Graham's two appraoches: less than net current asset or 7 PE

My first, more limited, technique confines itself to the purchase of common stocks at less than
their working-capital value, or net-current-asset value, giving no weight to the plant and other
fixed assets, and deducting all liabilities in full from the current assets. We used this approach
extensively in managing investment funds, and over a 30-odd year period we must have earned
an average of some 20 per cent per year from this source. For a while, however, after the mid-
1950's, this brand of buying opportunity became very scarce because of the pervasive bull
market. But it has returned in quantity since the 1973-74 decline. In January 1976 we counted
over 300 such issues in the Standard & Poor's Stock Guide--about 10 per cent of the total. I
consider it a foolproof method of systematic investment--once again, not on the basis of
individual results but in terms of the expectable group outcome.

The second approach is similar to the first in its underlying philosophy. It consists of buying
groups of stocks at less than their current or intrinsic value as indicated by one or more simple
criteria. The criterion I prefer is seven times the reported earnings for the past 12 months.
You can use others--such as a current dividend return above seven per cent or book value more
than 120 percent of price, etc. We are just finishing a performance study of these approaches
over the past half-century--1925-1975. They consistently show results of 15 per cent or better per
annum, or twice the record of the DJIA for this long period. I have every confidence in the
threefold merit of this general method based on (a) sound logic, (b) simplicity of application, and
(c) an excellent supporting record. At bottom it is a technique by which true investors can exploit
the recurrent excessive optimism and excessive apprehension of the speculative public.

At this point let me consider briefly an approach with which we were closely identified when
managing the Graham-Newman fund. This was the purchase of shares at less than their working
capital value. That gave such good results for us over a forty-year period of decision making that
we eventually renounced all other common-stock choices based on the usual valuation
procedures, and concentrated on these "sub-asset stocks". The "renaissance of value", which we
are talking about today involves the reappearance of this kind of investment opportunity. A
Value-Line publication last month listed 100 such issues in the non-financial category. Their
compilation suggests that there must be at least twice as many sub-working capital choices in the
Standard & Poor's Monthly Stock Guide. (However, don't waste $25 in sending for an
advertised list of "1000 Stocks Priced at Less Than Working Capital". Those responsible
inexcusably omitted to deduct the debt and preferred stock liabilities from the working capital in
arriving at the amount available for the common.)
It seems no more than ordinary sense to conclude that if one can make up, say a 30-stock
portfolio of issues obtainable at less than working capital, and if these issues meet other value
criteria including the analysts' belief that the enterprise has reasonably good long-term prospects,
why not limit one's selection to such issues and forget the more standard valuation methods and
choices we have previously discussed? I think the question is a logical one, but it raises various
practical issues: How long will such "fire sale stocks" – as Value Line called them – continue to
be given away; what would be the consequences if a large number of decision-makers began as
of tomorrow to concentrate on that group; what should the analyst do when these are no longer
available?