Benjamin Graham, also known as the father of value investing, had a very interesting investment strategy. A strategy which when practiced correctly, can help an individual amass great wealth with small capital.
This is what we call, Cigar-Butt Investing, where we look for cheap and unloved companies that are good for “one last puff”, similar to a Cigar Butt.
I’ll be sharing the key criteria used in this investment strategy as well as talk about some of the companies which you can invest in if you want to use this investment strategy.
What is this Investing Strategy?
Essentially, Graham looked for unloved and undervalued stocks with the use of several criteria.
He looked for value in them that no one else can see while using a margin of safety. I will be going through these criteria that Graham used:
Companies with average or better Quality Ratings
When looking for companies to invest in, we want to find stable companies, to stay on the safe side. To do this, we can invest in companies that are rated at least B+ and above by the Standard & Poor. It is a good way to look for companies that are on the safe side, since the S&P’s rating system is used widely.
Current Asset to Debt Ratio > 1.10
Current Asset to Debt Ratio is essentially taking the current assets of the companies divided by the total debt. This ratio gives visibility on the company’s debts and whether or not they have the power to pay off all their debts with their current assets.
Current Ratio > 1.50
The current ratio tells us a company’s ability to pay off its short-term obligations or those due within a year. This is calculated by using current assets dividend by current liabilities. Having it above 1 tells us that the company is able to pay off all its short term debts if it liquidates all its current assets.
Having it above 1.50 means that after the company pays off all its debts, it will still have money left over, which can be used to reward shareholders through dividends or share buybacks.
Increasing EPS year on year
This is quite straightforward. When investing in companies, we want them to be earning more money and increasing their value year on year. Preferably, we would like its earnings for the past 5 years to be increasing.
Price/Earnings Ratio < 9.0
The price to earnings ratio is used to determine how undervalued or overvalued a stock is. If a stock is trading at a PE ratio of 10, it means that you are paying $10 for every $1 of earnings.
If a stock has a high PE ratio it could mean that it is very overvalued or that investors are expecting high growth rates in the future. This ratio is crucial when used to tell a company’s current value in the stock market’s eyes.
Of course when using the P/E ratio, it is wise to refer to the company’s historical averages as companies in different industries, will have a different average for their P/E ratios.
Price/Book Ratio < 1.20
The price to book ratio is calculated by taking the price per share divided by its book value, or its net asset value per share. The net asset value is derived from using the total assets minus the total liabilities.
If a company’s P/B ratio is above 1, it tells us that, if a stock has to pay off all their liabilities by liquidating all their assets, they will break even or have left over assets or cash. This can be used to reward shareholders through dividends or share buybacks.
Find a Company that pays Dividends
When doing this type of investing strategy, it might take a while before the stock price actually reaches its intrinsic value. While waiting, wouldn’t it be great to receive some dividends along the way while waiting?
It could take months or even years before a stock’s price reaches its intrinsic value. Before that comes, why not collect some dividends along the way while waiting for that!
My Thoughts
This method of investing is a great start for people who have low capital, since you are assuming low risk in return for high reward.
These stocks are typically penny stocks, which mean that even with low capital, you can become vested and profit greatly.
3 Stocks You Can Consider:
- MoneyMax Financial Services
- Hanwell Holdings
- Nam Lee Pressed Metal Inds
These 3 stocks fit the most of the criteria above, having P/B ratios below 0.8, P/E ratios below 9 with the exception of Nam Lee (9.38) and increasing Earnings and Revenue. Watch out in the near future as I will be doing analysis for these stocks!
I hope this article will be educational for you guys! I hope to take positions in these 3 stocks soon after their next financial results release. As always, you can take a look at my portfolio updates to see my current positions !
“This article first appeared on sgstockmarketinvestor.com“
