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6 Criteria Value Stocks Must Meet

07/19/2012 10:30 am EST


Kelley Wright

Managing Editor, Investment Quality Trends

For Ben Graham-style value investors, the path to success begins with sticking to this six-point test for new longs, says Kelley Wright of Investment Quality Trends.

If you’re a value investor, my guest today, Kelley Wright, is going to talk to us about his criteria for finding value in companies and in the stock market. So Kelley, talk about the criteria you use to kind of find value in the stock market.

Sure. I wish it was something real esoteric—you know, we could say, “Okay, here’s the double secret”—but actually what we use is a set of six criteria that just come from our old grandfather, Benjamin Graham. Very simply:

  • We want to find companies that have a long track record, preferably seven out of 12 years with increasing earnings.
  • We also want that company to have increased their dividends at least five times in the last 12 years.
  • We’re looking for companies that have institutional sponsorship. You have to have institutions interested, because those are the big gorillas with the money that drive prices up.
  • We want companies that have a sufficient float. We don’t particularly care about capitalization, whether it’s large cap, mid cap, small cap, but we don’t want to be in a thinly-traded stock. You don’t ever want to make an appointment to buy or sell.
  • Lastly, we’re looking for companies that have paid uninterrupted dividends for at least 25 years. [The missing criteria that Kelley did not mention is a S&P Quality ranking of B+ or higher, as mentioned below—Editor.]

So, we’ve got a lot of numbers in there: 25 years, 12 years for earnings, 12 years for dividends. Really the significance of those is that a normal business cycle is going to last about four years. So, over the course of 12 years, you’re going to get three full business cycles. Then, in terms of 25 years, you’re going to get the whole soup to nuts. You’re going to get inflation, deflation, expansion, recession, bull market, bear market, the whole nine yards.

So, what it boils down to is we’re looking for consistency, for continuity, and for companies that know how to put either their services or their products in a favorable light to consumers so that they buy and that the earnings continue to come in.

You know, there are over 15,000 publicly-traded companies, and when you pour those 15,000 through these simple little criteria, we actually eliminate all but 330 to 340 companies.

Let me ask about the dividend side of that. For instance, Apple (AAPL), who typically doesn’t pay a dividend—although maybe they will start doing it on a regular basis now—it’s a company that didn’t pay dividends but had strong earnings, increasing earnings, even though maybe an expensive stock. Would that still meet the criteria of value if you thought 600 would go to 1,200?

Well, the thing is that the real value to a company in terms of how we measure it is the return to the investor, and there’s nothing more fundamental than the cash dividend.

When you have a company that’s paid a cash dividend for an extended period of time, what happens then is that company can sort of develop a pattern of high and low dividend yield. That makes our job a lot easier, because we can see it.

Buyers are attracted to it when the yield is at X, and that interest starts to wane as the dividend yield goes closer and closer to Y. So without a dividend history, and without a pattern of high and low dividend yield, it makes it really difficult to value a company.

Apple, which is just now going to pay a dividend for the first time, all we know is that at $600, Apple is going to yield 2%, but we really don’t know how to extrapolate that out. So, we’ll have to wait and see until Apple grows up.

Alright. Finally, you’d love everything to meet all six criteria all the time, but is it a dealbreaker if it’s four of the six that meet criteria?

Not at all. Not at all. Actually, a company will stay in our roster as long as they keep at least four of the criteria. The only one that’s really sacrosanct is the uninterrupted dividends, and if their S&P earnings and dividend quality ranking falls below B+. Other than that, we have quite a few stocks in our roster that maintain for this.

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