What would Ben Do?

Don’t you just hate it when people give you broadly general ideas but no specific details?

Me too.

So, sure, I’ve posted some things on this blog that probably sound pretty good, but you might be asking yourself, “HOW do I actually implement this stuff?”

Well today I’ll be tossing out a few details. Now as you’re no doubt aware, there are as many different opinions on how to make money in the stock market as there are stock market “experts.” And I’m certainly not going to wade through them all, or even a small sampling of them.

Nope.

What I’m going to do is go straight to the source. And in the investing realm that means looking at what Warren Buffett’s mentor, Benjamin Graham, would do in times such as these.

Markets are volatile, economies are weak, governments are bailing out everyone and their dogs and people are panicking. What’s a good investor to do?

Well, if you’re like Benjamin Graham you’d rub your hands together with glee and start looking for undervalued stocks. When there’s panic everywhere, that’s the time Graham would swoop in and buy. Warren Buffett is that way too.

So in a nutshell, what would Graham look for?

First, he would insist on a substantial Margin of Safety. In his words, ”we have here, by definition, a favorable difference between price on the one hand and indicated or appraised value on the other. That difference is the safety margin. It is available for absorbing the effect of miscalculations or worse than average luck.”

Of course that begs the question, how do we get this Margin of Safety?

A few things Graham liked to see were…

1. A steady stream of dividends. He also liked to see a long history and he liked to see the dividends increasing over time.

2. The dividend yield to be more than the yield of a 10-year U.S. Treasury note.

3. Positive earnings for at least 7 years. And as with dividends, an increasing trend was better.

4. A P/E ratio less than the Earnings yield of the interest rate on a 10-year U.S. Treasury note (the Earnings Yield is the inverse of the P/E). So if the T-note was returning 4% annually, Graham liked to see a P/E of less than 25 (i.e. 1/0.04).

Plug these criteria into your favorite stock screener and see what pops out. Of course there’s more due diligence required, but Graham’s rules are a good start. And if the markets keep falling, you should be very happy, as more and more excellent stocks will become undervalued.

So while the others are panicking, stick to the facts, use logic and if you’re happy with your analysis, buy regardless of what everyone else is doing or saying.

As Graham was fond of saying, “you’re not right because people agree or disagree with you; you’re right because your facts and reasoning are right.”