Benjamin Graham

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Benjamin Graham: Intrinsic Value and Buying Cash at a Discount

By Dr. Steve Sjuggerud, President, Investment U
Monday, June 9, 2003: Issue #246

I’d like to share with you what was likely the most popular investment tool presented at a seminar I spoke at over the weekend. It was the concept of Benjamin Graham’s Intrinsic Value Number

Benjamin Graham is the father of value investing. In the 1930s, he wrote the bible on securities analysis, which is still the main book on the subject today. Benjamin Graham was legendary investor Warren Buffett’s mentor, having taught him in college at Columbia.

Trading coach Van Tharp tells me that during the worst bear market of the 1930s, Graham averaged returns of 17% a year. And during the last great bear market (the dozen years before the bottom in 1982), the average annual return on stocks meeting Graham’s criteria was 33.7% a year, according to one study.

The concept behind the Benjamin Graham Intrinsic Value Number, when it comes down to it, is basically buying cash at a discount (actually cash and things that can be easily turned into cash-in other words, Net Current Assets). Graham’s idea is that if you can pay as little as two-thirds of “cash” for a stock, you’ve really got nothing to lose.

How the Benjamin Graham Intrinsic Value Number Works

Here’s how you get to Graham’s Number for any company: It’s simply Current Assets minus Total Debts.

Current assets are defined as anything that can be turned into cash within a year. Total debt is self-explanatory. So another way to describe Benjamin Graham’s Intrinsic Value Number is: It is simply a company’s Net Current Assets. Yet another way to think of it is basically what cash is left if you were to pay off all debts. And, if you find a company that’s going for two-thirds – or 66% of – the value of its cash, that’s a value.

As you might expect, it’s difficult to find stocks this cheap. To give you an idea of how stringent the criteria are: Out of the thousands of stocks out there, only a tiny handful qualify as good value investments under Benjamin Graham’s criteria.

My friend Dan Ferris of the Extreme Value newsletter has profitably used this strategy to discover such gems as Blair Corp, Gateway Computer, and Circuit City stores in his newsletter, which have all risen dramatically in recent months.

Let’s take a look at Circuit City as an example, so you’ll see how easy it is to locate a true “intrinsic value” investment by determining its Graham’s Number on your own

Determining the Intrinsic Value Number On Your Own

First we need to get the Current Assets and the Total Liabilities of Circuit City. We’ll do this in Yahoo! Finance (www.yahoo.com, click on “Finance”). We’ll enter the stock symbol of Circuit City (CC), and then click on Financials. On the Balance Sheet here’s what we find:

$3.6bn Current Assets
$2.1bn Total Debts

Therefore Graham’s Number (or net current assets) is $1.5 billion. Now let’s consider the market value of Circuit City (also called the “market cap”) Is Circuit City still an extraordinary bargain, selling at less two-thirds of its net current assets?

At the moment, Circuit City’s market value is $1.3 billion. So you can buy the stock for less than its net current assets–you’re buying at a discount to cash, in a sense. A bargain. However, in order to buy at two-thirds of the Benjamin Graham Intrinsic Value number (1.5 billion, in this case), you’d want Circuit City’s market value to be at $1.0 billion or less (66% of 1.5 billion). Cutting to the chase, today’s current price for Circuit City ($6.50, which equates out to $1.3 billion in market cap – see Crib Sheet below for a definition) isn’t at the 66% level we’d need to make this a “Benjamin Graham Number” investment. The price will have to come down to $5.00 per share for that.

You can do this homework yourself to find stocks that meet this criteria. It will likely take a little wrestling of stock screeners and spreadsheets, or checking out the Value Line.

Paying two-thirds of net current assets is the idea behind Benjamin Graham’s Intrinsic Value Number. Buying stocks this cheap sure sounds like a no-brainer. Consider how your favorite stocks stack up.

Good Investing,

Steve

P.S. For more information on Benjamin Graham, visit the following piece from the Investment U Archive.

Today’s Investment U Cribsheet

IU GLOSSARY: Market capitalization (or just “market cap”): The total dollar value of a company’s outstanding shares, calculated as number of shares times current market price. Among other things, this figure is used to indicate a corporation’s “size.”