I often write about Benjamin Graham, because he is considered
the father of value investing. His clear teachings of how to
analyze stocks and bonds using formulas and restrictive
conditions make sense to me and are easy to follow. His book,
The Intelligent Investor
, first published in 1949, provides all of the information needed
to become a successful value investor.
Benjamin Graham taught investment courses at Columbia University
in addition to running his Graham-Newman Partnership, investment
advisors, for many years. Many of his students at Columbia became
successful investors, including Warren Buffett.
Warren Edward Buffett, born 80 years ago in Omaha, Nebraska, is
the "Oracle of Omaha." Warren Buffett grew up in Omaha and
Washington, D.C. before attaining his bachelors and masters
degrees from the University of Nebraska and Columbia University.
Mr. Buffett became interested in investing at an early age and
attended Columbia because Benjamin Graham and David Dodd, another
well-known securities analyst, taught there.
Buffett then went to work for Buffett-Falk, his father's
brokerage company, before joining Graham-Newman for three years.
Mr. Buffett then ventured out on his own and formed several
investment partnerships, which purchased a company called
Berkshire Hathaway, a textile manufacturing firm. In 1962,
Buffett liquidated his partnerships to focus on Berkshire, and
the rest is history.
Warren Buffett made one successful investment after another using
Berkshire Hathaway as his conduit. He had learned well from
Benjamin Graham. Buffett became adamant that his stocks provide a
wide margin of safety. The intrinsic value of a company must
out-weigh the company's stock price.
Want to invest like Warren Buffett? Here are seven guidelines to
get you started in the right direction. You can find additional
information on Warren Buffett here. http://www.buffettbuys.com.
Buy Companies at Bargain Prices.
Warren Buffett is a true value investor. Buying companies cheap
is what being a value investor is all about. Purchase stocks
below their intrinsic value and fill your portfolio with these
companies. Pay less attention to earnings per share. Look for
solid return on equity, high operating margins and low debt. In
addition, look for companies that generate lots of cash and have
a consistent operating history during the past 10 years.
Wait for the right time to buy. Patient investors are the best
prepared when opportunities emerge. Because of market turbulence,
stocks of great companies become available to trade at very cheap
valuations. This doesn't mean buy stocks and forget about them!
Tracking performance is key and so is getting out when necessary
(when your stock is overvalued or trouble is on the horizon).
Invest only in companies that will outperform for decades. Follow
this approach and you will gradually develop an outstanding stock
portfolio like Warren Buffett.
Go Against Conventional Wisdom.
Attempt to be fearful when others are greedy and to be greedy
only when others are fearful. Going against the crowd can be an
effective way to make money.
Stick with What You Know.
Stay within your circle of confidence. If you don't understand
what a company does or how it makes money, avoid it.
You must be able to act without affirmation from others (or the
market) on your investment decisions.
Buy Companies with Competitive Advantages.
Warren Buffett calls this an "economic moat," which gives a
company barriers or protection from its competition. Examples of
competitive advantages include high capital costs for rival
companies to enter a business, a strong brand identity or patent
Believe in America.
Warren Buffett has faith in the long-term prosperity of U.S.
companies. This allows him to make investment decisions that are
not based on where we are in economic cycles.
Berkshire Hathaway's largest holdings include a who's who of
American business. Listed below are its major holdings from
largest to smallest:
Wells Fargo (
American Express (
Procter & Gamble (
Kraft Foods (
Johnson & Johnson (JNJ)
Wal-Mart Stores (WMT)
Wesco Financial (WSC)
Berkshire has many more holdings, of course. The eight companies
listed above each have market values of more than $2 billion. In
addition to the many public companies contained in the portfolio,
Berkshire owns 100% of many other companies including: Benjamin
Moore, Burlington Northern Santa Fe, Clayton Homes, Fruit of the
Loom, Geico Auto Insurance, International Dairy Queen, Johns
Manville, Jordan's Furniture, Pampered Chef, See's Candies and
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Twice a year, I combine Warren Buffett's and Ben Graham's
criteria for choosing stocks for a special feature in Cabot
Benjamin Graham Value Letter, the publication I edit. To find
investment opportunities for you, I looked for stocks with:
1) Free cash flow of more than $20 million -
cash needs include dividends, operating expenses, capital
improvements and research.
