## Help Me To Clarify Graham's Financial Criteria and Make It Scannable

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Topic Author
golongterm
Posts: 3
Joined: Sun Oct 04, 2020 9:50 am

### Help Me To Clarify Graham's Financial Criteria and Make It Scannable

Ok so I just read the quote out of II that is discussed in this thread: viewtopic.php?t=91931

To give some additional context, here is the full paragraph as written in the 1972 version:
The quoted phrase in our caption was used earlier in the chapter
to describe the kind of common stocks to which defensive
investors should limit their purchases—provided also that they
had paid continuous dividends for a considerable number of years.
A criterion based on adjectives is always ambiguous. Where is the
dividing line for size, for prominence, and for conservatism of
financial structure? On the last point we can suggest a specific standard that, though arbitrary, is in line with accepted thinking. An
industrial company’s finances are not conservative unless the common stock (at book value) represents at least half of the total capitalization, including all bank debt.
3 For a railroad or public utility
the figure should be at least 30%.
So I've bolded the specific section that was in question. It seems the consensus on that thread is that Graham finds a particular stock financially "conservative" if (common stock)/(total assets) > 0.5. The specific post I'm referring to is here:
magician wrote: Sat Mar 03, 2012 10:25 pm Common stock represents at least half of total capitalization. Total capitalization is debt plus equity which is total assets. So he's not saying that a company is conservative if debt ÷ total assets < 1.0; he's saying that a company is conservative if common stock ÷ total assets > 0.5.
This confuses me, however, because as the total value of common stock increases over total assets, doesn't that make the stock more overvalued? I'm wondering why the poster put greater than (>) instead of less than (<) in that particular mathematical expression.

I'm also wondering from all of you if we can come to a consensus that this is accurate.

Furthermore, and perhaps most importantly, I'd really like it if I could find a particular scannable term (or set of terms) that could match this expression (something like P/E or P/B). This would essentially make scanning for individual stocks that fit this criteria a much less laborious task.

I also found this thread on stack https://money.stackexchange.com/questio ... t-investor which suggests that the proper parameter to use would be Debt to Equity, and you would be looking for a value of less than 1. Can anyone confirm this?
alex_686
Posts: 6835
Joined: Mon Feb 09, 2015 2:39 pm

### Re: Help Me To Clarify Graham's Financial Criteria and Make It Scannable

I suspect that they are referencing "Enterprise Value": https://www.investopedia.com/terms/e/en ... evalue.asp

In short: EV = Market Cap + Debt

A company can not increase its EV by issuing debt and doing a stock buy back. Nor can it change its value by doing a stock offering to buy back debt. You should be back in the same place.

I think you are confusing the value of the company with its assets. And by assets I assume you are talking about "Book Value". During Graham's time book value was a important and powerful metric. With the exception of financial companies, not so much. How much physical stock in rails and rolling stock is important for a rail road, less so for technology heavy, asset light companies of today.

I would be careful about reading Graham too closely. He is a key foundational intellectual figure in investment theory. Leverage is a important consideration. However the percentages you are quoting are from a specific time. Theory and market structure have evolved.

Key to this is that he is giving 2 different leverage numbers. Why can banking and railroads have higher leverage? Well, it is because they are more stable industries. Maybe we should use a sliding scale depending on how stable the company is and its ability to support debt?
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.