Value Investing

Ben Graham Formula and Malaysian Value Stocks

With a dearth of value causing investors to reach for yield, some are finding value in unexpected places (Iraq, Kazakhstan, Mongolia, Israel and other countries). Malaysia right now is experiencing significant political turmoil and while the market has rallied on election results, any further strife could cause equities to drop. Regardless of whether stocks fall or not, CLSA has put out a report of the cheapest Malaysian stocks based on Ben Graham Formula. The formula is explained below and many stocks which match the criteria are examined.

Ben Graham Formula Finding value, old school style

Famous for his philosophy of “value investing”, Ben Graham stated 10 rules for stock selection, the first five measuring “reward” (price relative to earnings) and the second five measuring “risk”  financial soundness and earnings stability). Mirroring these 10 “value” requirements, CLSA Asia screened our ex-financials coverage universe: 13 of 31 stocks score 5/10 and above – big-caps are Genting, PGas, Tenaga, Gamuda, Genting(M) and KLK. Small-caps top the list, with Padini scoring 7 (highest) and rubber glove stocks Top Glove, Hartalega scoring 6. At the bottom of the list, we are underweight Astro, BumiArmada and Maxis. Stocks showing value and dovetailing with “base case” election outcome top picks are Tenaga, Gamuda, PGas, Genting(M), UEM Land, Top Glove and Padini.

Ben Graham Formula 10 value requirements

  • Is PE ratio less than half the reciprocal of the 10yr government bond yield?

The 10-year MGS yields 3.48%; half of the reciprocal (29) is 14.4x. Reflecting Malaysia’s historical PE premium, there are only 6 stocks that trade at a lower 13CL multiple than 14.4x: Genting, Genting(M), TNB, YTL Power, AirAsia and Padini.

  • Is the PE ratio less than 40% of the 5yr average?

A measure of “cheapness” of the stock relative to its history, only Tenaga is now trading on a 13CL PE lower than 40% of its 5-yr average.

  • Is the dividend yield at least 2/3rd of the 10yr government bond yield?

Within our Malaysia coverage universe, there are 3 stocks that have no dividend yield: IHH, SapuraKencana and MMHE. There are a further 11 stocks that have a dividend yield below 2/3rds of the 10-year MGS (i.e. 2.3%) – among these, Dialog, Tenaga and Genting(M) stand out as stocks where rising FCF yield provides room for substantial dividend upside. The remainder 18 stocks have yields in excess, the top five dominated by telcos (Digi, Axiata, Maxis) as well as BAT and Padini.

  • Is the share price below 2/3rd of tangible book value per share (BVPS)?

Noting that our Malaysian coverage has seen a parallel rise in P/B and ROE over the last few years, only SP Setia trades below 2/3rds of its tangible BVPS.

  • Is the share price less than 2/3rd of net current assets per share?

There are no stocks under coverage trading below 2/3rds of net current assets.

  • Is the net gearing ratio (net debt/equity) less than 100%?

There are only 2 stocks with net gearing above 100%: YTL Power and Astro, both of which are supported by stable cashflows. There are 9 stocks in net cash position – those that tie in with high dividends and/or the potential for higher dividends going forward include Padini, Genting(M), Dialog and Top Glove.

  • Is the current ratio (current assets / current liabilities) greater than 2x?

The current ratio is a liquidity metric that reflects an ability to service short-term obligations. In Malaysia, reflecting broadly low gearing levels, 15 out of the 31 stocks considered have a current ratio greater than 2x: these include IOI, Genting, PGas, IJM Land, Padini, UEM Land, Felda, Hartalega, Top Glove and KLK.

  • Is total gross debt less than 2x net current assets?

There are 18 stocks that satisfy this filter – among those with particularly high net current asset to debt ratios are the Genting, Genting(M), plantation stocks (KLK, IOI, Felda), rubber glove players (Top Glove, Hartalega), and IJM Land and Padini.

  • Has EPS growth over the last 5 years averaged more than 7%?

Noting earnings volatility over the 2007-08 period due to the global credit crisis, we look at EPS growth for our Malaysian universe in the relatively more stable 5 years spanning 2009 to 2013. We have 21 stocks which have a 5-year average earnings growth above 7%, notables being Genting, Genting(M), Petronas Gas (PGas), Gamuda, UEM Land, Padini, Top Glove and Hartalega.

  • Has EPS growth been negative no more than 1 year out of past 5 years?

Over the 5 years spanning 2009-2013, there are 18 stocks posting at least four years of earnings growth, among which are Genting, the telcos, Gamuda, AirAsia, UEM Land and the rubber glove players. Companies which have seen consistent earnings growth (i.e. no earnings decline) are PGas, Dialog, UEM Land and Padini.

Finding value, old school style

Ben Graham’s defensive investor approach ostensibly provides an intrinsic “checklist” approach to value-based investing. Admittedly some of the criteria as contained within the “10 rules” are more relevant than others as are the underlying parameters – for the latter, where necessary, we have tweaked accordingly to better reflect recent operating conditions e.g. for rules 9 and 10, the original checklist requires a 10 year history but bearing in mind macro volatility over the last decade and the relatively younger vintage of the Malaysian stock market, we have used a more recent 5 year period instead.