2) Net profit margin more than 15% - a good
indicator of growth sustainability.
3) Return on equity more than 15% - a barometer
of future appreciation.
4) Discounted cash flow value higher than
current price - Standard & Poor's is a good source to find
discounted cash flow estimates.
5) Market capitalization more than $1 billion -
small companies not allowed.
6) Standard & Poor's rating of B+ or better
- indicates financial stability and steady growth of earnings and
7) Positive earnings growth during the past
five years with no deficits - very important to adhere to.
8) Dividends currently paid - always important
and helps your return, too.
I screened our Benjamin Graham Common Stock Database and found
two high-quality companies that fit our criteria. Both companies
are giants in the Information Technology sector, and both are
producing impressive growth numbers.
is the leading maker of software, primarily because of its
dominance in desktop computer operating systems and office
productivity products. The company's Windows operating systems
run more than 90% of all personal computers throughout the world.
Microsoft's server software products are used in 70% of all
computer server systems.
Microsoft has two relatively new product lines. Cloud computing,
which provides computing and storage on the Internet, is gaining
in popularity, and the company has become one of the leaders.
Video games have also become big business, and Microsoft has
become a leader with its Xbox video game system and accessories.
The company recently introduced Kinect to compete with the
popular Wii and PlayStation Move games. Kinect is based on a
webcam for the Xbox console and enables users to control and
interact with the Xbox 360 without the need to touch a game
controller. The player uses gestures and spoken commands to
control a variety of games.
The software giant continues to spend heavily on research and
development to maintain its front-running positions in the
technology sector. Sales increased 25% and EPS soared 55% during
the quarter ended 9/30/10-quite remarkable for a company with $65
billion in annual sales. Analysts are forecasting a sales gain of
9% for the next 12-month period and an increase of 11% for
earnings per share. I believe Microsoft will produce
substantially better growth during the next 12 months, which will
drive its stock price considerably higher. MSFT shares are
clearly undervalued at 10.2 times analysts' forward 12-month
earnings per share estimates. MSFT pays a decent dividend
yielding 2.4% (which is about 10 times the amount paid by my bank
on my savings account).
is another leading software manufacturer with a worldwide reach.
The company provides totally different products and services than
Microsoft, though. Oracle is the largest developer, manufacturer
and seller of information management software and services. The
company's database software and product support services provide
a large revenue stream enabling Oracle opportunities to expand.
Also, during the past several years, Oracle has purchased an
impressive number of large software providers, which will help
achieve management's goal to offer a complete line of business
software solutions to customers.
Management's acquisition strategy with the objective of
positioning the company for strong growth is generating
extraordinary results despite the weak U.S. economy. Oracle's
January 2010 purchase of Sun Microsystems is producing cost
savings and new sales opportunities. Sales increased 48% (partly
due to the Sun acquisition), and earnings jumped 40% during the
three months ended 8/31/10. I expect sales and earnings to rise
20% or more during the next 12 months driven by new acquisitions
and by expansion into faster growing foreign markets.
ORCL has begun paying a small dividend, which currently yields
0.7%. The company's shares sell at 13.8 times forward 12-month
earnings per share, which is very reasonable for a company
growing at a 20% pace.
I will continue to follow Microsoft and Oracle and other
blue-chip, high-quality companies in my Cabot Benjamin Graham
Value Letter. My next issue, coming soon, will focus on
undervalued stocks with low price to earnings growth (PEG)
ratios. I hope you won't miss it!
J. Royden Ward
For Cabot Wealth Advisory
Editor's Note: You can find additional stocks selling at bargain
prices in the Cabot Benjamin Graham Value Letter. In every issue,
you'll find my legendary Maximum Buy and Minimum Sell Prices for
over 250 stocks. Get started with
Cabot Benjamin Graham Value Letter