance of this Ben Graham screening criteria over past many years. Although I believe this screening method should beat index, we do not know how good this particular screening method is over past many decades.

From my understanding, although Ben described this "passive investor" screening approach in his book, he himself never used that in his own practise. His approach was mainly "NCAV" bargain stocks plus arbitrage and special situation plays.

springsnailt wrote: 1. Financial conditions: (a) current assets at least 1.5 times current liabilities, and (b) debt not more than 100% of net current assets.

2. Earnings stability: No deficit in the last five years.

3. Dividend record: some current dividend

4. Earnings growth: earnings larger than five years ago (I used >2% average annual growth in operating income during the past five years).

5. Price: Less than 120% net tangible assets (I used <150%).

It as he described in The Intelligent Investor.

**blast_investor** Mon Feb 27, 2006 11:39 pm

On Espey Manufacturing & Electronics Corp (ESP) :

I do not like this stock. This stock market cap is small, microcap. But its valuation is not very cheap. Too expensive.

**springsnailt** Tue Feb 28, 2006 12:07 am

Thanks!

I've read somewhere that by strictly using these criteria, at most 5-10 stocks (sometimes none) may be selected each year during the past five years. It did beat the index by a pretty large margin.

So you suggest a better approach is to screen stocks by industry? My feeling is by

1. Combining intrisic value approach and comparative approach,
2. Considering insider purchase behavior, and
3. Further analyzing of the sector/industry landscape.

would lead to better results.

blast_investor wrote: I see, That was the criteria Ben put out for "passive investors". I believe he meant this criteria for a really diversified portfolio, 30 or 50 more stocks.

Ben claimed that this approach would beat index. I wonder if there was any researcher that did a backtesting on this approach to test the performance of this Ben Graham screening criteria over past many years. Although I believe this screening method should beat index, we do not know how good this particular screening method is over past many decades.

From my understanding, although Ben described this "passive investor" screening approach in his book, he himself never used that in his own practise. His approach was mainly "NCAV" bargain stocks plus arbitrage and special situation plays.

springsnailt wrote: 1. Financial conditions: (a) current assets at least 1.5 times current liabilities, and (b) debt not more than 100% of net current assets.

2. Earnings stability: No deficit in the last five years.

3. Dividend record: some current dividend

4. Earnings growth: earnings larger than five years ago (I used >2% average annual growth in operating income during the past five years).

5. Price: Less than 120% net tangible assets (I used <150%).

It as he described in The Intelligent Investor.

**blast_investor** Tue Feb 28, 2006 12:27 am

I myself mainly use bottom up approach. The cheap stock picks will lead me into favorable industry by itself.

I would agree with Joel Greenblatt that most of macro-economics analysis is not that important. Cheap valuation is most important.

My approach is not far from what you said below.

On the other hand, investors (individual or professional) mainly have 2 styles in value investor portfolio construction: one is very diversified, 30 to 50 or more stock picks in 1 portfolio. another is focused.

The diversified approach can afford mistake, can afford to use mechanical stock screening approach without deep study of business, such as 10K , 10Q etc. The best I heard of is the Joel Greenblatt's "Magic Formula" method in this camp. I do not believe 10 stocks in a portfolio are safe enough with this approach even using Ben's original criteria. 10 stocks are just too focused. All the screening tool so far I have seen is just dumb without understanding business.

The focused approach is going to be tough. The investor is really going for hero like Warren Buffett's performance with 5 to 20 stocks focused portfolio. In this case, I do not believe any screening tool can solve the challenge. Screening tool is just a tool to help research. In the end, it is the capability and subjective judgement of investors that matter most in performance of this focused style. Hopefully, knowledge of human can remove the dumb part of screening tool by deeply understanding business.

springsnailt wrote: Thanks!

I've read somewhere that by strictly using these criteria, at most 5-10 stocks (sometimes none) may be selected each year during the past five years. It did beat the index by a pretty large margin.

