Monday, 6 February 2012

One simple criterion to base stock purchases - FOCUS ON EARNINGS

Toward the end of his life, Benjamin Graham spent many hours looking for one simple criterion on which to base stock purchases.  His focus turned to EARNINGS.

"My research indicates that the best results come from simple earnings criterions."

His multiple criteria for selecting investment-quality stocks have remained the most reliable.  What makes an "investment-quality stock"?

  • Financial condition is conservative and working capital position is strong. (Check the Balance Sheet).
  • Earnings are reasonably stable, allowing for business conditions that fluctuate over a 10-year period. (Check the Income Statement).
  • Average earnings bear a satisfactory ratio to market price. (Check the Valuation).

As investors become more familiar with these guidelines, they follow them easily and automatically, or so it seems.

Buffett and his partner, Charlie Munger, say they don't sweat over formal rules or procedures when trying to determine if a stock has growth potential.

For those of us with less talent and experience than Buffett and Munger, however, it is acceptable to work out a portfolio plan and run a checklist tally of a stock's pluses and minuses.

  • Quantitative data are useful only to the extent that they are supported by a qualitative survey of the enterprise.
  • The companies with the best investment potential are consistently profitable.
  • The P/E ratio should be low compared with those of other companies in the same industry.
  • The P/E ratio establishes the upper share price limit on intrinsic value.
  • Earnings and other estimates should err on the side of understatement.  That, in itself, makes for a margin of safety.

Also read:
Ben Graham's checklist for finding undervalued stocks

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