Ben Graham’s 10 rules for value investing – thresholds used:

1) Is the PE ratio less than one-half the reciprocal of the 10yr government bond yield?

2) Is the PE ratio less than 40% of the 5yr average?

3) Is the dividend yield at least 2/3rd of the 10yr government bond yield?

4) Is share price below 2/3rd of tangible book value per share (BVPS)?

5) Is the share price less than 2/3rd of net current assets per share?

6) Is the net gearing ratio (net debt/equity) less than 100%?

7) Is the current ratio (current assets/current liabilities) greater than 2x?

8) Is total gross debt less than 2x net current assets?

9) Has EPS growth over the last 5 years averaged more than 7%?

10) Has EPS growth been negative no more than 1 year out of the past 5?

Ben Graham formula Checklist Score Chart

Ben Graham Metrics and Screen Chart

1) Is the PE ratio less than one-half the reciprocal of the 10yr government bond yield?

In other words, the question is whether the stock has an earnings yield (reciprocal of PE) twice the government bond yield. In Malaysia, the 10-year MGS (Malaysian government security) yield is 3.48%, the reciprocal is 28.7 and one-half of that is 14.4x. Malaysian stocks that make the cut are Genting, Genting Malaysia, TNB, YTL Power, Air Asia and Padini.

CLSA Malaysia Universe FY13 PE Chart

2) Is the PE ratio less than 40% of the 5-yr average?

This is a measure to show how “cheap” or “expensive” the stock is relative to its history. The only stock in the CLSA Malaysia universe that has a 13CL P/E lower than 40% of its 5-yr average is Tenaga.

5yr  average PE versus Current Chart

3) Is the dividend yield at least 2/3rds of the 10yr government bond yield?

Within our Malaysia stock coverage, there are three stocks that have no dividend yield at all: IHH, SapuraKencana and MMHE. With the 10-year MGS at 3.48% (and 2/3rd of that equal to 2.3%), there are a further 11 stocks that have a yield below 2/3rds of the government 10-year – among these, Dialog, Tenaga and Genting Malaysia stand out as stocks where rising FCF yield provides room for substantial increases in dividends going forward. The remaining 18 stocks have yields in excess, the top five dominated by telcos Digi, Maxis and Axiata but also including consumer stocks BAT and Padini.

FY13 Dividend yeild Chart

4) Is share price below 2/3rds of tangible book value per share?

Our Malaysian universe of stocks has seen rising P/B multiples over the last few years, mirroring a parallel increase in ROEs – as such, there is currently only one stock which is trading below 2/3rds of its tangible BVPS namely property developer SP Setia.

Share Price Chart

Share Price Versus BVPS Chart

5) Is share price less than 2/3rds of net current assets per share?

There are no stocks in our Malaysian coverage which are currently trading below 2/3rds of their net current assets. As has been pointed out by CLSA’s Damian Kestel, among others, there are some metrics which feel less relevant these days and this is perhaps one of them.

6) Is the net gearing ratio (net debt/equity) less than 100%?

In Malaysia, there are only two stocks with net gearing above 100%: YTP Power and Astro, both of which are backed by relatively stable utility / concession-type cashflows. There are 9 stocks in a net cash position – those that tie in with high dividends or the potential for higher dividends going forward include Padini, Genting Malaysia, Dialog and Top Glove.

CLSA Gearing Levels Chart

7) Is the current ratio greater than 2x?

The current ratio is a liquidity metric that reflects an ability to service shortterm obligations i.e. current assets/current liabilities. In Malaysia, partially reflecting broadly low gearing levels, 15 out of the 31 stocks considered have a current ratio greater than 2x: these include IOI, Genting, Petronas Gas, IJM Land, Padini, UEM Land, Felda, Hartalega, Top Glove and KLK.

CLSA Current Ratio Chart

8) Is total gross debt less than 2x net current assets?

There are 18 stocks out of the 31 ex-financials under coverage in our Malaysia universe with total debt < 2x net current assets. Among stocks with particularly high net current asset to gross debt ratios are the Genting group of companies, the plantation stocks, the rubber glove players as well as IJM Land and Padini.

Net Current Assets Chart

9) Has EPS growth over the last 5 years averaged more than 7%?

Given the earnings volatility over the 2007-08 period stemming from the global credit crisis, we look at EPS growth for our Malaysian universe in the relatively more stable five years spanning 2009 to 2013. We have 21 stocks which have 5-year average earnings growth above 7%, among the notable being the Genting group, the rubber gloves players Top Glove and Hartalega, as well as Petronas Gas, Gamuda, UEM Land and Padini.

While Tenaga and Telekom also make the cut, their respective earnings histories are much more volatile with sharp y-y swings in profitability noted – neither of these stocks satisfy the condition laid down in question 10.

EPS Growth Chart

10) Has EPS growth been negative no more than 1 year out of the past 5 years?

Over the 5 years spanning 2009-2013, there are 18 stocks in our Malaysia ex-financials coverage universe to post at least four years of earnings growth, among which are Genting, the telcos (Digi, Axiata), Gamuda, Air Asia, UEM Land and the rubber glove players. Companies which have seen consistent earnings growth (i.e. no financial years with y-y earnings decline) are Petronas Gas, Dialog, UEM Land and Padini.