Saturday, May 17, 2008
When to Sell? Lessons from Benjamin Graham
Assuming you found a stock that passed Benjamin Graham's criteria.
1. Adequate size - minimum US $ 100 million sales, US $ 50 million assets
2. A sufficiently strong financial conditions - current assets : current liabilities 2:1. Public utilities company debt: equity < 2 times
3. Earning stability - some earnings for the past 10 years
4. Dividend record - uninterrupted payments for at least 20 years
5. Earning growth - A minimum increase of at least 1/3 in EPS in the past 10 years.
6. Moderate Price/Earnings ratio - not more than 15 times
7. Moderate ratio of price to assets - not more than 1.5 times. A rule of thumb : should not exceed 22.5 times.
As you can see, the buy criteria is quite tough as it will help you to avoid a company that is too small, almost no debt, must have some growth prospect, low PE, low price/book, not losing money for too long to avoid stigma, etc. No wonder Graham was rejecting Buffett(when he worked for Gram) buy recommendations more often than not.
Again, assuming that you found a stock that worth about $ 30 /share and you manage to buy at $ 15 /share. The next important question is holding period, if the stock reaches your intrinsic value within 1 year, you pocket a very nice profit of 100%. It is still not too bad if the stock take 5 years to realize its intrinsic value. 10 years is patience testing but still is not too bad, 7% CAGR. However, the greatest fear is this:
What if the stock will never realize its intrinsic value ? This is what most calls Ghaham's dogs.
How long should you wait? His answer was 2 - 3 years. He reasoned if a stock would never realized its value in 2 -3 years, it probably never would. In this case, it is better to sell and reinvest in a new stock.