It Is All About The Benjamin

| July 21, 2016

proofDuring times of a frothy bull market or a crushing bear market, journalists and analysts call for a return of evaluating stocks based on their inherent value. Rather than price a stock at what people think it will be worth in the future or what people think the price should be if everything is perfect, a stock should be valued by its assets and cash flow just as legendary investor Benjamin Graham did years ago. Eventually the market will return to reality and these beaten down stocks will rise in price again to match its true worth. Whether you call it value investing or just prudent stock picking, it certainly makes sense when nothing is making sense.

Unfortunately, the stock market is not always sensible. History shows it has constantly overshot and undershot the value of just about everything and every stock. The reversion to the mean happens all the time as a stock’s price goes from one extreme to another. It is like being in a room full of athletes where the average height is 5 foot 10 inches but everyone is either a basketball player or a gymnast. Very few of them would actually be 5 foot 10 inches. Most of them would be 8 inches taller or shorter than the average.

This does not mean Graham’s method is useless. It just does not apply very well to today’s stock market with high-speed trading, quantitative easing, ETFs, and dark pools. On the other hand, Graham’s method is suited for researching a stock to see if it is worthy of investment dollars. Graham’s method is very good at identifying potential investments by screening out obvious losers.

Luckily, today there is the Internet with stock screening software. In most cases, it is free and simple to use. Just pick your parameters and hit ‘Enter’ and within a fraction of a second, you have a good sized sample of stocks. So if you want a list of small cap stocks under $5 per share, with a dividend yield greater than 1%, and a price-to-cash ratio under 3, you will reduce the universe of stocks to research from over 7000 to a grand total of 26. Using this screen, I found one stock that looked particularly promising. Gafisa, SA (GFA, $1.37) is a Brazilian residential construction company, yikes. While this sounds strange, it actually looks like a good choice for an investment.

Its market cap is equal to its cash and it pays a dividend of 2.0% which is better than most certificates of deposits. Despite being a low-priced, low volume, micro-cap, it is covered by five institutions. Plus, it is located in economically challenged Brazil, which went from being the darling of emerging markets a few years ago to an insane mess when the world quit buying its commodities. As a result, its share price collapsed by 85% and has been patiently waiting for a return to glory. This could happen sooner rather than later. After the Brexit vote when financial markets and foreign currencies were in free-fall, this stock hardly waivered. Now the only question is will anybody buy Brazil’s resources so more Brazilians have more money to buy more homes.

This is where it can be tough to be a value-oriented disciple of Graham. Everything on paper shows that this is a sure-fire winner but the market is not allowing it to be so. This is where the key to making money on this stock needs to be highlighted. Time… lots of it. It could take a while before it moves upward in price. In the meantime, just be happy to collect a decent dividend. It will take the perfect combination of foreign exchange, interest rates, commodity prices, taxes, tariffs, and confidence to move the stock, but when it does, it will shoot up quickly (which is why it is worth making a larger than usual initial purchase). This is not a speculation or a gamble where you need to minimize risk. The stock may fluctuate in price but at least you have the dividend and a huge cash position to keep things honest. Plus, the cash either makes the company an attractive takeover target or gives GFA the chance to takeover one of its competitors. Both scenarios would benefit this company.

Owning a stock like this can give you peace of mind regardless of the state of the market. With a stock like this, there is no need to check the price every five minutes or stay awake every night. This is probably the best feature of investing like Benjamin Graham.


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Category: Investing in Penny Stocks

About the Author ()

Brad Hartung is the author of The Speculator’s Handbook and the blog, Small Cap Pirate. He specializes in making sound investment decisions in stocks that have the potential to significantly grow in value like biotech and junior resource mining.