So you suggest a better approach is to screen stocks by industry? My feeling is by

1. Combining intrisic value approach and comparative approach,
2. Considering insider purchase behavior, and
3. Further analyzing of the sector/industry landscape.

would lead to better results.

**springsnailt** Tue Feb 28, 2006 11:04 am

This is very helpful. Thanks. It may be a good thing that the machines still couldn't replace human in fundamental stock picking jobs. :D

**blast_investor** Tue Feb 28, 2006 11:29 am

I doubt machine or computer can really beat human in this value investing game.

However, we can not under-estimate the machine power. For example, the best of breed, the "magic formula" from Joel Greenblatt claimed 30% long term return. This 30% return would put majority of mutual fund managers or investment newsletter pros into shame.

springsnailt wrote: This is very helpful. Thanks. It may be a good thing that the machines still couldn't replace human in fundamental stock picking jobs. :D

**springsnailt** Tue Feb 28, 2006 2:01 pm

Joel Greenblatt has two books: You Can Be a Stock Market Genius, and The Little Book That Beats the Market. Are they useful readings?

**blast_investor** Tue Feb 28, 2006 2:10 pm

I have read both books. Both are wonderful books.

You Can Be a Stock Market Genius is mainly about special situations.

The Little Book That Beats the Market is about Magic Formula, a computational mechanical method.

springsnailt wrote: Joel Greenblatt has two books: You Can Be a Stock Market Genius, and The Little Book That Beats the Market. Are they useful readings?

**grapes** Wed Mar 01, 2006 4:00 pm

I have a little doubt about the magic formula. Joel tests the fomula using the previous 17 years data, which mostly are booming times. Will it work for the 17 years just before his test when the market is not so booming? Some people believe that after the 2002-2003 recession, the market will be similar to the previous 34 to 17 years from now, namely under the pressure of flying commodity price and inflation.

blast_investor wrote: I have read both books. Both are wonderful books.

You Can Be a Stock Market Genius is mainly about special situations.

The Little Book That Beats the Market is about Magic Formula, a computational mechanical method.

springsnailt wrote: Joel Greenblatt has two books: You Can Be a Stock Market Genius, and The Little Book That Beats the Market. Are they useful readings?

**grapes** Wed Mar 01, 2006 4:00 pm

I have a little doubt about the magic formula. Joel tests the fomula using the previous 17 years data, which mostly are booming times. Will it work for the 17 years just before his test when the market is not so booming? Some people believe that after the 2002-2003 recession, the market will be similar to the previous 34 to 17 years from now, namely under the pressure of flying commodity price and inflation.

blast_investor wrote: I have read both books. Both are wonderful books.

You Can Be a Stock Market Genius is mainly about special situations.

The Little Book That Beats the Market is about Magic Formula, a computational mechanical method.

springsnailt wrote: Joel Greenblatt has two books: You Can Be a Stock Market Genius, and The Little Book That Beats the Market. Are they useful readings?

**springsnailt** Wed Mar 01, 2006 4:09 pm

flying commodity price, maybe; bad inflation, unlikely because of the global market. I actually believe value investing would perform even better (relatively to more aggressive methods) during non-booming periods of time.

grapes wrote: I have a little doubt about the magic formula. Joel tests the fomula using the previous 17 years data, which mostly are booming times. Will it work for the 17 years just before his test when the market is not so booming? Some people believe that after the 2002-2003 recession, the market will be similar to the previous 34 to 17 years from now, namely under the pressure of flying commodity price and inflation.

blast_investor wrote: I have read both books. Both are wonderful books.

You Can Be a Stock Market Genius is mainly about special situations.

The Little Book That Beats the Market is about Magic Formula, a computational mechanical method.

springsnailt wrote: Joel Greenblatt has two books: You Can Be a Stock Market Genius, and The Little Book That Beats the Market. Are they useful readings?